**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**Washington,DC 20549**

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FORM 10-K/A

**AmendmentNo. 1**

**ANNUALREPORT PURSUANT TO SECTION 13 OR 15(d) OF THESECURITIES EXCHANGE ACT OF 1934**

**For the fiscal year ended December 31,2004**

**Commissionfile number 0-31913**

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AEROGEN, INC.

(Exact name of registrantas specified in its charter)
| Delaware                                                        | ** ** | **33-0488580**                       |
|-----------------------------------------------------------------|------------|--------------------------------------|
| (State or other jurisdiction of  incorporation or organization) |       | (I.R.S. Employer  Identification No. |
| **2071  Stierlin Court, Suite 100  Mountain View, CA**     | ** ** | **94043**(Zip  Code)                 |
| (Address of principal executive offices)                        |       |                                 |

 

**Registrant’s telephone number,including area code:**(650) 864-7300

**Securities registered pursuant to Section 12(b) ofthe Act:**None

**Securities registered pursuant to Section 12(g) ofthe Act:**

**CommonStock, $0.001 Par Value**

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

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

The aggregate market valueof the common stock held by non-affiliates of the registrant, based upon theclosing price on the Nasdaq SmallCap Market reported on June 30, 2004 was$12,619,359. Shares of common stock held by each executive officer, directorand each person who is known by the Registrant to own 5% or more of theRegistrant’s outstanding common stock have been excluded in that such personsmay be deemed to be affiliates; share ownership information of certain personsknown by the Registrant to own great than 5% of the outstanding common stockfor purposes of the preceding calculation is based solely on information on Schedule13Gs filed with the Commission and is as of June 30, 2004. Thisdetermination of affiliate status is not a conclusive determination for otherpurposes.

The number of shares of theregistrant’s Common Stock outstanding on March 31, 2005 was 7,298,834.

Indicate by check mark if disclosure of delinquentfilers pursuant to Item 405 of Regulation S-K is not contained herein, and willnot be contained, to the best of registrant’s knowledge, in definitive proxy orinformation statements incorporated by reference in Part III of this Form 10-Kor any amendment to this Form 10-K. o

**EXPLANATORYNOTE**

We are filing this amendment to our Annual Report on Form 10-K,originally filed with the Securities and Exchange Commission on April 15,2005, solely for the purpose of amending Exhibit 23.1 and the tablesincluded in the Notes to Consolidated Financial Statements on pages 74 and75 in the Annual Report on Form 10-K. This amendment only changes theAnnual Report by amending Exhibit 23.1 and correcting clerical errors inthe tables included in the Notes to Consolidated Financial Statements onpages 74 and 75, which summarize unaudited historical quarterly financialdata that were the subject of our 10-Q/As filed on April 18, 2005; no otherinformation included in the Annual Report on Form 10-K is amended by thisForm 10-K/A.

 

 

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**AEROGEN, INC.FORM 10-K ANNUAL REPORTFOR THE FISCAL YEAR ENDED DECEMBER 31, 2004**

**TABLEOF CONTENTS**
|           |   |                                                                                             | **Page** |
|-----------|--------|--------------------------------------------------------------------------------------------------|----------|
| Part I    |
| Item 1.   |   | Business                                                                                         | 1        |
| Item 2.   |   | Properties                                                                                       | 19       |
| Item 3.   |   | Legal Proceedings                                                                                | 19       |
| Part II   |
| Item  5.  |   | Market  for Registrant’s Common Equity and Related Stockholder Matters                      | 20       |
| Item  6.  |   | Selected  Consolidated Financial Data                                                            | 22       |
| Item  7.  |   | Management’s  Discussion and Analysis of Financial Condition and Results of  Operations     | 23       |
| Item  7A. |   | Quantitative  and Qualitative Disclosure About Market Risk                                       | 32       |
| Item  8.  |   | Consolidated  Financial Statements and Supplementary Data                                        | 45       |
| Item 9A   |   | Controls and  Procedures                                                                         | 76       |
| Part III  |
| Item  10. |   | Directors  and Executive Officers of the Registrant                                              | 78       |
| Item 11.  |   | Executive  Compensation                                                                          | 80       |
| Item  12. |   | Security  Ownership of Certain Beneficial Owners and Management and Related Stockholder  Matters | 83       |
| Item  13. |   | Certain  Relationships and Related Transactions                                                  | 92       |
| Item  14. |   | Principal  Accountant Fees and Services                                                          | 93       |
| Part IV   |
| Item  15. |   | Exhibits,  Financial Statement Schedules                                                         | 95       |
|      |   | Signatures                                                                                       | 98       |
|      |   | Exhibit  Index                                                                                   | 99       |

 

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**PART I**

**Item 1. BUSINESS**

***Notice Concerning Forward-Looking Statements***

This Annual Report on Form 10-K(“Form 10-K”) of Aerogen, Inc. contains “forward-lookingstatements” within the meaning of Section 27A of the Securities Act of1933, as amended, and Section 21E of the Securities Exchange Act of 1934,as amended. These forward-looking statements are not historical facts, butrather are based on current expectations, estimates and projections about ourindustry, our beliefs and our assumptions. Words such as “anticipate,” “expect,”“intend,” “plan,” “believe,” “seek,” “estimate” and variations of these words,and similar expressions, are intended to identify forward-looking statements.These statements are not guarantees of our future performance and are subjectto risks, uncertainties and other factors, some of which are beyond ourcontrol, are difficult to predict and could cause actual results to differmaterially from those expressed, implied or forecast in the forward-lookingstatements. In addition, the forward-looking events discussed in this Form 10-Kmight not occur. These risks and uncertainties include, among others, thosedescribed in “Risk Factors” and elsewhere in this Form 10-K. Readersare cautioned not to place undue reliance on these forward-looking statements,which reflect our management’s view only as of the date of this Form 10-K.Except as required by law, we undertake no obligation to update anyforward-looking statement, whether as a result of new information, futureevents or otherwise.

***Introduction***

Aerogen, Inc. (“Aerogen” or the “Company”) is aspecialty pharmaceutical company developing novel drug-device combinationaerosol products for treatment of respiratory disorders in the critical caresetting. Based on our proprietary OnQ® Aerosol Generator (“OnQ”), we are developingrespiratory products for marketing by us, and products in collaboration with,and for marketing by, pharmaceutical and biotechnology companies for bothrespiratory therapy and for the delivery of drugs through the lungs to thebloodstream.

Our current products address many of the limitationspresented by use of traditional nebulizers for pulmonary drug delivery. Webelieve that our drug products in development for pulmonary drug delivery usingour proprietary technology could have a major impact on the treatment ofrespiratory disorders in the critical care setting.

Our goal is to become the leading provider ofaerosol-based pulmonary drug delivery products in the acute care setting,particularly for patients on ventilators. We have identified a multi-billiondollar market opportunity where our OnQ technology, coupled with drugs alreadycommercialized but not previously delivered by the pulmonary route and/or drugsnovel to inhalation, addresses an unfulfilled market need.

We launched our first nebulizer, the Aeroneb® Portable NebulizerSystem, in June 2001 and our second nebulizer, the Aeroneb® Professional Nebulizer System (“Aeroneb Pro,” “AeronebPro System”), in June 2002. Our third nebulizer, the Aeroneb® Go Nebulizer (“Aeroneb Go”) was commercializedin January 2004.

Our lead therapeutic product, in a Phase 2 clinicaltrial, is an aerosolized antibiotic comprising a formulation of amikacindelivered via Aerogen’s Pulmonary Drug Delivery System (“PDDS”) (previously referredto as a “next generation” or “optimized” Aeroneb Professional Nebulizer System)for the treatment of patients on ventilators with ventilator-associatedpneumonia (“VAP”). ThisPhase 2 clinical trial was initiated on December 28, 2004, and involvesthe enrollment of 108 patients at approximately 31 study sites, with eachpatient to be studied for 28 consecutive days. Based upon estimates provided byour study sites, we anticipated we would have a majority of our sitesopen, and the first patients enrolled, during the first quarter of2005. As of March 31, 2005, however, we had only 8 sitesopen due to 

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administrativedelays at the sites 33 patients with suspected VAP screened for entry intothe trial, and no patients enrolled. Until all sites are openand we observe steady enrollment, we will be unableto reliably project the completion date of the trial. In light of thefact that we currently have no patients enrolled in this study, weare uncertain at this time when the study will be completed, if atall.

Our business plan also includes the development, incollaboration with pharmaceutical and biotechnology company partners, ofrespiratory products that will combine our technology with the partners’proprietary compounds. The partner companies generally will commercialize theseproducts, which may utilize a version of our PDDS, one of our Aeronebnebulizers or an Aerodose® inhaler.

In addition to our respiratory therapy activities, wehave the capability to develop novel pulmonary drug products for systemic druginput in collaboration with pharmaceutical and biotechnology companies andother partners. Systemic drug delivery of biotechnology products via the lungsprovides significant market opportunities. We have developed an Aerodoseinhaler for the delivery of insulin via the pulmonary route to Type 1 and Type2 diabetic patients, and have successfully taken the product through Phase 2atesting and design verification testing of the commercial version of theinhaler. Product development activities have been placed on hold, pending anagreement with an appropriate partner willing to commit the financial resourcesrequired to complete the development, registration and commercialization of theproduct.

Aerogen was incorporated in the state of California inNovember 1991 under the name Fluid Propulsion Technologies, Inc. Ourname was changed to AeroGen, Inc. in April 1997 and then to Aerogen, Inc.in May 2002. In March 1998, we changed our domicile to the state ofDelaware. Our principal executive offices are located at 2071 Stierlin Court, Suite 100,Mountain View, California 94043; our telephone number is (650) 864-7300.Our business comprises one industry segment—the development, manufacture andcommercialization of pulmonary drug delivery products.

In May 2000, we acquired Cerus Limited, which isnow our wholly owned subsidiary, Aerogen (Ireland) Limited. Cerus was adevelopment stage company engaged in the development of pulmonary inhalationdevices, utilizing our OnQ Aerosol Generator. Aerogen (Ireland) Limiteddeveloped our Aeroneb Professional Nebulizer System, and manages its assemblyand distribution, incorporating OnQs produced in our Mountain View facility.Aerogen (Ireland) Limited also manufactures and distributes the Aeroneb Go formarkets outside the U.S.

As of December 31, 2004,Aerogen had cash and cash equivalents of approximately $16.9 million.We believe this cash balance is sufficient to sustain operations into the firstquarter of 2006; however, if we do not receive funds from certain expectedproduct sales and/or royalties, our cash balance may not sustain plannedoperations beyond the middle of the fourth quarter of 2005. In order tocontinue operations beyond that time, we will need to raise additional capital,either through strategic transactions, collaborative relationships, the sale ofassets, licensing of technologies and/or products, public or privatefinancings, or other arrangements.

“Aerogen®,” “Aerodose®,” “Aeroneb®,” “OnQ®” and theassociated brand marks are our trademarks. This Form 10-K alsoincludes references to registered service marks and trademarks of othercompanies, which are indicated when used in this Form 10-K.

***Pulmonary Drug Delivery***

Pulmonary drug delivery iswidely used to treat respiratory diseases. In addition, we believe it is aviable means to deliver drugs to the bloodstream via the lungs. The size of theinhaled droplets generally influences where the drug will be deposited in thelungs. Large droplets, greater than three microns in diameter, typically are depositedin the conducting airways of the lung, where they may be useful in treatingdiseases such as asthma, chronic obstructive pulmonary disease (“COPD”) andcystic fibrosis. 

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Smalldroplets, at three microns or less in diameter, are more likely to pass throughthe conducting airways into the deep lung, where they may be absorbed into thebloodstream to treat diseases such as diabetes. Our technology permits drugdelivery to the lungs in a liquid aerosol of a defined droplet size within arange of one to five microns MMAD (Mass Median Aerodynamic Diameter).

*Acute CareMarket—Respiratory Disorders*

Respiratory disorders are associated with impairedquality of life, reduced life expectancy and significant treatment costs.Approximately 1.2 million patients are treated in the intensive care units(“ICUs”) of United States hospitals each year for respiratory disordersincluding pneumonia, COPD, asthma and respiratory distress syndrome (“RDS”).The cost of drugs for treatment of these patients totals approximately$3.5 billion per year, averaging approximately $500 per day in the ICU.There are also less prevalent diseases, such as neonatal pulmonary hypertensionand infant respiratory distress syndrome (“IRDS”), which have few but costlytreatments available. Other than for treatment of airways diseases, virtuallyall drug therapy for treatment of respiratory disorders in the ICU is givensystemically by injection or infusion. This reflects, in part, the historicallack of sufficiently reproducible and efficient pulmonary drug deliverytechnologies.

We are currently focusing on the evaluation ofproducts for marketing in the U.S. by Aerogen, for treatment of respiratorydisorders in the acute care setting, including respiratory infections inventilated patients, neonatal pulmonary hypertension and acute exacerbations ofCOPD. We are also focusing on improving pulmonary drug delivery generally forpatients using nebulizers and those receiving therapy via externally-assistedbreathing devices.

Approximately 1.5 million patients are placed onventilators in United States hospitals each year. The presence of a breathing(endotracheal) tube promotes introduction of bacteria into the lungs and is asignificant risk factor for the development of pneumonia (ventilator-associatedpneumonia, or “VAP”). Approximately 10% to 30% of mechanically ventilatedpatients develop VAP; the risk increases with increasing duration of mechanicalventilation. Despite aggressive therapy with intravenous antibiotics, VAP isassociated with a very high mortality rate (20% to 50%). Current therapy reliesalmost exclusively upon intravenous antibiotics. Treatment with the requiredhigh doses of intravenous antibiotics can be associated with severe sideeffects. Historically, aerosol therapy has not been utilized due to the lowefficiency and reproducibility of available devices in delivering drugs to thelungs.

We estimate neonatal pulmonary hypertension affectsmore than 40,000 neonates annually in the United States. The only approvedtreatment for infants of greater than 34 weeks gestational age is inhalednitric oxide (“NO”), which is expensive and has significant side effects. Inaddition, 30% to 50% of neonates treated with NO do not respond. There is nocurrently approved treatment for pulmonary hypertension in infants of less than34 weeks gestational age.

We estimate approximately150,000 patients per year in the U.S. require mechanical ventilation for anacute exacerbation of COPD (“AECOPD”), a rapid worsening of lung function,commonly triggered by a bacterial or viral infection. Intensive care unit (“ICU”)admission for AECOPD is associated with a 10-day average hospital stayand greater than 20% mortality within the following year. Current therapy islargely supportive, including mechanical ventilation, standard bronchodilatorsand antibiotics as clinically indicated.

***Systemic Drug Delivery***

In addition to our focus on pulmonary drug delivery inthe acute care setting, we pursue systemic drug input via the pulmonary routeon an opportunistic basis. The physiology of the lungs makes pulmonary deliveryan attractive method for delivery of drugs to the bloodstream. The absorptivesurface area of the deep lung in the adult approximates 70 square meters, andis only one to two cells in thickness. This large 

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surface area is availablefor the free exchange of oxygen, carbon dioxide and other molecules between theair and the bloodstream. This permits drugs deposited in the deep lung to betransported rapidly into the bloodstream.

Pulmonary drug delivery isbeing evaluated for non-invasive delivery of drugs to the bloodstream to treatnon-respiratory diseases. There is increasing interest in pulmonary drugdelivery as a result of the inability of currently available, non-injectabledosage forms to deliver molecules such as proteins and peptides to thebloodstream effectively. For these large molecules, oral delivery isineffective due to rapid breakdown of the molecules following ingestion. Dosageforms such as intravenous or intramuscular injections and implants, whileeffective for delivering proteins and peptides, have many drawbacks, includingpain, inconvenience, expense, risk of infection and poor compliance.Alternatives like transdermal and nasal dosage forms do not generally allowreproducible delivery of large molecules. We believe that systemic drugdelivery of biotechnology products via the lungs may provide significant marketopportunities**.** For example, pulmonary deliveryis being considered for drugs such as insulin, which require rapid input to thebloodstream for optimal therapy.

***Methods for Pulmonary Drug Delivery and TheirLimitations***

Three basic classifications of devices are currentlybeing used for pulmonary drug delivery: metered dose inhalers (“MDIs”), drypowder inhalers (“DPIs”), and nebulizers. These devices were developedoriginally for local treatment of respiratory diseases, including asthma andCOPD, and have inherent limitations in delivering drugs to the lungs. Metereddose inhalers consist of a portable canister containing the drug as asuspension or solution mixed with a volatile propellant, traditionally achlorofluorocarbon. In order to administer the drug, the patient must activatethe inhaler by pressing down on the canister while simultaneously inhalingslowly and evenly. Even with repeat training, many patients using MDIs havedifficulty coordinating activation of the device with their breathing. Once theinhaler is activated, particles are released at an initial velocity of at least30 miles per hour. Metered dose inhalers typically deliver only 10% to 20% ofthe drug to the lungs. Newer hydrofluoralkane (“HFA”) versions deliver a higherpercentage of the dose, but are available for a few drug formulations. Most ofthe remainder of the drug is deposited in the mouth and swallowed. To overcomethese limitations, patients are sometimes prescribed holding chambers, orspacers, to use with their MDIs. These spacers increase the complexity of useand reduce the portability of MDIs. In the acute care setting, for patients onventilators, MDIs are used by opening the ventilator circuit and sprayingmedication into the tubing via a spacer. It takes several actuations for ametered-dose inhaler, over several minutes, timed with inhalation, to deliverthe dose levels typically prescribed for a patient in the ICU. This requiressignificant time and the associated expense of an attendant respiratorytherapist. Available formulations are limited mainly to bronchodilators andsteroids.

Traditional DPIs were introduced to overcome some of theproblems inherent with the use of MDIs. Dry powder inhalers deliver drypowdered aerosols without using a compressed propellant. Dry powder inhalersare breath activated and thus eliminate the need for the press and breathcoordination associated with use of MDIs; however, traditional DPIs havemeaningful limitations that may prevent their broad use in pulmonary drugdelivery. Dry powder inhalers usually require a strong, deep inhalation tocreate the air velocity that generates the aerosol and delivers the drug.Children, the elderly and patients with breathing difficulties often cannotachieve the strong inhalation necessary to generate the required dose. Inaddition, these devices do not allow the patient to inhale the desired drug inmultiple breaths, and moisture entering into the dry powder inhaler from theenvironment, or a patient’s own breath, can result in dose-to-dose variation.Because there is no mechanism in ventilator circuits for actuating DPIs, theyare not used to administer drugs to the lungs of patients on ventilators inclinical practice.

Traditional nebulizers create a continuous liquidaerosol that can be inhaled by patients through a mask or mouthpiece. With theuse of a nebulizer, patients can breathe normally, thereby requiring less 

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patient coordination andcooperation than use of MDIs or DPIs. Traditional jet nebulizers typicallyrequire an external source of compressed air or oxygen and are therefore bulkyand noisy. Nebulizer treatments are time-consuming and inefficient, with lessthan 20% of the drug typically reaching the lungs in ambulatory patients. Theremainder of the drug is either aerosolized during the patient’s exhalation andreleased into the surrounding air, or it is left behind in the nebulizer.Because of these limitations, traditional nebulizers are only appropriate forrelatively inexpensive, small-molecule drugs that can be formulated and storedas liquids. In the acute care setting, jet nebulizers are used to introduceaerosol into the ventilator circuit for inhalation by the patient.

The use of jet nebulizers results in introduction ofadditional air into a ventilator circuit, disturbing the precise control of airpressures used to ventilate patients and to monitor their pulmonary function.Perhaps most significantly, these delivery devices are inefficient, resultingin only a very small amount of the drug dose (1% to 3%) ever reaching thepatient’s lungs. Ultrasonic nebulizers (which rely on droplets breaking freefrom standing waves at the surface of the drug solution) are more efficientthan jet nebulizers, but are expensive, heat the administered drug and areunable to nebulize suspensions.

To date there has beenlittle emphasis on improving the efficiency of pulmonary drug delivery in thehospital setting. Of the $3.5 billion in annual drug sales for respiratoryindications in the ICU, the overwhelming majority represents use of intravenousformulations. Few drugs, other than generic bronchodilators, are given via thepulmonary route due to the inefficiency and lack of reproducibility ofcurrently available devices in delivering drugs to the lungs.

***Our Core Technology and Marketed Products***

*OnQ AerosolGenerator*

The OnQ Aerosol Generator technology produces liquidaerosol via a mechanism called an electronic micropump, comprising a domedaperture plate that contains over 1,000 tapered apertures, or holes, of adiscrete shape and size. The aperture plate is produced through anelectroforming process using a metal alloy. The aperture plate is surrounded bya vibrational element that, when energy is applied to this element, causes theaperture plate to vibrate over 100,000 times per second. This creates amicro-pumping action that draws drug solutions or suspensions in contact withthe concave surface of the plate through the apertures to form a lowvelocity, fine droplet aerosol. The aerosol droplet size formed is determinedby the size of the holes in the aperture plate, and the flow rate is controlledby the voltage and frequency applied to the vibrational element. A controllablemanufacturing process is used to produce aperture plates with selected holesizes that result in aerosol droplets of a predetermined size. When the OnQAerosol Generator is incorporated into one of our nebulizers or inhalers, it iscapable of producing consistently sized, high-quality respirable aerosols,which can be optimized for a specific indication.

We have demonstrated theability to aerosolize solutions and suspensions of drugs of both small andlarge molecular weight. Results to date indicate that the OnQ technology doesnot affect the integrity of proteins or peptides.

*Benefits of OurTechnology*

·        *Optimization and Customization of Aerosol Droplet Size.  *TheOnQ Aerosol Generator delivers a low-velocity liquid aerosol of preciselydefined average droplet size. It enables us to provide aerosols with dropletsranging from one to three microns MMAD in diameter for deposition in the deeplung for systemic drug delivery or three to five microns MMAD in diameter forrespiratory therapy.

·        *Ease of Formulation.  *Drugs can be aerosolized insolution or suspension. The OnQ Aerosol Generator uses no propellants orpressure, and generates negligible heat. We have evaluated the 

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OnQ Aerosol Generator witha wide range of drugs, proteins and peptides and have thus far not observed anydegradation or any other adverse impact on drug integrity. In many cases, wecan use existing drug formulations, eliminating the need to demonstrate thestability of new formulations.

·        *Flexibility of Dosing.*   The OnQ Aerosol Generator canbe used for the administration of drugs as a single dose, or as a unit dosefrom a multi-dose canister. For example, our Aerodose insulin inhaler containsa titration mechanism, developed with Ypsomed (formerly Disetronic MedicalSystems), which allows a diabetic patient to deliver a specific dose of insulinfrom a glass cartridge designed to hold up to two weeks of inhaleable insulinfor the average Type 2 diabetic patient.

·        *Breath-Activation.*   We have developed a breath-activationfeature that triggers aerosol formation and is designed to enable a broad rangeof patients to obtain consistent dosing over one or more breaths. This featureis designed so that drug will be aerosolized only when the patient’s inhalationflow rate has reached a predetermined threshold, which can be pre-programmedfor a particular target patient population. If a patient exhales or coughs, theaerosolization will stop and will only resume when the patient begins inhalingagain. Our electronic controls are designed to allow us to customize productsfor both relaxed and controlled breathing.

·        *Dosage Guidance.*   We can incorporate electronicfeatures to provide information to the patient or respiratory attendant. Lightscan indicate when a dose is ready for inhalation and when the total dose hasbeen inhaled. Audible/vibratory signals can be used to indicate other systemmodes. Additional features may include indicators of patient compliance withthe prescribed regimen and lockout features to prevent abuse or overdose.

·        *Convenience.*   Our products are designed to belightweight and easy for patients and care-providers to use. Aerodoseinhalers fit in the palm of the hand and can be carried in a shirt pocket orsmall purse. We believe our products will require minimal patient or cliniciantraining, are easy to assemble and use and offer the potential to improveclinical outcomes and to increase compliance with prescribed treatmentregimens. The Aeroneb Go Nebulizer is designed to be faster, easier to use andmore efficient than currently commercialized nebulizers. The AeronebProfessional Nebulizer System is lightweight and provides efficient generationof aerosol close to the lung.

Our OnQ Aerosol Generatorhas been incorporated into our nebulizers and inhalers. Since 2002, much of oureffort has been directed to streamlining and improving the manufacturingprocesses for our OnQ technology. We also undertook development of a lower costOnQ using components similar to those used in our commercially availablenebulizers, but with a changed configuration. This new OnQ Aerosol Generator isincorporated into the Aeroneb Go and the Aeroneb Pro.

*Our NebulizerProducts*

*Aeroneb Go Nebulizer.  *Ournewest commercial product, the Aeroneb Go Nebulizer, was CE marked in July 2003and received 510(k) clearance from the FDA in November 2003. Thisproduct replaces the Aeroneb Portable Nebulizer System in the home market.

The Aeroneb Go is a fast, efficient, simple-to-usenebulizer developed for the millions of patients worldwide who requirerespiratory therapy in and away from home. The product was designed toeliminate many of the problems associated with current methods of medicationdelivery when using nebulizers. Unlike many compressor, ultrasonic, ormesh-based nebulizers, the Aeroneb Go allows patients to complete theirtreatments quickly, and delivers a high-quality respirable aerosol.

In June 2003, we made initial commercialshipments of the product to Norway via our distributor Normed, as part of atest market. In September 2003, we entered into an agreement with EvoMedical Solutions (“Evo”), formerly Medical Industries America Inc.” formarketing and manufacturing of the Aeroneb Go, under which Evo has exclusiverights to manufacture and market the product in the United 

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States and certaincountries worldwide. In connection with our agreement with Evo, we receivedupfront payments from Evo totaling $2.5 million in 2003; in addition,Aerogen is supplying its OnQ Aerosol Generators to Evo under a transfer pricingarrangement, and Evo will pay us royalties on its gross sales of the Aeroneb Goand on Evo’s sales of accessories. First commercial shipments occurred in theUnited States in January 2004.

*Aeroneb Professional NebulizerSystem.  *The Aeroneb Professional Nebulizer System wasintroduced worldwide in June 2002. The product is CE marked in Europe andreceived 510(k) clearance in the United States as a nebulizer intended toaerosolize physician-prescribed solutions for inhalation approved forgeneral-purpose nebulization. The product is the first significant advance inmore than 20 years in respiratory drug therapy specifically for patientson ventilators in the hospital, and is designed to improve the efficiency ofdrug delivery and reduce personnel and drug costs associated with inpatientcare, particularly for patients on ventilators. Use of the Aeroneb Pro Systemon the ventilator increases the efficiency of drug deposition in the lungs ofpatients when compared *in vitro*with use of small volume jet nebulizers. The Aeroneb Pro is flexible because itcan be used not only on the ventilator, but also in the hospital or in anambulance, and it can also be used with both adult and children’s masks. Thedevice is autoclaveable, so it is suitable for multi-patient use, and its lowresidual volume allows efficient drug delivery to the lungs. The Aeroneb ProSystem is small and lightweight, allowing it to be positioned close to thepatient’s airway and is designed to allow the addition of medication to thenebulizer without opening the ventilator tubing, thereby potentially reducing amajor source of infection. The drug is aerosolized without the use ofcompressed air and therefore avoids the introduction of additional air andpressure into the ventilator circuit.

We have worldwide agreements with ventilatormanufacturers, including Puritan Bennett (“PB”), Maquet, and Respironics, underwhich they sell the Aeroneb Pro System with certain of their ventilators. Wealso have an agreement with Cardinal Health under which Cardinal’s RespiratoryCare Products Group sales force is marketing the product to ICUs in the UnitedStates. These ICUs represent an installed base of approximately 100,000ventilators from several manufacturers. In Europe, we have agreements withadditional distributors on a country-by-country basis, who are targeting theinstalled base of ventilators in those countries.

Aerogen has entered into a worldwide, non-exclusivesupply agreement with Datex-Ohmeda, Inc., a division of Instrumentarium,which was acquired by GE Healthcare in October 2003. Under the agreement,Aerogen is supplying GE Healthcare with a customized version of the Aeroneb Profor integration into future products designed for critical care. GE Healthcarelaunched their first two critical care products incorporating Aerogentechnology in the fourth quarter of 2004.

Aerogen’s sales of the Aeroneb Pro System wereapproximately $3.5 million, $3.0 million and $1.6 million in 2004,2003 and 2002, respectively. The product was launched in June 2002, and isnow available in over 30 countries.

Finally, we have developed a version of the AeronebPro specifically for use in pre-clinical research and inhalation studies,marketed as the Aeroneb® Lab (Aeroneb Lab).

Sales of our OnQ andAeroneb products accounted for 71%, 77% and 75% of our total revenues in 2004,2003, and 2002, respectively.

***Our Drug Product Pipeline***

We intend to incorporateour versatile and flexible OnQ technology into a portfolio of devices and drugproducts, some to be developed for commercialization by us, and some to bedeveloped with partners who will market the product themselves. We also intendto continue to out-license our technology for applications outside of the fieldof pulmonary drug delivery.

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***Aerogen Products Under Development for Treatment ofRespiratory Disorders***

We intend to create and market in the United States arespiratory product portfolio consisting of pharmaceutical products thatincorporate our Pulmonary Drug Delivery System (“PDDS”) for delivery ofdrug-containing aerosols to patients in the acute care setting.

Our activities for therapeutic products to be marketedby Aerogen is focused on product development, clinical testing, regulatoryapproval and commercialization within the United States. The rights to theseproducts outside the United States will most likely be licensed to partners whowill undertake the studies and other activities necessary to obtain regulatoryapprovals in their territories.

We are developing Aerogen’s PDDS as a proprietaryplatform for the high-efficiency delivery of aerosolized drugs to the lungs ofpatients on ventilators in the acute-care setting. The PDDS comprises a uniquesoftware-driven controller, which is capable of sensing the performance of aventilator and aerosolizing the drug during a predetermined portion of theventilator cycle, alternatively, it can be breath-activated for use inextubated patients. In addition, the PDDS incorporates an OnQ Aerosol Generatorwith a particle size that has been customized for the individual therapeuticapplication. Initial *in vitro*studies document lung deposition of drug that is typically greater than 60% ofthe administered dose. This product has been CE marked in Europe, for use inour Phase 2 clinical trial to deliver amikacin. We do not intend to market thePDDS as a stand-alone device, as we intend to use it exclusively for ourdrug/device combination products in the acute care setting.

*Aerosolized Antibiotics.  *Ourlead combination product is our PDDS with the aminoglycoside amikacin, underdevelopment to address the large unmet need for more effective treatment ofVAP. Aminoglycosides, as a class of antibiotics, are effective in treatingpulmonary infections associated with gram-negative organisms, such as *Pseudomonas aeruginosa,* when administeredsystemically. However, they penetrate poorly from the blood to the lungrelative to other classes of antibiotics, and often cause unwanted systemictoxicities (including damage to kidneys and hearing). The potential toadminister aerosolized amikacin allows for the possibility of more effectivelytreating VAP while minimizing the toxicity associated with systemicallyadministered aminoglycosides.

Our aerosolized amikacin PDDS completed its firstPhase 2 study in France in 2003. In this study, we compared drug deposition inthe lungs of 12 ventilated patients in which a preservative-free solution ofamikacin was administered by three different devices: a first generation clinicalversion of the PDDS, the commercially available Aeroneb Pro System and thecommercially available AirlifeTM Misty-NebTM nebulizer. This particularformulation has been associated with off-label use administered by aerosol fortreatment of pulmonary infections in children with cystic fibrosis. The studyconfirmed the higher efficiency of the PDDS versus the two comparator devices.

The second Phase 2clinical trial with this product was initiated on December 28, 2004, andinvolves the enrollment of 108 patients at approximately 31 study sites, witheach patient to be studied for 28 consecutive days. Based upon estimatesprovided by our study sites, we anticipated we would have a majorityof our sites open, and the first patients enrolled, during the firstquarter of 2005. As of March 31, 2005, however, wehad only 8 sites open due to administrative delays at the sites, 33patients with suspected VAP screened for entry into the trial, and nopatients enrolled. Until all sites are open and we observe steady enrollment, we willbe unable to reliably project the completion date of the trial. Inlight of the fact that we currently have no patients enrolled in this study, weare uncertain at this time when the study will be completed, if atall.

*Other Product DevelopmentOpportunities*

We are evaluating variousdrugs, including generically available drugs and proprietary drugs in-licensedor available for in-licensing from third parties, for development as Aerogendrug/device 

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combinationproducts with our PDDS. Drug development opportunities in the acute caresetting include treatment of neonatal pulmonary hypertension (withprostacyclins), asthma (with bronchodilators and anti-inflammatory agents),COPD (with protease inhibitors, phosphodiesterase inhibitors, mucoactiveagents) and ARDS (protease inhibitors, anti-coagulative agents, inhibitors offibrosis).

*Our ProductDevelopment Process*

Feasibility is the first stage of development for ourdrug products. In the feasibility stage, we determine the solubility of thedrug, the type of solution or suspension we would likely need in order to usethe drug in our inhalers or nebulizers, our ability to aerosolize the drug andthe likely stability of the drug when used with our nebulizers or inhalers. Inthis stage, we conduct laboratory studies primarily focused on the drug itself,and its compatibility with the OnQ Aerosol Generator.

During the preclinical development stage, we focus onthe customization of our nebulizer or inhaler for use with a particular drug.We determine the appropriate container to hold the drug in the nebulizer orinhaler, the method of delivery of the drug to be aerosolized, the type ofbreath-activation mechanism or ventilator sensing algorithm that is likely tobe needed and the configuration of the aperture plate for the product.Preclinical development is conducted primarily in the laboratory and istargeted toward development and the initial production of the nebulizer orinhaler to be used in the clinical studies.

After feasibility testingand preclinical development, the products are tested in human subjects. Ourproducts are combinations of discrete devices and drugs, and therefore theregulatory pathway, and the clinical programs that will be required for productapprovals are complex due to the presence of both drug and device elements inour products. As the regulatory requirements are discussed in detail with theUnited States Food and Drug Administration (“FDA”) and clarified, it ispossible that certain products will be less attractive commercial targets forAerogen marketing than others. For example, in 2001 and 2002, we weredeveloping products to deliver albuterol and ipratropium via our hand-heldAerodose respiratory inhaler for home use. Based on regulatory feedback thatsuch products would most likely require a New Drug Application (“NDA”), we haveput these products on hold due to the likely need for costly clinical programsand the extended time to regulatory approval for generic drug productsdelivered from a new device. In December of 2002, the FDA established theOffice of Combination Products to streamline the regulatory life cycle ofcombination products, however, the jurisdictional questions and regulatoryapproaches are still to be defined. The Aerodose respiratory inhaler developedfor these programs has proven of interest for partnered activities wherepartners have proprietary drugs for treatment of either a respiratory problemor for systemic drug input that will require an NDA.

***Partnered Drug Development Activities***

We are collaborating, andintend to continue to collaborate, with pharmaceutical and biotechnologycompanies to develop novel pulmonary drug delivery products for respiratorytherapy and for systemic drug input via the pulmonary route. Suchcollaborations can take one of two approaches: either a company contacts uswith a proprietary drug to be delivered to the lungs, or we proactivelyidentify product opportunities and approach potential partners after obtainingpreclinical data, if possible.

*Respiratory Therapy*

The flexibility of our technology to facilitateimproved respiratory therapy has attracted potential development partners. Wecurrently have feasibility activities underway with potential partners withundisclosed compounds for respiratory therapy and systemic drug input. Afeasibility study can be paid for by us or by the partner company. Generally,development agreements and the associated activities can be canceled at anytime by the company funding the work. In the drug delivery area, it is common forpharmaceutical and biotechnology companies to conduct feasibility studies withmultiple partners. Once feasibility of a particular drug has been established,the pharmaceutical and biotechnology companies 

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typically fund additionaldevelopment work. Following collaborative development of a product, the partnerwill typically commercialize the product and pay us a royalty on the partner’ssales.

We signed a collaborative agreement in July 2002with Discovery Laboratories, Inc. (“Discovery Labs”) to explore pulmonarydelivery of aerosolized human surfactant in the hospital setting. Aerosolizedsurfactant has the potential for treatment of many respiratory conditions. Thepreclinical data developed as a result of our agreement with Discovery Labs hasindicated that our technology can effectively aerosolize surfactant whilemaintaining the integrity of the formulation.

In 2002, we signed a Cooperative Research andDevelopment Agreement with the United States Army for pulmonary delivery ofnovel vaccines (subsequently amended to include antiviral applications).Initial preclinical work was done by the United States Army Medical ResearchInstitute for Infectious Diseases (“USAMRIID”). In addition, grant proposalsfor aerosol research on both vaccines and antiviral agents were submitted toUSAMRIID. Both were favorably reviewed, but funding for the proposals is notcurrently available.

In March 2005, we signed an agreement with BiotaHoldings Ltd. for the development of CS-8958, one of the new LANI(long-acting neuraminidase inhibitor) compounds being developed by Biota andSankyo, suitable for use with Aerogen’s proprietary Aeroneb Go.

Our Aerodose inhalers andour Aeroneb nebulizers are all customizable for use with partner drugs inprograms funded by the partners, and these devices can be, and have been, madeavailable for different preclinical and clinical programs.

*Systemic DrugDelivery*

In addition to our respiratory therapy activities, ourstrategy includes collaborating with pharmaceutical and biotechnology companiesto develop novel pulmonary drug delivery products for systemic therapy.

We have developed an Aerodose inhaler for delivery ofinsulin to diabetic patients. The Aerodose insulin inhaler is designed toutilize a patient-adjustable titration cartridge for pulmonary delivery ofinsulin, allowing patients to precisely adjust their insulin dose based onanticipated carbohydrate intake and other factors. The titration mechanism wasdeveloped in conjunction with Ypsomed.

Phase 1 clinical studies using prototype Aerodoseinhalers delivering insulin were conducted in the United Kingdom and Germanyand were completed in 2000. The studies compared insulin inhalation tosubcutaneous injection, focusing on both the absorption of insulin into thebloodstream and its glucose-lowering effects. Subjects used Aerodose inhalersconfigured for slow, deep inhalations and production of a small-droplet aerosolappropriate for systemic drug delivery. Results from the first study indicatedthat the absorption and glucose-lowering effects of inhaled insulin, relativeto injected insulin, were consistent with the effects reported in the publishedliterature for other inhaled insulin dosage forms. In the second study, optimalaerosolization parameters were defined, resulting in the selection of a finaldesign for our commercial version of the inhaler.

Phase 2 trials were initiated in Europe and the UnitedStates in 2000, and completed in 2001. These studies were designed to provideadditional evidence of Aerodose inhaler performance, inter- and intra-subjectvariability and dose proportionality of circulating levels of insulin followinginhalation in Type 2 (non-insulin dependent) diabetic patients. The resultsindicated that delivery of insulin into the bloodstream by inhalation was nomore variable within a patient than when insulin was delivered subcutaneouslyto the same patient, and that inhaled insulin performed consistently, across abroad dose-range, relative to injected insulin. In the four studies wehave completed, there were no serious adverse events or clinically significantdifferences in lung function between the inhaled and subcutaneous treatments.

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We have****an agreementwith Diosynth B.V., a business unit of Akzo Nobel, for the supply of clinicaland commercial quantities of recombinant human insulin for use in the product.We successfully completed our design verification testing for the Aerodose insulininhaler during 2002. In December 2003, Aerogen’s high-concentrationinsulin formulation met stability requirements through twelve months oftesting. Stability studies have been completed.

We believe that the natureof the diabetes market requires a major pharmaceutical company partner with adiabetes franchise to effectively market the product. In late 2002, it becameapparent that we would be unable to partner our inhaled insulin product underappropriate financial terms hence we halted development of the product. We mayrevisit that decision once clarity as to the overall safety of inhaled insulinis provided by the companies who are developing the leading inhaled insulinproduct.

***Technology Out-licensing***

Our aerosol generatortechnology has proven to be of value to industries focused outside the field ofpulmonary drug delivery. In 1999, we entered into an exclusive licenseagreement with a worldwide consumer company permitting it to use a modifiedversion of the aerosol generator in the fields of air fresheners and insectrepellants. Under the license agreement, we receive minimum annual paymentsand, in the third quarter of 2004, began to earn royalties based on net salesof units and refills above a certain threshold. The license also gives us accessto any improvements in the technology made by the consumer company during theconduct of its development and manufacturing activities. The first productcovered by the agreement was launched outside the United States in January 2003,which triggered an increase in the minimum royalty payments to Aerogen, andadditional countries were launched in 2004, increasing our royalty receipts. Wewill continue to explore out-licensing opportunities for our technologiesoutside the field of pulmonary drug delivery.

***Research and Development Spending***

During 2004, 2003 and 2002we spent approximately $11.2 million, $11.5 million and$17.4 million, respectively, on our own research and developmentactivities, and approximately none, $0.2 million and $0.4 million in2004, 2003 and 2002, respectively, for customer-sponsored research anddevelopment activities.

***Manufacturing***

We plan to manufacture our OnQ Aerosol Generators andoutsource the manufacture of the other components used in our products. Wemanufacture the aperture plates and assemble the OnQs at our Mountain View,California facility. We design the remaining components of our products, suchas molded parts and electronic circuitry, and outsource the manufacture and/orassembly of these parts to qualified vendors. The manufacture of cartridges andsterile drug filling will also be outsourced, minimizing the need for capitalinvestment in specialized drug filling facilities. The Aeroneb Pro is assembledfor us by outside vendors in Ireland. The Aeroneb Go is manufactured andassembled by Evo for markets in North America and Japan.

We outsource production ofmany components of our products to manufacturers in the United States andelsewhere. Generally, there is more than one potential supplier for thesecomponents, but some are manufactured to our specifications and an interruptionin supply could adversely affect our ability to manufacture and supply ourproducts. The brazing andovermolding processes used in assembly of our OnQ Aerosol Generators areconducted at third party facilities. Even though we have qualified secondsuppliers for the brazing services, loss of the use of the primary facilitiescould result in significant delays in our supply of components while we ramp upproduction at the second sites and/or establish alternate provider sites. Palladium,which we use in our OnQ aperture plate, is expensive and is subject to price 

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volatility.The palladium plating bath chemicals we use to manufacture our OnQ AerosolGenerators are formulated by a single supplier.

***Sales and Marketing***

The Aeroneb Pro is sold to United States hospitals byCardinal Health, and by major ventilator Original Equipment Manufacturers (“OEMs”)including Maquet**,**Respironics,****GEHealthcare****and Puritan Bennett. Outside theUnited States, we have agreements with independent distributors on acountry-by-country basis, and also with ventilator OEMs mentioned above. Wegenerally intend to maintain the marketing rights for our acute carerespiratory drug products in the United States and to commercialize theproducts in other countries through marketing partners or distributors.Products developed in collaboration with partner companies will generally becommercialized by the partners.

The Aeroneb Go Nebulizeris sold by Evo in the United States to home medical equipment dealers andpharmacies. Evo currently markets the Aeroneb Go outside of the United States,in Canada, France and Japan. Aerogen also sells the Aeroneb Go through itsindependent distributors in Norway, Sweden, Greece, Ireland and Switzerland.

***Competition***

There is intense competition in our target markets. Wecurrently compete with device and medical equipment companies for sales of ournebulizer products; as we introduce our drug products, we will compete withpharmaceutical and biotechnology companies, hospitals, research organizations,individual scientists and nonprofit organizations engaged in developingnon-invasive drug delivery dosage forms. In the area of systemic drug delivery,which is currently dominated by injectable dosage forms, our competitionincludes companies providing oral, buccal, intranasal, transdermal and colonicabsorption delivery technologies. We also compete with entities producing anddeveloping injectable dosage forms. Several of these entities are working on sustained-releaseinjectable systems. While these systems still require injections, the lowernumber of injections could allow these products to compete effectively withnon-invasive therapies.

The pulmonary drug delivery market, in particular, isintensely competitive. Several companies, including Alkermes, Inc.,Aradigm Corporation, Battelle Pharma, PARI, Microdose, Respironics, Mannkindand Nektar Therapeutics, are developing competing pulmonary drug deliverydosage forms. These competing dosage forms typically are designed to treatrespiratory disorders or to deliver drugs systemically. We also facecompetition from existing pulmonary drug delivery dosage forms such as MDIs,DPIs and nebulizers, which have been used effectively to treat respiratory diseasesin certain patient populations for years. There can be no assurance thatcompetitors will not develop and introduce products or technologies that arecompetitive with, or superior to, ours.

Some of our products are expected to be more expensivethan MDIs and currently available DPIs, as the products are expected to providesignificant advantages over currently marketed devices, and are packaged indifferent dosage forms. It is difficult to predict whether, and to what extent,our products will be reimbursed by insurance companies, health maintenanceorganizations or government healthcare providers. In addition, although webelieve that physicians are likely to recommend our products to their patients,it is impossible to predict to what extent or how quickly this may occur.

Most competitors havegreater research and development capabilities, experience, manufacturing,marketing, financial and managerial resources than we do. Accordingly, they maysucceed in developing competing products and technologies, obtaining regulatoryapproval for products or gaining market acceptance more rapidly than we can. Webelieve that our products will not only compete on the basis of efficacy, butalso on patient convenience, efficiency, dose reproducibility, safety and cost.

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***Intellectual Property and Proprietary Rights***

Our ability to compete effectively depends in part ondeveloping and maintaining the proprietary aspects of our aerosolizationtechnology. As of December 31, 2004, we held 26 issued United Statespatents and 11 issued international patents. In addition, we had 19 pendingUnited States patent applications and 35****pendinginternational patent applications as of that date. None of the issued patentsexpire earlier than 2011. Our patents are directed at, among other things, thefollowing: (i) apparatus and methods for generating aerosols, includingvibrating dome technology in which liquid is drawn through tiny tapered holesin the dome to be emitted as a mist of controlled droplet size and speed; (ii) particularaspects of aperture plate dome construction and use; and (iii) particularembodiments of our aerosolization devices, including pressure assistingbreathing systems for use in the hospital. The pending patent applicationsinclude coverage for numerous improvements on the fundamental aspects of ouraerosolization technology.

The pharmaceutical and medical device industries havebeen characterized by extensive litigation regarding patents and otherintellectual property rights, and companies in these industries have usedintellectual property litigation to gain a competitive advantage. In 1999, weprevailed in a United States Patent and Trademark Office (the “USPTO”) patentinterference involving United States Patent No. 5,261,601, assigned toBespak, plc. The USPTO granted all but one of the independent claims of Bespak’s5,261,601 patent to Aerogen which issued in Aerogen’s United States patent6,629,646. A settlement between Aerogen and Bespak provided a cross-licensearrangement from which Aerogen has a license to 5,261,601’s equivalent patentsin foreign countries and Bespak received a license to the same patent in theUnited States. The scope of the granted license was limited to productsemploying technology that was disclosed by Bespak in United States Patent No. 5,261,601.The license does not extend to any of our technology that was not disclosed inthis patent. Additionally, in April 2003, we received notice that a Germanpatent infringement suit had been filed by PARI GmbH in the District Court inMunich, Germany alleging that Aerogen’s Aeroneb Pro product infringes a patentlicensed to PARI GmbH. In May 2003, we filed an action in the Germanpatent office requesting that the patent in question be rendered null and void.In July 2004, the Federal Patent Court in Munich, Germany ruled in favorof Aerogen by nullifying all contested claims of this patent, which is owned byThe Technology Partnership plc (“TTP”) of Hertfordshire, England, and islicensed to PARI, GmbH of Munich, Germany. The Court ordered TTP to pay Aerogen’slegal expenses related to this nullity action to the maximum extent allowedunder German law. During October 2004, TTP requested, and was granted, athree-month extension of time to file an appeal of this decision, and grantedadditional extensions through February 2005. PARI assumed control over thenullity case from TTP on December 14, 2004. The decision on the nullityaction has been appealed to the German Supreme Court, with PARI submitting itsarguments in support of the appeal in March 2005. Additionally, during October 2004TTP formally served Aerogen with the infringement suit that PARI had advisedAerogen in April 2003 had already been filed in Munich, Germany. Apreliminary hearing on the infringement case is scheduled for June 2005. Webelieve that this suit is without merit and intend to vigorously defend againstall allegations in the suit. Although the infringement suit claims that Aerogeninfringes solely on the patent claims that have since been ruled null and void,there can be no guarantee that the German Supreme Court will not reverse ormodify the nullity ruling and again provide PARI with the legal standing toreassert their infringement suit.

At the time ofcommencement of employment, our international employees generally sign offerletters specifying basic terms and conditions of employment. In general, ourUnited States employees are not subject to written employment agreements. Eachof our employees has, however, entered into a standard confidential informationand invention assignment agreement that provides that the employee will notdisclose any of our confidential information received during the course oftheir employment and that, with some limited exceptions, the employee willassign to us any and all inventions conceived or developed during the course ofemployment.

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***Government Regulation***

Our products are subject to extensive regulation bynumerous governmental authorities, principally the FDA in the United States, aswell as numerous state and foreign regulatory agencies. We need to obtainclearance of our device products by the FDA before we can begin marketing ourproducts in the United States. Similar requirements or approvals generally arerequired in other countries before our products can be marketed in thosecountries.

Product development and approval within thisregulatory framework is uncertain, can be unpredictable with respect to reviewtimes and requires substantial resources. The nature and extent of thegovernmental premarket review process or requirements for our products willvary depending on the regulatory categorization of particular products. Becauseour products may be characterized as devices, drugs or biologics, theregulatory approval path will not be the same for all of our device products.

Those of ourproducts that are regulated as medical devices will be classified into one ofthree classes on the basis of the controls deemed by the FDA to be necessary toreasonably ensure their safety and effectiveness. The class for any particularproduct, as follows, will determine the regulatory route:

·        *Class I:  *General controls, e.g., labeling,premarket notification, if not exempted, and adherence to the quality systemregulation (“QSR”);

·        *Class II:*   General controls and specialcontrols, (e.g., performance standards and postmarket surveillance); and

·        *Class III:*   Premarket approval.

*Device Regulatory PremarketRequirements in the United States.  *Before a new devicecan be marketed, its manufacturer must obtain marketing clearance througheither a premarket notification under Section 510(k) of the UnitedStates Federal Food, Drug and Cosmetic Act or approval of a premarket approvalapplication.

*510(k) clearance.  *A510(k) clearance typically will be granted if a company establishes thatits device is “substantially equivalent” to a legally marketed Class I orII medical device, or to a Class III device that was on the market priorto 1976 for which the FDA has not required the submission of a premarketapproval application. A 510(k) clearance must contain information tosupport the claim of substantial equivalence, which may include laboratory testresults or the results of other studies. Commercial distribution of a devicesubject to the 510(k) requirement may begin only after the FDA issues anorder finding the device to be substantially equivalent to a predicate device.It generally takes from three to twelve months from the date of submission toobtain clearance of a 510(k) submission, but it may take longer. The FDAmay determine that a proposed device is not substantially equivalent to alegally marketed device, that additional information is needed before asubstantial equivalence determination may be made, or that the product must beapproved through the premarket approval process. An FDA determination of “notsubstantially equivalent,” a request for additional information, or therequirement that a premarket approval application be filed could delay marketintroduction of products that fall into this category. Furthermore, for anydevices cleared through the 510(k) process, modifications or enhancementsthat could significantly affect safety or effectiveness, or constitute a majorchange in the intended use of the device, require new 510(k) submissions.We received 510(k) clearance for the Aeroneb® Portable Nebulizer System, the AeronebProfessional Nebulizer System and the Aeroneb Go Nebulizer, and we expect thatfuture similar nebulizer products will also proceed through the 510(k) clearanceroute.

*Premarket approval.  *Ifa device does not qualify for the 510(k) premarket notification procedure,a company must file a premarket approval application. The premarketapproval application requires more extensive pre-filing testing than requiredfor a 510(k) premarket notification, and usually involves a 

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significantly longerreview process. A premarket approval application must be supported by validscientific evidence that typically includes extensive data, includingpreclinical and clinical trial data, to demonstrate the safety and efficacy ofthe device. If clinical trials are required, and the device presents a “significantrisk,” an investigational device exemption (“IDE”) application must be filedwith the FDA and must be approved before a clinical trial begins. The IDE mustbe supported by appropriate data, such as animal and laboratory testingresults. Clinical trials may begin if the FDA and the appropriate institutionalreview boards both approve the IDE. Trials must be conducted in conformancewith FDA regulations and the institutional review boards’ requirements. Thesponsor or the FDA may suspend the trials at any time if it is believed thatthey pose unacceptable health risks, or if the FDA finds deficiencies in theway that they are being conducted. Data from clinical trials are often subjectto varying interpretations that could delay, limit or prevent FDA approval. Ifthe device presents a “nonsignificant risk” to trial subjects, clinical trialsmay begin on the basis of appropriate institutional review board approval.

A premarket approval application may be denied ifapplicable regulatory criteria are not satisfied, or the FDA may impose certainconditions upon the applicant, such as postmarket testing and surveillance. Thepremarket approval application process can be expensive, uncertain and lengthy,and approvals may not be granted. A number of third parties’ devices for whichpremarket approval has been sought have never been approved for marketing.After approval, a new application or a supplement is required if certainmodifications are made to the device, its labeling or its manufacture.

*New Drug Application and BiologicsLicense Application (“BLA”).  *New chemical entities orbiologics will be regulated as such and premarket approval will be required. Ifa specific inhaler or nebulizer is designed to be used in combination with thenew chemical entity or biologic, it will need to be included in theapplication. The combination of an already-approved drug or biologic with analready-approved device may be treated in the same regulatory manner. If clinicalstudies of such drugs or drug-device combinations used in humans are requiredby the FDA, then an IND will be required before those studies can be initiatedin the United States. Approval of an NDA, or a BLA, will be required before theproduct can be marketed. In addition to reports of the preclinical and clinicaltrials conducted under an effective IND application, the NDA or BLA wouldinclude information pertaining to the preparation of the drug substance, themanufacture of the inhaler or nebulizer, analytical methods, details on themanufacture of finished products and proposed packaging and labeling.Submission of an NDA or BLA does not assure FDA approval for marketing. Theapplication process generally takes several years to complete. The process maytake substantially longer if, among other things, the FDA has questions orconcerns about the safety or efficacy of a product. In general, the FDArequires at least two properly conducted, prospective, randomizeddouble-blinded and well-controlled clinical studies demonstrating efficacy withsufficient levels of statistical assurance. The process for approval ofproducts regulated as drugs and biologics outside the United States is similarto the NDA/BLA process within the United States. For partner products thatincorporate drugs or biologics, we anticipate that an NDA or BLA will berequired in addition to, or separate from, any 510(k) clearance that wemay be required to obtain.

There can be no assurance that approval for any of ourproducts will be granted on a timely basis, or at all. Notwithstanding thesubmission of safety and efficacy data, the FDA ultimately may decide that theapplication does not satisfy all of its regulatory criteria for approval. TheFDA also may require additional clinical tests (i.e., Phase 4 clinical trials)following the NDA or BLA approval to confirm safety and efficacy. These studiescan often extend for years after a product’s launch. Upon approval, a productmay only be marketed for the approved indications.

In addition, the FDA may in some circumstances imposerestrictions on the use of a product that may be difficult and expensive.Product approvals may be withdrawn if compliance with regulatory requirementsis not maintained or if problems occur after the product reaches the market.The FDA also requires reporting of certain safety and other information thatbecomes known to a manufacturer of an approved product.

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*European Union Clearance of Devices.  *Commercializationof medical devices in the European Union is regulated under a system whichpresently requires that all medical devices sold in the European Union bear theCE mark, an international symbol of adherence to quality assurance standards,demonstrated fulfillment of the essential requirement and clinical effectiveness.Medical devices are classified in accordance with Annex IX of the MedicalDevice Directive (“MDD”). The classification determines which conformityassessment procedure the manufacturer must follow in order to affix the CE markon its products. In 2001, we obtained the CE mark for the Aeroneb Pro, and in2002 we received the CE mark for our clinical PDDS, which we used in ourAmikacin clinical study in France. In July 2003 the Aeroneb Go Nebulizerwas CE marked. We cannot be certain that we will obtain a CE mark, or that wewill not have delays in obtaining a CE mark, for any other product.

*Post-Approval Requirements.  *Regulatoryapproval, if granted, may entail limitations on the indicated uses for which aproduct may be marketed, and product approvals, once granted, may be withdrawnif problems occur after initial marketing. Manufacturers of FDA-regulatedproducts are subject to pervasive and continuing governmental regulation,including extensive recordkeeping requirements and reporting of adverseexperiences associated with product use. Compliance with these requirements iscostly, and failure to comply properly can result in withdrawal of a productapproval.

*Good Manufacturing Practices.  *Wewill be required to adhere to applicable FDA cGMP as set forth in the QSR,which include testing, controls and documentation requirements. Other countrieshave similar requirements. Failure to comply with these and other applicableregulatory requirements may result in, among other things, warning letters,fines, injunctions, civil penalties, recall or seizure of products, total orpartial suspension of production, failure of the government to review pendingmarketing clearances or approval applications, withdrawal of marketingclearances or approvals and criminal prosecution.

*Hazardousmaterials.  *Our operations involve use of hazardous andtoxic materials and generate hazardous, toxic and other wastes. We are subjectto federal, state and local laws and regulations governing the use, storage,handling and disposal of such materials and certain waste products. Although webelieve that our safety procedures for using, handling, storing and disposingof such materials comply with these standards required by state and federallaws and regulations, we cannot completely eliminate the risk of accidental contaminationor injury from these materials.

***Employees***

We had approximately 74employees as of December 31, 2004. Approximately 19 of those employees arelocated at our Irish facility. Our employees are not represented by acollective bargaining agreement. All employees are eligible to participate inan employee stock option plan and generally receive options vesting over afour-year period at the time they join the Company, and subsequent options thatgenerally vest over three to four years. We had approximately 88****employees at the beginning of 2003. We reduced ourworkforce on January 3, 2003 by 22 employees in connection with arestructuring. In January 2004, we announced a furlough of nine employees,seven of which were subsequently terminated in March 2004. We believe ourrelations with our employees are good.

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***Executive Officers***
| **Name**                | ** ** | ** ** | ** ** | **Age**                                                                       | ** ** | **Position** |
|-------------------------|------------|------------|------------|-------------------------------------------------------------------------------|------------|--------------|
| Jane E. Shaw, Ph.D.     |       | 66         |       | Chief Executive Officer  and Chairman of the Board of Directors               |
| Yehuda Ivri             |       | 53         |       | Chief Technical  Officer, Director and Founder                                |
| Robert S. Breuil        |       | 43         |       | Chief Financial  Officer, Vice President, Corporate Development               |
| Robert S. Fishman, M.D. |       | 43         |       | Vice President,  Scientific Affairs                                           |
| Nancy Isaac             |       | 43         |       | Vice President,  Regulatory Affairs and Quality                               |
| John S. Power           |       | 45         |       | Managing Director  Aerogen (Ireland) Limited and Senior Vice President, Sales |
| Angela Strand           |       | 36         |       | Vice President,  Marketing                                                    |
| Mauro Folena            |       | 45         |       | Vice President,  Operations                                                   |

 

**Jane E. Shaw, Ph.D.**,   hasserved as Chairman of our Board of Directors and as our Chief Executive Officersince 1998. Dr. Shaw held various scientific and management positions withALZA Corporation, a pharmaceutical company, from 1970 to 1994, most recently asPresident and Chief Operating Officer from 1987 to 1994. Dr. Shaw receiveda B.Sc. and Ph.D. in Physiology from Birmingham University in England. Dr. Shawserves as a director of OfficeMax Corporation, Intel Corporation, and McKessonCorporation.

**Yehuda Ivri,**   founded Aerogen in 1991 and has servedas a member of our Board of Directors since its inception. Mr. Ivri hasserved as our Chief Technical Officer since 1996 and previously was our ChiefScientist and Vice President. Mr. Ivri received an M.S. in MechanicalEngineering from the Technion-Israel Institute of Technology.

**Robert S. Breuil,**   Chief Financial Officer, Vice PresidentCorporate Development, joined Aerogen in April 2002 as Vice President,Corporate Development. In July 2002 Mr. Breuil was appointed ChiefFinancial Officer. Prior to joining Aerogen, Mr. Breuil was employed byALZA Corporation from 1994 to 2002, where he served in numerous leadershippositions including Controller of ALZA Pharmaceuticals and Director ofCorporate Planning and Analysis. Prior to joining ALZA, Mr. Breuil servedfor eight years as a Naval Officer and Aviator. Mr. Breuil received a B.S.in Electrical Engineering at the United States Naval Academy and an M.B.A. fromthe Stanford Graduate School of Business.

**Robert S. Fishman, M.D. F.C.C.P.,**   Vice President, Scientific Affairs,joined Aerogen in June 1998 as Director of Clinical Operations and waspromoted to Vice President of Clinical Operations in 2001. He assumed theexpanded role of Vice President of Scientific Affairs in July 2002. Priorto joining Aerogen, Dr. Fishman was Director of Clinical Affairs atHeartport, Inc. where he led the clinical trials, medical monitoring, andclinical training development functions. Prior to Heartport, he was AssistantProfessor of Medicine at Stanford University and was Associate Medical Directorof the Stanford Lung and Heart-Lung Transplant Program. He received an A.B. inBiology from Harvard University and an M.D. from Stanford University School ofMedicine, and completed his fellowship training in pulmonary and critical caremedicine at Massachusetts General Hospital. Dr. Fishman continues to teachrespiratory physiology at Stanford. He is a Fellow of the American College ofChest Physicians and a member of the American Thoracic Society.

**Nancy Isaac, J.D., M.P.H.,**   Vice President, Regulatory Affairs andQuality, joined Aerogen in July 2002. Prior to joining Aerogen she waswith BD Biosciences, a business segment of Becton, Dickenson &Company, from 1989 to 1993 and returned after graduate school from 1997 to 2002in various regulatory capacities, and finally as Worldwide Vice President,Regulatory and Quality. Ms. Isaac 

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has also held regulatorypositions at Genzyme Corporation and SYVA. Ms. Isaac received a J.D. fromBoston University, a Masters in Public Health from Harvard University, and aBachelor of Science in Cell and Molecular Biology from San Francisco StateUniversity. She is also a member of the State Bar of California.

**John Power,**   Managing Director and Senior VicePresident, Sales, has served as Senior Vice President, Sales since August 2002and as Vice President, European Operations and Managing Director, Aerogen(Ireland) Limited since May 2000. Mr. Power was the founder and ManagingDirector of Cerus Limited (now Aerogen (Ireland) Limited), from 1998 to 2000. Mr. Powerwas Engineering Manager in Mechanical Development at Nellcor Puritan Bennettfrom 1993 to 1997, and an engineering consultant to various companies from 1988to 1992. Registered with I. Eng. status from UK Engineering Council, Mr. Powerholds qualifications in both Computer Mechanical and Production Engineering andan MBA from Oxford Brookes University, Oxford, England.

**Angela Strand,**   VicePresident, Marketing, joined Aerogen in November 2000. Prior tojoining Aerogen, Ms. Strand served from 1999 to 2000 as Vice President ofMarketing for Novacept, a women’s healthcare company recently acquired byCytyc, and Vice President of Sales and Marketing for eCliniq, an internet-basedhealthcare software concern. Following graduate school in 1992 through 1999,she served in leadership positions with Baxter Healthcare and FemRx, a women’shealthcare company acquired by Johnson & Johnson. Ms. Strandreceived a B. S. with high honors in Communications and an M.B.A. in marketingand finance, both from the University of Tennessee.

**Mauro J.Folena**,   VicePresident of Operations, joined Aerogen in February 2005. Prior to joiningAerogen, Mr. Folena was Director of Operations for HoneywellInternational, from 2001 to 2004, where he led a multi-site pressure sensormanufacturing operation. Prior to his years at Honeywell, Mr. Folena wasemployed by National Semiconductor from 1977 to 1998, where he worked in thefield of equipment engineering, and development of high volume manufacturingoperations. Mr. Folena received a bachelor’s degree in Information SystemsManagement from the University of San Francisco and is a Certified Instructorin Total Productive Maintenance (T.P.M.) from the Japan Institute of PlantMaintenance.

***Corporate Disclosures***

Our Web site address is *www.aerogen.com*. We make available free ofcharge through our Web site, our annual report on Form 10-K,quarterly reports on Form 10-Q, current reports on Form 8-K,and all amendments to these reports as soon as reasonably practicable afterfiling, by providing a hyperlink directly to our reports. Information containedon our website is not a part of this report. We make available free of charge,on or through out website’s investor relations page, our Code of Ethics. Youmay read and copy materials that Aerogen files with the SEC at the SEC’s PublicReference Room at 450 Fifth Street, NW, Washington, DC 20549. You mayobtain information on the operation of the Public Reference Room bycalling the SEC at 1-800-SEC-0330. The SEC also maintains anInternet site at http://www.sec.gov that contains reports, proxy andinformation statements, and other information.

***Certain Financial Information***

As of December 31,2004, 2003 and 2002, 82%, 88% and 73%, respectively, of our long-lived assetswere maintained in the United States. For the years ended December 31,2004, 2003 and 2002, 40%, 22% and 29%, respectively, of our consolidatedrevenues were generated in the United States.

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**Item 2. PROPERTIES**

Our United States operations are currently located ina single 32,148 square foot building in Mountain View, CA. We conduct ourmanufacturing activities in this facility. The lease on this space was amendedin November 2003 to defer a significant portion of our rent during atwo-year period to be paid during the last six years of the lease in exchangefor the issuance of 60,000 shares of common stock to our landlord, and again inMarch 2004, to, among other things, reduce our occupancy to 32,148 squarefeet, reduce the term of the lease to five years and to reduce our rentalexpense in exchange for cash payments, forfeiture of our security deposit andthe issuance of 50,000 shares of common stock to our landlord. See Exhibits10.12.1 and 10.12.2 for a full description of these two amendments.

Aerogen (Ireland) Limitedleases a laboratory and office facility of approximately 2,500 square feet inGalway, Ireland on a lease that will expire on December 31, 2006. In early2002 we entered into a 980-year land lease with the Irish DevelopmentAgency for approximately $220,000. We estimate a new facility on the site wouldcost approximately $1.5 million. We do not have final plans for thebuilding of the facility; when we do, it would likely be financed through amortgage on the property, guaranteed by us, with the remainder provided by usin the form of a loan to our subsidiary.

**Item 3. LEGAL PROCEEDINGS**

Aerogen is a party to alawsuit brought by PARI GmbH alleging patent infringement in Germany. InMay 2003, we filed an action in the German patent office requesting thatthe patent in question be rendered null and void. In July 2004, theFederal Patent Court in Munich, Germany ruled in favor of Aerogen by nullifyingall contested claims of this patent, which is owned by The TechnologyPartnership plc (“TTP”) of Hertfordshire, England, and is licensed to PARI,GmbH of Munich, Germany. The Court ordered TTP to pay Aerogen’s legal expensesrelated to this nullity action to the maximum extent allowed under German law. DuringOctober 2004, TTP requested, and was granted, a three-month extension oftime to file an appeal of this decision, and granted additional extensionsthrough February 2005. PARI assumed control over the nullity case from TTP on December 14,2004. The decision on the nullity action has been appealed to the GermanSupreme Court, with PARI submitting its arguments in support of the appeal in March 2005.Additionally, during October 2004 TTP formally served Aerogen with theinfringement suit that PARI had advised Aerogen in April 2003 had alreadybeen filed in Munich, Germany. A preliminary hearing on the infringement caseis scheduled for June 2005. We believe that this suit is without merit andintend to vigorously defend against all allegations in the suit.

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**PART II**

**Item5.** MARKET FOR REGISTRANT’S COMMON EQUITY AND RELATEDSTOCKHOLDER MATTERS

***Stock Listing, Trading and Dividend Policy***

Ourcommon stock traded on the Nasdaq Stock Market® under the symbol AEGN from November 10,2000 to December 26, 2002, and has been listed on the Nasdaq SmallCapMarket since December 26, 2002. The high and low sales price for 2003 and2004 adjusted for the October 31, 2003 one-for-five reverse stocksplit are as follows:
| ** **  | ** ** | **High** | ** ** | **Low** | ** ** |
|-------------|------------|----------|------------|---------|------------|
| Q1 ’03 |       | $        | 2.50       |    | $          | 0.25 |   |
| Q2 ’03 |       | $        | 5.00       |    | $          | 0.75 |   |
| Q3 ’03 |       | $        | 6.40       |    | $          | 1.55 |   |
| Q4 ’03 |       | $        | 5.30       |    | $          | 1.65 |   |
| Q1 ’04 |       | $        | 4.00       |    | $          | 2.16 |   |
| Q2 ’04 |       | $        | 3.80       |    | $          | 2.41 |   |
| Q3 ’04 |       | $        | 3.22       |    | $          | 1.79 |   |
| Q4 ’04 |       | $        | 2.49       |    | $          | 1.53 |   |

 

As of March 25, 2004, there were approximately195 holders of record of our common stock. We have not paid any dividends onour common stock and have no present intention to do so, as we expect tocontinue investing in our business, and incurring losses, for several years.

Under the terms of our Series A-1Preferred Stock, holders as of the last day of each calendar quarter areentitled to dividends, payable in cash or common stock at the Company’selection. The value of these quarterly dividends has been, and is currently,$0.45 per share of Series A-1 Preferred Stock. If the Company elects to paythese dividends in common stock, the number of common shares currently payableon each share of Series A-1 Preferred Stock is equal to $0.45 divided bythe closing price of the common stock on the last trading day of each quarter. TheCompany has elected to pay this dividend with the Company’s common stock foreach quarter of 2004, and has issued a total of 613,921 common shares forpayment of the 2004 dividends through March 25, 2005.

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***Equity Compensation Plan Information***

The following tableprovides certain information with respect to all of our equity compensationplans in effect as of December 31, 2004.
| **Plan Category**                                            | ** ** | ** ** | ** ** | **Number of securities to be  issued upon exercise of  outstanding options and rights** | ** ** | **Weighted average exercise  price of outstanding  options and rights** | ** ** | **Number of securities available for  future issuance under equity  compensation plans (excluding  securities in column (a)** | ** ** |
|-------------------------------------------------------------------|------------|------------|------------|-------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------------------------------------------------------------------------------------|------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|
| ** **                                                        | ** ** | **(a)**    | ** ** | **(b)**                                                                                                                                   | ** ** | ** **                                                                                            | ** ** |
| Equity compensation  plans approved by security  holders(1)(2)(3) |       |       | 4,083,401  |                                                                                                                                      |       |                                                                                                  | $          | 3.60                                                                                                                                                                                      |       |   |   | 3,462,898 |   |   |
| Equity compensation  plans not approved by security holders       |       |       | 0          |                                                                                                                                      |       |                                                                                                  | —     |                                                                                                                                                                                      |       |   | 0 |   |   |

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(1)*         *Consists of Aerogen’s 2000 EquityIncentive Plan, 2000 Non-Employee Directors’ Stock Option Plan, 2000 EmployeeStock Purchase Plan, 1996 Amended and Restated Stock Plan and 1994 Amended andRestated Stock Plan.

(2)*         *The 2000 Equity Incentive Plan has aprovision for increasing the number of shares available for the grant ofoptions on an annual basis by a number of shares equal to the least of (i) 4.5%of the then outstanding shares of common stock on a fully diluted basis, (ii) 400,000shares, or (iii) a lesser number of shares determined by Aerogen’s Boardof Directors. In 2004, the Board of Directors increased the number of sharesavailable for grant under the 2000 Equity Incentive Plan by 40,000 sharespursuant to this provision, and, in addition, authorized an additional4,515,309 shares for issuance under the plan, which was subsequently approvedby Aerogen stockholders.

(3)*         *The 2000 Employee Stock Purchase Plan hasa provision for increasing the number of shares available for purchase underthe plan on an annual basis by a number equal to the least of (i) 1.0% ofthe then outstanding shares of common stock on a fully diluted basis, (ii) 50,000shares, or (iii) a lesser number of shares determined by Aerogen’s Boardof Directors. In 2004, the Board of Directors and the stockholders of Aerogenapproved an increase in the number of shares available for grant under the 2000Employee Stock Purchase Plan by an additional 1,589,752 shares.

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**Item 6. SELECTED CONSOLIDATED FINANCIAL DATA**

Thefollowing selected consolidated financial data should be read in conjunctionwith Management’s Discussion and Analysis of Financial Condition and Results ofOperations (Item 7 of this Form 10-K) and the Consolidated FinancialStatements and Supplementary Data (Item 8 of this Form 10-K). Theconsolidated financial data for periods prior to the periods covered by theconsolidated financial statements included in Item 8 of this Form 10-K arederived from audited consolidated financial statements not included in thisdocument.
| ** **                                                                                                  | ** ** | **For the years ended, December 31,** | ** ** |
|-------------------------------------------------------------------------------------------------------------|------------|----------------------------------------------------------------|------------|
| ** **                                                                                                  | ** ** | **2004**                                                       | ** ** | **2003** | ** ** | **2002** | ** ** | **2001** | ** ** | **2000** | ** ** |
| **Consolidated Statement of  Operations Data:**                                                             |       |                                                           |       |   |   |   |   |   |   |   |   |
| Total revenues                                                                                              |       | $                                                              | 6,248      |   | $ | 4,171 |   | $ | 2,532 |   | $ | 2,469 |   | $ | 5,832 |   |
| **Costs  and expenses:**                                                                                    |       |                                                           |       |   |   |   |   |   |   |   |   |
| Cost of products sold                                                                                       |       | 4,051                                                          |       | 2,296 |   | 1,786 |   | 285 |   | — |   |
| Research and development                                                                                    |       | 11,185                                                         |       | 11,744 |   | 17,772 |   | 21,698 |   | 16,219 |   |
| Selling, general and administrative                                                                         |       | 6,789                                                          |       | 6,507 |   | 8,382 |   | 8,138 |   | 4,143 |   |
| Purchased in-process research and development                                                               |       | —                                                         |       | — |   | — |   | — |   | 3,500 |   |
| Litigation settlement                                                                                       |       | —                                                         |       | — |   | — |   | 2,000 |   | — |   |
| Total costs and expenses                                                                                    |       | 22,025                                                         |       | 20,547 |   | 27,940 |   | 32,121 |   | 23,862 |   |
| Loss from operations                                                                                        |       | (15,777                                                        | )          | (16,376 | ) | (25,408 | ) | (29,652 | ) | (18,030 | ) |
| Interest and other income (expense), net                                                                    |       | 5,703                                                          |       | (1,043 | ) | 497 |   | 2,250 |   | 1,160 |   |
| Net loss                                                                                                    |       | (10,074                                                        | )          | (17,419 | ) | (24,911 | ) | (27,402 | ) | (16,870 | ) |
| Dividend related to beneficial conversion feature of  preferred stock                                       |       | (13,097                                                        | )          | — |   | — |   | — |   | (16,517 | ) |
| Net loss attributable to common stockholders                                                                |       | $                                                              | (23,171    | ) | $ | (17,419 | ) | $ | (24,911 | ) | $ | (27,402 | ) | $ | (33,387 | ) |
| Net loss per common share attributable to common  stockholders, basic and diluted                           |       | $                                                              | (4.86      | ) | $ | (4.22 | ) | $ | (6.17 | ) | $ | (6.96 | ) | $ | (36.49 | ) |
| Shares used in computing  net loss per common share attrubutable to common stockholders, basic and  diluted |       | 4,765                                                          |       | 4,126 |   | 4,036 |   | 3,936 |   | 915 |   |

 
| ** **                                                | ** ** | **December 31,** | ** ** |
|-----------------------------------------------------------|------------|-----------------------|------------|
| ** **                                                | ** ** | **2004**              | ** ** | **2003** | ** ** | **2002** | ** ** | **2001** | ** ** | **2000** | ** ** |
| **Consolidated Balance Sheet  Data:**                     |       |                  |       |   |   |   |   |   |   |   |   |
| Cash, cash  equivalents and available-for-sale securities |       | $                     | 16,883     |   | $ | 762 |   | $ | 8,887 |   | $ | 36,077 |   | $ | 60,976 |   |
| Working capital                                           |       | 15,315                |       | (2,181 | ) | 8,679 |   | 33,457 |   | 60,639 |   |
| Total assets                                              |       | 25,755                |       | 9,576 |   | 19,194 |   | 43,468 |   | 66,712 |   |
| Warrant liability                                         |       | 10,296                |       | — |   | — |   | — |   | — |   |
| Long-term  obligations, less current portion              |       | 267                   |       | 246 |   | 205 |   | 212 |   | 184 |   |
| Redeemable  convertible preferred stock                   |       | 15,749                |       | — |   | — |   | — |   | — |   |
| Accumulated  deficit                                      |       | (119,545              | )          | (109,471 | ) | (92,052 | ) | (67,141 | ) | (39,739 | ) |
| Total stockholders’  equity (deficit)                |       | (7,149                | )          | 1,680 |   | 15,744 |   | 38,531 |   | 64,228 |   |
|                                                           |            |                       |            |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

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**Item7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTSOF OPERATIONS**

The following discussionof our financial condition and results of operations should be read inconjunction with the consolidated financial statements and the related notesincluded in Item 8 of this Form 10-K. This discussion may containforward-looking statements that involve risks and uncertainty. We undertake noduty to update these forward-looking statements. Should events occur subsequentto the filing of this Form 10-K that require us to update theforward-looking information contained in this Form 10-K, the updatedinformation will be filed with the SEC in a quarterly report on Form 10-Qor a Form 8-K, or disclosed in a press release. As a result of many factors,including those set forth under “Risk Factors” and elsewhere in thisForm 10-K, our actual results may differ materially from those anticipatedin any forward-looking statements.

***Overview***

Aerogen, Inc. (“Aerogen,” the “Company” or “we”)was incorporated in November 1991. We are a specialty pharmaceuticalcompany developing novel drug/device combination aerosol products for treatmentof respiratory disorders in the critical care setting. Based upon ourproprietary OnQ Aerosol Generator, we are developing respiratory products formarketing by us, and products in collaboration with, and marketing by,pharmaceutical and biotechnology companies for both respiratory therapy and forthe delivery of drugs through the lungs to the bloodstream.

In 2004, we had two nebulizer products on the market.We have an accumulated deficit of approximately $119.5 million as ofDecember 31, 2004. In 2002, we generated significant revenues from our plannedprincipal operations and exited the development stage. However, we willcontinue to devote substantial efforts to the development of current and futureproducts. We expect to incur significant additional operating losses over thenext several years and expect cumulative losses to increase, primarily due tothe costs associated with the manufacturing and marketing of our products, theexpansion of our research and development activities and the general expansionof our business activities. We anticipate that our quarterly results willfluctuate for the foreseeable future. Therefore, period-to-period comparisonsshould not be relied upon as predictive of the results in future periods. Oursources of working capital have primarily been equity financings, convertibledebentures, product revenues, research and development revenues, license fees,royalties, and interest earned on investments.

In June 2001 we launched our first commercialproduct, the Aeroneb Portable Nebulizer System, a simple, compact and silentnebulizer for use in the home setting. In June 2002 we launched the AeronebProfessional Nebulizer System, developed for use in a hospital settingincluding the treatment of patients on ventilators. In January 2004, theAeroneb Go Nebulizer was launched in the United States by our commercialpartner Evo. All of our products incorporate a version of our proprietary OnQaerosol generator. Since the launch of the first Aeroneb product, we haverecorded cumulative revenues of $9.7 million associated with sales of theAeroneb products and component parts as of December 31, 2004. Prior to ouragreement with Evo, the Aeroneb Portable Nebulizer System had been promoted inthe United States by a small sales force under contract from a division ofCardinal Health, and by several home medical equipment distributors. TheAeroneb Pro is available in over 30 countries worldwide under agreements withventilator OEMs including Maquet, Respironics, Tyco-Puritan Bennett and GEHealthcare, as well as independent distributors, including Cardinal Health, inthe United States and select countries. 

In June 2003, we made initial commercialshipments of our Aeroneb Go product to Norway, via our distributor Normed, aspart of a test market. In September 2003, we entered into an agreementwith Evo for marketing and manufacturing of the Aeroneb Go, under which Evo hasexclusive rights to manufacture and market the product in the United States andcertain countries worldwide. In connection withour 

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agreement with Evo, wereceived upfront payments from Evo totaling $2.5 million in 2003; inaddition, Aerogen is supplying its OnQ Aerosol Generators to Evo under atransfer pricing arrangement, and Evo will pay us royalties on its gross salesof the Aeroneb Go and related accessories. First commercial shipments occurredin the United States in January 2004, and in Japan during the thirdquarter of 2004.

We perform feasibility and initial development work tocustomize our nebulizers and inhalers to deliver specific drugs, for our ownaccount or under agreement with third parties who compensate us for expensesincurred in performing this work. Once feasibility is demonstrated for apotential product, we may seek to enter into a development agreement with thecorporate partner holding the commercial rights to the compound to be used inthe product, under which we would expect to receive reimbursement from partnersfor our fully-burdened development expenses incurred under approved work plans,and royalties on future total product sales similar collaborations, androyalties based on our partner’s sales of products, if and when commercialized.We recognize research and development revenues as reimbursable research anddevelopment expenses are incurred. We also expect to receive revenue fromproducts that we manufacture and we expect to out-license marketing and/ormanufacturing rights to products or territories that do not fit within our areaof commercial focus.

The Company’s lead pharmaceutical product underdevelopment for its own account is a drug/device combination product whichdelivers the aminoglycoside amikacin to the lungs for treatment ofVentilator-Associated Pneumonia (“VAP”). The second Phase 2 clinical trialwith this product was initiated on December 28, 2004, and involves theenrollment of 108 patients at approximately 31 study sites, with each patientto be studied for 28 consecutive days. Based upon estimates provided byour study sites, we anticipated we would have a majority of our sitesopen, and the first patients enrolled, during the first quarter of2005. As of March 31, 2005, however, we had only 8 sitesopen due to administrative delays at the sites, 33 patients with suspectedVAP screened for entry into the trial, and no patientsenrolled. Until all sites are open and weobserve steady enrollment, we will be unableto reliably project the completion date of the trial. In lightof the fact that we currently have no patients enrolled in this study, weare uncertain at this time when the study will be completed, if atall.

We have incurred stock-based compensation expenses of$0.3 million, $1.0 million and $1.4 million, for the years endedDecember 31, 2004, 2003 and 2002, respectively. Stock-based compensationincluded in research and development expenses was $0.1 million,$0.3 million and $0.5 million for the years ended December 31, 2004,2003 and 2002, respectively. Stock-based compensation included in selling,general and administrative expenses was $0.2 million, $0.7 millionand $0.9 million, respectively, for the years ended December 31, 2004,2002 and 2001. As of December 31, 2004, there was no remaining deferredstock-based compensation. We anticipate incurring additional stock-basedcompensation expense in the future as a result of fluctuations in the marketvalue of our common stock, which will continue to have a direct impact on thevalue of common stock options held by non-employees.

We had federal and state net operating loss carryforwards of approximately $82.4 million and $35.4 million,respectively, as of December 31, 2004. We also had aggregate federal and stateresearch and development tax credit carryforwards of approximately$2.2 million and $2.3 million, respectively, as of December 31, 2004. Thenet operating loss and credit carryforwards will expire, if not utilized, invarious amounts beginning in 2009 for federal purposes and 2005 for statepurposes. Due to the uncertainty regarding the ultimate utilization of the netoperating loss and credit carryforwards, we have not recorded any benefit forlosses, and a valuation allowance has been recorded for the entire amount ofthe net deferred tax asset. Utilization of net operating losses and credits maybe substantially limited by the change in ownership provisions of the InternalRevenue Code of 1986 and similar state provisions. The annual limitation mayresult in the expiration of net operating losses and credits before they can beused.

During 2002, we had tworeductions in force, one in January and one in June, involving the terminationof a total of 48 employees. The prospective annualized payroll related savingsresulting from 

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the reductionsin force was $3.9 million, the majority of which was in research anddevelopment. Severance-related costs were $0.3 million, all of which wasexpensed and paid during 2002. In December 2002, we began a restructuring,which included the suspension of further development of our Aerodose insulininhaler, followed by an additional reduction in force in January 2003terminating 22 employees with an annualized payroll related savings of$2.3 million. Severance-related costs were $0.2 million, all of whichwas expensed and paid during the quarter ending March 31, 2003. InJanuary 2004, we announced a furlough of nine employees, seven of whichwere subsequently terminated on March 22, 2004. Severance-related costswere $0.2 million.

***Critical Accounting Policies and Estimates***

Aerogen’s discussion and analysis of our financialcondition and results of operations are based upon our consolidated financialstatements, which have been prepared in accordance with accounting principlesgenerally accepted in the United States of America. The preparation of thesefinancial statements requires us to make estimates and judgments that affectthe reported amounts of assets, liabilities, revenues and expenses, and relateddisclosure of contingent assets and liabilities. On an on-going basis, weevaluate our estimates, including inventories, bad debts, intangible assets(including goodwill), warranty obligations, contingencies and litigation. Webase our estimates on assumptions that are believed to be reasonable under the circumstances,the results of which form the basis for making judgments about carrying valuesof assets and liabilities that are not readily apparent from other sources.Actual results may differ from these estimates under different assumptions orconditions.

We have an Irish subsidiary, which accounted forapproximately 7% of our net loss for the year ended December 31, 2004 and 21%of our assets and 16% of our total liabilities as of December 31, 2004. Inpreparing our consolidated financial statements, we are required to translatethe financial statements of the foreign subsidiary from the currency in whichit keeps its accounting records into United States dollars. Under the relevantaccounting guidance, the treatment of these gains or losses is dependent uponour determination of the functional currency. The determination of thefunctional currency is based on our judgment and involves consideration of allrelevant economic facts and circumstance affecting the subsidiary. Based on ourassessment, we consider our Irish subsidiary’s local currency, the Euro, to bethe functional currency. 

We believe thefollowing critical accounting policies affect our more significant judgmentsand estimates used in the preparation of our consolidated financial statements.

·        We write down ourinventory for estimated obsolescence or unmarketable inventory in an amountequal to the difference between the cost of inventory and the estimated marketvalue based upon assumptions about future demand and market conditions. Ifactual market conditions are less favorable than those projected by management,additional inventory write-downs may be required.

·        We provide for theestimated cost of product warranty at the time revenue is recognized. While weengage in product quality programs and processes, including actively monitoringand evaluating the quality of our component suppliers, our warranty obligationis affected by product failure rates, material usage and delivery costsincurred in correcting any product failure. Should actual product failure ratesor material usage differ from our estimates, revisions to the estimatedwarranty liability would be required.

·        We record revenues fromproduct sales at the time of product shipment, provided an enforceable claimexists, any significant rights to return product have expired and collection ofthe receivable is probable. To date, we have made minor discounts to revenuefor one customer program or incentive offering, which was done at the time ofthe sale to this customer. If we determined to take additional actions toinitiate such incentive offerings, such action might result in a reduction ofrevenue at the time the incentive is offered. Our assessment of the facts at agiven time may result 

25

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in revenues beingrecorded in a period other than what they would have been, based on actualsubsequent events.

·        Werecord revenue from royalties arrangements when we are able to estimate theamounts due, which generally is when they are reported to us. Prior to thattime, we may not have the ability to accurately estimate the royalties due tous. As a result, we may record the revenue in a period subsequent to when therelated sales have occurred.

·        Wereview the need for an allowance for doubtful accounts for estimated lossesresulting from the failure of our customers to make required payments. Ifconditions change, additional allowances may be required.

·        Currently, we haveestablished a full valuation allowance with respect to all of our deferred taxassets. Changes in our estimates of future taxable income may cause us toreverse the valuation allowance. Subsequently, we would report income taxexpenses in amounts approximating the statutory rates.

·        We recognize royalties onour sales to Evo based on their sales of the Aeroneb Go. In addition, wereceived up-front payments totaling $2.5 million, which we are amortizing asroyalty revenue on a straight-line basis over the 5-year term of the agreement.

·        The value of our warrantliability resulting from the A-1 Financing is adjusted to its then-estimatedfair value at the end of each reporting period based on a valuation model.Increases or decreases are reflected as non-operating expense or income,respectively, on the statement of operations. Changes in the assumptions usedto estimate the value could cause the recorded liability of the warrants tochange. Increases in our stock price could cause the recorded value of thewarrants to increase significantly, which would result in us recording anon-operating expense in the period of the change. Such changes in the futureare likely to be material. 

·        We record a deemed dividend related to the beneficial conversionfeature of convertible securities when there is a difference between theconversion price and the fair market value, if any, of the convertiblesecurities on the commitment date (transaction date). The convertiblesecurities include provisions which could cause the conversion rate to changein the event of future equity issuances of the Company. If this occurs, theCompany would record additional deemed dividends on the convertible securities.

·        In accordance withStatement of Financial Accounting Standards (“SFAS”) No. 142 “Goodwill andOther Intangible Assets” (“SFAS 142”), we perform an annual assessment forimpairment of our goodwill by applying a fair-value-based test. Future eventscould lead us to conclude that the recorded value of our goodwill has beenimpaired.

***Results of Operations***

***Comparison of years ended December 31, 2004, 2003and 2002***

*Product sales.  *Productsales were $4.4 million in 2004, $3.2 million in 2003 and$1.9 million in 2002. We launched the Aeroneb Pro in June 2002. Theincrease in product sales in 2003 over 2002 was due to a full year of sales forthe Aeroneb Pro in 2003. The increase in product sales in 2004 over 2003 wasdue to continued increases in our sales of the Aeroneb Pro, as well as sales ofour OnQ Aerosol Generators to Evo Medical Solutions (“Evo” formerly MedicalIndustries America) during the first two quarters of 2004.

*Research and development revenues.  *Therewere no research and development revenues for the year ended December 31,2004. Research and development revenues were $0.3 million in 2003 and$0.4 million in 2002. The revenue decrease in 2003 compared with 2002resulted from the ending of the Puritan Bennett contract in 2002. Research anddevelopment revenues can be expected to vary from period to 

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period based on theactivities requested by partners in any particular period, and therefore arenot predictable.

*Royalty and other revenues.  *Royaltyand other revenues were $1.8 million in 2004, $0.6 million in 2003 and$0.3 million in 2002. The increase in royalty and other revenue in 2004over 2003 was partially due to up-front payments associated with the September2003 agreement with Evo, which resulted in amortization of $0.5 million duringthe year ended 2004, compared to $0.1 million in 2003. During the first twoquarters of 2004, royalties of $0.3 million were recognized on Evo’s firstcommercial shipments of the Aeroneb®, which pays royalties on its gross productand accessory sales. In addition, royalty revenue from a consumer company thathas licensed our aerosol technology for use in the field of air fresheners andinsect repellants, has increased to $1.0 million in 2004, compared to $0.5 millionin 2003, and $0.2 million in 2002, and is expected to increase substantiallyagain in 2005. An additional increase in royalty and other revenue in 2003 over2002 was due to up front payments associated with the September 2003commercial agreement with Evo, which resulted in $0.1 million of amortizationin 2003, related to the $2.5 million in upfront payments which are beingamortized ratably over the five year term of the agreement.

*Cost of products sold.  *Costof products sold was $4.1 million in 2004, $2.3 million in 2003 and$1.8 million in 2002. In 2004 the average cost of sales was 91%, comparedto 72% in 2003 and 95% in 2002. In 2004, the average cost of sales was higherthan in 2003, due to the low yields related to the start of commercial manufacturingof the OnQ Aerosol Generator for sale to Evo. In addition, we recognized a reserve of $100,000 against cost of goodssold for potential costs related to Aerogen’s support of the Evo riskmitigation plan, implemented in response to the FDA’s Class II, firm-initiatedrecall of Evo’s Aeroneb Go product. In 2003, the average cost of saleswas lower than in 2002 due to the change in product mix, and to improvements inour manufacturing processes. In 2002, the cost of products sold was high as apercentage of product sales due primarily to low yields early in the yearassociated with the start-up of the commercial manufacturing processes and themove to the new facility in Mountain View, California. During the second halfof 2002, we saw improved margins as volumes increased and as we completed ourmove into our new facility, which incorporates more automated manufacturingprocesses and improved environmental controls. We anticipate that costs perunit will decrease over time as volumes increase, and as we refine ourmanufacturing processes and focus on cost reductions.

*Research and development expenses.  *Researchand development expenses were $11.2 million in 2004, $11.7 million in2003 and $17.8 million in 2002. The decrease in research and developmentexpenses of $0.5 million in 2004 was primarily due to a reduction of $1.0million in facilities related expenses, reduced payroll and related expenses of$0.4 million associated with reductions in force in 2003, a decrease of $0.2million related to decreased stock compensation expense, and a decrease of $1.3million in research and development spending related to absorbed manufacturingcosts as we began commercial operations and increased our sales. Thesereductions were partially offset by increased spending of $2.4 million relatedto preparations for a Phase 2 clinical trial for our aerosolized antibioticproduct. The decrease in research and development expenses of $6.1 millionin 2003 compared with 2002 was primarily due to a reduction of$3.4 million in payroll-related expenses and $0.2 million in stockcompensation expenses associated with the reductions in force, a reduction of$1.4 million in expenses associated with a halt of the development of thecommercial version of the Aerodose insulin inhaler, reductions of$0.3 million in expense associated with the completion of the developmentof an Aerodose respiratory inhaler, reductions in facility related expenses of$0.2 million, and other spending reductions of $0.7 million,partially offset by increased spending in clinical trials of our aerosolizedantibiotic product of $0.2 million. During the quarter ended March 31,2003, we reduced our headcount in research and development by seventeen. Costsassociated with terminating these individuals were $0.1 million based on aseverance package calculated on length of service. We expect spending forresearch and development in 2005 to increase as we complete our Phase 2clinical trial of our aerosolized antibiotic product, and prepare for a Phase 3clinical trial.

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Research and development expenses relate to our ownresearch and development projects, as well as the costs related to developmentactivities for our partners. Development expenses for partner activitiesapproximate revenues from those partners. Research and development expensesinclude salaries and benefits for scientific and development personnel, laboratorysupplies, consulting services, clinical expenses and the expenses associatedwith the development of manufacturing processes, in each case including relatedoverhead. We expect research and development spending to increase over the nextseveral years as we increase clinical activities and expand our research anddevelopment activities in support of our products and those which we develop inpartner collaborations. The increase in research and development expenditurescannot be predicted reliably, as it depends in part upon our success inentering into new partnering agreements and the timing of development andclinical activities that are largely controlled by our partners.

*Selling, general and administrativeexpenses.  *Selling, general and administrative expenseswere $6.8 million in 2004, $6.5 million in 2003 and $8.4 millionin 2002. The increase of $0.3 million in selling, general and administrativeexpenses was primarily due to an increase in outside legal expenses of $0.6million, and an increase in audit and tax service fees of $0.1 million,partially offset by a decrease in stock compensation expense of $0.5 million.The decrease in selling, general and administrative expense for 2003 ascompared to 2002 was primarily due to reductions in payroll related expenses of$1.1 million and $0.2 million in stock compensation expensesassociated with the reduction in force, reductions in trade shows andadvertising expenses of $0.1 million, and reductions in outside servicesof $0.8 million, partially offset by a $0.6 million increase in legalexpenses and a $0.2 million increase in insurance expense. During thequarter ended March 31, 2003, we reduced our headcount in selling, general andadministration by five. Costs associated with terminating these individualswere approximately $39,000 based on a severance package calculated on length ofservice. We expect spending for selling, general and administration in 2005 tobe comparable to 2004.

*Interest and other income, net.  *Netinterest expense was $0.4 million in 2004, compared with $1.0 millionof net interest expense in 2003 and $0.5 million of net interest income in2002. Interest expense in 2004 was primarily related to imputed interest,totaling $0.4 million, resulting from the beneficial conversion feature of theconvertible debenture and the value associated with the warrant issued to theCarpenter Family Trust in 2004, as well as interest paid on all debentures of$0.1 million. Interest expense, totaling $1.0 million, in 2003 isprimarily due to imputed interest resulting from the beneficial conversionfeature of the convertible debenture and the value associated with the warrantsissued to SF Capital in 2003. There was no interest expense in 2002. Interestincome in 2004 was $0.2 million compared with $0.1 million in 2002and $0.5 million in 2002. The increase in interest income in 2004 comparedto 2003 is primarily due to higher average cash and investment balances, and toa lesser extent, higher interest rates. The decrease in interest income in 2003compared to 2002 is primarily due to lower average cash and investmentbalances, and to a lesser extent, lower interest rates. 

*Decrease in warrant liability.*   The issuance in the first closing ofSeries A-1 Convertible Preferred Stock on March 23, 2004 included warrants topurchase 4,999,810 shares of common stock, and the second closing on May 12,2004 included warrants to purchase 6,249,580 shares of common stock. Theaggregate fair value of the warrants on their issuance dates totaled $16.1million, and was recorded as a liability with subsequent changes to the fairvalue of the warrants recorded as a non-operating item through the statement ofoperations. For the year ended December 31, 2004, the aggregate fair value ofthe warrants decreased to $10.3 million, resulting in a gain of $5.8 million.

*Dividends related to Convertible Preferred Stock*.   We record a deemeddividend related to the beneficial conversion feature of convertible securitieswhen there is a difference between the proceeds allocated to thepreferred stock and the transaction date fair value of the common stockissuable upon conversion, in an amount not to exceed the proceeds allocated tothe preferred stock in the transaction. For the year ended December 31, 2004, atotal deemed dividend of $11.7 million was reflected in our net 

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loss attributable tocommon stockholders. Each holder of A-1 Preferred is entitled to receivecumulative dividends in preference to any dividend on the common stock at therate of 6% of the Series A-1 Stated Value per share, paid quarterly in arrearson the first day of January, April, July and October in each year (the “PreferredDividends”). The Preferred Dividends will be paid, at the Company’s election,out of legally available funds or through the issuance of shares of commonstock. For the twelve months ended December 31, 2004 cumulative dividends of$1.4 million had been accrued on the A-1 Preferred, and these dividends haveall been paid through the issuance of an aggregate of 613,921 shares of theCompany’s common stock.

We report segments inaccordance with SFAS No. 131, “Disclosures About Segments of an Enterpriseand Related Information.” SFAS 131 requires the use of a managementapproach in identifying segments of an enterprise. The Company consists of oneoperating segment.

***Liquidity and Capital Resources***

The Company has incurred net losses since inceptionand is expected to incur substantial losses for the next several years. Theauditor’s report on our consolidated financial statements as of December 31,2004 contains an explanatory paragraph, which refers to our recurring operatinglosses and negative cash flows from operations and notes that these mattersraise substantial doubt about our ability to continue as a going concern. Theaccompanying consolidated financial statements have been prepared on a goingconcern basis which contemplates continuity of operations, realization ofassets and liquidation of liabilities in the ordinary course of business and donot reflect adjustments that might result if we were not to continue as a goingconcern.

To date, we have financed our operations primarilythrough equity and convertible debt financings, product revenues, research anddevelopment revenues, licensing fees, royalties, and the interest earned onrelated proceeds. The process of developing products will continue to requiresignificant research and development, clinical trials and regulatory approvals.These activities, together with selling, general and administrative expenses,are expected to result in substantial operating losses for the next severalyears. As of December 31, 2004, Aerogen had cash and cash equivalents ofapproximately $16.9 million. Based on current expectations of sales androyalty levels and operating costs, existing capital resources will not enablethe Company to maintain current and planned operations beyond the first quarterof 2006; however, if we do not receive certain expected product sales and/orroyalties, our cash balance may not sustain planned operations beyond the middleof the fourth quarter of 2005. We are pursuing a number of alternatives tomaximize stockholder value, including strategic transactions, collaborativepartnerships and the licensing on sale of certain of our intellectual property.If these efforts are not successful, we will need to raise additional capitalbefore the end of 2005 to continue operations. Licensing or collaborativearrangements, if necessary to raise additional funds, may require us torelinquish rights to either certain of our products or technologies ordesirable marketing territories, or all of these.

Net cash used in operating activities for the yearended December 31, 2004 was $14.5 million, primarily due to the operating lossof $10.1 million, payments to our landlord totaling $1.6 million in connectionwith the restructuring of our Mountain View, CA facility lease, comprising pastdue rent, security deposit and rent reduction fees, and non-cash operatingexpenses of $2.7 million. Net cash used in operating activities for the yearended December 31, 2003, was $9.9 million, primarily due to theoperating loss of $17.4 million, partially offset by an increase indeferred revenue of $2.2 million, depreciation expense of$1.3 million, amortization of stock based compensation of$1.0 million, amortization of discounts on notes of $1.0 million anddeferred rent of $0.8 million. Net cash used in operating activities forthe year ended December 31, 2002, was $24.0 million, primarily due tothe net operating loss of $24.9 million and the payment of accruedliabilities of $1.9 million, partially offset by the amortization of stockbased compensation of $1.4 million, and depreciation of $1.2 million.

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Net cash used by investing activities for the yearended December 31, 2004 was $0.8 million and was due to the acquisition ofproperty and equipment related to manufacturing process improvements. Net cashprovided by investing activities for the year ended December 31, 2003 was$5.2 million and was due to the maturity of available-for-sale securitiesof $5.6 million, partially offset by $0.4 million for acquisition ofproperty and equipment. Net cash provided by investing activities for the yearended December 31, 2002 was $11.0 million and was due to the maturityof available-for-sale securities of $22.8 million, partially offset by$8.1 million for the purchase of available-for-sale securities and$3.7 million for acquisition of property and equipment. 

Net cash provided by financing activities was$31.4 million, $2.1 million, and $0.5 million, for the years endedDecember 31, 2004, 2003 and 2002, respectively. In 2004, $30.9 million wasprovided from the issuance of preferred stock and warrants related to the saleof Series A-1 Convertible Preferred Stock and associated common stock warrants,and $0.8 million in net proceeds from the issuance of debentures andconvertible debentures, partially offset by the repayment of a $0.3 milliondebenture. In 2003, $2.0 million was provided by the sale of two separateconvertible debentures, and a minimal amount was provided by purchases ofcommon stock under our employee stock purchase plan. In 2002, approximately$0.5 million was provided almost equally by repayment of earlier loans tostockholder/executives, and by purchases of common stock under our employeestock purchase plan. 

The development ofour technology and future products requires a commitment of substantial fundsto conduct the costly and time-consuming research, development and clinicaltrials required to develop and refine our technology and future products and tobring those products to market. Our future capital requirements and operatingexpenses will depend on many factors including, but not limited to, researchand development activities, the timing, cost, extent and results of clinicaltrials, our success in licensing drugs for use in our products, regulatoryapprovals, the status of competitive products, manufacturing and marketingcosts associated with commercialization of our products, costs involved inobtaining and maintaining patents, and our ability to enter into and maintaincollaborative agreements.

Wecurrently have no material commitment for capital expenditures. We lease ourMountain View, CA facility under a non-cancelable operating lease, expiring inFebruary 2009. Future minimum payments due under this lease are as follows:
| ** **      | ** ** | ** **              | ** ** | **One Year** | ** ** | **One to Three** | ** ** | **Three to Five** | ** ** | **More than**  | ** ** |
|-----------------|------------|-------------------------|------------|-------------------|------------|----------------------------|------------|-----------------------------|------------|---------------------|------------|
| ** **      | ** ** | **Total**               | ** ** | **And Less** | ** ** | **Years**                  | ** ** | **Years**                   | ** ** | **Five Years** | ** ** |
| ** **      | ** ** | **(in thousands)** | ** ** |
| Operating Lease |       | $                       | 4,587      |              |       | $                          | 990        |                        |       |                | $          | 3,404 |   |   |   | $ | 193 |   |   |   | $ | — |   |   |
|                 |            |                         |            |                   |            |                            |            |                             |            |                     |            |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

These minimum payments include a reasonable estimateof future common area maintenance charges.

In addition, we have a commitment of approximately$267,000 to Irish investors under a tax advantaged Business Expansion Scheme(as that term is defined under Irish tax law) that must be repaid out of theoperating profits, if any, of our Irish subsidiary.

Our long-term liquidity also depends upon our abilityto attract and maintain collaborative relationships, to increase revenues fromthe sale of our products, to develop and market new products and ultimately, toachieve profitability.

As of December 31, 2004,we did not have any off-balance sheet arrangements, as defined in Item 303(a)(4)(ii) ofSEC Regulation S-K.

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***Recent Accounting Pronouncements***

In December 2004, the Financial AccountingStandards Board (“FASB”) issued FASB Statement No. 123R (revised 2004) “Share-BasedPayment,” which is a revision of FASB Statement No. 123 “Accounting forStock-Based Compensation.” Statement 123R supersedes APB Opinion No. 25 “Accountingfor Stock Issued to Employees,” and amends FASB Statement No. 95 “Statement ofCash Flows.” Generally, the approach in Statement 123R is similar to theapproach described in Statement 123. However, Statement 123R requires allshare-based payments to employees, including grants of employee stock options,to be recognized in the income statement based on their fair values. Pro formadisclosure is no longer an alternative. The new standard will be effective forthe Company in the quarter ending September 30, 2005. The Company is inthe process of assessing the impact of adopting this new standard.

In December 2004, the Financial AccountingStandards Board issued Statement of Financial Accounting Standards No. 151 “InventoryCosts” (“SFAS 151”), which adopts wording from the International AccountingStandards Board’s IAS 2 “Inventories” in an effort to improve the comparabilityof international financial reporting. The new standard indicates that abnormalfreight, handling costs, and wasted materials (spoilage) are required to betreated as current period changes rather than as a portion of inventory cost.Additionally, the standard clarifies that fixed production overhead should beallocated based on the normal capacity of a production facility. The provisionsof SFAS 151 are effective for fiscal years beginning after June 15, 2005.Adoption of SFAS 151 is not expected to have a material impact on the Company’sfinancial position or results of operations.

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**Item 7A. QUANTITATIVE AND QUALITATIVE DISCLOSUREABOUT MARKET RISK**

*Interest rate risk.  *Interestrate risk represents the risk of loss that may impact our financial position,operating results or cash flows due to changes in interest rates. This exposureis directly related to our normal operating activities. Our cash and cashequivalents are invested in money market funds and are generally of ashort-term nature. Due to the short term nature of these investments, we do notbelieve that near-term changes in interest rates will have a material effect onour future results of operations.

*Exchange rate risk.  *Dueto our Irish operations, we have market risk exposure to adverse changes inforeign exchange rates. The revenues and expenses of our subsidiary, Aerogen(Ireland) Limited, are denominated in its local currency. The Irish subsidiary’sfunctional currency is the Euro (previously the Irish punt). At the end of eachperiod, the revenues and expenses of our subsidiary are translated into UnitedStates dollars using the average currency rate in effect for that period, andassets and liabilities are translated into United States dollars using theexchange rate in effect at the end of that period. Fluctuations in exchangerates therefore impact our financial condition and results of operations, asreported in United States dollars. To date, we have not experienced anysignificant negative impact as a result of fluctuations in foreign currencymarkets. As a policy, we do not engage in speculative or leveragedtransactions, nor do we hold financial instruments for trading purposes.

If we expand our overseasoperations, our operating results may become subject to more significantfluctuations based on changes in exchange rates of foreign currencies inrelation to the United States dollar. We will periodically analyze our exposureto currency fluctuations and may adjust our policies to allow for financialhedging techniques to minimize exchange rate risk.

***FactorsThat May Affect Future Operating Results***

*Ourbusiness and the value of our stock are subject to a number of risks, many ofwhich are set out below. Additional risks that we do not yet know of, or thatwe currently believe are immaterial, may also impair our business. If any ofthese risks actually materialize, our business, financial condition oroperating results could be materially adversely affected, which would likelyhave a corresponding impact on the value of our common stock. These riskfactors should be reviewed carefully.*

**Inorder to continue as a going concern, we will need capital in excess of ourcurrent cash resources.**

We expect our current cashand cash equivalents will allow us to continue planned operations untilapproximately the first quarter of 2006; however, if we do not receive expectedproduct revenues and/or royalties, our cash balance may be insufficient tosustain operations beyond the middle of the fourth quarter of 2005. Our currentcash resources will be insufficient to complete Phase 3 clinical trials for anyof our products, and may be insufficient to complete our current Phase 2clinical trial. Sufficient cash to complete our Phase 2 and Phase 3 trials maybe provided from strategic transactions or collaborative partnerships, such asfrom out-licensing and partnering one or more of our pharmaceutical products,or from product sales in excess of our expectations. There can be no guarantee,however, that these capital resources will materialize in sufficient magnitudeor at all, or that product sales or operating expenses will meet ourexpectations. In the alternative, the Company will have to raise significantcapital through the sale of convertible debt, convertible securities, and/orcommon stock, and there can be no guarantee that such capital will be availableon favorable terms, if at all, and could result in significant dilution to ourcurrent stockholders.

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**Thelead investor in our preferred stock financing has voting rights that mayprevent us from raising additional capital, selling an exclusive license to ourintellectual property, selling our assets or merging with or otherwise beingacquired by another entity.**

As stated in theCertificate of Designations of our Series A-1 ConvertiblePreferred Stock (the “A-1 Preferred”), Xmark Fund, L.P. andXmark Fund, Ltd. (the “Xmark Funds”) currently have the right to prevent usfrom, among other things, issuing securities with rights that aresenior or equal to the A-1 Preferred, increasing the authorizednumber of shares of our common stock, or providing any security interest in ourassets outside of the ordinary course of business. The Xmark Funds haverecently stated in letters to us, which they have publicly filed, that theywill not approve any capital raising transaction presented to them unless wecomply with certain conditions. Although there are ways in which wecould raise capital that would not require the approval of the Xmark Funds,the position of the Xmark Funds may make it more difficult for us toraise capital on favorable terms, in sufficient amounts to meetour business objectives, or at all.

**Ourlargest stockholders may exert significant influence on us.**

Based upon our records, and upon the public filingsmade by holders of our A-1 Preferred reporting their securities sales andpurchases, three holders of our A-1 Preferred, including the Xmark Funds,appear to have owned 50.4% of the A-1 Preferred outstanding as of March 31,2005. Those same records and filings also indicate that, as of March 31,2005, the holders of our A-1 Preferred also owned an aggregate of up to1.97 million common shares. If all of the A-1 Preferred outstanding as ofMarch 31, 2005 were to convert into common, and the holders of the A-1Preferred were to indeed still own 1.97 million additional common shares, then (i) asfew as seven of the A-1 Preferred holders, including the Xmark Funds,would own 52.9% of the then-outstanding common shares of the company and (ii) allof the A-1 Preferred holders, as a group, would own at least 68.3% of theCompany’s then-outstanding common stock before accounting for common stock thatmay have been acquired by them in the open market and/or via unreportedacquisitions.

While each of these A-1Preferred holders, except the Xmark Funds, is contractually prohibited fromowning more than 4.99% of the Company’s common stock at any one time, anyinvestor can waive this limitation as to the shares it holds upon 61 days’written notice to the Company. On November 3, 2004, the Xmark Fundsdelivered to us a written waiver of this limitation, thereby permitting theconversion of any or all of their A-1 Preferred into common stock at anytime on or after January 3, 2005. Based upon the number of the Company’scommon shares outstanding as of March 31, 2005, and upon the publicfilings of Xmark, if the Xmark Funds were to convert all of their A-1Preferred, and no other holder of A-1 Preferred were to convert, then thetotal number of shares of outstanding Aerogen common stock would increase to atleast 8,432,164 shares, of which the Xmark Funds would own at least 1,255,635shares, or 14.89%, based upon our records of common stock already received byXmark pursuant to common stock dividends, less the sales of common stockpublicly reported by Xmark. To our knowledge, the A-1 Preferred investorshave not acted as a group in seeking, negotiating, or making their investmentin the Company, and consider themselves to be independent investors. Due to thetermination of our rights plan, there can be no assurance that furtherconcentration of ownership will not occur, or that these securities will not beresold to different investors who may or may not act as a group.

**Theconversion of our A-1 Preferred into common stock and the exercise ofcommon stock warrants issued to the Series A-1 Preferred investorsmay depress the price of our common stock and will substantially dilute theownership interests of existing common stockholders.**

If the A-1 Preferredstockholders were to exercise all of the common stock warrants they hold andconvert all of the shares of A-1 Preferred they owned as of March 31,2005, they would own approximately 19,103,340 shares of our common stock, inaddition to any other shares such stockholders may now or in 

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thefuture own. Furthermore, as of March 31, 2005, a total of 613,921****shares of Aerogen common stock had been issued, or were inthe process of being issued, to the A-1 Preferred stockholders insatisfaction of Aerogen’s quarterly dividend obligation to them for thequarters ended March 31, June 30, September 30, and December 31,2004. If the A-1 Preferred stockholders exercise the warrants or convertour preferred stock into shares of common stock and sell the shares into themarket, such sales could have a negative effect on the market price of ourcommon stock and will dilute the holdings of our existing common stockholders.Dilution or the potential for dilution also could materially impair our abilityto raise capital through the future sale of equity securities. If the Companywere to issue additional equity securities in a future financing transaction ata per share price lower than the current conversion price of the A-1Preferred, then the conversion price of the A-1 Preferred wouldautomatically adjust downward to be equal to the common stock equivalent priceof the newly-issued securities. In such a circumstance, the exercise of thewarrants issued with the Series A-1 Preferred Stock would also bereduced to that lower price. While the Company currently has no plans to issuesecurities in a manner that would trigger these anti-dilution provisions, itmay elect to do so in the future. The full details of these anti-dilutionprovisions are contained in the Series A-1 Convertible PreferredStock Certificate of Designation, which was filed on the Company’s Form 8-Kon March 26, 2004 and incorporated by reference herein.

**Wehave a history of losses, anticipate future losses and may never achieve ormaintain** profitability.

We have never beenprofitable. Through December 31, 2004, we have incurred an accumulateddeficit of approximately $119.5 million. We expect to continue to incursubstantial losses over at least the next several years as we:

·        expandour research and development efforts;

·        expandour preclinical and clinical testing activities;

·        expandour manufacturing efforts, including our commercial production capability; and

·        buildour sales and marketing capabilities and launch our products currently beingdeveloped.

To achieve and sustainprofitability, we must, alone or with others, develop, obtain regulatoryapproval for, manufacture, market and sell products. We cannot be sure that wewill generate sufficient product revenues, royalties or research and developmentrevenues to become profitable or to sustain profitability.

**Ourinternal controls may not be sufficient to ensure timely and reliable financialinformation.**

We have recently restatedour financial results for the quarters ended March 31, June 30 and September 30,2004 to reflect adjustments to our previously reported financial information. Therestatements arose, in part, due to errors related to the initial valuation,classification and subsequent accounting of the warrants issued in conjunctionwith the A-1 Financing. In connection with the treatment of our financialresults for the year ended December 31, 2004, management has evaluated theeffectiveness of our disclosure controls and procedures as of December 31,2004, and as a result, has determined that for any future issuance of complexequity or derivative instruments, an outside expert with experience concerningthe related accounting issues will be consulted, or additional internal staffwill be trained or hired. In addition, enhanced review and documentationprocedures have been implemented in our accounting process in order to ensureaccuracy of all accounting entries. However, as of December 31, 2004,management has determined that our disclosure controls and procedures were noteffective because these enhanced procedures were not in place.

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**Ouroperating results may fluctuate significantly and may fail to meet theexpectations of investors.**

We expect that ouroperating results may fluctuate in the future, and may vary from investors’expectations, depending on a number of factors described in this “Risk Factors”section including:

·        demandfor our existing products and any we may introduce in the future;

·        timingof the introduction of new products and enhancements of existing products;

·        changesin domestic and international economic, business, regulatory, industry andpolitical conditions;

·        allocationof our resources, particularly when they are limited;

·        thecosts and expenses relating to any litigation;

·        theability to successfully identify and consummate appropriate collaborations withcorporate partners; and

·        our manufacturing,development and marketing partners’ changing priorities and resources.

**Wemay experience in the future a significant backlog of unfilled orders for ourproducts that may adversely impact our distributors’ ability or willingness tosell our products.**

Due to our extremelylimited cash resources at the end of 2003 and during the first quarter of 2004,we were at times unable to procure critical components and/or manufacturingservices necessary to satisfy customer demand for our products, most of whomwere unable to provide cash payments in a timeframe that resolved ourprocurement issues. As a result, we accumulated a backlog of orders that werenot completely filled by the end of the second quarter of 2004, but which werefilled in the third quarter of 2004. In the future, there can be no guaranteethat future backlogs will not be more material, or that customerdissatisfaction related to delays in order fulfillment will not adverselyaffect future orders and sales.

**Ourstock price may continue to be volatile.**

The market pricesfor securities of many companies in the life sciences industry havehistorically been highly volatile, and the market from time-to-time has experiencedsignificant price and volume fluctuations unrelated to the operatingperformance of particular companies. Prices for our common stock may beinfluenced by many factors, including:

·        marketconditions relating to the life sciences industry;

·        investorperception of us as a company;

·        securitiesanalysts’ recommendations;

·        delaysin the development, regulatory approval or commercialization of our products;

·        announcementsof technological innovations or new commercial products by us, our partners orcompetitors;

·        failureto establish new collaborative relationships or termination of existingcollaborative relationships;

·        developmentsor disputes concerning patent or intellectual property rights;

·        regulatoryand pricing developments in both the United States and foreign countries;

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·        publicconcern as to the safety of drugs and drug delivery technologies, includingthose of our competitors;

·        period-to-periodfluctuations in financial results; and

·        economicand other external factors.

Our common stock iscurrently trading at a market price significantly below the initial publicoffering price. There can be no assurance that the price will increase in thefuture or will recover to the initial public offering price. Furthermore, the A-1Preferred is not traded in the public market and has many rights and privilegesthat are superior to our common stock, including certain redemption rights. Asof March 31, 2005, the holders of the currently outstanding A-1Preferred collectively own at least 68% of the Company’s outstanding equity onan as-converted basis. The limited amount of our total equity that publiclytrades as common stock could, therefore, be subject to additional volatilitypressures.

**Manyof our products are in research and development stages, which makes itdifficult to evaluate our business and prospects.**

Many of ourproducts are in the research or development stages. Before we can begin tocommercialize our new products, we will need to invest in substantialadditional activities, generally including the conduct of clinical trials. Tofurther develop our products, we will need to obtain additional funds andaddress engineering and design issues, including ensuring that our productsdeliver a consistent and reproducible amount of drug to the lung and that theycan be manufactured successfully. We cannot assure that:

·        ourresearch and development efforts will be successful;

·        anyof our inhaler, nebulizer or drug/device combination products will prove safeand effective;

·        wewill obtain regulatory clearance or approval to sell any additional products;or

·        any of our existing orfuture products can be manufactured in commercial quantities or at anacceptable cost or marketed successfully.

**Ourtechnologies are relatively unproven, so they may not work effectively orsafely enough to commercialize inhalers, future nebulizer products ordrug-containing products.**

Since our pulmonarydrug delivery technologies are new and relatively unproven, many of ourproducts are currently in the research, development or clinical stages.Extensive additional testing will need to be performed to demonstrate that:

·        drugsmay be safely and effectively delivered using our technologies;

·        ourinhalers, nebulizers and pulmonary drug delivery systems are safe across a rangeof drugs and formulations;

·        ourproducts consistently deliver accurate and reproducible amounts of drug overtime; and

·        drugformulations are stable in our products.

If our products do notprove to be safe and effective, we may be required to abandon some or all ofthem. If we cannot develop new products, our business will suffer.

**Ifclinical trials of our drug/device combination products are not successful,drug products using our technology or inhalers may not be commercialized.**

Before either we or ourpartners can file for regulatory approval for the commercial sale ofcombination products using our technology or inhalers, the United States Foodand Drug Administration 

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(“FDA”),and other governmental agencies in other countries, will require extensiveclinical trials to demonstrate product safety and efficacy. We are developingdrug/device combinations which will require clinical testing. To date, we havecompleted limited clinical trials using clinical prototypes. If we do notsuccessfully complete appropriate clinical trials, we will not be able tocommercialize our products. The results of initial clinical trials do notnecessarily predict the results of more extensive clinical trials. Furthermore,we cannot be certain that clinical trials of our products will demonstrate thatthey are safe and effective to the extent necessary to obtain regulatoryapprovals. Many companies in the pharmaceutical and biotechnology industrieshave suffered significant setbacks in advanced clinical trials, even after achievingpromising results in earlier trials.

**Wehave limited experience manufacturing our technology. We depend on keysuppliers and contract manufacturers, and their failure to supply us may delayor prevent commercialization of our products.**

We have built ourown manufacturing capabilities to produce key components of our products. Wehave manufactured only limited quantities of our first three products, andlimited clinical supplies of other products. We currently produce all of theOnQ Aerosol Generators for our products, partnered or not, in a singlefacility. We plan to continue using contract manufacturers to produce certainother key components and subassemblies of our products, many of which areproduced in unique facilities and/or with unique tooling. We may assemble someof our products ourselves, or we may use contract manufacturers for the finalassembly of all of our products. We do not have long-term supply contracts withmost of our key suppliers or contract manufacturers. In addition, some of themare currently our sole source of supply. We may not be able to enter into, ormaintain, satisfactory contracts or arrangements. In addition, manufacturing ofour products could be delayed by supply problems at our suppliers or contractmanufacturers. If we need to qualify a new supplier or redesign the product,there could be significant delay, and a regulatory filing could be requiredbefore we could use the new supplier to provide material for our products.There can be no assurance that we, or our contract manufacturers, cansuccessfully manufacture in high volumes in a timely manner, at an acceptablecost, or at all. We cannot assure that:

·        thedesign of our products will permit their manufacture on a commerciallysustainable scale;

·        manufacturingand quality control problems will not arise as we attempt to scale-upproduction; or

·        anyscale-up of production can be achieved in a timely manner or at a commerciallyreasonable cost.

Failure to address theseissues adequately could delay or prevent clinical testing and commercializationof our products.

**OurAerodose**® inhaled insulinproduct is our most mature product in development for systemic drug delivery;however, we have suspended development of that product.

We have completed foursmall clinical trials (two Phase 1 and two Phase 2a) of our Aerodose insulininhaler product. Early studies generally focus on the safety of a productrather than its effectiveness in treating the disease. We cannot be sure thatthe results of these and/or other additional clinical trials will prove thesafety and effectiveness of our product. We have not secured an agreement witha marketing partner to fund the additional development and clinical trialsnecessary to obtain regulatory approval and to commercialize the product;therefore we have not yet resumed our work on that product, and do not expectto re-start the program until we have an acceptable partner to pay foradditional clinical trials. We cannot assure that we will ever be able to enterinto a satisfactory agreement with a marketing partner, and we currently do nothave sufficient funds to conduct the necessary development and clinicalprograms ourselves.

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**Ofour drug/device combination products currently under active development, ouramikacin product is the most advanced, and is the only one to have completed ahuman clinical trial.**

Our ability to become asuccessful specialty pharmaceutical company depends upon our ability tocommercialize our own combination drug/device products, the majority of whichwill incorporate our Pulmonary Drug Delivery System (“PDDS”). Although our PDDSleverages the basic technology platform of the Aeroneb Pro, it has not beenapproved as a commercial product. Our lead product in development, a PDDS drugcombination product incorporating the aminoglycoside amikacin, has onlycompleted one small Phase 2 clinical trial; a second Phase 2 clinical trial forthis product is ongoing. In addition to the satisfactory completion of thistrial, the development of this product will require, at a minimum, a Phase 3clinical trial in order to support a New Drug Application (“NDA”), which mustbe filed with the FDA to obtain approval prior to marketing the product in theUnited States. If these clinical trials fail to meet their objectives, or arehalted for safety reasons, we may be required to suspend further development ofthis product, conduct additional clinical trials, or return to an earlier stageof research and development. Any or all of these possible outcomes couldmaterially impair our ability to raise additional capital on attractiveeconomic terms, if at all.

**The Company’sPhase 2 clinical trial of its lead product underdevelopment, aerosolized amikacin, has experienced delays, andwe are uncertain at this time when the study will be completed, if at all.Timelines for the Company’s clinical trials are subject to uncertainties beyondthe Company’s control, including the potential for slower thanexpected opening of clinical study sites, enrollment of patients, or aninability to enroll patients at all.**

The Company’s leadpharmaceutical product under development is a drug/device combinationproduct which delivers the aminoglycoside amikacin to the lungs for treatmentof Ventilator-Associated Pneumonia (“VAP”). The second Phase 2 clinical trialwith this product was initiated on December 28, 2004; this trial involvesthe enrollment of 108 patients at approximately 31 study sites, with eachpatient to be studied for 28 consecutive days. Based upon estimates provided byour study sites, we anticipated we would have a majority of our sitesopen, and the first patients enrolled, during the first quarter of2005. As of March 31, 2005, however, we had only 8 sitesopen due to administrative delays at the sites, 33 patients with suspectedVAP screened for entry into the trial, and no patients enrolled. Untilall sites are open and weobserve steady enrollment, we will be unableto reliably project the completion date of the trial. In light of thefact that we currently have no patients enrolled in this study, weare uncertain at this time when the study will be completed, if atall.

**Ourability to market and sell our products depends upon receiving regulatoryapprovals, which we may not obtain.**

Our products are subjectto extensive regulation by the FDA, state and local government agencies, and byinternational regulatory authorities. These agencies regulate the development,testing, manufacture, labeling, storage, approval, advertising, promotion, saleand distribution of medical devices, drugs and biologics. If we, or ourpartners, fail to obtain regulatory clearances or approval to develop or tomarket our products, our business will be harmed and we, or our collaborativepartners, will not be able to market and sell our products. Even if granted,regulatory approvals may include significant limitations on the uses for whichproducts may be tested or marketed. Once obtained, required approvals may bewithdrawn, or we may not remain in compliance with regulatory requirements. Theprocess for obtaining necessary regulatory approvals for drugs and biologics isgenerally lengthy, expensive and uncertain. Obtaining and maintaining foreignregulatory approvals in multiple countries is expensive, and we cannot becertain that we will receive approvals in any foreign country in which we orour partners plan to market our products. If we or our partners fail to obtainregulatory approval in the United States or in any foreign country in which weplan to market our products, our revenues will be lower. A longer than expected

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regulatoryprocess, additional or significant changes in regulatory requirements, or moreexpensive clinical studies than we anticipate, may cause us to stop developmentof particular products.

**Wemay not be able to develop certain products if we do not enter into additionalcollaborative relationships or gain access to compounds from third parties.**

Our strategy dependspartially on our ability to enter into collaborative relationships withpartners to conduct and fund the clinical trials, manufacturing, marketing andsales activities necessary to commercialize certain products. To developproducts to be marketed by us, we will need to purchase or license, andpossibly reformulate and package, drugs for use with our Aerodose inhalers and PDDS.We cannot assure that we will be able to establish these kinds of arrangementson favorable terms, or at all, or that our existing or future collaborativearrangements will be successful.

**Ifour products do not gain commercial acceptance, we will not generatesignificant revenue.**

Our success incommercializing our products depends on many factors, including acceptance byhealthcare professionals and patients. Their acceptance of our products willdepend largely on our ability to demonstrate that our products can compete withalternative delivery systems with respect to:

·        safety;

·        efficacy;

·        thebenefits associated with pulmonary delivery;

·        easeof use; and

·        price.

We cannot be sure that ourproducts will compete effectively, or that we, or our partners, will be able tosuccessfully market any products in a timely manner.

**If weare unable to develop a successful sales and marketing effort, we will not beable to sustainably commercialize our products.**

We currently have a smallsales and marketing staff and modest marketing budget, and many of ourcompetitors have substantial sales and marketing infrastructures andsignificant marketing budgets. We rely on third party distributors to sell ourproducts, some of which have limited experience in the markets that we aretrying to access. Our success in commercializing our respiratory products inthe United States and worldwide will depend on our and our partners’ ability todevelop and execute a successful sales and marketing effort. There can be noassurance that our current products, which include the Aeroneb Pro and theAeroneb Go will be successful. In any event, these products are not expected togenerate revenues sufficient enough to solely support the Company’s operationsin the foreseeable future. Our distribution and marketing partners havesignificant discretion in allocating and applying their selling and marketingefforts, so we have limited ability to predict or manage the end-useracceptance of our products, and there can be no guarantee that we can meetdemand that rises sharply as a result of our partners’ selling and/or marketingefforts.

**Ourcorporate partners may not commercialize our products or may develop productsthat compete against our products.**

Our business modelincludes collaborations with pharmaceutical and biotechnology companies. Therecan be no assurance that we will be able to enter into arrangements that resultin successful commercial products. Even if we do enter into such arrangements,we will depend on corporate partners to commercialize the products developed incollaboration with us. If any of our existing or future corporate 

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partnersdo not complete the development and commercialization of products to which theyhave obtained rights from us, our business could be impaired. In the drugdelivery industry, it is common for corporate partners to conduct feasibilitystudies with multiple partners. There can be no assurance that our existing orfuture corporate partners will continue to choose our technology over their owntechnology or that of our competitors. Collaboration agreements generallyprovide that the partner can terminate the agreement at any time.

**If weare unable to attract and retain the highly skilled personnel necessary for ourbusiness, we may not be able to develop our products successfully.**Our Chairman and Chief Executive Officer has indicated a desire to retire.

Because of the specializednature of our business, we depend upon qualified scientific, engineering,technical and managerial personnel. In particular, our business and prospectscurrently depend in large part upon the continued employment of Dr. JaneE. Shaw, our Chairman and Chief Executive Officer. In late 2004, Dr. Shawindicated a desire to retire by the middle of 2005. As a result, our Board ofDirectors has initiated a search for a new Chief Executive Officer, which isongoing. There is intense competition for qualified personnel in our businessand our location in Northern California makes recruiting qualified personnelfrom outside the San Francisco Bay area more difficult due to the very highcost of housing. Therefore, we may not be able to attract and retain thequalified personnel necessary to grow our business, including a Chief ExecutiveOfficer to replace Dr. Shaw. The loss of the services of existingpersonnel without timely and effective replacement, as well as the failure torecruit additional key scientific, technical, engineering and managerialpersonnel in a timely manner, would harm our research and development programsand our business.

**Ifour manufacturing facilities, or those of our subcontractors and/or licensees,do not meet federal, state and international manufacturing standards, we maynot be able to sell our products in the United States or internationally.**

Our manufacturing facilities, and those of oursubcontractors and manufacturing licensee Evo Medical Solutions, Inc. (“Evo”),are subject to periodic inspection by regulatory authorities and our operationswill continue to be regulated by the FDA for compliance with Quality SystemRegulation (“QSR”). Evo was the subject of an FDA inspection that was completedin early July 2004, and pursuant to which Evo received a Form-483with ten observations, and which was followed by a warning letter concerningthe Aeroneb Go. In response to the warning letter, Evo voluntarily suspendedshipments of the Aeroneb Go for a 3-week period until a risk mitigationplan could be developed and presented to the FDA. Similarly, Aerogenvoluntarily suspended shipments of OnQ Aerosol Generators to Evo, whichresulted in no revenues from OnQ Aerosol Generator sales to Evo during the lastsix months of 2004. Evo implemented a risk mitigation plan that was reviewed bythe FDA, which included enhanced patient education as to the importance ofcleaning the device in accordance with the manufacturer’s directions for useand the importance of having spare batteries and a backup device available ifthe user-patient is treating a life-threatening disease, the stocking ofreplacement handsets at distributors and customer support for rapid-turnaroundof reported failures, as well as the provision of a back-up handset to certainidentified, high-risk patients. Evo’s implementation of the risk mitigationplan was structured according to the FDA’s regulations for a Class II,firm-initiated recall, and updates are being forwarded to the FDA.

Evo resumed Aeroneb Go shipments incorporating theirexisting inventory of OnQ Aerosol Generators in accordance with their riskmitigation plan. Aerogen has implemented several design and manufacturingchanges to enhance the inherent durability of the OnQ Aerosol Generator.Aerogen resumed commercial shipments during the first quarter of 2005. Althoughthese changes were implemented upon successful completion of design verificationtesting, we cannot be certain that these changes will be successful inenhancing the durability and reliability of the device. During the year ended 

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December 31, 2004,reserves totaling $100,000 against cost of goods sold were established forpotential costs related to Aerogen’s support of the Evo risk mitigation plan,but we cannot assure that this reserve will be adequate to cover all expensesthat are or will be related to the recall.

All medical devices marketed in the European Union arerequired to bear the CE Mark. Aerogen, Evo and certain Aerogen subcontractorsare required to comply with the Medical Device Directive (“MDD”) and complywith ISO, the International Organization for Standards, to meet the qualitystandards. ISO is a worldwide network of national standards institutes. ISO hasdeveloped ISO 13485 in order to assist companies in implementing and operatingquality management systems to meet the MDD.

As of May 2004, the Galway, Ireland, and MountainView, California, facilities successfully obtained certification to ISO13485:2003. If Aerogen, Evo or Aerogen’s subcontractors fail to maintaincompliance with QSRs, ISO 13485 or other international regulatory requirements,we may be required to, among other things, recall product or cease all or partof our operations until we comply with the regulations. We cannot be certainthat our facilities, or those of Evo and/or our subcontractors, will be foundto comply on an ongoing basis with the QSRs, ISO or other internationalregulatory requirements.

The State of Californiarequires that we maintain a license to manufacture medical devices at ourMountain View facility, and our facilities and manufacturing processes may beinspected from time to time to monitor compliance with the applicable regulations.We are subject to licensing requirements and periodic inspections by theCalifornia Department of Health Services, the County of Santa Clara and variousenvironmental agencies. If we are unable to maintain a license following anyfuture inspections, we will be unable to manufacture or ship any products.Similar requirements exist in other jurisdictions where our products aremanufactured.

**Werely on several, sole-source outside manufacturing service providers and rawmaterial suppliers. If one or more of these outside vendors becomes unable tosupply us, we may be unable to locate an alternate supplier, which mayadversely impact our ability to sell our products.**

We outsource production ofmany components of our products to manufacturers in the United States andelsewhere. Generally, there is more than one potential supplier for thesecomponents, but some are manufactured to our specifications and an interruptionin supply could adversely affect our ability to manufacture and supply ourproducts. The brazing and overmolding processes used in assembly of our OnQAerosol Generators are conducted at third party facilities. Even though we havequalified second suppliers for the brazing services, loss of the use of theprimary facilities could result in significant delays in our supply ofcomponents while we ramp up production at the second sites and/or establishalternate provider sites. Palladium, which we use in our OnQ aperture plate, isexpensive and is subject to price volatility. The palladium plating bathchemicals we use to manufacture our OnQ Aerosol Generators are formulated by asingle supplier.

**Ourproducts may not be commercially viable if government health administrationauthorities, private health insurers or other third-party payors do not provideadequate reimbursement for the cost of our products.**

In both domestic and foreign markets, sales of ourpotential products will depend, in part, on the availability of reimbursementfrom third-party payors such as government health administration authorities,private health insurers and other organizations. Third-party payors oftenchallenge the price and cost-effectiveness of medical products and services.There is significant uncertainty about the reimbursement status of newlyapproved healthcare products. We cannot assure that any of our products will bereimbursed by third-party payors. In addition, we cannot assure that ourproducts will be considered cost-effective or that adequate third-partyreimbursement will be available to enable us to maintain price levelssufficient to realize a profit.

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Legislation andregulations affecting the pricing of health care products may change before ourproducts are approved for marketing, and any such changes could further limitreimbursement. The Aeroneb Pro is not currently reimbursed by insurance orgovernment entities, which may limit its market penetration. In addition,changes to Medicare reimbursement policies for nebulizers and/or the drugs usedwith them, particularly as a result of the Medicare Prescription DrugImprovement and Modernization Act of 2003, may limit the market penetration ofthe Aeroneb Go in the United States

**Ourcompetitors may be more successful in developing competing technologies andgaining market acceptance.**

We currently compete with device and medical equipmentcompanies for sales of our nebulizer products; as we introduce our drugproducts, we will compete with pharmaceutical and biotechnology companies,hospitals, research organizations, individual scientists and nonprofitorganizations engaged in developing non-invasive drug delivery dosage forms. Inthe area of systemic drug delivery, competing non-invasive alternatives toinjectable drug delivery include oral, buccal, intranasal, transdermal andcolonic absorption dosage forms. We also compete with entities producing anddeveloping injectable dosage forms. Several of these entities are working onsustained-release injectable systems. While these systems still requireinjections, the lower number of injections could allow these products tocompete effectively with non-invasive therapies.

Many of these companiesand entities have greater research and development, manufacturing, marketing,financial and managerial resources and experience than we do. Accordingly, ourcompetitors may succeed in developing competing technologies and products,obtaining regulatory approval for products or gaining market acceptance morerapidly than we can. If competitors bring effective products to market beforewe do, there is a risk that we may not be able to gain significant market sharebecause our competitors may have firmly established their products in themarket. It is also possible that a competitor may develop a technology orproduct that renders our technology or products obsolete.

**Wemay be unable to effectively protect our intellectual property, which couldenable third parties to use our technology and impair our ability to competeeffectively.**

Our ability to compete effectively depends in part ondeveloping and maintaining the proprietary aspects of our aerosolizationtechnology. We cannot be sure that the patents we have obtained, or any patentswe may obtain as a result of our pending United States or international patentapplications and, in particular, our vibratory aerosolization technology, whichis technology that aerosolizes liquids by vibrating a metal plate that containsholes, will provide any competitive advantages for our products.

We also cannot assure that those patents will not besuccessfully challenged, invalidated or circumvented in the future. Inaddition, we cannot assure that competitors, many of which have substantialresources and have made substantial investments in competing technologies, havenot already applied for, or obtained, or will not seek to apply for and obtain,patents that will prevent, limit or interfere with our ability to make, use andsell our products either in the United States or in international markets.Patent applications are maintained in secrecy for a period after filing. We maynot be aware of all of the patents and patent applications potentially adverseto our interests.

A number of pharmaceutical, medical device and othercompanies, as well as universities and research institutions, have filed patentapplications or have issued patents relating to methods and apparatuses foraerosolization and pulmonary drug delivery. We have become aware of, and maybecome aware of in the future, patent applications and issued patents thatrelate to certain aspects of the technology employed in our products, includingcertain aspects of vibratory aerosolization technology and drug/devicecombinations. Our pending patent applications, and those that we may file inthe future, may not result in patents being issued. We do not believe that ourproducts currently infringe any valid and enforceable 

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claims of the issuedpatents that we have reviewed. However, if third-party patents or patentapplications contain claims infringed by our products and such claims areultimately determined to be valid, we may not be able to obtain licenses tothose patents at a reasonable cost, if at all, or be able to develop or obtainalternative technology. Our inability to do either would have a materialadverse effect on our business, financial condition, results of operations andprospects. We cannot assure that we will not have to defend ourselves in courtagainst allegations of infringement of third-party patents, or that suchdefense would be successful.

In addition to patents, werely on trade secrets and proprietary know-how, which we seek to protect, inpart, through confidentiality and proprietary information agreements. Werequire our employees and all consultants to execute confidentiality agreementsupon the commencement of employment or a consulting relationship with us. Wecannot assure that employees or consultants will not breach these agreements,that we would have adequate remedies for any breach or that our trade secretswill not otherwise become known to or be independently developed bycompetitors.

**Wehave in the past and may become in the future subject to patent litigation,which has been and may be costly to defend and could invalidate our patents.**

The pharmaceutical and medical device industries havebeen characterized by extensive litigation regarding patents and otherintellectual property rights, and companies in these industries have usedintellectual property litigation to gain a competitive advantage. We cannotassure that we will not become subject to, whether within or outside of theUnited States, patent infringement claims or litigation or interferenceproceedings declared by the United States Patent and Trademark Office, (“USPTO”),to determine the priority of inventions. Although we prevailed in a 1999interference proceeding before the USPTO, that granted to Aerogen all but oneof the independent claims of Bespak’s 5,261,601 patent, we entered into across-license agreement with Bespak, as a result of which Bespak has a licenseto certain of our technology, including the right to sublicense. The scope ofthe granted license was limited to products employing technology which wasdisclosed by Bespak in United States Patent No. 5,261,601. Additionally,in April 2003, we received notice that a German patent infringement suithad been filed by PARI GmbH in the District Court in Munich, Germany allegingthat Aerogen’s Aeroneb Pro product infringes a patent licensed to PARI GmbH. InMay 2003, we filed an action in the German patent office requesting thatthe patent in question be rendered null and void. In July 2004, theFederal Patent Court in Munich, Germany ruled in favor of Aerogen by nullifyingall contested claims of this patent, which is owned by The TechnologyPartnership plc (“TTP”) of Hertfordshire, England, and is licensed to PARI,GmbH of Munich, Germany. The Court ordered TTP to pay Aerogen’s legal expensesrelated to this nullity action to the maximum extent allowed under German law. DuringOctober 2004, TTP requested, and was granted, a three-month extension oftime to file an appeal of this decision, and granted additional extensionsthrough February, 2005. PARI assumed control over the nullity case from TTP on December 14,2004. The decision on the mullity action has been appealed to the GermanSupreme Court, with PARI submitting its arguments in support of the appeal in March 2005.Additionally, during October 2004 TTP formally served Aerogen with theinfringement suit that PARI had advised Aerogen in April 2003 had alreadybeen filed in Munich, Germany. A preliminary hearing on the infringement caseis scheduled for June 2005. We believe that this suit is without merit andintend to vigorously defend against all allegations in the suit. Although theinfringement suit claims that Aerogen infringes solely on the patent claimsthat have since been ruled null and void, there can be no guarantee that theGerman Supreme Court will not reverse or modify the nullity ruling and againprovide PARI with the legal standing to reassert their infringement suit.

Our patent positioninvolves complex legal and factual questions and is generally uncertain. Legalstandards relating to the validity and scope of patent claims in thebiotechnology and pharmaceutical field are evolving. Defending and prosecutingintellectual property suits, USPTO interference proceedings and related legaland administrative proceedings are costly and time-consuming. Furtherlitigation may be 

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necessaryto enforce our patents, to protect our trade secrets or know-how or todetermine the enforceability, scope and validity of the proprietary rights ofothers. Any litigation or interference proceedings will be costly and willresult in significant diversion of effort by technical and managementpersonnel. An adverse determination in any of the litigation or interferenceproceedings to which we may become a party could subject us to significantliabilities to third parties, require us to license disputed rights from thirdparties or require us to cease using such technology, which would have amaterial adverse effect on our business, financial condition, results ofoperations and future growth prospects. Patent and intellectual propertydisputes in the medical device area have often been settled through licensingor similar arrangements, which could include ongoing royalties. We cannotassure that we can obtain the necessary licenses on satisfactory terms, if atall.

**If wewere successfully sued for product liability, we could face substantialliabilities that may exceed our resources.**

Researching, developingand commercializing medical devices and pharmaceutical products entailsignificant product liability risks. The use of our products in clinical trialsand the commercial sale of our products may expose us to liability claims.These claims might be made directly by consumers, by our partner companies or byothers selling such products. Companies often address the exposure of this riskby obtaining product liability insurance. Although we currently have productliability insurance, we cannot assure that we can maintain such insurance orobtain additional insurance on acceptable terms in amounts sufficient toprotect our business or at all. A successful claim brought against us in excessof our insurance coverage would have a material adverse effect on our business.

**Weuse hazardous and toxic materials and must comply with environmental laws andregulations, which can be expensive and restrict how we do business.**

Our operations involve the use of hazardous and toxicmaterials and generate hazardous, toxic and other wastes. In particular, we usea special metal alloy to build our aerosol generators, a component of which isregulated as a hazardous material. The risk of accidental contamination orinjury from hazardous and toxic materials cannot be completely eliminated. Inthe event of such an accident, we could be held liable for any damages thatresult, and this liability could exceed our resources. Our operations could beshut down by government officials if we were not in compliance withenvironmental laws.

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**ITEM 8. CONSOLIDATED FINANCIAL STATEMENTS ANDSUPPLEMENTARY DATA**

**AEROGEN, INC.INDEX TO CONSOLIDATED FINANCIAL STATEMENTS**
|                                                                                                                                                          | ** ** | **Page** |
|----------------------------------------------------------------------------------------------------------------------------------------------------------|------------|----------|
| Report of Independent  Registered Public Accounting Firm                                                                                                 |       | 46       |
| Consolidated Balance Sheets as of  December 31, 2004 and 2003                                                                                       |       | 47       |
| Consolidated Statements of  Operations for the years ended December 31, 2004, 2003 and 2002                                                         |       | 48       |
| Consolidated Statements of  Stockholders’ Equity (Deficit) and comprehensive income for the years ended  December 31, 2004, 2003 and 2002 |       | 49       |
| Consolidated Statements of  Cash Flows for the years ended December 31, 2004, 2003 and 2002                                                         |       | 52       |
| Notes to Consolidated  Financial Statements                                                                                                              |       | 53       |
| Selected Quarterly  Consolidated Financial Data (unaudited)                                                                                              |       | 74       |
| Financial Statement Schedule                                                                                                                             |       | 95       |
| Schedule  II: Valuation and Qualifying Accounts for the fiscal years ended  December 31, 2004, 2003 and 2002                                   |       | 97       |

 

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**REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTINGFIRM**

To the Board of Directors and Stockholders of Aerogen, Inc.

In our opinion, the consolidated financial statementslisted in the accompanying index present fairly, in all material respects, thefinancial position of Aerogen, Inc. and its subsidiary (the “Company”) at December 31,2004 and 2003, and the results of their operations and their cash flows foreach of the three years in the period ended December 31, 2004 inconformity with accounting principles generally accepted in the United Statesof America. These financial statements are the responsibility of the Company’smanagement. Our responsibility is to express an opinion on these financialstatements based on our audits. We conducted our audits of these statements inaccordance with the standards of the Public Company Accounting Oversight Board(United States). Those standards require that we plan and perform the audit toobtain reasonable assurance about whether the financial statements are free ofmaterial misstatement. An audit includes examining, on a test basis, evidencesupporting the amounts and disclosures in the financial statements, assessingthe accounting principles used and significant estimates made by management,and evaluating the overall financial statement presentation. We believe thatour audits provide a reasonable basis for our opinion.

Theaccompanying consolidated financial statements have been prepared assuming thatthe Company will continue as a going concern. As discussed in Note 1 to theconsolidated financial statements, the Company has suffered recurring lossesand negative cash flows from operations that raise substantial doubt about itsability to continue as a going concern. The consolidated financial statementsdo not include any adjustments that might result from the outcome of thisuncertainty.
| PricewaterhouseCoopers LLP |
|----------------------------|
| San Jose, California       |
| March 31, 2005             |

 

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**AEROGEN, INC.CONSOLIDATED BALANCE SHEETS**
| ** **                                                                                              | ** ** | **December 31,**                                             | ** ** |
|---------------------------------------------------------------------------------------------------------|------------|-------------------------------------------------------------------|------------|
| ** **                                                                                              | ** ** | **2004**                                                          | ** ** | **2003** | ** ** |
| ** **                                                                                              | ** ** | **(In thousands, except  per share amounts)** | ** ** |
| **ASSETS**                                                                                              |       |                                                              |       |   |   |
| Current assets:                                                                                         |       |                                                              |       |   |   |
| Cash and cash equivalents                                                                               |       | $                                                                 | 16,883     |   | $ | 762 |   |
| Accounts receivable                                                                                     |       | 1,225                                                             |       | 445 |   |
| Inventories, net                                                                                        |       | 775                                                               |       | 301 |   |
| Prepaid expenses and other current assets                                                               |       | 942                                                               |       | 428 |   |
| Total current assets                                                                                    |       | 19,825                                                            |       | 1,936 |   |
| Property and equipment, net                                                                             |       | 2,964                                                             |       | 3,901 |   |
| Goodwill                                                                                                |       | 1,951                                                             |       | 1,796 |   |
| Intangible assets                                                                                       |       | 147                                                               |       | 135 |   |
| Restricted cash                                                                                         |       | —                                                            |       | 1,200 |   |
| Other assets                                                                                            |       | 868                                                               |       | 608 |   |
| Total assets                                                                                            |       | $                                                                 | 25,755     |   | $ | 9,576 |   |
| **LIABILITIES,  REDEEMABLE CONVERTIBLE PREFERRED STOCK AND STOCKHOLDERS’ EQUITY (DEFICIT)**        |       |                                                              |       |   |   |
| Current  liabilities:                                                                                   |       |                                                              |       |   |   |
| Accounts payable                                                                                        |       | $                                                                 | 1,043      |   | $ | 937 |   |
| Deferred revenue, current                                                                               |       | 500                                                               |       | 500 |   |
| Dividends payable                                                                                       |       | 1,094                                                             |       | — |   |
| Convertible debentures, net                                                                             |       | —                                                            |       | 1,486 |   |
| Accrued liabilities                                                                                     |       | 1,873                                                             |       | 1,194 |   |
| Total current liabilities                                                                               |       | 4,510                                                             |       | 4,117 |   |
| Deferred rent                                                                                           |       | 234                                                               |       | 1,658 |   |
| Deferred revenue, non-current                                                                           |       | 1,848                                                             |       | 1,875 |   |
| Warrant liability                                                                                       |       | 10,296                                                            |       | — |   |
| Other long-term liabilities                                                                             |       | 267                                                               |       | 246 |   |
| Total liabilities                                                                                       |       | 17,155                                                            |       | 7,896 |   |
| Commitments and  contingencies (Note 6)                                                                 |       |                                                              |       |   |   |
| Redeemable  convertible preferred stock, par value $0.001                                               |       |                                                              |       |   |   |
| Authorized: 5,000  shares; issued and outstanding:                                                      |       |                                                              |       |   |   |
| 1,099 and no  shares at December 31, 2004 and 2003                                                 |       |                                                              |       |   |   |
| (Liquidation preference: $32,963 at December 31,  2004)                                            |       | 15,749                                                            |       | — |   |
| Stockholders’  equity (deficit):                                                                   |       |                                                              |       |   |   |
| Common  stock, par value $0.001:                                                                        |       |                                                              |       |   |   |
| Authorized:  95,000 shares; issued and outstanding:                                                     |       |                                                              |       |   |   |
| 5,318 and 4,396 shares at December 31, 2004 and  2003, respectively                                |       | 6                                                                 |       | 4 |   |
| Additional paid-in capital                                                                              |       | 111,691                                                           |       | 110,991 |   |
| Notes receivable from stockholders                                                                      |       | (292                                                              | )          | (280 | ) |
| Deferred stock-based compensation, net                                                                  |       | —                                                            |       | (264 | ) |
| Accumulated other comprehensive income (loss)                                                           |       | 991                                                               |       | 700 |   |
| Accumulated deficit                                                                                     |       | (119,545                                                          | )          | (109,471 | ) |
| Total stockholders’ equity (deficit)                                                               |       | (7,149                                                            | )          | 1,680 |   |
| Total liabilities,  redeemable convertible preferred stock and stockholders’ equity (deficit) |       | $                                                                 | 25,755     |   | $ | 9,576 |   |

 

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

47

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**AEROGEN, INC.CONSOLIDATED STATEMENTS OFOPERATIONS**
| ** **                                                                                                | ** ** | **Years Ended December 31,**  | ** ** |
|-----------------------------------------------------------------------------------------------------------|------------|----------------------------------------------|------------|
| ** **                                                                                                | ** ** | **2004**                                     | ** ** | **2003** | ** ** | **2002** | ** ** |
| ** **                                                                                                | ** ** | **(In thousands, except per share amounts)** | ** ** |
| Revenues:                                                                                                 | ** ** | ** **                                   | ** ** | ** ** | ** ** | ** ** | ** ** |
| Product sales                                                                                             |       | $                                            | 4,428      | ** ** | $ | 3,198 |   | $ | 1,896 |   |
| Research and development                                                                                  |       | —                                       | ** ** | 348 |   | 386 |   |
| Royalty and other                                                                                         |       | 1,820                                        | ** ** | 625 |   | 250 |   |
| Total revenues                                                                                            |       | 6,248                                        | ** ** | 4,171 |   | 2,532 |   |
| Costs and  expenses:                                                                                      | ** ** | ** **                                   | ** ** | ** ** | ** ** | ** ** | ** ** |
| Cost of products sold                                                                                     |       | 4,051                                        | ** ** | 2,296 |   | 1,786 |   |
| Research and development(1)                                                                               |       | 11,185                                       | ** ** | 11,744 |   | 17,772 |   |
| Selling, general and administrative(2)                                                                    |       | 6,789                                        | ** ** | 6,507 |   | 8,382 |   |
| Total costs and expenses                                                                                  |       | 22,025                                       | ** ** | 20,547 |   | 27,940 |   |
| Loss from operations                                                                                      |       | (15,777                                      | )          | (16,376 | ) | (25,408 | ) |
| Interest income (expense), net                                                                            |       | (372                                         | )          | (996 | ) | 487 |   |
| Decrease in  warrant liability                                                                            |       | 5,840                                        | ** ** | — |   | — |   |
| Other income  (expense), net                                                                              |       | 235                                          | ** ** | (47 | ) | 10 |   |
| Net loss                                                                                                  |       | (10,074                                      | )          | (17,419 | ) | (24,911 | ) |
| Dividends related to redeemable convertible  preferred stock  (Note 7)                                    |       | (13,097                                      | )          | — |   | — |   |
| Net loss attributable to common stockholders (Note  7)                                                    |       | $                                            | (23,171    | ) | $ | (17,419 | ) | $ | (24,911 | ) |
| Net loss per share attributable to common  stockholders, basic and diluted                                |       | $                                            | (4.86      | ) | $ | (4.22 | ) | $ | (6.17 | ) |
| Shares used in  computing net loss per share  attributable to common stockholders, basic and diluted | ** ** | 4,765                                        | ** ** | 4,126 | ** ** | 4,036 | ** ** |

----

(1)          Including stock-basedcompensation expense of $103,000, $304,000 and $514,000 in 2004, 2003 and 2002,respectively.

(2)*         *Includingstock-based compensation expense of $169,000, $702,000 and $841,000 in 2004,2003 and 2002, respectively.

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

48

----

**AEROGEN, INC.CONSOLIDATED STATEMENTS OFSTOCKHOLDERS’ EQUITY (DEFICIT)**
| ** **                                                                  | ** ** | ** **            | ** ** | ** **  | ** ** | ** **     | ** ** | **Notes**        | ** ** | ** **        | ** ** | **Accumulated**        | ** ** | ** **             | ** ** | ** **                | ** ** |
|-----------------------------------------------------------------------------|------------|-----------------------|------------|-------------|------------|----------------|------------|------------------|------------|-------------------|------------|------------------------|------------|------------------------|------------|---------------------------|------------|
| ** **                                                                  | ** ** | ** **            | ** ** | ** **  | ** ** | **Additional** | ** ** | **Receivable**   | ** ** | **Deferred**      | ** ** | **Other**              | ** ** | ** **             | ** ** | **Total**                 | ** ** |
| ** **                                                                  | ** ** | **Common Stock** | ** ** | **Paid-In** | ** ** | **From**       | ** ** | **Stock-Based**  | ** ** | **Comprehensive** | ** ** | **Accumulated**        | ** ** | **Stockholders’** | ** ** |
| ** **                                                                  | ** ** | **Shares**            | ** ** | **Amount**  | ** ** | **Capital**    | ** ** | **Stockholders** | ** ** | **Compensation**  | ** ** | **Income (Loss)** | ** ** | **Deficit**            | ** ** | **Equity (Deficit)** | ** ** |
| ** **                                                                  | ** ** | **(in thousands)**    | ** ** |
| Balances, December 31, 2001                                            |       |                  | 4,029      |        |       |           | $          | 4                |       |              |       | $                      | 110,444    |                   |       |                      | $          | (693 | ) |   |   | $ | (4,069 | ) |   |   | $ | (14 | ) |   |   | $ | (67,141 | ) |   |   | $ | 38,531 |   |   |
| Repayment of notes receivable from stockholders                             |       |                  | —     |        |       |           | —     |             |       |              | —     |                   |       |                   | 285        |                      |       |   | — |   |   |   | — |   |   |   | — |   |   |   | 285 |   |   |
| Issuance of common stock pursuant to employee stock purchase  plan for cash |       |                  | 50         |        |       |           | —     |             |       |              | 260        |                   |       |                   | —     |                      |       |   | — |   |   |   | — |   |   |   | — |   |   |   | 260 |   |   |
| Issuance of common stock upon exercise of stock  options for cash |       |                  | 4          |        |       |           | —     |             |       |              | 10         |                   |       |                   | —     |                      |       |   | — |   |   |   | — |   |   |   | — |   |   |   | 10 |   |   |
| Repurchase of common stock                                                  |       |                  | (2         | )           |       |           | —     |             |       |              | (7         | )                      |       |                   | —     |                      |       |   | — |   |   |   | — |   |   |   | — |   |   |   | (7 | ) |   |
| Deferred stock-based compensation                                           |       |                  | —     |        |       |           | —     |             |       |              | (1,194     | )                      |       |                   | —     |                      |       |   | 1,194 |   |   |   | — |   |   |   | — |   |   |   |   |   |   |
| Stock-based compensation                                                    |       |                  | —     |        |       |           | —     |             |       |              | —     |                   |       |                   | —     |                      |       |   | 1,355 |   |   |   | — |   |   |   | — |   |   |   | 1,355 |   |   |
| Accrued interest on notes receivable from  stockholders                |       |                  | —     |        |       |           | —     |             |       |              | —     |                   |       |                   | (26        | )                         |       |   | — |   |   |   | — |   |   |   | — |   |   |   | (26 | ) |   |
| Changes in unrealized loss on available-for-sale  securities      |       |                  | —     |        |       |           | —     |             |       |              | —     |                   |       |                   | —     |                      |       |   | — |   |   |   | (50 | ) |   |   | — |   |   |   | (50 | ) |   |
| Foreign currency translation                                                |       |                  | —     |        |       |           | —     |             |       |              | —     |                   |       |                   | —     |                      |       |   | — |   |   |   | 297 |   |   |   | — |   |   |   | 297 |   |   |
| Net loss                                                                    |       |                  | —     |        |       |           | —     |             |       |              | —     |                   |       |                   | —     |                      |       |   | — |   |   |   | — |   |   |   | (24,911 | ) |   |   | (24,911 | ) |   |
| Balances,  December 31, 2002                                           |       |                  | 4,081      |        |       |           | $          | 4                |       |              |       | $                      | 109,513    |                   |       |                      | $          | (434 | ) |   |   | $ | (1,520 | ) |   |   | $ | 233 |   |   |   | $ | (92,052 | ) |   |   | $ | 15,744 |   |   |

 

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

49

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**AEROGEN, INC.CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY (DEFICIT)**
| ** **                                                                    | ** ** | ** **              | ** ** | ** **     | ** ** | **Notes**      | ** ** | ** **       | ** ** | **Accumulated**   | ** **     | ** **             | ** ** | ** **             | ** **  |
|-------------------------------------------------------------------------------|------------|-------------------------|------------|----------------|------------|----------------|------------|------------------|------------|-------------------|----------------|------------------------|------------|------------------------|-------------|
| ** **                                                                    | ** ** | ** **              | ** ** | **Additional** | ** ** | **Receivable** | ** ** | **Deferred**     | ** ** | **Other**         | ** **     | ** **             | ** ** | **Total**              | ** **  |
| ** **                                                                    | ** ** | **Common Stock**   | ** ** | **Paid-In**    | ** ** | **From**       | ** ** | **Stock-Based**  | ** ** | **Comprehensive** | ** **     | **Accumulated**        | ** ** | **Stockholders’** | ** **  |
| ** **                                                                    | ** ** | **Shares**              | ** ** | **Amount**     | ** ** | **Capital**    | ** ** | **Stockholders** | ** ** | **Compensation**  | ** **     | **Income (Loss)** | ** ** | **Deficit**            | ** **  | **Equity (Deficit)** | ** ** |
| ** **                                                                    | ** ** | **(in thousands)** | ** ** |
| Balances, December 31, 2002                                              |       |                    | 4,081      |           |       |           | 4          |             |       |              | 109,513        |                   |       |                   | (434        | ) |   |   | (1,520 | ) |   |   | 233 |   |   |   | (92,052 | ) |   |   | 15,744 |   |   |
| Issuance of warrants                                                          |       |                    | —     |           |       |           | —     |             |       |              | 529            |                   |       |                   | —      |   |   |   | — |   |   |   | — |   |   |   | — |   |   |   | 529 |   |   |
| Beneficial conversion feature related to issuance of  convertible debentures  |       |                    | —     |           |       |           | —     |             |       |              | 593            |                   |       |                   | —      |   |   |   | — |   |   |   | — |   |   |   | — |   |   |   | 593 |   |   |
| Issuance of common stock upon conversion of  convertible debentures |       |                    | 230        |           |       |           | —     |             |       |              | 402            |                   |       |                   | —      |   |   |   | — |   |   |   | — |   |   |   | — |   |   |   | 402 |   |   |
| Issuance of common stock to landlord                                          |       |                    | 60         |           |       |           | —     |             |       |              | 180            |                   |       |                   | —      |   |   |   | — |   |   |   | — |   |   |   | — |   |   |   | 180 |   |   |
| Repayment of notes receivable from stockholders                               |       |                    | —     |           |       |           | —     |             |       |              | —         |                   |       |                   | 167         |   |   |   | — |   |   |   | — |   |   |   | — |   |   |   | 167 |   |   |
| Issuance of common stock pursuant to employee stock  purchase plan for cash   |       |                    | 25         |           |       |           | —     |             |       |              | 22             |                   |       |                   | —      |   |   |   | — |   |   |   | — |   |   |   | — |   |   |   | 22 |   |   |
| Issuance of common stock upon exercise of stock  options for cash   |       |                    | —     |           |       |           | —     |             |       |              | 2              |                   |       |                   | —      |   |   |   | — |   |   |   | — |   |   |   | — |   |   |   | 2 |   |   |
| Repurchase of common stock                                                    |       |                    | —     |           |       |           | —     |             |       |              | —         |                   |       |                   | —      |   |   |   | — |   |   |   | — |   |   |   | — |   |   |   | — |   |   |
| Deferred stock-based compensation                                        |       |                    | —     |           |       |           | —     |             |       |              | (250           | )                      |       |                   | —      |   |   |   | 250 |   |   |   | — |   |   |   | — |   |   |   | — |   |   |
| Stock-based compensation                                                      |       |                    | —     |           |       |           | —     |             |       |              | —         |                   |       |                   | —      |   |   |   | 1,006 |   |   |   | — |   |   |   | — |   |   |   | 1,006 |   |   |
| Accrued interest on notes receivable from  stockholders                  |       |                    | —     |           |       |           | —     |             |       |              | —         |                   |       |                   | (13         | ) |   |   | — |   |   |   | — |   |   |   | — |   |   |   | (13 | ) |   |
| Changes in unrealized loss on available-for-sale  securities             |       |                    | —     |           |       |           | —     |             |       |              | —         |                   |       |                   | —      |   |   |   | — |   |   |   | (16 | ) |   |   | — |   |   |   | (16 | ) |   |
| Foreign currency translation                                                  |       |                    | —     |           |       |           | —     |             |       |              | —         |                   |       |                   | —      |   |   |   | — |   |   |   | 483 |   |   |   | — |   |   |   | 483 |   |   |
| Net loss                                                                      |       |                    | —     |           |       |           | —     |             |       |              | —         |                   |       |                   | —      |   |   |   | — |   |   |   | — |   |   |   | (17,419 | ) |   |   | (17,419 | ) |   |
| Balances,  December 31, 2003                                             |       |                    | 4,396      |           |       |           | $ 4   |             |       |              | $ 110,991 |                   |       |                   | $ (280 | ) |   |   | $  (264 | ) |   |   | $ 700 |   |   |   | $ (109,471 | ) |   |   | $   1,680 |   |   |

 

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

50

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**AEROGEN, INC.CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY (DEFICIT)**
| ** **                                                                         | ** ** | ** **            | ** ** | ** **  | ** ** | ** **     | ** ** | **Notes**        | ** ** | ** **        | ** **     | **Accumulated**        | ** ** | ** **             | ** **  | ** **                | ** ** |
|------------------------------------------------------------------------------------|------------|-----------------------|------------|-------------|------------|----------------|------------|------------------|------------|-------------------|----------------|------------------------|------------|------------------------|-------------|---------------------------|------------|
| ** **                                                                         | ** ** | ** **            | ** ** | ** **  | ** ** | **Additional** | ** ** | **Receivable**   | ** ** | **Deferred**      | ** **     | **Other**              | ** ** | ** **             | ** **  | **Total**                 | ** ** |
| ** **                                                                         | ** ** | **Common Stock** | ** ** | **Paid-In** | ** ** | **From**       | ** ** | **Stock-Based**  | ** ** | **Comprehensive** | ** **     | **Accumulated**        | ** ** | **Stockholders’** | ** **  |
| ** **                                                                         | ** ** | **Shares**            | ** ** | **Amount**  | ** ** | **Capital**    | ** ** | **Stockholders** | ** ** | **Compensation**  | ** **     | **Income (Loss)** | ** ** | **Deficit**            | ** **  | **Equity (Deficit)** | ** ** |
| ** **                                                                         | ** ** | **(in thousands)**    | ** ** |
| Balances, December 31, 2003                                                   |       |                  | 4,396      |        |       |           | 4          |             |       |              | 110,991        |                   |       |                   | (280        | )                         |       |   | (264 | ) |   |   | 700 |   |   |   | (109,471 | ) |   |   | 1,680 |   |   |
| Issuance of common stock upon exercise of stock  options for cash        |       |                  | 5          |        |       |           | —     |             |       |              | 8              |                   |       |                   | —      |                      |       |   | — |   |   |   | — |   |   |   | — |   |   |   | 8 |   |   |
| Stock-based compensation                                                           |       |                  | —     |        |       |           | —     |             |       |              | 8              |                   |       |                   | —      |                      |       |   | 264 |   |   |   | — |   |   |   | — |   |   |   | 272 |   |   |
| Issuance of common stock for A-1 Preferred  dividends                              |       |                  | 100        |        |       |           | —     |             |       |              | 314            |                   |       |                   | —      |                      |       |   | — |   |   |   | — |   |   |   | — |   |   |   | 314 |   |   |
| Issuance of common stock upon conversion of  convertible debentures      |       |                  | 334        |        |       |           | 1          |             |       |              | 585            |                   |       |                   | —      |                      |       |   | — |   |   |   | — |   |   |   | — |   |   |   | 586 |   |   |
| Issuance of common stock upon conversion of  convertible preferred stock |       |                  | 433        |        |       |           | 1          |             |       |              | 601            |                   |       |                   | —      |                      |       |   | — |   |   |   | — |   |   |   | — |   |   |   | 602 |   |   |
| Issuance of common stock to landlord                                               |       |                  | 50         |        |       |           | —     |             |       |              | 165            |                   |       |                   | —      |                      |       |   | — |   |   |   | — |   |   |   | — |   |   |   | 165 |   |   |
| Beneficial conversion feature related to issuance of  convertible debenture        |       |                  | —     |        |       |           | —     |             |       |              | 422            |                   |       |                   |        |                      |       |   |   |   |   |   |   |   |   |   |   |   |   |   | 422 |   |   |
| Issuance of warrants                                                               |       |                  |       |        |       |           |       |             |       |              | 5              |                   |       |                   |        |                      |       |   |   |   |   |   |   |   |   |   |   |   |   |   | 5 |   |   |
| Accrued dividend on convertible preferred stock                               |       |                  | —     |        |       |           | —     |             |       |              | (1,408         | )                      |       |                   | —      |                      |       |   | — |   |   |   | — |   |   |   | — |   |   |   | (1,408 | ) |   |
| Accrued interest on notes receivable from  stockholders                            |       |                  | —     |        |       |           | —     |             |       |              | —         |                   |       |                   | (12         | )                         |       |   | — |   |   |   | — |   |   |   | — |   |   |   | (12 | ) |   |
| Foreign currency translation                                                       |       |                  | —     |        |       |           | —     |             |       |              | —         |                   |       |                   | —      |                      |       |   | — |   |   |   | 291 |   |   |   | — |   |   |   | 291 |   |   |
| Net loss                                                                           |       |                  | —     |        |       |           | —     |             |       |              | —         |                   |       |                   | —      |                      |       |   | — |   |   |   | — |   |   |   | (10,074 | ) |   |   | (10,074 | ) |   |
| Balances, December 31, 2004                                                   |       |                  | 5,318      |        |       |           | $ 6   |             |       |              | $ 111,691 |                   |       |                   | $ (292 | )                         |       |   | $   — |   |   |   | $ 991 |   |   |   | $ (119,545 | ) |   |   | $ (7,149 | ) |   |

 

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

51

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**AEROGEN, INC.CONSOLIDATED STATEMENTS OFCASH FLOWS**
| ** **                                                                   | ** ** | **Years Ended December 31,** | ** ** |
|------------------------------------------------------------------------------|------------|---------------------------------------------|------------|
| ** **                                                                   | ** ** | **2004**                                    | ** ** | **2003** | ** ** | **2002** | ** ** |
| ** **                                                                   | ** ** | **(In thousands)**                          | ** ** |
| **Cash flows from operating activities:**                                    |       |                                        |       |   |   |   |   |
| Net loss                                                                     |       | $                                           | (10,074    | ) | $ | (17,419 | ) | $ | (24,911 | ) |
| Adjustments to reconcile  net loss to net cash used in operating activities: |       |                                        |       |   |   |   |   |
| Depreciation and  amortization                                               |       | 1,209                                       |       | 1,251 |   | 1,209 |   |
| Decrease in  warrant liability                                               |       | (5,840                                      | )          | — |   | — |   |
| Changes in  inventory reserves                                               |       | 283                                         |       | 11 |   | 15 |   |
| Loss on disposal  of property and equipment                                  |       | 804                                         |       | 4 |   | 180 |   |
| Accrued interest  on notes receivable from stockholders                      |       | (13                                         | )          | (13 | ) | (26 | ) |
| Amortization of  notes discount (premium)                                    |       | —                                      |       | 6 |   | 9 |   |
| Amortization of  deferred stock-based compensation                           |       | 272                                         |       | 1,006 |   | 1,355 |   |
| Non cash interest  expense on convertible debentures                         |       | 584                                         |       | 1,018 |   | — |   |
| Changes in operating  assets and liabilities:                                |       |                                        |       |   |   |   |   |
| Accounts  receivable                                                         |       | (690                                        | )          | 558 |   | (666 | ) |
| Inventories                                                                  |       | (705                                        | )          | 95 |   | 110 |   |
| Restricted cash                                                              |       | 1,200                                       |       | — |   | — |   |
| Prepaid expenses  and other current assets                                   |       | (470                                        | )          | 708 |   | 267 |   |
| Accounts payable                                                             |       | 62                                          |       | (102 | ) | (243 | ) |
| Accrued  liabilities                                                         |       | 662                                         |       | (37 | ) | (1,893 | ) |
| Deferred rent                                                                |       | (1,424                                      | )          | 832 |   | 603 |   |
| Deferred revenue                                                             |       | (27                                         | )          | 2,167 |   | 8 |   |
| Other                                                                        |       | (289                                        | )          | 2 |   | 30 |   |
| Net cash used in  operating activities                                       |       | (14,456                                     | )          | (9,913 | ) | (23,953 | ) |
| **Cash flows from investing activities:**                                    |       |                                        |       |   |   |   |   |
| Acquisition of  property and equipment                                       |       | (842                                        | )          | (376 | ) | (3,728 | ) |
| Purchases of  available-for-sale securities                                  |       | —                                      |       | — |   | (8,134 | ) |
| Proceeds from  maturities of available-for-sale securities                   |       | —                                      |       | 5,599 |   | 22,817 |   |
| Net cash provided  by (used in) investing activities                         |       | (842                                        | )          | 5,223 |   | 10,955 |   |
| **Cash flows from financing activities:**                                    |       |                                        |       |   |   |   |   |
| Proceeds from  issuance of common stock                                      |       | 8                                           |       | 24 |   | 270 |   |
| Repurchase of  common stock                                                  |       | —                                      |       | — |   | (7 | ) |
| Proceeds from  issuance of preferred stock and warrants, net                 |       | 30,921                                      |       | — |   | — |   |
| Proceeds from  issuance of convertible notes, net                            |       | 505                                         |       | 1,950 |   | — |   |
| Repayment of note  receivable from stockholder                               |       |                                        |       | 167 |   | 285 |   |
| Net cash provided  by financing activities                                   |       | 31,434                                      |       | 2,141 |   | 548 |   |
| Effect of exchange  rate changes on cash and cash equivalents                |       | (15                                         | )          | 45 |   | 2 |   |
| Net increase  (decrease) in cash and cash equivalents                        |       | 16,121                                      |       | (2,504 | ) | (12,448 | ) |
| Cash and cash  equivalents at beginning of year                              |       | 762                                         |       | 3,266 |   | 15,714 |   |
| Cash and cash  equivalents at end of year                                    |       | $                                           | 16,883     |   | $ | 762 |   | $ | 3,266 |   |
| **Supplemental disclosure of noncash investing and  financing activities:**  |       |                                        |       |   |   |   |   |
| Deferred  stock-based compensation, net of cancellations                     |       | $                                           | —     |   | $ | (250 | ) | $ | (1,194 | ) |
| Issuance of common  stock upon conversion of debt                            |       | $                                           | 586        |   | $ | 402 |   | $ | — |   |
| Issuance of  warrants                                                        |       | $                                           | —     |   | $ | 529 |   | $ | — |   |
| Issuance of  commont stock for dividends                                     |       | $                                           | 314        |   | $ | — |   | $ | — |   |
| Issuance of common  stock for future services                                |       | $                                           | 165        |   | $ | 180 |   | $ | — |   |
| **Supplemental disclosure of cash flow  information:**                       |       |                                        |       |   |   |   |   |
| Cash paid during  the year for interest                                      |       | $                                           | 1          |   | $ | 1 |   | $ | 1 |   |

 

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

52

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**AEROGEN, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Tabular amounts in thousands, except share and per share amounts)**

**NOTE1—FORMATION AND BUSINESS OF THE COMPANY:**

Aerogen, Inc., or the “Company,” was incorporatedin the state of California on November 18, 1991 to develop products usingits proprietary OnQ aerosol generator to aerosolize liquids. The Company wasreincorporated in the state of Delaware in 1998. The Company has commencedplanned principal operations and during 2002 generated significant revenuestherefrom. Accordingly, the Company exited the development stage in December 2002.

The Company has incurred net losses since inceptionand is expected to incur substantial losses for the next several years. Theauditor’s report on the consolidated financial statements as of December 31,2004 contains an explanatory paragraph, which refers to our recurring operatinglosses and negative cash flows from operations and notes that these mattersraise substantial doubt about our ability to continue as a going concern. Theaccompanying consolidated financial statements have been prepared on a goingconcern basis which contemplates continuity of operations, realization ofassets and liquidation of liabilities in the ordinary course of business and donot reflect adjustments that might result if we were not to continue as a goingconcern.

To date, the Company hasfinanced its operations primarily through equity and convertible debtfinancings, product revenues, research and development revenues, licensingfees, royalties, and the interest earned on related proceeds. The process ofdeveloping products will continue to require significant research anddevelopment, clinical trials and regulatory approvals. These activities,together with selling, general and administrative expenses, are expected toresult in substantial operating losses for the next several years. As of December 31,2004, Aerogen had cash and cash equivalents of approximately $16.9 million.Based on current expectations of sales and royalty levels and operating costs,existing capital resources will not enable the Company to maintain current andplanned operations beyond the first quarter of 2006; however, if we do not receivecertain expected product sales and/or royalties, our cash balance may notsustain planned operations beyond the middle of the fourth quarter of 2005. In2005, the company will seek to raise such capital from various possiblesources, such as strategic transactions, collaborative partnerships, the saleof assets, licensing of technologies and/or products, the public equitymarkets, private financings, and debt, or some combination thereof. If revenuesare less than expected, or costs exceed expectations, the Company may need toobtain additional capital sooner than expected. Such efforts may not besuccessful. Collaborative arrangements, if necessary to raise additional funds,may require the Company to relinquish rights to either certain of our productsor technologies or desirable marketing territories, or all of these.

**NOTE2—SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:**

***Basis of consolidation***

The consolidated financialstatements include the accounts of the Company and its wholly-owned subsidiary,Aerogen (Ireland) Limited. All intercompany balances and transactions have beeneliminated in consolidation.

***Use of estimates***

The preparation offinancial statements in conformity with accounting principles generallyaccepted in the United States of America requires management to make estimatesand assumptions that affect the reported amounts of assets and liabilities anddisclosures of contingent assets and liabilities at the date of 

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**AEROGEN, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) (Tabular amounts in thousands, except share and per share amounts)**

thefinancial statements and the reported amounts of revenues and expenses duringthe reporting period. Actual results could differ from those estimates.

***Cash and cash equivalents***

The Company considers allhighly liquid investments purchased with original maturities of three months orless to be cash equivalents. Cash and cash equivalents include money market anddeposit accounts.

***Inventories***

Inventories are stated atthe lower of cost (on a first in, first out basis) or market value. Reservesfor potentially excess and obsolete inventory are made based upon management’sanalysis of inventory levels and future sales forecasts.

***Depreciation and amortization***

Property and equipment arestated at cost less accumulated depreciation and amortization. Depreciation isprovided using the straight-line method over the estimated useful lives of theassets, generally three to five years. Amortization of leasehold improvementsis provided on a straight-line basis over the life of the related asset or thelease term, if shorter. Upon sale or retirement of assets, the cost and relatedaccumulated depreciation and amortization are removed from the balance sheetand the resulting gain or loss is reflected in operations.

***Goodwill and other intangible assets***

Goodwill and other intangible assets primarily consistof goodwill and acquired workforce related to the acquisition of the Company’ssubsidiary, and were amortized on a straight-line basis to operations over sixand two years, respectively, through December 31, 2001. In accordance withStatement of Financial Accounting Standards (“SFAS”) No. 142 “Goodwill andOther Intangible Assets” (“SFAS 142”), goodwill and other intangibleassets are no longer systematically amortized, but, rather, the Companyperforms an annual assessment for impairment by applying a fair-value-basedtest. No impairment charges have been recorded to date.

In accordance withSFAS 142, the Company discontinued the amortization of goodwill effective January 1,2002. In addition, the Company re-characterized any unamortized acquiredassembled workforce as goodwill because it is no longer defined as an acquiredintangible asset under SFAS No. 141, “Business Combinations.”Accordingly, no goodwill or acquired workforce amortization was recognizedduring the years ended December 31, 2004, 2003 and 2002. The provisions ofSFAS 142 also required the completion of a transitional impairment testwithin 12 months of adoption, with any impairment treated as a cumulativeeffect of change in accounting principle. The Company has completed annualimpairment tests in 2004 and 2003, which did not result in impairment ofrecorded goodwill.

***Impairment of long-lived assets***

The Company reviewslong-lived assets for impairment whenever events or changes in circumstancesindicate that the carrying amount of an asset might not be recoverable. Whensuch an event occurs, management determines whether there has been animpairment by comparing the anticipated 

54

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**AEROGEN, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) (Tabular amounts in thousands, except share and per share amounts)**

undiscountedfuture net cash flows to the related asset’s carrying value. If an asset isconsidered impaired, the asset is written down to fair value, which isdetermined based either on discounted cash flows or appraised value, dependingon the nature of the asset.

***Warranty accrual***

TheCompany offers a warranty of certain products and records a liability for theestimated future costs associated with warranty claims, which is based onhistorical experience and the Company’s estimated level of future costs.Warranty costs are reflected in the statement of operations as a cost ofproducts sold. A reconciliation of the changes in the Company’s warrantyliability for the years ending December 31, 2004 and 2003 is as follows:
| Warranty accrual  at January 1, 2003       |   | $    | 101    |   |
|-------------------------------------------------|--------|------|--------|--------|
| Accruals for  warranties issued during the year |   | 73   |   |
| Settlements made  in kind during the year       |   | (36  | )      |
| Balance at December 31, 2003               |   | 138  |   |
| Accruals for warranties issued during the year  |   | 226  |   |
| Settlements made  in kind during the year       |   | (113 | )      |
| Balance at  December 31, 2004              |   | $    | 251    |   |

 

***Concentration of credit risk and other risks anduncertainties***

The Company maintains its cash and cash equivalents inaccounts with two financial institutions in the United States and one financialinstitution in Ireland. Deposits in these institutions may exceed the amount ofinsurance provided on such deposits. The Company has not experienced any losseson its deposits of cash and cash equivalents to date.

Carrying amounts of certain of the Company’s financialinstruments, including cash and cash equivalents, accounts receivable, accountspayable and accrued liabilities approximate fair value due to their relativelyshort maturities.

Each product developed by the Company generally willrequire clearance or the approval of the FDA and/or international regulatoryagencies prior to the first commercial sale of the product. The Company cannotbe assured that its products will receive or maintain the necessary clearanceor approval. If the Company is denied approval, or if approval is delayed,suspended, or rescinded, this may have a material adverse impact on the Company.

The Company is subject to risks common to companies inthe pharmaceutical industry including, but not limited to, new technologicalinnovations, dependence on key personnel, protection of proprietary technology,compliance with government regulations, uncertainty of market acceptance ofproducts, product liability and the need to obtain additional financing.

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**AEROGEN, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) (Tabular amounts in thousands, except share and per share amounts)**

Thefollowing table summarizes customers with net sales greater than 10% of theCompany’s total net sales for the years ended December 31, 2004, 2003, and2002:
| ** ** | ** ** | **Years Ended December 31,** | ** ** |
|------------|------------|---------------------------------------------|------------|
| ** ** | ** ** | **2004**                                    | ** ** | **2003** | ** ** | **2002** | ** ** |
| Customer A |       |                                        | 35         | % |   |   | 52 | % |   |   | 55 | % |   |
| Customer B |       |                                        | 7          | % |   |   | 12 | % |   |   | 0 | % |   |
| Customer C |       |                                        | 18         | % |   |   | 14 | % |   |   | 0 | % |   |
| Customer D |       |                                        | 21         | % |   |   | 3 | % |   |   | 0 | % |   |
| Customer E |       |                                        | 0          | % |   |   | 0 | % |   |   | 24 | % |   |

 

Thefollowing table summarizes customers with outstanding accounts receivablebalance greater than 10% of the Company’s total outstanding accounts receivableas of December 31, 2004, and 2003.
| ** ** | ** ** | **As of December 31,** | ** ** |
|------------|------------|---------------------------------------|------------|
| ** ** | ** ** | **2004**                              | ** ** | **2003** | ** ** |
| Customer A |       |                                  | 40         | % |   |   | 56 | % |   |
| Customer C |       |                                  | 10         | % |   |   | 28 | % |   |
| Customer D |       |                                  | 20         | % |   |   | 0 | % |   |

 

***Revenue recognition***

The Company utilizes distributors to market itsproducts, and recognize revenue at the time of product shipment, provided anenforceable claim exists, title has transferred, any significant rights to returnproduct have expired and collection of the receivable is reasonably assured. TheCompany’s customers are not granted rights of return, except in the instance ofdefective product. The price is fixed at the date of sale, the buyer takestitle upon shipment from the Company’s facilities, and their obligation to payis not contingent upon resale of the product. The Company has no obligation forfuture performance to bring about resale of the product by the buyer.

The Company recognizes royalty revenue related to upfront payments associated with an October 2003 commercial licensing anddistribution agreement, which are being amortized ratably over the five yearterm of the agreement. These amounts are recorded as deferred revenue untilrecognized as royalty revenue. Related to this agreement, the Company alsoearns royalty revenues on its licensee’s sales of the related product. Under aseparate license agreement, minimum royalty revenues are recognized as earned,and the remaining amounts are recognized during the periods that the amountsbecome known and payments have been received, which have been, and are expectedto be, one quarter after they have been earned.

Research and developmentrevenues, which are earned under agreements with third parties for contractresearch and development activities, are recorded as the related expenses areincurred. Charges to the third parties are based upon negotiated rates for fulltime equivalent employees of the Company and actual out-of-pocket costs. Ratesfor full time equivalent employees are intended to approximate the Company’santicipated costs, including overhead. Payments received that are related tofuture performance are recorded as deferred revenue, and are recognized asrevenues as they are earned. None of the revenues recognized to date arerefundable if the relevant research effort is not successful.

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**AEROGEN, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) (Tabular amounts in thousands, except share and per share amounts)**

***Research and development costs***

Research and development costs are charged tooperations as incurred. Any expenditure associated with products not yetapproved by regulatory authorities is expensed. For research and developmentprojects that are funded under agreements with third parties, the costs relatedto these activities are included in research and development expense. Legalexpenses related to patent development are expensed to research and developmentas incurred.

***Foreign currency translation***

The Company’s Irishsubsidiary uses the Euro as its functional currency. Assets and liabilities aretranslated at exchange rates in effect at the balance sheet date and revenueand expense accounts at average exchange rates during the period. Resultingtranslation adjustments are recorded directly to a separate component ofstockholders’ equity.

***Advertising Costs***

Advertising costs areexpensed as incurred and were $102,000 in 2004, $80,000 in 2003, and $109,000in 2002.

***Income taxes***

The Company accounts forincome taxes under the provisions of SFAS No. 109, “Accounting for IncomeTaxes.” Under this method, deferred tax assets and liabilities are determinedbased on the difference between the financial statement and tax bases of assetsand liabilities using enacted tax rates in effect for the year in which thedifferences are expected to affect taxable income. Valuation allowances areestablished when necessary to reduce deferred tax assets to the amountsexpected to be realized.

***Segments***

TheCompany operates in one segment, using one measurement of profitability tomanage its business. Revenues recorded by geographic region for the years endedDecember 31, 2004, 2003, and 2002 were as follows:
| ** **     | ** ** | **Years Ended December 31,** | ** ** |
|----------------|------------|---------------------------------------------|------------|
| ** **     | ** ** | **2004**                                    | ** ** | **2003** | ** ** | **2002** | ** ** |
| Total revenues |       | $                                           | 6,248      |   | $ | 4,171 |   | $ | 2,532 |   |
| United States  |       | 40                                          | %          | 22 | % | 29 | % |
| Ireland        |       | 60                                          | %          | 78 | % | 71 | % |
|                |            |                                             |            |  |  |  |  |  |  |  |

 

Longterm assets by geographic region based on physical location of the assets wereas follows:
| ** **    | ** ** | **As of December 31,** | ** ** |
|---------------|------------|---------------------------------------|------------|
| ** **    | ** ** | **2004**                              | ** ** | **2003** | ** ** |
| United States |       |                                  | 82         | % |   |   | 88 | % |   |
| Ireland       |       |                                  | 18         | % |   |   | 12 | % |   |

 

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**AEROGEN, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) (Tabular amounts in thousands, except share and per share amounts)**

Revenuesby geographic region, based on shipping location of the external customer wereas follows:
| ** **     | ** ** | **Years Ended December 31,** | ** ** |
|----------------|------------|---------------------------------------------|------------|
| ** **     | ** ** | **2004**                                    | ** ** | **2003** | ** ** | **2002** | ** ** |
| Total revenues |       | $                                           | 6,248      |   | $ | 4,171 |   | $ | 2,532 |   |
| United States  |       | 63                                          | %          | 51 | % | 51 | % |
| Japan          |       | 11                                          | %          | 19 | % | 26 | % |
| United Kingdom |       | 1                                           | %          | 0 | % | 17 | % |
| Switzerland    |       | 4                                           | %          | 17 | % | 0 | % |
| Other          |       | 21                                          | %          | 13 | % | 6 | % |
|                |            |                                             |            |  |  |  |  |  |  |  |

 

***Accounting for stock-based compensation***

TheCompany accounts for stock-based compensation using the intrinsic value methodunder Accounting Principles Board Opinion No. 25 (“APB No. 25”), “Accountingfor Stock Issues to Employees,” and related interpretations, SFAS No. 123 “Accountingfor Stock-Based Compensation,” and complies with the disclosure provisions ofSFAS No. 148, “Accounting for Stock Based Compensation Transition andDisclosure, an Amendment of FASB Statement No. 123.” The followingprovides a reconciliation of net loss and net loss per common share to pro formanet loss and pro forma net loss per common shares as if the Company had appliedthe fair value recognition provisions of SFAS No. 123 to all employeeawards:
| ** **                                                                                               | ** ** | **Years Ended December 31,** | ** ** |
|----------------------------------------------------------------------------------------------------------|------------|---------------------------------------------|------------|
| ** **                                                                                               | ** ** | **2004**                                    | ** ** | **2003** | ** ** | **2002** | ** ** |
| Net loss—as  reported                                                                               |       | $                                           | (10,074    | ) | $ | (17,419 | ) | $ | (24,911 | ) |
| Add: stock-based employee compensation included in reported  net loss                                    |       | 264                                         |       | 990 |   | 1,335 |   |
| Deduct: total stock-based employee compensation determined  under fair value based method for all awards |       | (1,623                                      | )          | (2,054 | ) | (3,933 | ) |
| Net loss—pro forma                                                                                  |       | $                                           | (11,433    | ) | $ | (18,483 | ) | $ | (27,509 | ) |
| As reported                                                                                              |       | $                                           | (4.86      | ) | $ | (4.22 | ) | $ | (6.17 | ) |
| Pro forma                                                                                                |       | $                                           | (5.15      | ) | $ | (4.48 | ) | $ | (6.82 | ) |

 

The above pro forma disclosures may not berepresentative of the pro forma effect in future years because options vestover several years and additional grants may be made each year.

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**AEROGEN, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) (Tabular amounts in thousands, except share and per share amounts)**

Thefair value of options granted was estimated on the date of grant using theBlack-Scholes option pricing model, using the following assumptions:
| ** **                                | ** ** | **Stock option plans**                                     | ** ** |
|-------------------------------------------|------------|----------------------------------------------------------------------|------------|
| ** **                                | ** ** | **Years Ended December 31,**                          | ** ** |
| ** **                                | ** ** | **     2004     ** | ** ** | **     2003     ** | ** ** | **     2002     ** | ** ** |
| Risk-free  interest rate                  |       |                                                                 | 3.96       | % |   |   | — |   |   |   | 3.54 | % |   |
| Expected life (in  years)                 |       |                                                                 | 6          |   |   |   | — |   |   |   | 4 |   |   |
| Dividend yield                            |       |                                                                 | —     |   |   |   | — |   |   |   | — |   |   |
| Expected  volatility                      |       |                                                                 | 100        | % |   |   | — |   |   |   | 148 | % |   |
| Weighted average  fair values             |       |                                                                 |       |   |   |   |   |   |   |   |   |   |   |
| Exercise price less than market price     |       |                                                                 | $          | — |   |   |   | $ | — |   |   |   | $ | — |   |   |
| Exercise price equal to market price      |       |                                                                 | $          | 2.25 |   |   |   | $ | — |   |   |   | $ | 3.25 |   |   |
| Exercise price  greater than market price |       |                                                                 | $          | — |   |   |   | $ | — |   |   |   | $ | — |   |   |

 
| ** **                                | ** ** | **Employee Stock Purchase Plan  (ESPP)** | ** ** |
|-------------------------------------------|------------|---------------------------------------------------------|------------|
| ** **                                | ** ** | **Years Ended December 31,**             | ** ** |
| ** **                                | ** ** | **   2004   **            | ** ** | **   2003   ** | ** ** | **   2002   ** | ** ** |
| Risk-free  interest rate                  |       |                                                    | 3.50       | % |   |   | 2.13 | % |   |   | 2.31 | % |   |
| Expected life (in  years)                 |       |                                                    | 2          |   |   |   | 2 |   |   |   | 2 |   |   |
| Dividend yield                            |       |                                                    | —     |   |   |   | — |   |   |   | — |   |   |
| Expected  volatility                      |       |                                                    | 100        | % |   |   | 154 | % |   |   | 148 | % |   |
| Weighted average  fair values             |       |                                                    |       |   |   |   |   |   |   |   |   |   |   |
| Exercise price less than market price     |       |                                                    | $          | 1.07 |   |   |   | $ | 0.90 |   |   |   | $ | 4.50 |   |   |
| Exercise price equal to market price      |       |                                                    | $          | — |   |   |   | $ | — |   |   |   | $ | — |   |   |
| Exercise price  greater than market price |       |                                                    | $          | — |   |   |   | $ | — |   |   |   | $ | — |   |   |

 

The Company accounts forequity instruments issued to non-employees in accordance with the provisions ofSFAS No. 123 and EITF Issue No. 96-18 “Accounting for EquityInstruments that are Issued to Other Than Employees for Acquiring, or inConjunction with Selling, Goods or Services,” which require that such equityinstruments are recorded at their fair value on the measurement date, which istypically the date of grant. The measurement of stock-based compensation issubject to periodic adjustment as the underlying equity instruments vest.

***Comprehensive income (loss)***

Comprehensive income(loss) generally represents all changes in stockholders’ equity (deficit)except those resulting from investments or contributions by stockholders. TheCompany’s unrealized gains and losses on foreign currency translation gains andlosses represent the only components of comprehensive income (loss) that areexcluded from the Company’s net loss for the years ended December 31,2004, 2003 and 2002.

***Net loss per common share***

Basic net loss per share is computed by dividing thenet loss by the weighted average number of vested common shares outstanding forthe period. Diluted net loss per share is computed giving effect to allpotential dilutive common shares, including convertible securities, options andwarrants. For the periods 

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**AEROGEN, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) (Tabular amounts in thousands, except share and per share amounts)**

reported below, thesepotentially dilutive securities were not included in the diluted net loss pershare calculations because the effect would be antidilutive.

In periods of positive earnings, net income per shareis computed using the two-class method as required by Emerging Issues TaskForce Statement No. 03-06 “Participating Securities and the Two Class MethodUnder FASB Statement No. 128, Earnings Per Share.” In computing basic anddiluted net income per share, net income is allocated first to the preferredstockholders based on both their dividend rights and their rights toparticipate in the earnings for the period as if all of the earnings for theperiod had been distributed. The residual earnings are then allocated to thecommon stockholders in determining basic and diluted net income per share.

Areconciliation of the numerator and denominator used in the calculation ofbasic and diluted net loss per share attributable to common stockholdersfollows:
| ** **                                                                                                           | ** ** | **Years Ended December 31,** | ** ** |
|----------------------------------------------------------------------------------------------------------------------|------------|---------------------------------------------|------------|
| ** **                                                                                                           | ** ** | **2004**                                    | ** ** | **2003** | ** ** | **2002** | ** ** |
| Net loss  attributable to common stockholders                                                                        |       | $                                           | (23,171    | ) | $ | (17,419 | ) | $ | (24,911 | ) |
| Weighted average shares outstanding                                                                                  |       | 4,765                                       |       | 4,127 |   | 4,050 |   |
| Less: Weighted  average shares subject to repurchase                                                                 |       | —                                      |       | (1 | ) | (14 | ) |
| Weighted average  shares used in computing basic and diluted net loss per share attributable to  common stockholders |       | 4,765                                       |       | 4,126 |   | 4,036 |   |
|                                                                                                                      |            |                                             |            |  |  |  |  |  |  |  |

 

Thefollowing outstanding options, common stock subject to repurchase, warrants andconvertible debentures were excluded from the computation of diluted net lossper share as they had an antidilutive effect:
| ** **                          | ** ** | **Years Ended  December 31,** | ** ** |
|-------------------------------------|------------|-----------------------------------------|------------|
| ** **                          | ** ** | **2004**                                | ** ** | **2003** | ** ** | **2002** | ** ** |
| Options to  purchase common stock   |       | 4,083                                   |       | 477 |   | 665 |   |
| Shares issuable  through ESPP       |       | 16                                      |       | — |   | 115 |   |
| Common stock  subject to repurchase |       | —                                  |       | 1 |   | 1 |   |
| Warrants                            |       | 11,767                                  |       | 428 |   | 4 |   |
| Convertible  debentures             |       | —                                  |       | 630 |   | — |   |
| Preferred stock                     |       | 1,099                                   |       | — |   | — |   |

 

***Recent accounting pronouncements***

In December 2004, the Financial Accounting Board(“FASB”) issued FASB Statement No. 123R (revised 2004), “Share-BasedPayment,” which is a revision of FASB Statement No. 123 “Accounting forStock-Based Compensation.” Statement 123R supersedes APB Opinion No. 25 “Accountingfor Stock Issued to Employees,” and amends FASB Statement No. 95 “Statementof Cash Flows.” Generally, the approach in Statement 123R is similar to theapproach described in Statement 123. However, Statement 123R requires allshare-based payments to employees, including grants of employee stock options,to be recognized in the income statement based on their fair values. Pro formsdisclosure is no longer an alternative. The new standard will be effective forthe Company in the quarter ending September 30, 2005. The Company is inthe process of assessing the impact of adopting this new standard.

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**AEROGEN, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) (Tabular amounts in thousands, except share and per share amounts)**

In December 2004, theFinancial Accounting Standards Board issued Statement of Financial AccountingStandards No. 151 “Inventory Costs” (“SFAS 151”), which adopts wordingfrom the International Accounting Standards Board’s IAS 2 “Inventories” in aneffort to improve the comparability of international financial reporting. Thenew standard indicates that abnormal freight, handling costs, and wastedmaterials (spoilage) are required to be treated as current period chargesrather than as a portion of inventory cost. Additionally, the standardclarifies that fixed production overhead should be allocated based on thenormal capacity of a production facility. The provisions of SFAS 151 areeffective for fiscal years beginning after June 15, 2005. Adoption of SFAS151 is not expected to have a material impact on the Company’s financial positionor results of operations.

**NOTE 3—LITIGATION SETTLEMENT:**

In October 2001, theCompany settled a lawsuit brought by the Company against Becton Dickinson (“BD”).As a result of the settlement, the Company owns all of the intellectualproperty developed by either party under the now terminated agreement, and BDhas a nonexclusive license to certain technology developed by BD under theagreement for use outside the field of inhaled insulin. Under the settlementagreement, the Company paid BD a total of $2 million, in two equalinstallments in October 2001 and February 2002. The litigationsettlement was immediately expensed to operations, as the technology acquiredwill be used in conjunction with a product that had not yet been approved forsale by regulatory authorities.

**NOTE 4—BALANCE SHEET COMPONENTS:**

Inventoriesare summarized as follows:
| ** **      | ** ** | **December 31,** | ** ** |
|-----------------|------------|-----------------------|------------|
| ** **      | ** ** | **2004**              | ** ** | **2003** | ** ** |
| Raw materials   |       | $                     | 499        |   | $ | 228 |   |
| Work-in-process |       | 228                   |       | 30 |   |
| Finished goods  |       | 48                    |       | 43 |   |
| Net inventories |       | $                     | 775        |   | $ | 301 |   |

 

Propertyand equipment consists of the following:
| ** **                                       | ** ** | **December 31,** | ** ** |
|--------------------------------------------------|------------|-----------------------|------------|
| ** **                                       | ** ** | **2004**              | ** ** | **2003** | ** ** |
| Laboratory,  computer and office equipment       |       | $                     | 4,269      |   | $ | 3,964 |   |
| Furniture                                        |       | 484                   |       | 482 |   |
| Land                                             |       | 286                   |       | 263 |   |
| Leasehold  improvements                          |       | 1,644                 |       | 3,577 |   |
| Construction-in-progress                         |       | —                |       | 119 |   |
|                                             |       | 6,683                 |       | 8,405 |   |
| Less: Accumulated  depreciation and amortization |       | (3,719                | )          | (4,504 | ) |
| Net property and  equipment                      |       | $                     | 2,964      |   | $ | 3,901 |   |

 

On September 30,2003, the Company entered into an agreement with Evo for manufacturing andmarketing of the Aeroneb Go Nebulizer. During October 2003, Aerogenreceived upfront payments 

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**AEROGEN, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) (Tabular amounts in thousands, except share and per share amounts)**

totaling$2.5 million for distribution rights and for the sale of certainequipment. Per the terms of the Company’s agreement with Evo, this equipmentbecame repurchasable by the Company for one dollar. The equipment remains onthe Company’s premises and, for accounting purposes, has been reclassified toother assets at December 31, 2004 and 2003 and continues to be amortized.The net book value of these assets at December 31, 2004 and 2003 was$299,000 and $571,000, respectively.

Inconnection with the Cerus Limited acquisition in May 2000, the Companyrecorded goodwill and other intangible assets. Goodwill and other intangibleassets consist of the following:
| ** **               | ** ** | **December 31,** | ** ** |
|--------------------------|------------|-----------------------|------------|
| ** **               | ** ** | **2004**              | ** ** | **2003** | ** ** |
| Goodwill, net            |       | $                     | 1,951      |   | $ | 1,796 |   |
| Other intangible  assets |       | $                     | 147        |   | $ | 135 |   |

 

Goodwill related to the Company’s Irish subsidiary isimpacted by changes in the U.S. dollar-to-Euro exchange rate.

Accruedliabilities consists of the following:
| ** **                   | ** ** | **December 31,** | ** ** |
|------------------------------|------------|-----------------------|------------|
| ** **                   | ** ** | **2004**              | ** ** | **2003** | ** ** |
| Payroll and  related expense |       | $                     | 580        |   | $ | 499 |   |
| Accrued warranty             |       | 251                   |       | 138 |   |
| Other accrued  liabilities   |       | 1,042                 |       | 557 |   |
| Accrued  liabilities         |       | $                     | 1,873      |   | $ | 1,194 |   |

 

**NOTE 5—OTHERLONG-TERM LIABILITIES:**

In April 1999, CerusLimited established an Irish Revenue approved Business Expansion Scheme (“BES”)under which it raised approximately 196,000 Euro. The BES is an Irish Revenueapproved Business Expansion Scheme that grants investors tax breaks on theamounts invested. The maximum amount that the BES investors are entitled toreceive from Aerogen (Ireland) Limited was $267,000, when translated as of December 31,2004. The BES investors have certain dividend and liquidation preferences inour Irish subsidiary. The obligation has been classified as other long-termliabilities.

**NOTE6—COMMITMENTS AND CONTINGENCIES:**

***Facility leases***

The Company leases its facilities in Ireland under anoperating lease that expires in December 2006. In April of 2002, theCompany entered into a 980-year lease with the Irish Development Agency for a0.8-acre plot of land for a one-time payment of approximately $220,000. At thistime the Company has not determined if and/or when it will build on the land.

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**AEROGEN, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) (Tabular amounts in thousands, except per share amounts)**

The Company leases its facilities in Mountain View,California under an operating lease that, under its original terms, expired in February 2012.Under the terms of the original lease, the Company was required to providesecurity to the landlord in the form of a $1,200,000 letter of credit to remainin effect for the entire term of the lease. The letter of credit was secured bya certificate of deposit for $1,200,000, which was classified as restrictedcash at December 31, 2003.

In March 2004, the Company negotiated a leaseamendment with its landlord. Under the terms of the amended lease, Aerogenrelocated to the first floor of its two-story building in Mountain View, CA,and now occupies roughly 32,000 square feet, which is about one half of thebuilding area that the Company had occupied. Under the terms of the amendedlease, Aerogen made aggregate payments during the quarter ended June 30,2004 totaling $1,625,000 which was comprised of $75,000 for a new securitydeposit, $414,000 in past due rent, and $1,136,000 in rent reduction fees, ofwhich $900,000 was funded by relinquishment to the landlord of cash underlyingthe Company’s standby letter of credit. The Company was required to fund up to$140,000 in building access improvements, which were completed in November 2004.The Company paid the landlord $140,000 as payment in full of the Company’sshare of those improvements, and has paid an additional $43,000 formodifications to the building’s electrical systems. As part of the leaserestructuring, the Company issued 50,000 shares of common stock to thelandlord. The excess of the value paid to the landlord, including cash,building improvements and stock, over the amounts due, will be amortized asrent expense over the remaining term of the lease. The lease now terminates in February 2009.

Rent expense for the years ending December 31,2004, 2003 and 2002 was approximately $1,304,000, $3,119,000 and $2,828,000,respectively.

Futureaggregate minimum rental and maintenance commitments under non-cancelable operatingleases, including common area maintenance fees in effect at December 31,2004 are:
| ** **             | ** ** | **Years Ending**   | ** ** |
|------------------------|------------|-------------------------|------------|
| ** **             | ** ** | **December 31,**   | ** ** |
| ** **             | ** ** | **(in thousands)** | ** ** |
| 2005                   |       |                    | 990        |   |   |
| 2006                   |       |                    | 1,150      |   |   |
| 2007                   |       |                    | 1,102      |   |   |
| 2008                   |       |                    | 1,152      |   |   |
| 2009                   |       |                    | 193        |   |   |
| Total minimum payments |       |                    | $          | 4,587 |   |   |
|                        |            |                         |            |  |  |  |

 

***Executive Severance Benefit Plan***

In September 2000,the Board of Directors adopted the Executive Severance Benefit Plan (“SeverancePlan”), which provides the Company’s officers with severance benefits upon theinvoluntary termination of their employment in certain circumstances followingan acquisition of the Company. Benefits under the Severance Plan include salarycontinuation, health benefits and option acceleration.

***Contingencies***

The Company is a party to alawsuit brought by PARI GmbH alleging patent infringement in Germany. InMay 2003, the Company filed an action in the German patent officerequesting that the 

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**AEROGEN, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) (Tabular amounts in thousands, except per share amounts)**

patent in question berendered null and void. In July 2004, the Federal Patent Court in Munich,Germany ruled in favor of Aerogen by nullifying all contested claims of thispatent, which is owned by The Technology Partnership plc (“TTP”) ofHertfordshire, England, and is licensed to PARI, GmbH of Munich, Germany. TheCourt ordered TTP to pay Aerogen’s legal expenses related to this nullityaction to the maximum extent allowed under German law. During October 2004,TTP requested, and was granted, a three-month extension of time to file anappeal of this decision, and granted additional extensions through February,2005. PARI assumed control over the nullity case from TTP on December 14,2004. The decision on the nullity action has been appealed to the GermanSupreme Court, with PARI submitting its arguments in support of the appeal in March 2005.Additionally, during October 2004 TTP formally served Aerogen with theinfringement suit that PARI had advised Aerogen in April 2003 had alreadybeen filed in Munich, Germany. A preliminary hearing on the infringement caseis scheduled for June 2005. We believe that this suit is without merit andintend to vigorously defend against all allegations in the suit.

From time to time, theCompany may become involved in litigation relating to additional claims arisingfrom the ordinary course of business. Management is not currently aware of anysuch matters that will have a material adverse affect on the financialposition, results of operations or cash flows of the Company.

**NOTE 7—CONVERTIBLE DEBT:**

In September 2003, the Company entered into aloan and securities purchase agreement pursuant to which two convertibledebentures and two warrants were issued to SF Capital.

The first debenture was issued on September 11,2003, in the principal amount of $950,000, bore interest at the rate of 10% peryear, had an original maturity of December 31, 2003, and the principalamount of which was convertible into 542,857 shares of the Company’s commonstock at a conversion price of $1.75 per share. This debenture was subsequentlyamended in January 2004 to extend its maturity to June 1, 2004. Thewarrant associated with this first debenture is exercisable for 271,428 sharesof common stock at an exercise price of $1.75 per share. SF Capital convertedthe entirety of this first debenture, along with all accrued interest, into anaggregate of 564,224 common shares, in the fourth quarter of 2003 and the firstquarter of 2004.

The second SF Capital debenture was issued on November 3,2003, in the principal amount of $1,000,000, bore interest at the rate of 10%per year, had an original maturity of March 1, 2004, and the principalamount of which was initially convertible into 304,878 shares of the Company’scommon stock at an original conversion price of $3.28 per share. This debenturewas amended in January 2004 to extend its maturity to June 1, 2004.SF Capital exchanged this debenture and all accrued interest for shares ofthe Company’s A-1 Preferred Stock, and associated warrants in May 2004.

The second warrant is exercisable for 164,257 sharesof common stock at an adjusted exercise price of $3.044 per share, as adjusted.Total interest expense recognized relating to the second warrant discount was$36,000 and $68,000 during 2004 and 2003, respectively.

The terms of the warrants preclude SF Capital fromconverting or exercising if such exercise would result in SF Capital and itsaffiliates owning in excess of 9.999% of the Company’s outstanding stock.

In January 2004, the Company entered into a loanand securities purchase agreement pursuant to which a convertible debenture(the “Carpenter Debenture”) and a warrant (the “Carpenter Warrant”) 

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**AEROGEN, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) (Tabular amounts in thousands, except per share amounts)**

were issued to theCarpenter 1983 Family Trust UA (“the Carpenter Trust”), the trustees of whichare Aerogen’s Chairman and Chief Executive Officer, Dr. Jane Shaw and herhusband Peter Carpenter. The Company received approximately $505,000 in grossproceeds in exchange for the Carpenter Debenture and the Carpenter Warrant. TheCarpenter Debenture was convertible into 164,258 shares of common stock at aconversion price of $3.044 per share. The Carpenter Warrant is exercisable for82,129 shares of common stock at an exercise price of $3.044 per share, andexpires in January 2008. The difference between the conversion price andthe fair market value of the common stock on the commitment date (transactiondate) resulted in a beneficial conversion feature recorded on the CarpenterDebenture of $263,694. The Carpenter Warrant was assigned an initial value of$154,297, estimated using the Black-Scholes valuation model, and has beenclassified as equity. The following assumptions were used to determine the fairvalue of the Carpenter Warrant using the Black-Scholes valuation model: term offour years, risk free rate of 3.25%, volatility of 100%, and a dividendyield of zero. The initial values assigned to both the Carpenter Debenture andthe Carpenter Warrant were allocated based on their relative fair values. Thediscount on the Carpenter Debenture for the beneficial conversion feature andCarpenter Warrant were amortized, using the effective interest method, tointerest expense over the original term of the Carpenter Debenture, which hadbeen scheduled to mature on March 1, 2004.

The issuance of the Carpenter Debenture triggered anexercise price adjustment on the November 3, 2003 debenture and warrantissued to SF Capital Partners, Ltd. (“SF Capital”). As a result, the exerciseprice of the November 2003 SF Capital warrant and debenture were reducedto $3.044 per share.

During March 2004, SF Capital converted theremaining principal balance and accrued interest on its September 11, 2003debenture into the Company’s common stock. Pursuant to the terms of thedebenture, SF Capital elected to have all of its interest paid in the form ofcommon stock. In the aggregate, this debenture and accrued interest wasconverted into a total of 564,224 shares of the Company’s common stock.

On March 12, 2004, SFCapital provided a $300,000 secured bridge loan to support the Company’soperations. This secured bridge loan was fully repaid on March 25, 2004.

**NOTE8—REDEEMABLE CONVERTIBLE PREFERRED STOCK:**

As of December 31, 2004, the Company hasauthorized 5,000,000 shares of redeemable convertible preferred stock, $0.001par value, of which 1,098,761 shares were issued and outstanding, compared tonone outstanding at December 31, 2003.

On March 23, 2004, the Company completed thefirst closing of a $32.7 million equity financing (the “A-1Financing”). The A-1 Financing occurred in two closings, and involved thesale and issuance of a total of 1,142,094 shares of Series A-1redeemable convertible preferred stock (the “A-1 Preferred”) of theCompany that are initially convertible into an aggregate of 11,420,940 sharesof common stock of the Company, as well as the issuance of warrants to purchaseup to 11,249,390 shares of common stock at an exercise price of $3.25 pershare.

In the first closing, the Company issued 499,981shares of A-1 Preferred convertible into 4,999,810 shares of commonstock, and issued warrants to purchase 4,999,810 shares of common stock at anexercise price of $3.25, for gross cash proceeds to the Company of $14,999,430.

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**AEROGEN, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) (Tabular amounts in thousands, except per share amounts)**

On May 12, 2004, the Company completed the secondand final closing of the A-1 Financing. In the second closing, theCompany issued 642,113 shares of A-1 Preferred convertible into 6,421,130shares of common stock, and issued warrants to purchase 6,249,580 shares ofcommon stock at an exercise price of $3.25, for gross proceeds to the Companyof $19,263,000, including the exchange of $1,567,000 in previously-issueddebentures and accrued interest thereon. Gross cash proceeds from the secondclosing were $17,696,000.

Issuance costs related to the A-1 Financing were$1,775,000. Net cash proceeds to the Company were $30,921,000.

As a result of certain rights provided to theinvestors in the Series A-1 financing, the warrants to purchasecommon stock are accounted for as a liability and marked to market at eachperiod-end date. The aggregate fair value of the warrants of $8,200,000 and$7,937,000, for the first and second closings, respectively, was recorded as aliability, with the remaining net proceeds of $6,439,760 and $9,397,000, forthe first and second closings, respectively, recorded as preferred stock. Thedifference between the accounting conversion price of the preferred stock andthe fair market value of the underlying common stock on the commitment date(transaction date), limited to the allocated proceeds of the preferred stock,is recorded as a beneficial conversion feature which is treated as a deemeddividend. The total beneficial conversion feature for the year ended December 31,2004 was $11,690,000.

The fair value of the warrants and the correspondingliability is re-measured at each reporting period with any change in the fairvalue being recorded as a non-operating item in the statement of operations. Theaggregate fair value of the warrants decreased from $16.1 million to $10.3million during the year ended December 31, 2004, which resulted in theCompany recording a non-operating gain of $5.8 million on the statement ofoperations. The fair value of the warrant is determined at each reportingperiod using a valuation model which takes into consideration a variety ofassumptions, including stock price, stock volatility and the risk free rate.

As part of the A-1 Financing, SF Capital and theCarpenter Trust exchanged the outstanding secured convertible debenturespreviously issued to them for an aggregate of 52,232 shares of A-1Preferred at the second closing. Under the terms of the A-1 Financing, SFCapital retained its warrants originally issued in connection with both of its2003 debentures, and also received a new warrant to acquire 350,770 shares ofcommon stock at an exercise price of $3.25 per share in connection with itsdebenture exchange into A-1 Preferred. The Carpenter Trust retained itswarrant originally issued in connection with the Carpenter Debenture, but itdid not receive a new warrant in connection with the exchange of the CarpenterDebenture into A-1 Preferred.

In the event of any liquidation, dissolution orwinding up of the Company, the holders of A-1 Preferred shall be entitledto receive $30.00 per share (as adjusted for any stock splits, dividends,combinations or other recapitalizations) (the “Series A-1 StatedValue”) plus any unpaid dividends, on a pro rata basis, in preference to anydistribution made to the common stock (the “Liquidation Preference”). Once theLiquidation Preference has been paid in full, any remaining proceeds shall bedistributed ratably between the holders of the A-1 Preferred and commonstock, with the holders of A-1 Preferred deemed to hold that number ofshares of common stock into which the shares of A-1 Preferred are thenconvertible. The holders of a majority in interest of the A-1 Preferred,including Xmark Fund L.P. and Xmark Fund Ltd. (so long as they hold at least80,000 shares of A-1 Preferred), the “Requisite Holders”, may elect totreat an acquisition of the Company as a liquidation.

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**AEROGEN, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) (Tabular amounts in thousands, except per share amounts)**

Each holder of A-1 Preferred is entitled toreceive cumulative dividends in preference to any dividend on the common stockat the rate of 6% of the Series A-1 Stated Value per share, paidquarterly in arrears on the first day of January, April, July and October ineach year (the “Preferred Dividends”). The Preferred Dividends will be paid, atthe Company’s election, out of legally available funds or through the issuanceof shares of common stock valued as of the respective fiscal quarter period. Forthe twelve months ended December 31, 2004, cumulative dividends of$1,408,000 had been accrued on the A-1 Preferred, of these dividends,$314,000 had been paid as of December 31, 2004, and $1,094,000 was paid in2005 through the issuance of an aggregate of 613,921 shares of the Company’scommon stock.

The holder of any share or shares of A-1Preferred shall have the right, at the holder’s option at any time, to convertany such shares of A-1 Preferred into such number of fully paid andnonassessable shares of common stock as is obtained by: (i) multiplyingthe number of shares of A-1 Preferred to be converted by the Series A-1Stated Value and adding to such product the amount of any accrued but unpaiddividends with respect to such shares of A-1 Preferred to be converted;and (ii) dividing the result obtained pursuant to clause (i) above bythe Series A-1 Conversion Price then in effect. As of the date ofthis report, the “Series A-1 Conversion Price” is $3.00.

The conversion of A-1 Preferred into commonstock is limited so that no share may be converted that would cause the holderof such share (or such stockholder’s affiliates) to beneficially own more than4.99% of the Company’s then-outstanding common stock, provided that suchstockholder may waive the provision upon 61 days’ written notice to theCompany.

Currently, each share of A-1 Preferred isconvertible into ten (10) shares of common stock; this conversion ratio isonly adjusted in the event that the Company issues or sells certain equityinstruments at a price per common share equivalent that is less than $3.00 (thecurrent Series A-1 Conversion Price).

If the Company issues or sells any common stock, or isdeemed to have issued or sold common stock by issuing or selling options orother convertible securities, for consideration per share less than the Series A-1Conversion Price in effect immediately prior to the time of such issue or sale,then the then-existing Series A-1 Conversion Price shall be reducedto the lowest price per share at which any share of common stock was issued orsold or deemed to be issued or sold. However, the Company shall not be requiredto make any adjustment of the Series A-1 Conversion Price in thecase of the following issuances of shares of common stock from and after March 23,2004 (each an “Excluded Issuance”): (i) issuances upon the exercise of anyoptions or convertible securities granted, issued and outstanding on March 23,2004; (ii) issuances upon the grant or exercise of any stock or optionswhich may hereafter be granted or exercised under any employee benefit plan,stock option plan or restricted stock plan of the Company in existence on March 23,2004, so long as the issuance of such stock or options is approved by amajority of the independent members of the Board or a majority of the membersof a committee of independent directors established for such purpose; (iii) issuancesof securities as consideration for a merger or consolidation with, or purchaseof assets from, a non-affiliated third party or in connection with anystrategic partnership or joint venture with a non-affiliated third party withwhich the Company will enter into technology agreements (the primary purpose ofany such action is not to raise equity capital); (iv) shares of commonstock issuable upon conversion of A-1 Preferred or as payment-in-kinddividends on the A-1 Preferred; (v) shares of common stock issued orissuable as a result of any stock split, combination, dividend, distribution,reclassification, exchange or substitution for which an equitable adjustment isprovided for; and (vi) shares of common stock issued (or issuable uponexercise, exchange or conversion of 

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**AEROGEN, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) (Tabular amounts in thousands, except per share amounts)**

rights, options orwarrants outstanding from time to time) which the Requisite Holders expresslyelect in writing to treat as an Excluded Issuance.

The holders of A-1 Preferred are entitled tovote together with the holders of common stock as a single class. Each share ofA-1 Preferred shall have the number of votes equal to the number ofshares of common stock into which such share of A-1 Preferred isconvertible.

As long as at least200,000 shares of A-1 Preferred are outstanding, the consent of theRequisite Holders shall be required to take or agree to any of the followingactions: (1) amend, alter or repeal any of the provisions of the Company’sAmended and Restated Certificate of Incorporation, Bylaws or the Certificate ofDesignations, or in any way change the preferences, privileges, rights orpowers with respect to the A-1 Preferred or reclassify any class ofstock, including, without limitation, by way of merger or consolidation; (2) authorize,create, designate, issue or sell any (A) class or series of capital stock(including shares of treasury stock), (B) rights, options, warrants orother securities convertible into or exercisable or exchangeable for capitalstock or (C) any debt security which by its terms is convertible into orexchangeable for any capital stock or has any other equity feature or anysecurity that is a combination of debt and equity, which capital stock, in eachcase, is senior to or *pari**passu* with the A-1 Preferred; (3) increase thenumber of authorized shares of A-1 Preferred authorize the issuance of orissue any shares of A-1 Preferred (other than in connection with thepayment of Preferred Dividends); (4) increase or decrease the number ofauthorized shares of any class of capital stock of the Company; (5) agreeto any restriction on the Company’s ability to satisfy its obligationshereunder to holders of A-1 Preferred the Company’s ability to honor theexercise of any rights of the holders of A-1 Preferred; (6) declareor pay any dividend or make any distribution on shares of capital stock of theCompany (except with respect to shares of A-1 Preferred), or redeem,purchase or otherwise acquire for value, or set apart money or other propertyfor any mandatory purchase or analogous fund for the redemption, purchase oracquisition of any shares of capital stock of the Company (except with respectto the repurchase of shares of common stock held by employees, officers ordirectors of the Company, which has been approved by the Company’s Board ofDirectors); (7) consummate an acquisition or enter into an agreement withrespect to an acquisition; (8) materially change the nature or scope ofthe business of the Company to a business other than the manufacturing orformulation of devices or drugs for aerosol delivery; (9) consummate oragree to make any sale, transfer, assignment, pledge, lease, license or similartransaction by which the Company grants on an exclusive basis any rights to anyof the Company’s intellectual property other than intellectual propertyrelating to the Company’s insulin program or the licensing of any of theCompany’s intellectual property to a ventilator manufacturer for incorporationinto such manufacturer’s ventilator technology; (10) create, incur, assumeor suffer to exist, any lien, charge or other encumbrance on any of itsproperties or assets, other than liens of carriers, warehousemen, artisans,bailees, mechanics and materialmen incurred in the ordinary course of businesssecuring sums not overdue; or (11) agree to do any of the foregoing.

**NOTE 9—STOCKHOLDERS’ EQUITY:**

***Common Stock***

On October 30, 2003, a five-for-one reverse splitof the Company’s stock was approved by the shareholders. The reverse split waseffective on October 31, 2003. All references to common shares, warrantsand options to purchase common shares, per share amounts, common share pricesand exercise/conversion prices have been retroactively adjusted to reflect thestock split.

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**AEROGEN, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) (Tabular amounts in thousands, except per share amounts)**

Each share of common stock has the right to one vote.The holders of common stock are also entitled to receive dividends wheneverfunds are legally available and when declared by the Board of Directors,subject to the prior rights of holders of all classes of stock outstandinghaving priority rights as to dividends. No dividends on the Company’s commonstock have been declared or paid as of December 31, 2004.

The Company issued shares of its common stock tocertain employees under stock purchase and other agreements, some of whichcontain repurchase provisions in the event of termination of service with theCompany. The shares are generally released from repurchase provisions ratablyover two to four years. Included in common stock as of December 31, 2004,2003 and 2002 are no shares, no shares and 13,890 shares subject to repurchase,respectively.

The lease on our MountainView facility was amended in November 2003 to defer a significant portionof our rent during a two-year period to be paid during the last six years ofthe lease in exchange for the issuance of 60,000 shares of common stock to ourlandlord. In March 2004, the lease was amended again (see Note 7),and as part of the arrangement, the Company issued an additional 50,000 sharesof common stock to the landlord.

***Stock Option Plans***

The Company has reserved shares of common stock forissuance under the 2000 Equity Incentive Plan, the Amended and Restated 1996Stock Option Plan, and the Amended and Restated 1994 Stock Option Plan (the “StockPlans”). Under the Stock Plans, the Board of Directors may issue incentivestock options to employees and nonstatutory stock options to employees,consultants or nonemployee directors of the Company, and stock purchase rightsto employees, nonemployee directors, or consultants. The Board of Directors hasthe authority to determine to whom options will be granted, the number of shares,the term and exercise price (which cannot be less than fair market value atdate of grant for incentive stock options or 85% of fair market value fornonstatutory stock options). If an employee owns stock representing more than10% of the outstanding shares, the price of each share must be at least 110% offair market value, as determined by the Board of Directors. Options generallyvest over four years and expire ten years from date of grant. All optionsgranted prior to December 4, 2000, are immediately exercisable; if optionsare immediately exercised, the shares are subject to a right of repurchase bythe Company that lapses over time. Unvested shares obtained by early exerciseare subject to repurchase by the Company upon termination of the holder’s serviceto the Company. As of December 31, 2004, there were no longer any sharesof common stock subject to the Company’s repurchase rights. At December 31,2003 and 2002, 646 and 1,282 shares of common stock, respectively, were subjectto the Company’s repurchase rights.

On an annual basis, on the date of the annualstockholders’ meeting, the authorized shares available for issuance under theCompany’s 2000 Equity Incentive Plan will automatically be increased by anumber of shares equal to the lesser of 4.5% of the then outstanding shares ofcommon stock on a fully-diluted basis, 400,000 shares, or a lesser number ofshares determined by the Board of Directors. In May 2004, the number ofauthorized shares available for issuance under this plan was increased by4,915,309, including the annual increase of 400,000 as set forth in the plandocument.

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**AEROGEN, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) (Tabular amounts in thousands, except per share amounts)**

In 2000, the Company adopted the 2000 Non-EmployeeDirectors’ Stock Option Plan (“2000 Non-Employee Plan”) under which 50,000shares of common stock were originally reserved for issuance. The Companyterminated this plan on April 2, 2004. Under the terms of the 2000Non-Employee Plan, each new non-employee director elected was granted an optionto purchase 15,000 shares of common stock, which vested over a three-yearperiod. In addition, on an annual basis, the Plan provided that on the date ofthe annual stockholder meeting, each non-employee director was granted anoption to purchase 5,000 shares of common stock which vested over a three-yearperiod. The exercise price of such options will be the fair market value of thecommon stock on the date of grant and the term was 10 years. During 2003,the Company did not grant any stock options as it was subject to Californiablue sky laws which prohibit, among other things, the issuance of stock optionsunless the issuer has completed a successful review of its stock option planswith the state which was not the case in 2003.

Activityunder the Stock Plans has been as follows:
| ** **                        | ** ** | ** **    | ** ** | **Number of** | ** ** | **Weighted-Average** | ** ** |
|-----------------------------------|------------|---------------|------------|--------------------|------------|----------------------|------------|
| ** **                        | ** ** | **Available** | ** ** | **Options**        | ** ** | **Exercise**         | ** ** |
| ** **                        | ** ** | **Options**   | ** ** | **Outstanding**    | ** ** | **Price**            | ** ** |
| Balances,  December 31, 2001 |       |          | 141        |               |       |                 | 693        |   |   |   | $ | 19.39 |   |   |
| Reservation of  shares            |       |          | 187        |               |       |                 | —     |   |   |   | — |   |   |
| Options granted                   |       |          | (189       | )                  |       |                 | 189        |   |   |   | 3.44 |   |   |
| Options exercised                 |       |          | —     |               |       |                 | (4         | ) |   |   | 7.96 |   |   |
| Options canceled                  |       |          | 213        |               |       |                 | (213       | ) |   |   | 20.19 |   |   |
| Shares  repurchased               |       |          | 2          |               |       |                 | —     |   |   |   | — |   |   |
| Balances, December 31, 2002  |       |          | 354        |               |       |                 | 665        |   |   |   | 14.70 |   |   |
| Options exercised                 |       |          | —     |               |       |                 | —     |   |   |   | — |   |   |
| Options canceled                  |       |          | 188        |               |       |                 | (188       | ) |   |   | 18.47 |   |   |
| Balances, December 31, 2003  |       |          | 542        |               |       |                 | 477        |   |   |   | 13.22 |   |   |
| Reservation of shares             |       |          | 4,915      |               |       |                 | —     |   |   |   | — |   |   |
| Plan shares  expired              |       |          | (43        | )                  |       |                 | —     |   |   |   | — |   |   |
| Options granted                   |       |          | (3,845     | )                  |       |                 | 3,845      |   |   |   | 2.63 |   |   |
| Options exercised                 |       |          | —     |               |       |                 | (5         | ) |   |   | 1.85 |   |   |
| Options canceled                  |       |          | 234        |               |       |                 | (234       | ) |   |   | 7.52 |   |   |
| Balances,  December 31, 2004 |       |          | 1,803      |               |       |                 | 4,083      |   |   |   | $ | 3.60 |   |   |

 

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**AEROGEN, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) (Tabular amounts in thousands, except per share amounts)**

Theoptions outstanding and currently exercisable at December 31, 2004, byexercise price, are as follows:
| ** **               | ** ** | **Options Outstanding** | ** ** | **Options Vested and Exerercisable** | ** ** |
|--------------------------|------------|------------------------------|------------|-----------------------------------------------------|------------|
| ** **               | ** ** | ** **                   | ** ** | **Weighted**                                        | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **               | ** ** | ** **                   | ** ** | **Average**                                         | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **               | ** ** | ** **                   | ** ** | **Remaining**                                       | ** ** | **Weighted** | ** ** | ** ** | ** ** | **Weighted** | ** ** |
| ** **               | ** ** | **Number of**           | ** ** | **Contractual**                                     | ** ** | **Average** | ** ** | ** ** | ** ** | **Average** | ** ** |
| **Range of**        | ** ** | **Options**                  | ** ** | **Life**                                            | ** ** | **Exercise** | ** ** | **Number** | ** ** | **Exercise** | ** ** |
| **Exercise Prices** | ** ** | ** **                   | ** ** | **Outstanding**                                     | ** ** | **(in Years)** | ** ** | **Price** | ** ** | **      Exercisable      ** | ** ** | **         Price         ** | ** ** |
| $1.20 - $2.42            |       |                         | 283        |                                                |       |   | 9.18 |   |   |   | $ | 2.00 |   |   |   | 57 |   |   |   | $ | 1.85 |   |   |
| $2.65                    |       |                         | 3,315      |                                                |       |   | 9.49 |   |   |   | 2.65 |   |   |   | — |   |   |   | — |   |   |
| $2.69 - $2.83            |       |                         | 138        |                                                |       |   | 9.57 |   |   |   | 2.76 |   |   |   | — |   |   |   | — |   |   |
| $2.96 - $8.10            |       |                         | 111        |                                                |       |   | 7.49 |   |   |   | 4.76 |   |   |   | 62 |   |   |   | 5.43 |   |   |
| $15.00 - $15.05          |       |                         | 156        |                                                |       |   | 6.15 |   |   |   | 15.03 |   |   |   | 141 |   |   |   | 15.02 |   |   |
| $18.75                   |       |                         | 2          |                                                |       |   | 5.55 |   |   |   | 18.75 |   |   |   | 2 |   |   |   | 18.75 |   |   |
| $21.80                   |       |                         | 10         |                                                |       |   | 6.70 |   |   |   | 21.80 |   |   |   | 10 |   |   |   | 21.80 |   |   |
| $22.50                   |       |                         | 5          |                                                |       |   | 5.67 |   |   |   | 22.50 |   |   |   | 5 |   |   |   | 22.50 |   |   |
| $22.70                   |       |                         | 7          |                                                |       |   | 6.33 |   |   |   | 22.70 |   |   |   | 7 |   |   |   | 22.70 |   |   |
| $25.00                   |       |                         | 43         |                                                |       |   | 6.15 |   |   |   | 25.00 |   |   |   | 43 |   |   |   | 25.00 |   |   |
| $30.95                   |       |                         | 1          |                                                |       |   | 6.52 |   |   |   | 30.95 |   |   |   | 1 |   |   |   | 30.95 |   |   |
| $33.75                   |       |                         | 4          |                                                |       |   | 5.75 |   |   |   | 33.75 |   |   |   | 4 |   |   |   | 33.75 |   |   |
| $37.50                   |       |                         | 8          |                                                |       |   | 5.81 |   |   |   | 37.50 |   |   |   | 8 |   |   |   | 37.50 |   |   |
|                     |       |                         | 4,083      |                                                |       |   | 9.23 |   |   |   | $ | 3.60 |   |   |   | 340 |   |   |   | $ | 13.60 |   |   |
|                          |            |                              |            |                                                     |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

***Employee Stock Purchase Plan***

In November 2000, the stockholders approved the2000 Employee Stock Purchase Plan (the “Purchase Plan”) authorizing theissuance of 50,000 shares of common stock pursuant to purchase rights grantedto employees in the United States.

On an annual basis, on the date of the annualstockholders’ meeting for a period of 20 years, the share reserve willautomatically be increased by a number of shares equal to the lesser of 1.0% ofthe then outstanding shares of common stock on a fully diluted basis, 50,000shares, or a lesser number of shares determined by the Board of Directors. In May 2004,the number of authorized shares available for issuance under this plan wasincreased by 1,639,752.

The Purchase Plan is intended to qualify as anemployee stock purchase plan within the meaning of Section 423 of theInternal Revenue Code of 1986, as amended. As of December 31, 2004,112,438 shares of common stock have been purchased under the Purchase Plan and1,659,971 shares remain available for purchase.

The Purchase Plan permitseligible employees to purchase common stock at a discount through payrolldeductions during defined offering periods. The price at which stock ispurchased under the purchase plan is equal to 85% of the fair market value ofthe common stock on the first day of the offering period or 85% of the fairmarket value on the subsequent designated purchase dates, whichever is lower.

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**AEROGEN, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) (Tabular amounts in thousands, except per share amounts)**

***Deferred stock-based compensation***

During 2000 and 1999, the Company issued options tocertain employees under the Company’s equity compensation plans with exerciseprices below the deemed fair market value of the Company’s common stock at thedate of grant. In accordance with the requirements of APB 25, the Company hasrecorded deferred stock-based compensation for the difference between theexercise price of the stock options and the deemed fair market value of theCompany’s stock at the date of grant. This deferred stock-based compensation isamortized to expense on a straight line basis, over the period during which theCompany’s right to repurchase the stock lapses or the options become vested,generally four years. As of December 31, 2004, the Company had recordedcumulative deferred stock-based compensation related to these options in theamounts of $4,377,000, net of cancellations, of which $264,000, $990,000 and$1,335,000 had been amortized to expense during 2004, 2003 and 2002,respectively.

Stock-basedcompensation expense related to stock options granted to non-employees isrecognized on a straight-line basis as the stock options are earned. TheCompany believes that the fair value of the stock options is more reliablymeasurable than the fair value of the services received. The fair value of thestock options granted to non-employees is calculated at each reporting dateusing the Black-Scholes option-pricing model as prescribed by SFAS No. 123using the following assumptions:
| ** **                | ** ** | **Years Ended December 31,** | ** ** |
|---------------------------|------------|---------------------------------------------|------------|
| ** **                | ** ** | **  2004  **            | ** ** | **  2003  ** | ** ** | **  2002  ** | ** ** |
| Risk-free  interest rate  |       |                                        | 3.54       | % |   |   | 4.45 | % |   |   | 4.59 | % |   |
| Expected life (in  years) |       |                                        | 9.64       |   |   |   | 10 |   |   |   | 10 |   |   |
| Dividend yield            |       |                                        | —     |   |   |   | — |   |   |   | — |   |   |
| Expected volatility       |       |                                        | 100        | % |   |   | 100 | % |   |   | 100 | % |   |

 

The stock-basedcompensation expense will fluctuate as the fair market value of the commonstock fluctuates. In connection with the grant of stock options tonon-employees, the Company amortized to expense stock-based compensation in theamounts of $8,000, $16,000 and $20,000 in 2004, 2003 and 2002, respectively.

***Warrants***

In connection with financing arrangements entered intoby the Company in July 1995 and October 1997, the Company issuedwarrants to purchase 2,136 shares of common stock and warrants to purchase65,000 shares of Series C convertible preferred stock at exercise pricesof $11.70 and $1.00, respectively. Due to the automatic conversion of theconvertible preferred stock in connection with the Company’s initial publicoffering, the warrants for Series C convertible preferred stock becameexercisable for 4,333 shares of common stock at $15.00 per share. The warrantsissued in July of 1995 expired unexercised on June 30, 2002, and the October 1997warrants expired unexercised on October 14, 2004.

In connection with the issuance of convertibledebentures to SF Capital in September and November 2003, the Companyissued warrants to purchase 271,428 and 152,439 shares of common stock atoriginal exercise prices of $1.75 and $3.28, respectively (see Note 7).

In connection with the issuance of the CarpenterDebenture (see Note 7) in January 2004, the Company issued a warrant topurchase 82,129 shares of common stock at a price of $3.044 per share.

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**AEROGEN, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) (Tabular amounts in thousands, except per share amounts)**

In connection with theissuance of the Series A-1 Convertible Preferred Stock, the Company issuedwarrants to purchase a total of 11,249,390 shares of common stock at anexercise price of $3.25 per share (see Note 8).

***Notes receivable***

In May 1994, theCompany loaned $69,009 to a stockholder employee. The note bore interest at6.43% per annum, became due May 2003, and has been fully repaid. In August 1996,the Company loaned an additional $200,000 to the same individual. The note wasnon-interest bearing, was originally due in 2001 and is partiallycollateralized by 33,333 shares of common stock. The note was amended in 2002to extend the due date until December 31, 2006 and to bear interest at4.38% per annum. In July 2000, the Company loaned the same employee anadditional $50,000. This loan bears interest at 6.62% per annum, is due in July 2005and is collateralized by the same 33,333 shares of common stock. At December 31,2004, 2003 and 2002, $292,000, $279,000 and $371,000 of principal and accruedinterest were outstanding under these notes, respectively. The Company hasarranged with this stockholder/employee that the Company will receive a portionof the proceeds from certain sales of the employee’s non-collateralized Companystock until the employee’s notes to the Company have been paid in full.

**NOTE 10—INCOME TAXES:**

At December 31, 2004, the Company has a netoperating loss carryforward of approximately $82,355,000 for federal and$35,394,000 for state tax purposes. If not utilized, these carryforwards willbegin to expire in 2009 for federal and in 2004 for state purposes.

Thetax effects of temporary differences and carryforwards that give rise tosignificant portions of the net deferred tax assets as of December 31,2004 and 2003 are as follows:
| ** **                                 | ** ** | **December 31,** | ** ** |
|--------------------------------------------|------------|-----------------------|------------|
| ** **                                 | ** ** | **2004**              | ** ** | **2003** | ** ** |
| Deferred tax assets:                       |       |                  |       |   |   |
| Net operating loss carryforwards           |       | $                     | 31,282     |   | $ | 31,715 |   |
| Federal and state tax credit carryforwards |       | 3,852                 |       | 3,352 |   |
| Research and development capitalization    |       | 8,782                 |       | 2,499 |   |
| Depreciation and amortization              |       | 1,110                 |       | 1,075 |   |
| Accrued liabilities and reserves           |       | 396                   |       | 93 |   |
| Other                                      |       | 1,068                 |       | 1,617 |   |
|                                       |       | 46,490                |       | 40,351 |   |
| Less: Valuation allowance                  |       | (46,490               | )          | (40,351 | ) |
| Net deferred tax assets                    |       | $                     | —     |   | $ | — |   |

 

Based on the available objective evidence, managementbelieves it is likely that the net deferred tax assets are not fullyrealizable. Accordingly, the Company has established a full valuation allowanceagainst its net deferred tax assets as of December 31, 2004. The increasein the valuation allowance was $6,139,000, $6,723,000 and $8,689,000 during theyears ended December 31, 2004, 2003 and 2002, respectively.

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**AEROGEN, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) (Tabular amounts in thousands, except per share amounts)**

The Company has research credit carryforwards ofapproximately $2,207,000 and $2,323,000 for federal and state income taxpurposes, respectively. If not utilized, the federal credits will expire invarious amounts beginning in 2013. The state credits can be carried forwardindefinitely.

The Tax Reform Act of 1986limits the use of net operating loss and tax credit carryforwards in certainsituations where changes occur in the stock ownership of a company. In theevent the Company has a change in ownership, utilization of the carryforwardscould be restricted.

**NOTE 11—EMPLOYEE BENEFIT PLAN:**

In August 1996, theCompany adopted a retirement plan (the “401(k) Plan”), which is qualifiedunder Section 401(k) of the Internal Revenue Code of 1986. Eligibleemployees may make voluntary contributions to the 401(k) Plan of up to 20%of their annual compensation, not to exceed the statutory limit, and theCompany may make matching contributions. During the years ended December 31,2004, 2003 and 2002, the Company made approximately $23,000, $28,000 and$54,000, respectively, of matching contributions to the 401(k) Plan. Priorto 2001, the Company had not made any such contributions.

**NOTE12—QUARTERLY FINANCIAL DATA (UNAUDITED):**

The consolidated financial statements for March 31,2004, June 30, 2004, and September 30, 2004 have been restated fromamounts previously reflected in the Company’s Form 10-Q’s for thoserespective periods to reflect a revision in the accounting for the Company’s Series A-1Preferred Stock issuance and related warrants. Previously, the Company hadaccounted for the warrants as a component of permanent equity. The Companysubsequently concluded that the warrants should be recorded as a liability andmarked-to-market at the end of each reporting period (See Note 8). This changehad the impact of increasing total liabilities, and decreasing redeemableconvertible preferred stock and stockholders’ equity. Also as a result, theCompany changed the amount of the beneficial conversion feature recorded in thefirst and second quarter, and recorded gains and losses in each quarter due tothe change in the fair value of the warrant. The change is more fully describedin the Company’s Form 10-Q/A’s filed on April 15, 2005.

Thefollowing tables present certain unaudited, consolidated, quarterly financialinformation for the last eight quarters ended December 31, 2004:
| ** **                                             | ** ** | **Fiscal 2004 Quarter Ended** | ** ** |
|--------------------------------------------------------|------------|----------------------------------------------|------------|
| ** **                                             | ** ** | **March 31,**                           | ** ** | **June 30,** | ** ** | **September 30,** | ** ** | **December 31,** | ** ** |
| ** **                                             | ** ** | **(Restated)**                               | ** ** | **(Restated)** | ** ** | **(Restated)** | ** ** | ** ** | ** ** |
| Total revenues                                         |       | $                                            | 1,099      |   |   | $ | 1,695 |   |   |   | $ | 1,213 |   |   |   | $ | 2,241 |   |   |
| Gross margin                                           |       | 112                                          |       |   | (6 | ) |   |   | 74 |   |   |   | 197 |   |   |
| Loss from  operations                                  |       | (3,576                                       | )          |   | (3,745 | ) |   |   | (4,327 | ) |   |   | (4,129 | ) |   |
| Net income (loss)                                      |       | (5,415                                       | )          |   | (4,155 | ) |   |   | 1,652 |   |   |   | (2,156 | ) |   |
| Net income (loss)  attributable to common shareholders |       | $                                            | (11,875    | ) |   | $ | (9,783 | ) |   |   | $ | 337 |   |   |   | $ | (1,850 | ) |   |
| Net income (loss)  per common share, basic and diluted |       | $                                            | (2.66      | ) |   | $ | (2.05 | ) |   |   | $ | 0.07 |   |   |   | $ | (0.37 | ) |   |

 

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**AEROGEN, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) (Tabular amounts in thousands, except per share amounts)**

 
| ** **                                    | ** ** | **Fiscal 2003 Quarter Ended** | ** ** |
|-----------------------------------------------|------------|----------------------------------------------|------------|
| ** **                                    | ** ** | **March 31,**                           | ** ** | **June 30,** | ** ** | **September 30,** | ** ** | **December 31,** | ** ** |
| Total revenues                                |       |                                         | $          | 1,568 |   |   |   | $ | 1,114 |   |   |   | $ | 519 |   |   |   | $ | 970 |   |   |
| Gross margin                                  |       |                                         | 444        |   |   |   | 378 |   |   |   | 144 |   |   |   | (64 | ) |   |
| Loss from  operations                         |       |                                         | (4,375     | ) |   |   | (3,962 | ) |   |   | (4,127 | ) |   |   | (3,912 | ) |   |
| Net loss                                      |       |                                         | $          | (4,297 | ) |   |   | $ | (3,622 | ) |   |   | $ | (4,355 | ) |   |   | $ | (5,145 | ) |   |
| Net loss per common  share, basic and diluted |       |                                         | $          | (1.05 | ) |   |   | $ | (0.88 | ) |   |   | $ | (1.06 | ) |   |   | $ | (1.22 | ) |   |

 

Theeffect of the restatement adjustments on the previously reported amounts forthe year ended December 31, 2004 are set forth in the following table.
| ** **                                             | ** ** | **Condensed Consolidated Statement of Operations for the three months ended** | ** ** |
|--------------------------------------------------------|------------|----------------------------------------------------------------------------------------------------------------------------|------------|
| ** **                                             | ** ** | **March 31, 2004**                                                                                               | ** ** | **June 30, 2004** | ** ** | **September 30, 2004** | ** ** |
| ** **                                             | ** ** | **As restated**                                                                                                       | ** ** | **As Previously  reported** | ** ** | **As restated** | ** ** | **As Previously  reported** | ** ** | **As restated** | ** ** | **As Previously  reported** | ** ** |
| Decrease in  warrant liability                         |       | $                                                                                                                          | (1,060     | ) |   | $ | — |   |   |   | $ | (361 | ) |   |   | $ | — |   |   |   | $ | 5,742 |   |   |   | $ | — |   |   |
| Net income (loss)                                      |       | (5,415                                                                                                                     | )          |   | (4,355 | ) |   |   | (4,155 | ) |   |   | (3,794 | ) |   |   | 1,652 |   |   |   | (4,090 | ) |   |
| Dividends related  to convertible preferred stock      |       | (6,460                                                                                                                     | )          |   | (7,932 | ) |   |   | (5,628 | ) |   |   | (4,881 | ) |   |   | (514 | ) |   |   | (514 | ) |   |
| Net income (loss)  attributable to common stockholders |       | (11,875                                                                                                                    | )          |   | (12,287 | ) |   |   | (9,783 | ) |   |   | (8,675 | ) |   |   | 337 |   |   |   | (4,604 | ) |   |
| Net income (loss)  per share, basic and diluted        |       | (2.66                                                                                                                      | )          |   | (2.76 | ) |   |   | (2.05 | ) |   |   | (1.81 | ) |   |   | 0.07 |   |   |   | (0.96 | ) |   |
|                                                        |            |                                                                                                                            |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 
| ** **                                 | ** ** | **Condensed Consolidated Balance Sheets** | ** ** |
|--------------------------------------------|------------|----------------------------------------------------------|------------|
| ** **                                 | ** ** | **As restated**                                     | ** ** | **As Previously  reported** | ** ** | **As restated** | ** ** | **As Previously  reported** | ** ** | **As restated** | ** ** | **As Previously  reported** | ** ** |
| Warrant liability                          |       | $                                                        | 9,260      |   |   | $ | — |   |   | $ | 17,558 |   |   | $ | — |   |   | $ | 11,816 |   |   | $ | — |   |   |
| Total liabilities                          |       | 17,120                                                   |       |   | 7,860 |   |   | 22,832 |   |   | 5,274 |   |   | 17,690 |   |   | 5,874 |   |   |
| Redeemable  convertible preferred stock    |       | 6,440                                                    |       |   | 8,072 |   |   | 16,351 |   |   | 12,573 |   |   | 16,351 |   |   | 12,573 |   |   |
| Additional  paid-in capital                |       | 112,167                                                  |       |   | 118,735 |   |   | 111,779 |   |   | 131,694 |   |   | 111,527 |   |   | 131,442 |   |   |
| Accumulated  deficit                       |       | (114,886                                                 | )          |   | (113,826 | ) |   | (119,041 | ) |   | (117,620 | ) |   | (117,389 | ) |   | (121,710 | ) |   |
| Total stockholders’  equity (deficit) |       | (2,327                                                   | )          |   | 5,301 |   |   | (6,705 | ) |   | 14,631 |   |   | (5,234 | ) |   | 10,360 |   |   |
|                                            |            |                                                          |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

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**Item 9A. CONTROLS AND PROCEDURES**

*Evaluation of disclosure controlsand procedures.  *We conducted an evaluation of theeffectiveness of the design and operation of our “disclosure controls andprocedures” (“Disclosure Controls”) as of the end of the period covered by thisAnnual Report. The controls evaluation was done under the supervision and withthe participation of management, including our Chief Executive Officer (“CEO”)and Chief Financial Officer (“CFO”). Based on the evaluation as of the end ofthe period covered by this Annual Report, our CEO and CFO have concluded thatAerogen’s disclosure controls and procedures (as defined in Rules 13a-15(e) and15d-15(e) under the Securities Exchange Act of 1934, as amended (the “ExchangeAct”) were sufficiently effective to ensure that the information required to bedisclosed by Aerogen in the reports that we file under the Exchange Act isgathered, analyzed and disclosed with adequate timeliness, accuracy andcompleteness, with the exception of the accounting for complex derivativesdescribed below.

*Changes ininternal controls.  *We restated our financial resultsfor the quarters ended March 31, June 30, and September 30, 2004to reflect adjustments to our previously reported financial information. Therestatement arose due to errors related to the initial valuation, classification,and subsequent accounting for the warrants issued in connection with the salesof our Series A-1 Redeemable Convertible Preferred Stock on March 23,2004 and May 12, 2004.

In connection with the restatement of our financialresults for the quarters ended March 31, June 30 and September 30,2004, we have identified material weaknesses in our internal controls andprocedures. Also, as of the end of the period covered by this report, wecarried out an evaluation, under the supervision and participation of our ChiefExecutive Officer and Chief Financial Officer, of the effectiveness of thedesign and operation of our disclosure controls and procedures. We havedetermined that the disclosure controls and procedures were not effectivebecause they failed to identify the errors which led to the restatement. Inresponse, in March 2005, we implemented a policy that requires for anyfuture issuance of complex equity and derivative instruments or other complextransactions, an outside expert with experience concerning the relatedaccounting issues will be consulted, or additional internal staff will betrained or hired. In addition, enhanced review and documentation procedureshave been implemented in our accounting process in order to ensure accuracy ofall accounting entries. There have been no other changes in our internalcontrols subsequent to the date of the evaluation referred to above. Indesigning and evaluating the disclosure controls and procedures, managementrecognized that any controls and procedures, no matter how well designed andoperated, can provide only reasonable assurance of achieving the desiredcontrol objectives. It should be noted that the design of any system ofcontrols is based, in part, upon certain assumptions about the likelihood offuture events, and there can be no assurance that any design will succeed inachieving its stated goals under all potential future conditions, regardless ofhow remote.

Given the additional measures adopted by the Companyin March 2005, our Chief Executive Officer and our Chief Financial Officerhave concluded that our disclosure controls and procedures are now effectivelydesigned to ensure that information we are required to disclose in reports thatwe file or submit under the Securities Exchange Act of 1934 is recorded,processed, summarized and reported within the time periods specified inSecurities and Exchange Commission rules and forms.

*Limitationson the effectiveness of controls.  *The Company’smanagement, including CEO and CFO, does not expect that our Disclosure Controlsor our internal controls over financial reporting will prevent all errors andall fraud. A control system, no matter how well designed and operated, canprovide only reasonable, not absolute, assurance that the control system’sobjectives will be met. Further, the design of a control system must reflectthe fact that there are resource constraints, and the benefits of controls mustbe considered relative to their costs. Because of the inherent limitations inall control systems, no evaluation of controls can provide absolute assurancethat all control issues and instances of fraud, if any, within the company havebeen detected. These inherent limitations include the realities that judgmentsin decision-

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making can befaulty and that breakdowns can occur because of simple error or mistake.Controls can also be circumvented by the individual acts of some persons, bycollusion of two or more people, or by management override of the controls. Thedesign of any system of controls is based in part on certain assumptions aboutthe likelihood of future events, and there can be no assurance that any designwill succeed in achieving its stated goals under all potential future conditions.Over time, controls may become inadequate because of changes in conditions ordeterioration in the degree of compliance with policies or procedures. Becauseof the inherent limitations in a cost-effective control system, misstatementsdue to error or fraud may occur and not be detected. Accordingly, ourDisclosure Controls and our internal controls over financial reporting aredesigned to provide reasonable, not absolute, assurance that the objectives ofour disclosure control system are met and, as set forth above.

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**PART III**

**Item10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT**
| **Name and Positions with Aerogen in Addition to Director** | ** ** | ** ** | ** ** | **Age** | ** ** | **Director  Continuously Since** | ** ** |
|-----------------------------------------------------------------------------------------------------|------------|------------|------------|---------|------------|---------------------------------------|------------|
| **Class I Directors**                                                                          |       |       |       |    |       |                                  |       |
| Dr. Phyllis  I. Gardner                                                                        |       | 54         |       |    | 2000       |                                  |       |
| Robert Roe(1)                                                                                       |       | 63         |       |    | 2004       |                                  |       |
| **Class II Directors**                                                                         |       |       |       |    |       |                                  |       |
| Dr. Jane E.  Shaw (Chairman and Chief Executive Officer)                                       |       | 66         |       |    | 1998       |                                  |       |
| **Class III Directors**                                                                        |       |       |       |    |       |                                  |       |
| Jean-Jacques  Bienaime                                                                              |       | 51         |       |    | 1999       |                                  |       |
| Yehuda Ivri  (Chief Technical Officer)                                                              |       | 53         |       |    | 1991       |                                  |       |
| Bernard Collins                                                                                     |       | 56         |       |    | 2002       |                                  |       |

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(1)          RobertRoe joined the Board on December 16, 2004

**Business Experience of Directors**

***Class IDirectors***

**Phyllis Gardner**joinedAerogen’s Board of Directors in May 2000. Dr. Gardner is the SeniorAssociate Dean for Education and Student Affairs and Associate Professor ofMolecular Pharmacology and Medicine at Stanford University School of Medicine,and has been with the University since 1984. Between 1996 and 1998, Dr. Gardnerwas Vice President of Research and Principal Scientist of ALZA Corporation, apharmaceutical company, and head of the ALZA Technology Institute. Between 1994and 1996, Dr. Gardner was a consultant to ALZA. Dr. Gardner receiveda B.S. in Biology from the University of Illinois and an M.D. from HarvardMedical School.

**Robert L.Roe, M.D**. has served as a director of Aerogen since December 2004.Dr. Roe has over 28 years of management and pharmaceutical experience. Hehas served as President of Corcept Therapeutics, Inc. since 2001. From1999 to 2001, he served as President and Chief Executive Officer and a Directorof Allergenics, Inc. While at Cytel Corporation between 1996 and 1999, Dr. Roewas Executive Vice President, Chief Operating Officer and a Director. At ChugaiBiopharmaceuticals, Inc. from 1995 to 1996, he was Executive VicePresident, Chief Operating Officer and a Director. Starting at Syntex ResearchDivision, Syntex Corporation in 1976, Dr. Roe progressed through a seriesof clinical and development research roles culminating in the position ofPresident, Development Research Division and Senior Vice President of SyntexCorporation between 1992 and 1995. Dr. Roe received his A.B. from StanfordUniversity and his M.D. from the University of California, San Francisco.

***Class IIDirectors***

**JaneE. Shaw, Ph.D.**, has served as Chairman of our Board ofDirectors and as our Chief Executive Officer since 1998. Dr. Shaw heldvarious scientific and management positions with ALZA Corporation, apharmaceutical company, from 1970 to 1994, most recently as President and ChiefOperating Officer from 1987 to 1994. Dr. Shaw received a B.Sc. and Ph.D.in Physiology from Birmingham University in England. Dr. Shaw serves as adirector of OfficeMax Corporation, Intel Corporation, and McKesson Corporation.

***Class IIIDirectors***

**Jean-JacquesBienaimé**, has served on Aerogen’s Board of Directors since1999. Since November 2002, Mr. Bienaimé has been President, ChiefExecutive Officer and Chairman of the Board of Genencor International. Beforejoining Genencor, Mr. Bienaimé was President, Chief Executive Officer 

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and adirector of SangStat Medical Corporation since 1998 and Chairman of its Boardof Directors since October 2000. Mr. Bienaimé held various positionsat Rhône Poulenc Rorer Inc., from 1992 to 1998, most recently as Senior VicePresident of Corporate Marketing and Business Development. Mr. Bienaiméreceived an M.B.A. from the Wharton School of the University of Pennsylvaniaand a degree in Economics from Ecole Supérieure de Commerce de Paris in France.Mr. Bienaimé is also on the Board of Directors of NeurogesX, Saegis andEnsemble Corporation.

**BernardCollins,** currently is an independent consultant in the areasof business strategy and management. From 1994 to 2000, he was the VicePresident, International Operations at the Boston Scientific Corporation. Priorto that time he was a management consultant and held management positions inmedical device/healthcare companies. Mr. Collins received a B.A. inIndustrial Psychology from the National University of Cork. He serves as adirector of several privately held companies.

**Audit Committee**

The current members of theAudit Committee are Messrs. Collins, Roe and Bienaimé. The Audit Committee isresponsible for assisting the Board in its responsibilities of overseeing theCompany’s financial affairs. In this capacity, the Audit Committee reviews theCompany’s consolidated financial statements and quarterly earnings withmanagement and with the Company’s independent accountants, and consults withthe Company’s independent accountants concerning their audit plan, the resultsof their audit, the appropriateness of accounting principles used by theCompany, the adequacy of the Company’s internal controls and the independenceof the accountants. The Board ofDirectors annually reviews the Nasdaq listing standards definition ofindependence for Audit Committee members and has determined that all members ofthe Company’s Audit Committee are independent (as independence is currentlydefined in Rule 4350(d)(2)(A)(i) and (ii) of the Nasdaq listingstandards). The Board has determined that Jean-Jacques Bienaiméqualifies as an “audit committee financial expert,” as defined in applicableSEC rules. The Board made an assessment of Mr. Bienaimé’s level ofknowledge and experience based on a number of factors, including his formaleducation and experience as the president and chief executive of apublicly-traded biotechnology company.

***ExecutiveOfficers***

The information related toExecutive Officers required by this item is incorporated by reference to item 1of this Registration Statement.

**YehudaIvri,** founded Aerogen in 1991 and has served as a memberof our Board of Directors since its inception. Mr. Ivri has served as ourChief Technical Officer since 1996 and previously was our Chief Scientist andVice President. Mr. Ivri received an M.S. in Mechanical Engineering fromthe Technion-Israel Institute of Technology.

**Section 16(a)Beneficial Ownership Reporting Compliance**

Section 16(a) ofthe Securities Exchange Act of 1934 requires Aerogen’s directors and executiveofficers, and persons who own more than 10% of the Company’s Common Stock, tofile reports of ownership and changes in ownership of such stock with theSecurities and Exchange Commission (“SEC”). Directors, executive officers andgreater than 10% stockholders are required by SEC regulations to furnish theCompany with copies of all Section 16(a) forms they file.

To our knowledge, basedsolely on a review of the copies of such forms filed with the SEC and writtenrepresentations that no other reports were required to be filed during thefiscal year ended December 31, 2004, our directors, executive officers andgreater than 10% stockholders complied with all Section 16(a) filingrequirements except as follows:

·  Phyllis Gardner failed to timely file one Form4.

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**Code of Ethics**

We have adopted theAerogen, Inc. Code of Ethics which applies to all officers, directors,employees, associates and agents of Aerogen and any company that we own ormanage. Our Code of Ethics is available in the Corporate Governance section ofthe Investor Relations section of our web site at *www.aerogen.com*.If we make any substantive changes to our Code of Ethics or grant any waiverfrom a provision of the Code of Ethics to any executive officer or director wewill promptly disclose the nature of the amendment or waver on our web site.

**Item 11. EXECUTIVE COMPENSATION**

Thefollowing table sets forth certain information related to compensation paid oraccrued for services in all capacities during the fiscal years indicated withrespect to Dr. Jane E. Shaw, the Company’s Chairman and Chief ExecutiveOfficer and each of the Company’s other four most highly compensated executiveofficers at December 31, 2004 (the “Named Executive Officers”).

**SummaryCompensation Table**
|                                                 | ** ** | ** **                   | ** ** | ** **     | ** ** | ** **         | ** ** | **Securities** | ** ** | ** **  | ** ** |
|-------------------------------------------------|------------|------------------------------|------------|----------------|------------|--------------------|------------|----------------|------------|-------------|------------|
| ** **                                      | ** ** | **Annual Compensation** | ** ** | **Underlying** | ** ** | **All Other** | ** ** |
| **Name and Principal Positions** | ** ** | ** **                   | ** ** | **Year**       | ** ** | **Salary(1)**      | ** ** | **Bonus**      | ** ** | **Options** | ** ** | **Compensation** | ** ** |
| Dr. Jane E. Shaw, Ph.D.                    |       | 2004                         |       | $              | 269,984    |               |       | —         |       |        |       | 600,000 |   |   |   | — |   |   |
| Chairman and Chief Executive  Officer           |       | 2003                         |       | $              | 270,000    |               |       | —         |       |        |       | — |   |   |   | — |   |   |
|                                                 |       | 2002                         |       | $              | 271,188    |               |       | —         |       |        |       | — |   |   |   | — |   |   |
| Robert S.  Fishman, M.D.                        |       | 2004                         |       | $              | 239,990    |               |       | —         |       |        |       | 300,000 |   |   |   | — |   |   |
| Vice President, Scientific Affairs              |       | 2003                         |       | $              | 215,000    |               |       | —         |       |        |       | — |   |   |   | — |   |   |
|                                            |       | 2002                         |       | $              | 203,638    |               |       | —         |       |        |       | 9,000 |   |   |   | — |   |   |
| Robert S. Breuil(2)                             |       | 2004                         |       | $              | 239,990    |               |       | —         |       |        |       | 300,000 |   |   |   | — |   |   |
| Chief Financial Officer Vice  President         |       | 2003                         |       | $              | 210,000    |               |       | —         |       |        |       |   |   |   |   | — |   |   |
| Corporate Development                           |       | 2002                         |       | $              | 136,125    |               |       | —         |       |        |       | 36,500 |   |   |   | — |   |   |
| Nancy Isaac(3)                                  |       | 2004                         |       | $              | 221,395    |               |       | —         |       |        |       | 250,000 |   |   |   | — |   |   |
| Vice President, Regulatory Affairs and Quality  |       | 2003                         |       | $              | 205,000    |               |       | —         |       |        |       | — |   |   |   | — |   |   |
|                                            |       | 2002                         |       | $              | 83,637     |               |       | —         |       |        |       | 9,000 |   |   |   | — |   |   |
| Yehuda Ivri                                     |       | 2004                         |       | $              | 217,984    |               |       | —         |       |        |       | 250,000 |   |   |   | — |   |   |
| Chief Technical Officer                         |       | 2003                         |       | $              | 200,000    |               |       | —         |       |        |       | — |   |   |   | — |   |   |
|                                                 |       | 2002                         |       | $              | 160,022    |               |       | —         |       |        |       | 45,000 |   |   |   | — |   |   |
|                                                 |            |                              |            |                |            |                    |            |                |            |             |            |  |  |  |  |  |  |  |  |  |

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(1)          Amounts shown includecompensation earned and received by the Named Executive Officers as well asamounts deferred at the election of such persons under the Company’s TaxDeferral Investment Plan.

(2)          Mr. Breuil joinedthe Company in April 2002.

(3)          Ms. Isaac joinedthe Company in August 2002.

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Thefollowing table sets forth information relating to options granted in 2004 toeach Named Executive Officer. In addition, in accordance with rules of theSEC, the table shows hypothetical gains that would exist for such options basedon assumed rates of annual compound stock price appreciation of 5% and 10% peryear from the date the options were granted over the full option term.

***Options Grants in Fiscal YearEnded December 31, 2004***
| ** **            | ** ** | ** **                 | ** ** | **Potential Realizable**                                   | ** ** |
|-----------------------|------------|----------------------------|------------|-----------------------------------------------------------------|------------|
| ** **            | ** ** | ** **                 | ** ** | **Value at Assumed**                                  | ** ** |
| ** **            | ** ** | ** **                 | ** ** | **Annual Rates of**                                   | ** ** |
| ** **            | ** ** | ** **                 | ** ** | **Stock Price**                                            | ** ** |
| ** **            | ** ** | ** **                 | ** ** | **Appreciation for**                                       | ** ** |
| ** **            | ** ** | **Individual Grants** | ** ** | **Option Term(1)(4)**                                      | ** ** |
| **Name**              | ** ** | ** **                 | ** ** | **Number of  Securities  Underlying  Options  Granted(2)** | ** ** | **Percent of  Total Options  Granted to  Employees in  Fiscal Year(3)** | ** ** | **Exercise  Price Per  Share(4)** | ** ** | **Expiration  Date** | ** ** | **5%  Per Year** | ** ** | **10%  Per Year** | ** ** |
| Jane E. Shaw,  Ph.D.  |       |                       | 600,000    |                                                            |       |   | 16.1 | % |   |   | $ | 2.65 |   |   | 6/29/2014 |   | $ | 999,942 |   | $ | 2,534,051 |   |
| Robert Fishman,  M.D. |       |                       | 300,000    |                                                            |       |   | 8.1 | % |   |   | $ | 2.65 |   |   | 6/29/2014 |   | $ | 499,971 |   | $ | 1,267,025 |   |
| Robert S. Breuil      |       |                       | 300,000    |                                                            |       |   | 8.1 | % |   |   | $ | 2.65 |   |   | 6/29/2014 |   | $ | 499,971 |   | $ | 1,267,025 |   |
| Nancy Isaac           |       |                       | 250,000    |                                                            |       |   | 6.7 | % |   |   | $ | 2.65 |   |   | 6/29/2014 |   | $ | 416,643 |   | $ | 1,055,855 |   |
| Yehuda Ivri           |       |                       | 250,000    |                                                            |       |   | 6.7 | % |   |   | $ | 2.65 |   |   | 6/29/2014 |   | $ | 416,643 |   | $ | 1,055,855 |   |
|                       |            |                            |            |                                                                 |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

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(1)          The closing price of theCompany’s Common Stock as reported on the Nasdaq SmallCap Market was $1.96 on December 31,2004 and $1.36 on March 31, 2005. Actual gains, if any, on stock optionexercises are dependent on the future performance of the Company’s Common Stock.There can be no assurance that any of the value reflected in the table will beachieved.

(2)          Based on options topurchase a total of 3,835,000 shares of Common Stock granted to employeesduring the fiscal year ended December 31, 2004.

(3)          Options were granted atan exercise price equal to the fair market value of Aerogen Common Stock on thedate of the grant. Potential realizable value assumes appreciation from thevalue at the time of the grant. Value at the time of the grant is equal to theexercise price per share times the number of shares covered by the option.

The following table setsforth, with respect to the Named Executive Officers, certain informationrelated to options held by such officers during the fiscal year ended December 31,2004.

***Aggregated Option Exercise inFiscal Year Ended December 31, 2004***
| ** **               | ** ** | **Shares**   | ** ** | ** **           | ** ** | **Number of Securities  Underlying Unexercised** | ** ** | **Value of Securities  Underlying Unexercised** | ** ** |
|--------------------------|------------|--------------|------------|----------------------|------------|-----------------------------------------------------------------|------------|----------------------------------------------------------------|------------|
| ** **               | ** ** | **Acquired** | ** ** | **Value**            | ** ** | **Options at Year End(l)**                       | ** ** | **Options at Year End(2)**                      | ** ** |
| **Executives**           | ** ** | ** **   | ** ** | **on Exercise** | ** ** | **Realized**                                                    | ** ** | **Unexercisable**                                              | ** ** | **Exercisable** | ** ** | **Unexercisable** | ** ** | **Exercisable** | ** ** |
| Jane E. Shaw,  Ph.D.     |       |         | —     |                 |       |                                                            | —     |                                                           |       |   | 58,124 |   |   |   | 24,999 |   |   |   | $ | — |   |   |   | $ | — |   |   |
| Robert S.  Fishman, M.D. |       |         | —     |                 |       |                                                            | —     |                                                           |       |   | 27,948 |   |   |   | 303,450 |   |   |   | $ | 480 |   |   |   | $ | 240 |   |   |
| Nancy Isaac              |       |         | —     |                 |       |                                                            | —     |                                                           |       |   | 13,683 |   |   |   | 258,717 |   |   |   | $ | 128 |   |   |   | $ | 64 |   |   |
| Robert S. Breuil         |       |         | —     |                 |       |                                                            | —     |                                                           |       |   | 26,833 |   |   |   | 309,667 |   |   |   | $ | 480 |   |   |   | $ | 240 |   |   |
| Yehuda Ivri              |       |         | —     |                 |       |                                                            | —     |                                                           |       |   | 7500 |   |   |   | 253,000 |   |   |   | $ | 480 |   |   |   | $ | 240 |   |   |
|                          |            |              |            |                      |            |                                                                 |            |                                                                |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

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(1)          Certain of the optionsgranted before 2001 may be exercised under the Company’s early exerciseprogram; however, any shares purchased early are subject to repurchase by theCompany at the exercise price if the employee’s service with the Companyterminates prior to the vesting date. The repurchase right lapses over time.

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(2)          Marketvalue of the Company’s Common Stock at fiscal year end based on the closingsales price as reported on the Nasdaq Stock Market on December 30, 200($1.96) minus the exercise price of “in-the-money” options.

**Compensation of Directors**

Each non-employee director of the Company receives ayearly retainer of $10,000 (plus $1,000 for attending Board meetings, $500 forattending Board calls and $500 for attending Committee meetings and calls). Inthe fiscal year ended December 31, 2004, the total compensation paid tonon-employee directors was $56,500. [The members of the Board of Directors arealso eligible for reimbursement for their expenses incurred in attending Boardmeetings in accordance with Company policy.] During the fiscal year ended December 31,2004, Jean-Jacques Bienaime received $18,500 for his services on the Board andthe Board’s Compensation Committee and Audit Committee, Bernard Collinsreceived $21,500 for his services on the Board and the Board’s CompensationCommittee, Audit Committee and Corporate Governance Committee, and PhyllisGardner received $16,500 for her services on the Board and the Board’sCorporate Governance Committee. No other directors received any compensationfor their services on the Board or Board Committees during the fiscal yearended December 31, 2004.

The Company had a 2000Non-Employee Directors’ Stock Option Plan, approved by the stockholders in November 2000,that provided for the automatic grant of options to purchase shares of CommonStock to non-employee directors until it was terminated by the Aerogen Board ofDirectors in April 2004.

**Employment,Severance and Change of Control Agreements**

The Company does not have employment contracts withany of its executives. The Company has an Executive Severance Benefit Planwhich provides severance benefits to eligible executive employees selected bythe Board. Benefits are paid only upon involuntary termination of employmentwithout cause, or voluntary termination of employment for good reason, withinone month prior to or within 13 months following a change in control ofthe beneficial ownership of the Company. Upon execution of a release of claims,each eligible executive would receive 12 months of salary continuationpayable in monthly installments, continued health benefits for 12 monthsand option vesting acceleration. The vesting of 100% of the executive’sunvested options would accelerate immediately prior to the date of terminationsuch that the options would vest in 12 monthly installments beginning onthe date of termination. Dr. Jane E. Shaw, Robert S. Breuil,Robert S. Fishman, Nancy Isaac, Yehuda Ivri, and John S. Power arethe current participants in the Executive Severance Benefit Plan.

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**Item12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT ANDRELATED STOCKHOLDER MATTERS**

Thefollowing table sets forth the beneficial ownership of the Company’s CommonStock as of March 25, 2005, except as otherwise noted, (i) by eachperson, entity or “group” of persons or entities known by the Company to bebeneficial owners of more than 5% of the Company’s Common Stock, (ii) byeach director, and each of the Named Executive Officers listed in the SummaryCompensation Table, and (iii) by all executive officers and directors as agroup. Percentage ownership is based on 6,937,994 shares of Common Stock and988,145 shares of Series A-1 Preferred outstanding on March 25, 2005,together with options or warrants for that stockholder that are currentlyexercisable or exercisable within 60 days of March 25, 2005. Except asdescribed below, each person has sole voting and investment power with respectto the Common Stock described in the table. Unless otherwise indicated, theaddress of each of the individuals named below is: c/o Aerogen, Inc., 2071Stierlin Court, Suite 100, Mountain View, California 94043.
| **Beneficial Ownership**                                                                                                                  | ** ** | ** ** | ** ** | **Shares of Common   Stock Beneficially   Owned**(1) | ** ** | **Percent of Common   Stock Total**(2) | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------|------------|---------------------------------------------------------------------|------------|-------------------------------------------------------|------------|
| **5% Holders**                                                                                                                                 |       |       |       |                                                                |       |                                                  |       |   |   |
| Evan Sturza(3)  156 West 56th Street,  16th Floor  New York, NY 10019                                                                          |       |       | 991,307    |                                                                |       |                                                  | 14.3       | % |   |
| SF Capital Partners, Ltd.(4)  c/o Staro Asset Management, LLC  3600 South Lake Drive  St. Francis, WI 53235                                    |       |       | 364,700    |                                                                |       |                                                  | 4.99       | % |   |
| Entities Affiliated with Xmark Asset Management,  LLC(5)  152 West 57th, 21st Floor  New York, NY 10019                                        |       |       | 1,280,610  |                                                                |       |                                                  | 7.61       | % |   |
| Entities Affiliated with OrbiMed Advisors, LLC(6)  767 Third Avenue,  30th Floor  New York, NY 10017                                           |       |       | 364,700    |                                                                |       |                                                  | 4.99       | % |   |
| Entities Affiliated with HealthCap(7)  c/o HealthCap IV, GP SA  18 Avenue d’Ouchy  1006 Lausanne  Switzerland                             |       |       | 364,700    |                                                                |       |                                                  | 4.99       | % |   |
| Perceptive Life Sciences Master Fund, LLC(8)  c/o Perspective Advisors, LLC  5437 Connecticut Avenue NW,  Suite 100  Washington, DC 20015 |       |       | 364,700    |                                                                |       |                                                  | 4.99       | % |   |
| Entities  Affiliated with North Sound Capital, LLC(9)  53 Forest Avenue, Suite 202  Old Greenwich, CT 06870                               |       |       | 364,700    |                                                                |       |                                                  | 4.99       | % |   |

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| Bay Star Capital II, L.P.(10)  c/o Bay Star Capital Management, LLC  80 E. Sir Francis Drake, Suite 2B  Larkspur, CA 94939 |   |   | 364,700 |   |   |   | 4.99   | %      |   |
|---------------------------------------------------------------------------------------------------------------------------------|--------|--------|---------|--------|--------|--------|--------|--------|--------|
| SDS Capital Group SPC,  Ltd.(11)  c/o SDS Capital Group  53 Forest Avenue, Suite 203  Old Greenwich, CT 06870              |   |   | 364,700 |   |   |   | 4.99   | %      |   |
| Entities Affiliated with Pequot Capital  Management, Inc.(12)  500 Nyala Farm Rd.  Westport, CT 06880                      |   |   | 364,700 |   |   |   | 4.99   | %      |   |
| Entities Affiliated with ProMed  Management, Inc.(13)  125 Cambridgepark Drive  Cambridge, MA 02140                        |   |   | 364,700 |   |   |   | 4.99   | %      |   |
| Entities Affiliated with Ursus Capital(14)  156 West 56th Street,  16th Floor  New York, NY 10019                               |   |   | 364,700 |   |   |   | 4.99   | %      |   |
| Porter Partners, LP(15)  c/o Porter Capital Management  300 Drakes Landing Rd., Suite 175  Greenbrae, CA 94904             |   |   | 364,700 |   |   |   | 4.99   | %      |   |
| Entities Affiliated with BVF Partners LP(16)  227 West Monroe Street, Suite 4800  Chicago, Illinois 60606                  |   |   | 364,700 |   |   |   | 4.99   | %      |   |
| **Directors  and Executive Officers:**                                                                                          |   |   |    |   |   |   |   |   |   |
| Jane E. Shaw,  Ph.D.(17)                                                                                                        |   |   | 364,700 |   |   |   | 4.99   | %      |   |
| Yehuda lvri(18)                                                                                                                 |   |   | 188,333 |   |   |   | *      |   |   |
| John S. Power(19)                                                                                                               |   |   | 94,217  |   |   |   | *      |   |   |
| Robert Roe                                                                                                                      |   |   | *       |   |   |   | *      |   |   |
| Jean-Jacques  Bienaimé(20)                                                                                                 |   |   | 7,753   |   |   |   | *      |   |   |
| Robert S.  Breuil(21)                                                                                                           |   |   | 38,118  |   |   |   | *      |   |   |
| Bernard  Collins(22)                                                                                                            |   |   | 6,421   |   |   |   | *      |   |   |
| Robert S.  Fishman(23)                                                                                                          |   |   | 35,103  |   |   |   | *      |   |   |
| Phyllis I.  Gardner, M.D.(24)                                                                                                   |   |   | 5,999   |   |   |   | *      |   |   |
| Nancy Isaac,  J.D.(25)                                                                                                          |   |   | 15,617  |   |   |   | *      |   |   |
| Angela Strand(26)                                                                                                               |   |   | 20,429  |   |   |   | *      |   |   |
| Mauro Folena                                                                                                                    |   |   | *       |   |   |   | *      |   |   |
| All executive officers  and directors as a group (12 persons)(27)                                                          |   |   | 869,896 |   |   |   | 11.78  | %      |   |

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*                    Percentagesare not shown if holdings total less than 1% of total outstanding shares.

(1)          Includes outstandingstock options that will be vested on or before March 25, 2005, to purchaseshares of the Company’s Common Stock, as described in the footnotes below.

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(2)          The conversion of Series A-1Preferred Stock (“Preferred Stock”) into common stock and the exercise of theWarrants covered in this table is limited so that no holder of Preferred Stockor Warrants covered by this table may beneficially own (with such holder’saffiliates) more that 4.99% of the Company’s then-outstanding common stock (the“4.99% limitation”). Each stockholder may waive the 4.99% limitation only upon61 days’ written notice to the Company. The shares numbers in this columnrepresent the maximum number of shares of common stock that each sellingstockholder subject to the 4.99% limitation could hold upon conversion of itsPreferred Stock or exercise of its Warrants, based on 6,937,994 shares ofcommon stock outstanding as of March 25, 2005, and accounting for theshares resulting from the conversion or exercise.

(3)          Information is asprovided by the holder in his Schedule 13G/A filed with the SEC on August 9,2004; Evan Sturza is the owner of two separate entities that are exempt fromregistration under the Investment Advisors Act of 1940 (Ursus CapitalManagement LLC and Ursus Capital Management Corp.) and provide investmentmanagement services to two privately owned entities exempt from registrationunder the Investment Company Act of 1940 (Ursus Capital, L.P. and UrsusManagement LLC). Each of the entities, which have different beneficial owners,hold less than five percent of the common stock of the Company, but the aggregateholdings of the two entities exceed five percent of the common stock of theCompany. Ursus Capital, L.P. is managed by Ursus Capital Management LLC. EvanSturza is the sole member of Ursus Capital Management LLC, and possesses thepower to vote and to direct the disposition of all securities held by UrsusCapital, L.P. Ursus Offshore, Ltd. is managed by Ursus Capital ManagementCorp. Evan Sturza is the investment manager of Ursus Capital Management Corp.and possesses the power to vote and to direct the disposition of all securitiesheld by Ursus Offshore Ltd. For the purposes of Rule 13d-3 of theSecurities Exchange Act of 1934, Evan Sturza may be deemed to be the beneficialowner of the common stock of the Issuer held by these two separate entities. EvanSturza disclaims beneficial ownership of such shares common stock.

(4)          Includes (i) 29,707shares of common stock; (ii) 684,100 shares of common stock issuable uponthe conversion of Preferred Stock which are or will be convertible within 60days of March 25, 2005; (iii) 684,100 shares issuable upon exerciseof warrants that are or will be exercisable within 60 days of March 25,2005; and (iv) 59,203 shares issued or issuable in lieu of the cashpayment of quarterly dividends on the Preferred Stock held by SF CapitalPartners, Ltd. for the quarters ended March 31, June 30, September 30,December 31, 2004 and March 31, 2005, for a total of 1,457,110 shareswhich would, in aggregate, represent 17.5% of the Company’s outstanding commonstock. However, the terms of such Preferred Stock and Warrants preclude theholders thereof from converting or exercising (as applicable) its PreferredStock or Warrants (as applicable) if such conversion or exercise (asapplicable) would result in such holder and its affiliates beneficially owningin excess of 4.99% of the Company’s outstanding common stock following suchconversion or exercise (as applicable), provided that such stockholder maywaive the provision upon 61 days’ written notice to the Company. Inaddition, no warrant issued to SF Capital can be exercised if it would resultin SF Capital and/or its affiliates beneficially owning more than 9.999% of ouroutstanding common stock. This provision cannot be waived. Michael A. Rothand Brian J. Stark have the power to vote and to direct the disposition ofall securities owned by SF Capital Partners Ltd.

(5)          Includes (i) 503,370shares issuable upon the conversion of Preferred Stock held by Xmark Fund, LP; (ii) 629,960shares issuable upon the conversion of Preferred Stock held by Xmark Fund, Ltd.that are or will be convertible within 60 days of March 25, 2005; (iii) 65,416shares issued or issuable in lieu of the cash payment of quarterly dividends onthe Preferred Stock held by Xmark Fund, LP for the quarters ended March 31,June 30, September 30, December 31, 2004 and March 31,2005; and (iv) 81,864 shares issued or issuable in lieu of the cashpayment and quarterly dividends on the Preferred Stock held by Xmark Fund, Ltd.for the quarters ended March 31, June 30, September 30, 

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December 31, 2004 andMarch 31, 2005, for a total of 1,280,610 shares which would, in aggregate,represent 15.9% of the Company’s outstanding common stock. However, the termsof such Preferred Stock and Warrants preclude the holders thereof fromconverting or exercising (as applicable) its Preferred Stock or Warrants (asapplicable) if such conversion or exercise (as applicable) would result in suchholder and its affiliates beneficially owning in excess of 4.99% of the Company’soutstanding Common Stock following such conversion or exercise (as applicable),provided that such stockholder may waive the provision upon 61 days’ writtennotice to the Company. On November 3, 2004, Xmark Fund, LP and Xmark Fund,Ltd., provided a written waiver of this limitation to the Company. Accordingly,as of January 3, 2005, this 4.99% limitation on conversion no longerapplies to the shares of Preferred Stock held by these two funds. Xmark AssetManagement, LLC (“XAM”), serves as investment manager for each of Xmark Fund,LP and Xmark Fund, Ltd., as well as various other private investment funds. MitchellD. Kaye is the Manager of XAM, and as such, Mr. Kay possesses the power tovote and direct the disposition of all securities held by Xmark Fund, LP andXmark Fund, Ltd.

(6)          Includes (i) 21,712shares of common stock held by Caduceus Capital II LP (ii) 9,337 shares ofcommon stock held by Capital Master Fund Ltd. (iii) 21,712 shares ofcommon stock held by UBS Eucalyptus Fund LLC (iv) 35,611 shares of commonstock held by Hare & Co for the A/C Finsbury Worldwide PharmaceuticalTrust (v) 2,606 shares of common stock held by UBS Eucalyptus Fund, Ltd. (vi) 3,257shares of common stock held by HFC SHC Aggressive (vii) 500,000 sharesissuable upon the conversion of Preferred Stock held by Caduceus Capital MasterFund Ltd.; (viii) 215,000 shares issuable upon the conversion of PreferredStock held by Cadeceus Capital II, LP; (ix) 500,000 shares issuable uponthe conversion of Preferred Stock held by UBS Eucalyptus Fund, LLC; (x) 60,000shares issuable upon the conversion of Preferred Stock held by PW EucalyptusFund, Ltd; (xi) 650,000 shares issuable upon the conversion of Preferred Stockheld by Finsbury Worldwide Pharmaceutical Trust; (xii) 75,000 shares issuableupon the conversion of Preferred Stock held by HFC SHC Aggressive, that are orwill be convertible within 60 days of March 25, 2005; (xiii) 500,000shares issuable upon the exercise of a warrant held by Caduceus Capital MasterFund Ltd.; (xiv) 215,000 shares issuable upon the exercise of a warrantheld by Caduceus Capital II, LP; (xv) 500,000 shares issuable upon theexercise of a warrant held by UBS Eucalyptus Fund, LLC; (xvi) 60,000shares issuable upon the exercise of a warrant held by PW Eucalyptus Fund, Ltd;(xvii) 650,000 shares issuable upon the exercise of a warrant held byFinsbury Worldwide Pharmaceutical Trust; (xviii) 75,000 shares issuable uponthe exercise of a warrant held by HFC SHC Aggressive, that are or will beexercisable within 60 days of March 25, 2005, (xix) 37,642 sharesissued or issuable in lieu of the cash payment of quarterly dividends on thePreferred Stock held by Capital Master Fund Ltd. for the quarters ended March 31,June 30, September 30, December 31, 2004 and March 31,2005; (xx) 25,544 shares issued or issuable in lieu of the cash payment ofquarterly dividends on the Preferred Stock held by Caduceus Capital II, LP forthe quarters ended March 31, June 30, September 30, December 31,2004 and March 31, 2005; (xxi) 44,185 shares issued or issuable inlieu of the cash payment of quarterly dividends on the Preferred Stock held byUBS Eucalyptus Fund, Ltd. for the quarters ended March 31, June 30,September 30, December 31, 2004 and March 31, 2005;(xxii) 5,303 shares issued or issuable in lieu of the cash payment ofquarterly dividends on the Preferred Stock held by PW EucalyptusFund, Ltd. for the quarters ended March 31, June 30, September 30,December 31, 2004 and March 31, 2005; (xxiii) 57,440 sharesissued of issuable in lieu of the cash payment of quarterly dividends on thePreferred Stock held by Finsbury Worldwide Pharmaceutical Trust for thequarters ended March 31, June 30, September 30, December 31,2004 and March 31, 2005; and (xxiv) 6,629 shares issued or issuablein lieu of the cash payment of quarterly dividends on the Preferred Stock heldby HFC SHC Aggressive for the quarters ended March 31, June 30, September 30,December 31, 2004 and March 31, 2005, for a total of 4,270,978 shareswhich would, in aggregate, represent 39.0% of the Company’s outstanding commonstock. However, the 

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terms of such PreferredStock and Warrants preclude the holders thereof from converting or exercising(as applicable) its Preferred Stock or Warrants (as applicable) if suchconversion or exercise (as applicable) would result in such holder and itsaffiliates beneficially owning in excess of 4.99% of the Company’s outstandingcommon stock following such conversion or exercise (as applicable), providedthat such stockholder may waive the provision upon 61 days’ written noticeto the Company. OrbiMed Advisors LLC and OrbiMed Capital LLC act as investmentadvisers to certain collective investment funds. Samuel D. Isaly owns acontrolling interest in OrbiMed Advisors LLC and OrbiMed Capital LLC. OrbiMedCapital LLC is the investment adviser for Finsbury Worldwide PharmaceuticalTrust and HFC SHC Aggressive. OrbiMed Advisors LLC is the investment adviserfor Winchester Global Trust Company. OrbiMed Advisors LLC is also the generalpartner of Capital II, which is the joint venture partner of UBSEucalyptus Fund, LLC and of PW Eucalyptus Fund, Ltd. As such, Mr. Isalyhas the power to vote and to direct the disposition of all the securities heldby Winchester Global Trust Company, UBS Eucalyptus Fund, LLC, PW EucalyptusFund, Ltd., Finsbury Worldwide Pharmaceutical Trust and HFC SHCAggressive.

(7)          Includes (i) 50,091shares of common stock held by HealthCap IV LP; (ii) 36,124 shares ofcommon stock held by HeathCap IV BIS LP; (iii) 3,726 shares of common stockheld by HeathCap IV KB; (iv) 1,371 shares of common stock held by OFCOClub IV; (v) 660,650 shares issuable upon the conversion of PreferredStock held by HealthCap IV Bis, LP; (vi) 914,300 shares issuable upon theconversion of Preferred Stock held by HealthCap IV, LP; (vii) 66,710shares issuable upon the conversion of Preferred Stock held by HealthCap IV KB;(viii) 25,000 shares issuable upon the conversion of Preferred Stock heldby OFCO Club IV that are or will be convertible within 60 days of March 25,2005; (ix) 660,651 shares issuable upon the exercise of a warrant held byHealthCap IV Bis, LP; (x) 914,300 shares issuable upon the exercise of awarrant held by HealthCap IV, LP; (xi) 66,709 shares issuable upon the exerciseof a warrant held by HealthCap IV KB; (xii) and 25,000 shares issuable upon theexercise of a warrant held by OFCO Club IV that are or will be exercisablewithin 60 days of March 25, 2005; (xiii) 58,312 shares issued orissuable in lieu of the cash payment of quarterly dividends on the PreferredStock held by HealthCap IV Bis, LP for the quarters ended March 31, June 30,September 30, December 31, 2004 and March 31, 2005;(xiv) 80,796 shares issued or issuable in lieu of the cash payment ofquarterly dividends on the Preferred Stock held by HealthCap IV, LP forthe quarters ended March 31, June 30, September 30, December 31,2004 and March 31, 2005; (xv) 5,966 shares issued or issuable in lieuof the cash payment of quarterly dividends on the Preferred Stock held byHealthCap IV KB for the quarters ended March 31, June 30, September 30,December 31, 2004 and March 31, 2005; and (xvi) 2,211 sharesissued or issuable in lieu of the cash payment of quarterly dividends on thePreferred Stock held by OFCO Club IV for the quarters ended March 31,June 30, September 30, December 31, 2004 and March 31,2005, for a total of 3,571,917 shares which would, in aggregate, represent34.8% of the Company’s outstanding common stock. However, the terms of suchPreferred Stock and Warrants preclude the holders thereof from converting orexercising (as applicable) its Preferred Stock or Warrants (as applicable) ifsuch conversion or exercise (as applicable) would result in such holder and itsaffiliates beneficially owning in excess of 4.99% of the Company’s outstandingcommon stock following such conversion or exercise (as applicable), providedthat such stockholder may waive the provision upon 61 days’ written noticeto the Company. HealthCap IV GP S.A. is the general partner ofHealthCap IV, L.P. and HealthCap IV Bis, L.P. and possesses, throughits board of directors, the power to vote and direct the disposition of allsecurities held by HealthCap IV, L.P. and HealthCap IV Bis, L.P. Theboard of directors of HealthCap IV GP S.A., consists of Peder Fredrikson,a Swedish citizen and Francois Kaiser, a Swiss citizen. HealthCap IV GP ABis the general partner of HealthCap IV KB and possesses, through its boardof directors, the power to vote and direct the disposition of all securitiesheld by HealthCap IV KB. The board of directors of HealthCap IV GP ABconsists of Johan Christenson, Anki Forsberg, Staffan Lindstrand, MagnusPersson, Björn Odlander and Per 

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Samuelsson, each of whomare Swedish citizens. Odlander Fredrikson & Co AB as a member of OFCOClub IV and acting on behalf of the other members of OFCO Club IV hasthe power to vote and direct the disposition of all securities held by OFCOClub IV. Odlander Fredrikson & Co. AB is in turn controlled by Mr. Fredriksonand Mr. Odlander. Each of HealthCap IV, L.P., HealthCap IV Bis,L.P., HealthCap IV KB and OFCO Club IV are parties to a parallelinvestment agreement pursuant to which each of them has agreed to invest inparallel. The Odlander, Fredrikson Group acts as investment advisor to each ofHealthCap IV, L.P., HealthCap IV Bis, L.P. and HealthCap IV KB.

(8)          Includes (i) 55,974shares of common stock; (ii) 1,183,330 shares issuable upon the conversionof Preferred Stock which are or will be convertible within 60 days of March 25,2005; (iii) 1,333,330 shares issuable upon the exercise of a warrant thatis or will be exercisable within 60 days of March 25, 2005; and (iv) 109,342shares issued or issuable in lieu of the cash payment of quarterly dividends onthe Preferred Stock held by Perceptive Life Sciences Master Fund, Ltd. forthe quarters ended March 31, June 30, September 30, December 31,2004 and March 31, 2005, for a total of 2,681,976 shares which, inaggregate, would represent 28.4% of the Company’s outstanding common stock.However, the terms of such Preferred Stock and Warrants preclude the holdersthereof from converting or exercising (as applicable) its Preferred Stock orWarrants (as applicable) if such conversion or exercise (as applicable) wouldresult in such holder and its affiliates beneficially owning in excess of 4.99%of the Company’s outstanding common stock following such conversion or exercise(as applicable), provided that such stockholder may waive the provision upon61 days’ written notice to the Company. Joseph E. Edelman is the ManagingMember of Perceptive Advisors, LLC, the Investment Manager of Perceptive LifeSciences Master Fund, Ltd. (“Perceptive”). As such, Mr. Edelman hassole dispositive and voting authority for all Perceptive’s shares.

(9)          Includes (i) 7,166shares of common stock held by North Sound Legacy Fund LLC; (ii) 218,853shares of common stock held by North Sound Legacy International Fund Ltd.; (iii) 12,816shares of common stock held by North Sound Legacy Institutional Fund LLC; (iv) 18,000shares issuable upon the conversion of Preferred Stock held by North SoundLegacy Fund, LLC; (v) 384,000 shares issuable upon the conversion ofPreferred Stock held by North Sound Legacy International, Ltd.; (vi) 198,000shares issuable upon the conversion of Preferred Stock held by North SoundLegacy Institutional Fund, LLC that are or will be convertible within 60 daysof March 25, 2005; (vii) 40,000 shares issuable upon the exercise ofa warrant held by North Sound Legacy Fund, LLC; (viii) 975,000 sharesissuable upon the exercise of a warrant held by North Sound LegacyInternational, Ltd.; (ix) 485,000 shares issuable upon the exercise of awarrant held by North Sound Legacy Institutional Fund, LLC that are or will beexercisable within 60 days of March 25, 2005(x) 1,910 shares issuedor issuable in lieu of the cash payment of quarterly dividends on the PreferredStock held by North Sound Legacy Fund, LLC for the quarters ended March 31,June 30, September 30, December 31, 2004 and March 31,2005; (xi) 40,789 shares issued or issuable in lieu of the cash payment ofquarterly dividends on the Preferred Stock held by North Sound LegacyInternational, Ltd. for the quarters ended March 31, June 30, September 30,December 31, 2004 and March 31, 2005; and (xii) 20,998 sharesissued or issuable in lieu of the cash payment of quarterly dividends on thePreferred Stock held by North Sound Legacy Institutional Fund, LLC for thequarters ended March 31, June 30, September 30, December 31,2004 and March 31, 2005, for a total of 2,402,532 shares which, inaggregate, would represent 26.6% of the Company’s outstanding common stock.However, the terms of such Preferred Stock and Warrants preclude the holdersthereof from converting or exercising (as applicable) its Preferred Stock orWarrants (as applicable) if such conversion or exercise (as applicable) wouldresult in such holder and its affiliates beneficially owning in excess of 4.99%of the Company’s outstanding common stock following such conversion or exercise(as applicable), provided that such stockholder may waive the provision upon61 days’ written notice to the Company. North Sound Capital LLC is theinvestment advisor of North Sound Legacy Fund LLC, North Sound LegacyInstitutional Fund LLC, and North Sound Legacy International Ltd. ThomasMcAuley is the managing member of North 

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Sound Capital LLC, and isthe individual with the power to vote and to direct the disposition of allsecurities held by North Sound Legacy Fund, LLC, North Sound LegacyInternational, Ltd. and North Sound Legacy Institutional Fund, LLC.

(10)   Includes (i) 50,000 sharesof common stock; (ii) 450,000 shares issuable upon the conversion ofPreferred Stock which are or will be convertible within 60 days of March 25,2005; and (iii) 42,505 shares issued or issuable in lieu of the cashpayment of quarterly dividends on the Preferred Stock held by BayStarCapital II, LP for the quarters ended March 31, June 30, September 30,December 31, 2004 and March 31, 2005, for a total of 542,515 shareswhich, in aggregate, would represent 7.3% of the Company’s outstanding commonstock. However, the terms of such Preferred Stock and Warrants preclude theholders thereof from converting or exercising (as applicable) its PreferredStock or Warrants (as applicable) if such conversion or exercise (asapplicable) would result in such holder and its affiliates beneficially owningin excess of 4.99% of the Company’s outstanding common stock following suchconversion or exercise (as applicable), provided that such stockholder maywaive the provision upon 61 days’ written notice to the Company. BayStarCapital Management, LLC is the General Partner of BayStar Capital II, L.P.Lawrence Goldfarb, Steven M. Lamar, and Bay East, L.P. are the managingmembers of BayStar Capital Management, LLC. Steve Derby is the General Partnerof Bay East, L.P. As such, Lawrence Goldfarb, Steven M. Lamar, and SteveDerby are the individuals with the power to vote and to direct the dispositionof all securities owned by BayStar Capital II, LP.

(11)   Includes (i) 29,600 sharesof common stock; (ii) 450,000 shares issuable upon the conversion ofPreferred Stock which are or will be convertible within 60 days of March 25,2005; (iii) 500,000 shares issuable upon the exercise of a warrant that isor will be exercisable within 60 days of March 25, 2005; and (iv) 42,505shares issued or issuable in lieu of the cash payment of quarterly dividends onthe Preferred Stock held by SDS Capital Group SPC Ltd. for the quartersended March 31, June 30, September 30, December 31, 2004and March 31, 2005, for a total of 1,022,105 shares which, in aggregate,would represent 13.0% of the Company’s outstanding common stock. However, theterms of such Preferred Stock and Warrants preclude the holders thereof fromconverting or exercising (as applicable) its Preferred Stock or Warrants (asapplicable) if such conversion or exercise (as applicable) would result in suchholder and its affiliates beneficially owning in excess of 4.99% of the Company’soutstanding common stock following such conversion or exercise (as applicable),provided that such stockholder may waive the provision upon 61 days’written notice to the Company. SDS Management, LLC is the investment advisor toSDS Capital Group SPC, Ltd. Steve Derby is the sole managing member of SDSManagement, LLC, and as such, is the individual with the power to vote and todirect the disposition of all securities owned by SDS Capital GroupSPC, Ltd.

(12)   Includes (i) 149,840shares of common stock held by Pequot Scout Fund LP; (ii) 69,170 shares ofcommon stock held by Pequot Navigator Offshore Fund Inc.; (iii) 37,150shares of common stock held by Pequot Navigator Onshore Fund LP; (iv) 93,980shares issuable upon the conversion of Preferred Stock held by Pequot ScoutFund, LP; (v) 43,990 shares issuable upon the conversion of PreferredStock held by Pequot Navigator Offshore Fund, Inc.; (vi) 22,870shares issuable upon the conversion of Preferred Stock held by Pequot NavigatorOnshore Fund, LP that are or will be convertible within 60 days of March 25,2005; (vii) 390,000 shares issuable upon the exercise of a warrant held byPequot Scout Fund, LP; (viii) 181,000 shares issuable upon the exercise ofa warrant held by Pequot Navigator Offshore Fund, Inc.; (ix) 96,000shares issuable upon the exercise of a warrant held by Pequot Navigator OnshoreFund, LP that are or will be exercisable within 60 days of March 25, 2005;(x) 21,367 shares issued or issuable in lieu of the cash payment ofquarterly dividends on the Preferred Stock held by Pequot Scout Fund for thequarters ended March 31, June 30, September 30, and December 31,2004; (xi) 9,917 shares issued or issuable in lieu of the cash payment ofquarterly dividends on the Preferred Stock held by Pequot Navigator OffshoreFund, Inc. for the quarters ended March 31, June 30, September 30,and December 31, 2004; and (xii) 5,261 shares issued or 

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issuable in lieu of thecash payment of quarterly dividends on the Preferred Stock held by PequotNavigator Onshore Fund, LP for the quarters ended March 31, June 30, September 30and December 31, 2004, for a total of 1,120,545 shares which would, inaggregate, represent 14.4% of the Company’s outstanding common stock. However,the terms of such Preferred Stock and Warrants preclude the holders thereoffrom converting or exercising (as applicable) its Preferred Stock or Warrants(as applicable) if such conversion or exercise (as applicable) would result insuch holder and its affiliates beneficially owning in excess of 4.99% of theCompany’s outstanding common stock following such conversion or exercise (asapplicable), provided that such stockholder may waive the provision upon61 days’ written notice to the Company. Arthur J. Samberg is the soleowner of Pequot Capital Management, Inc., which is the investmentmanager/advisor to the Pequot Funds, and as such, possesses the sole power tovote and to direct the disposition of all the securities held by Pequot ScoutFund, LP, Pequot Navigator Offshore Fund, Inc. and Pequot NavigatorOnshore Fund, LP. Mr. Samberg disclaims beneficial ownership of any ofthese securities, except to the extent of his pecuniary interest.

(13)   Includes (i) 232,580shares of common stock ProMed Partners LP; (ii) 42,886 shares of commonstock ProMed Partners II LP; (iii) 37,564 shares of common stock held byProMed Offshore Fund Ltd.; (iv) 80,000 shares issuable upon conversion ofPreferred Stock held by David B. Musket; (v) 83,330 shares issuable uponthe exercise of warrants held by Paul Scharfer; (vi) 80,000 sharesissuable upon the exercise of warrants held by David B. Musket; (vii) 6,808shares of common stock held by David B. Musket; (viii) 222,900 sharesissuable upon the exercise of a warrant held by ProMed Partners LP; (ix) 41,100shares issuable upon the exercise of a warrant held by ProMed Partners II, LP.;(x) 36,000 shares issuable upon the exercise of a warrant held by ProMedOffshore Fund, Ltd. that are exercisable within 60 days of March 25, 2005;(xi) 12,213 shares issued or issuable in lieu of the cash payment ofquarterly dividends on the Preferred Stock held by ProMed Partners, LP for thequarters ended March 31, June 30, September 30, and December 31,2004; (xii) 2,254 shares issued or issuable in lieu of the cash payment ofquarterly dividends on the Preferred Stock held by ProMed Partners II, LPfor the quarters ended March 31, June 30, September 30, and December 31,2004; (xiii) 1,973 shares issued or issuable in lieu of the cash paymentof quarterly dividends on the Preferred Stock held by ProMed OffshoreFund, Ltd. for the quarters ended March 31, June 30, September 30,and December 31, 2004; (xiv) 2,653 shares issued or issuable in lieuof the cash payment of quarterly dividends on the Preferred Stock held by PaulScharfer for the quarters ended March 31, June 30, September 30,2004; and (xv) 7,071 shares issued or issuable in lieu of the cash paymentof quarterly dividends on the Preferred Stock held by David B. Musket for thequarters ended March 31, June 30, September 30, December 31,2004 and March 31, 2005, for a total of 889,332 shares which would, inaggregate, represent 11.9% of the Company’s outstanding common stock. However,the terms of such Preferred Stock and Warrants preclude the holders thereoffrom converting or exercising (as applicable) its Preferred Stock or Warrants(as applicable) if such conversion or exercise (as applicable) would result insuch holder and its affiliates beneficially owning in excess of 4.99% of theCompany’s outstanding common stock following such conversion or exercise (asapplicable), provided that such stockholder may waive the provision upon61 days’ written notice to the Company. ProMed Partners, L.P., ProMedPartners II, L.P. and ProMed Offshore Fund, Ltd. are managed byProMed Management, Inc. Barry Kurokawa and David B. Musket are theinvestment managers of ProMed Management, Inc. and as such, Mr. Kurokawaand Mr. Musket possess the power to vote and to direct the disposition ofall securities held by ProMed Partners, L.P., ProMed Partners II, L.P.,and ProMed Offshore Fund, Ltd.

(14)   Includes (i) 14,548 sharesof common stock held by Ursus Capital GSCO (ii) 125,870 shares issuableupon the conversion of Preferred Stock held by Ursus Capital LP; (iii) 168,530shares issuable upon the conversion of Preferred Stock held by Ursus Offshore,Ltd. that are or will be convertible within 60 days of March 25, 2005; (iv) 180,000shares issuable upon the exercise of a warrant held by Ursus 

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Capital, LP; (v) 155,000shares issuable upon the exercise of a warrant held by Ursus Offshore, Ltd.that are or will be exercisable within 60 days of March 25, 2005; (vi) 15,907shares issued or issuable in lieu of the cash payment of quarterly dividends onthe Preferred Stock held by Ursus Capital LP for the quarters ended March 31,June 30, September 30, December 31, 2004 and March 31,2005; (vii) 13,699 shares issued or issuable in lieu of the cash paymentof quarterly dividends on the Preferred Stock held by Ursus Offshore, Ltd.for the quarters ended March 31, June 30, September 30, December 31,2004 and March 31, 2005, for a total of 673,554 shares which would, inaggregate, represent 8.9% of the Company’s outstanding common stock. However,the terms of such Preferred Stock and Warrants preclude the holders thereoffrom converting or exercising (as applicable) its Preferred Stock or Warrants(as applicable) if such conversion or exercise (as applicable) would result insuch holder and its affiliates beneficially owning in excess of 4.99% of theCompany’s outstanding common stock following such conversion or exercise (asapplicable), provided that such stockholder may waive the provision upon61 days’ written notice to the Company. Ursus Capital, L.P. is managed byUrsus Capital Management LLC. Evan Sturza is the sole member of Ursus CapitalManagement LLC, and possesses the power to vote and to direct the dispositionof all securities held by Ursus Capital, L.P. Ursus Offshore, Ltd. ismanaged by Ursus Capital Management Corp. Evan Sturza is the investment managerof Ursus Capital Management Corp. and possesses the power to vote and to directthe disposition of all securities held by Ursus Offshore Ltd.

(15)   Includes (i) 11,580 sharesof common stock; (ii) 266,660 shares issuable upon the conversion ofPreferred Stock that are convertible within 60 days of March 25, 2005; (iii) 266,660shares issuable upon the exercise of a warrant that is exercisable within 60days of March 25, 2005; and (iv) 23,565 shares issued or issuable inlieu of the cash payment of quarterly dividends on the Preferred Stock held byPorter Partners, LP for the quarters ended March 31, June 30, September 30,December 31, 2004 and March 31, 2005, for a total of 568,465 shareswhich, in aggregate, would represent 7.6% of the Company’s outstanding commonstock. However, the terms of such Preferred Stock and Warrants preclude theholders thereof from converting or exercising (as applicable) its PreferredStock or Warrants (as applicable) if such conversion or exercise (asapplicable) would result in such holder and its affiliates beneficially owningin excess of 4.99% of the Company’s outstanding common stock following suchconversion or exercise (as applicable), provided that such stockholder maywaive the provision upon 61 days’ written notice to the Company. Jeffrey H.Porter has the sole power to vote and to direct the disposition of allsecurities held by Porter Partners, L.P.

(16)   Includes (i) 500,000shares issuable upon the exercise of a warrant held by Biotechnology ValueFund, L.P.; (ii) 316,663 shares issuable upon the exercise of a warrantheld by Biotechnology Value Fund II, L.P.; (iii) 766,664 shares issuableupon the exercise of a warrant held by BVF Investments, L.L.C.; and (iv) 83,333shares issuable upon the exercise of a warrant held by Investment 10, L.L.C.,that are or will be exercisable within 60 days of March 25, 2005, for atotal of 1,666,660 shares which would, in aggregate, represent 19.4% of theCompany’s outstanding common stock. However, the terms of such Preferred Stockand warrants preclude the holders thereof from converting or exercising (asapplicable) its Preferred Stock or warrants (as applicable) if such conversionor exercise (as applicable) would result in such holder and its affiliatesbeneficially owning in excess of 4.99% of the Company’s outstanding commonstock following such conversion or exercise (as applicable).

(17)   Includes (i) 62,291 sharesissuable upon the exercise of options that are or will be exercisable within60 days of March 25, 2005; (ii) 171,550 shares issuable upon theconversion of Preferred Stock that are convertible within 60 days of March 25,2005; (iii) 82,129 shares issuable upon the exercise of a warrant that isor will be exercisable within 60 days of March 25, 2005; ( (iv) 31,762shares issued or issuable in lieu of the cash payment of quarterly dividends onthe Preferred Stock for the quarters ended March 31, June 30, September 30,December 31, 2004 and March 31, 2005; (v) 12,485 shares ofcommon stock held by the Carpenter Family Trust, in which Dr. Shaw has aneconomic interest and 

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(vi) 97,689 shares ofcommon stock owned by Dr. Shaw, for a total of 457,906shares which would,in aggregate, represent 6.39% of the Company’s outstanding common stock. However,the terms of such Preferred Stock and warrants preclude the holders thereoffrom converting or exercising (as applicable) its Preferred Stock or warrants(as applicable) if such conversion or exercise (as applicable) would result insuch holder and its affiliates beneficially owning in excess of 4.99% of theCompany’s outstanding common stock following such conversion or exercise (asapplicable).

(18)   Includes 8,500 shares issuableupon the exercise of options that are or will be exercisable within 60 days of March 252005 and 146,500 shares held by the Yehuda & Zipora Ivri RevocableTrust, in which Mr. Ivri has an economic interest.

(19)   Includes 15,533 shares issuableupon the exercise of options that are or will be exercisable within 60 days of March 25,2005.

(20)   Includes 5,333 shares issuableupon the exercise of options that are or will be exercisable within 60 days of March 25,2005.

(21)   Includes 29,917 shares issuableupon the exercise of options that are or will be exercisable within 60 days of March 25,2005.

(22)   Consists of 4,000 sharesissuable upon the exercise of options that are or will be exercisable within 60days of March 25, 2005.

(23)   Includes 29,198 shares issuableupon the exercise of options that are or will be exercisable within 60 days of March 25,2005.

(24)   Includes 5,333 shares issuableupon the exercise of options that are or will be exercisable within 60 days of March 25,2005.

(25)   Consists of 15,617 sharesissuable upon the exercise of options that are or will be exercisable within 60days of March 25, 2005.

(26)   Consists of 19,311 shares issuableupon the exercise of options that are or will be exercisable within 60 days of March 25,2005.

(27)   Includesshares described in the notes above as applicable to directors and currentexecutive officers.

**Item 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS**

***Compensation Committee Interlocks and InsiderParticipation***

None of Aerogen’sexecutive officers services as a member of the board of directors ofcompensation committee of any entity that has one or more executive officersservices as a member of Aerogen’s Board of Directors or Compensation Committee.There are no family relationships among any directors or executive officers.

***Certain Transactions***

***Registration Rights Agreement****.  *The Company entered into an agreement with theholders of its preferred stock, excluding John S. Power, Aerogen’s VicePresident, European Operations, pursuant to which they have registration rightswith respect to the shares of Common Stock into which the preferred stock hasconverted.

***Indemnification Agreements****.  *The Company has indemnification agreements with itsdirectors and officers for the indemnification of and advancement of expensesto these persons to the full extent permitted by Delaware law and the Company’sby-laws. The Company intends to execute such agreements with its futuredirectors and officers.

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***Transactions with Officers andDirectors****.  *YehudaIvri, Aerogen’s Founder and Chief Technical Officer, has three notes payable tothe Company. On May 6, 1994, the Company received a promissory note forthe principal amount of $69,009. The note bore annual interest of 6.43%, becamedue in May 2003, and has been fully repaid. On August 15, 1996, theCompany received a promissory note from Mr. Ivri for the principal amountof $200,000. The note originally bore no interest and the entire principalbalance was due on the earliest of (i) August 14, 2001,(ii) 90 days after Mr. Ivri’s Common Stock was no longer subjectto a lock-up agreement with the underwriters of the Company’s initial publicoffering, or (iii) the date Mr. Ivri’s service with the Companyterminates pursuant to Mr. Ivri’s resignation or is terminated by theCompany for cause. This note was amended effective December 31, 2001 toprovide that (i) interest will accrue on the outstanding principal at arate of 4.38% per annum beginning January 1, 2002, (ii) principal andinterest will be due on the earlier of termination of Mr. Ivri’s servicewith the Company or December 31, 2006, and (iii) Mr. Ivri willpay the Company a portion of the proceeds of certain of his sales of CompanyCommon Stock until his notes to the Company have been paid in full. OnJuly 21, 2000, the Company received a promissory note from Mr. Ivrifor the principal amount of $50,000. The note bears interest at the rate of6.62%, and the principal and interest are due on the earlier of (i) July 21,2005 or (ii) the date at which Mr. Ivri’s service with the Companyterminates. These latter two notes are secured by 33,333 shares ofMr. Ivri’s Common Stock. On December 31, 2004, the principal andaccrued interest outstanding on the loans to Mr. Ivri totaled $292,478.

In January 2004, theCompany entered into a loan and securities purchase agreement pursuant to whicha secured convertible debenture in the aggregate principal amount of $500,000and a warrant were issued to the Carpenter Family Trust UA (the CarpenterTrust”), the trustees of which are Dr. Jane Shaw, Chairman and ChiefExecutive Officer of the Company, and her husband, Peter Carpenter. Thedebenture issued to the Carpenter Trust was converted into 164,258 shares ofcommon stock at a conversion price of $3.044 per share. The Carpenter Warrantis exercisable for 82,129 shares of common stock at an exercise price of $3.044per shares, and expires in January 2008. As part of the A-1 Financing, theCarpenter Trust exchanged the outstanding debentures for an aggregate of 52,232shares of A-1 Preferred at the second closing.

**Item14. PRINCIPAL ACCOUNTANT FEES AND SERVICES**

Thefollowing table presents fees for professional services rendered byPricewaterhouseCoopers, LLP for the audit of the Company’s financial statementsfor fiscal 2004 and 2003 and fees for tax services rendered byPricewaterhouseCoopers. LLP for fiscal 2004 and 2003.
| ** **    | ** ** | **Fiscal Year Ended** | ** ** |
|---------------|------------|---------------------------------|------------|
| ** **    | ** ** | **2004**                        | ** ** | **2003** | ** ** |
| ** **    | ** ** | **(in thousands)**         | ** ** |
| Audit Fees(1) |       |                            | 228        |   |   |   | 160 |   |   |
| Tax Fees(2)   |       |                            | 8          |   |   |   | 21 |   |   |
| Total Fees    |       |                            | 236        |   |   |   | 181 |   |   |

 

All fees described above were approved by the AuditCommittee.

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(1)   AuditFees—These are fees for professional services rendered byPricewaterhouseCoopers, LLP for the audit of the Company’s annual financialstatements and review of the financial statements included in the Company’s10-Q filings, and services that are normally provided in connection withstatutory and regulatory filings or engagements.

(2)          TaxFees—These are fees for professional services performed byPricewaterhouseCoopers, LLP with respect to tax compliance and tax advice.

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**Pre-ApprovalPolicies and Procedures**

The Audit Committee has adopted a policy andprocedures for the pre-approval of audit and non-audit services renderedby our independent auditors, PricewaterhouseCoopers LLP. The policy generallypre-approves specified services in the defined categories of audit services,audit-related services, and tax services up to specified amounts. Pre-approvalmay also e given as part of the Audit Committee’s approval of the scope of theengagement of the independent auditor or on an individual explicit case-by-casebasis before the independent auditor is engaged to provide each service. Thepre-approval of services may be delegated to one or more of the Audit Committee’smembers, but he decision must be reported to the full Audit Committee at itsnext scheduled meeting.

The Audit Committee has determined that the renderingof the services other than audit services by PricewaterhouseCoopers LLP iscompatible with maintaining the principal accountant’s independence.

The Audit Committee hasdetermined that the rendering of its non-audit services byPricewaterhouseCoopers LLP is compatible with maintaining the accountants’independence.

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**PART IV**

**Item15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES**
|                     | ** ** |                                                                                                                                               | ** ** | **Page**   |
|---------------------|------------|-----------------------------------------------------------------------------------------------------------------------------------------------|------------|------------|
| (a)   (1) |       | **Financial Statements**                                                                                                                      | ** ** | ** ** |
|                |       | Index to Consolidated Financial  Statements                                                                                                   |       | 45         |
| (a)   (2) |       | **Financial Statement Schedules**                                                                                                             | ** ** | ** ** |
|                |       | Report  of Independent Registered Public Accounting Firm on Financial Statement  Schedule.                                                    |       | 96         |
|                |       | Schedule  II—Schedule of Valuation and Qualifying Accounts.                                                                              |       | 97         |
|                |       | All other schedules have been omitted as they are  not required, not applicable, or the required information is otherwise  included.          |       |       |
| (a)   (3) |       | **Exhibits**                                                                                                                                  | ** ** | ** ** |
|                |       | The exhibits in  the accompanying Exhibit Index are filed or incorporated by reference as  part of this Annual Report on Form 10-K. |       |       |

 

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**REPORTOF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM ONFINANCIAL STATEMENT SCHEDULE**

To the Board of Directors and Stockholders of Aerogen, Inc.:

Ouraudits of the consolidated financial statements referred to in our report datedMarch 31, 2005 appearing in this Annual Report on Form 10-Kalso included an audit of the financial statement schedule listed in Item 15(a)(2) ofthis Form 10-K. In our opinion, the financial statement schedulepresents fairly, in all material respects, the information set forth thereinwhen read in conjunction with the related consolidated financial statements.
| /s/ PricewaterhouseCoopers LLP |
|--------------------------------|
| San Jose, California           |
| March 31, 2005            |

 

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Schedule II—Scheduleof Valuation and Qualifying Accounts (in thousands):
| ** **                            | ** ** | **Balance**           | ** ** | ** **    | ** ** | ** **     | ** ** | **Balance**        | ** ** |
|---------------------------------------|------------|-----------------------|------------|---------------|------------|----------------|------------|--------------------|------------|
| ** **                            | ** ** | **at beginning** | ** ** | ** **    | ** ** | ** **     | ** ** | **at end**    | ** ** |
| ** **                            | ** ** | **of period**    | ** ** | **Additions** | ** ** | **Deductions** | ** ** | **of period** | ** ** |
| **Provision for Inventories**         |       |                  |       |          |       |           |       |               |       |   |   |   |   |   |   |   |   |
| Fiscal year ended 2002                |       |                  | $          | 30            |       |           |       | $                  | 15         |   |   |   | $ | — |   |   |   | $ | 45 |   |   |
| Fiscal year ended 2003                |       |                  | $          | 45            |       |           |       | $                  | 11         |   |   |   | $ | (53 | ) |   |   | $ | 3 |   |   |
| Fiscal year ended 2004                |       |                  | $          | 3             |       |           |       | $                  | 283        |   |   |   | $ | — |   |   |   | $ | 286 |   |   |
| **Deferred  Tax Valuation Allowance** |       |                  |       |          |       |           |       |               |       |   |   |   |   |   |   |   |   |
| Fiscal year ended 2002                |       |                  | $          | 25            |       |           |       | $                  | 8          |   |   |   | $ | — |   |   |   | $ | 33 |   |   |
| Fiscal year ended 2003                |       |                  | $          | 33            |       |           |       | $                  | 7          |   |   |   | $ | — |   |   |   | $ | 40 |   |   |
| Fiscal year ended  2004               |       |                  | $          | 40            |       |           |       | $                  | 6          |   |   |   | $ | — |   |   |   | $ | 46 |   |   |

 

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**SIGNATURES**

Pursuantto the requirements of Section 13 or 15(d) of the Securities ExchangeAct of 1934, the registrant has duly caused this report to be signed on itsbehalf by the undersigned, thereunto duly authorized, in the City of MountainView, State of California, on the 15th day of April, 2005.
|          | AEROGEN, INC. |
|----------|--------------------|
|     | By:                | /s/  JANE E. SHAW, PH.D. |
|     |               | Jane E. Shaw,  Ph.D. |
| * * |               | *Chairman  and Chief Executive Officer* |
| * * |               | *(Principal  Executive Officer)* |

 

Pursuantto the requirements of the Securities Exchange Act of 1934, this report hasbeen signed below by the following persons on behalf of the registrant and inthe capacities and on the dates indicated.
|                             | **Name**          | ** **                                              | ** ** | ** **           | **Title** | ** ** | ** ** | ** ** | **Date** | ** ** |
|-----------------------------|-------------------|---------------------------------------------------------|------------|----------------------|-----------|------------|------------|------------|----------|------------|
| /s/  JANE E. SHAW           |              | Chairman and Chief Executive  Officer                   |       | April 15,  2005 |
| Jane E. Shaw                |              | *(Principal  Executive Officer)*                        |       |                 |
| *                           |              | Director                                                |       | April 15,  2005 |
| Phyllis I.  Gardner         |              |                                                    |       |                 |
| *                           |              | Director                                                |       | April 15,  2005 |
| Yehuda Ivri                 |              |                                                    |       |                 |
| *                           |              | Director                                                |       | April 15,  2005 |
| Jean-Jacques  Bienaimé |              |                                                    |       |                 |
| *                           |              | Director                                                |       | April 15,  2005 |
| Robert L. Roe               |              |                                                    |       |                 |
| *                           |              | Director                                                |       | April 15,  2005 |
| Bernard Collins             |              |                                                    |       |                 |
| /s/  ROBERT S. BREUIL       |              | Chief Financial Officer  and Vice President Development |       | April 15,  2005 |
| Robert S. Breuil            |              | *(Principal  Financial and Accounting Officer)*         |       |                 |
| * By:                       | /s/  JANE E. SHAW |                                                    |       |                 |      |
|                        | JANE E. SHAW      |                                                    |       |                 |      |
|                        | ATTORNEY-IN-FACT  |                                                    |       |                 |      |
|                             |                   |                                                         |            |                      |           |            |            |            |          |            |  |  |

 

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**INDEX TO EXHIBITS**
| No.   | ** ** | ** ** | ** ** | ** **                                                                                                                                                                                                                                                                                                                                                                                   | ** ** | **Note** | ** ** | ** ** | **Description of Exhibit Document** |
|-------|------------|------------|------------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|----------|------------|------------|------------------------------------------|
| 3.2   |       | (7)        |       | Amended and Restated Certificate of Incorporation of  Aerogen, Inc.                                                                                                                                                                                                                                                                                                                     |
| 3.2.1 |       | (8)        |       | Certificate of Amendment  to the Amended and Restated Certificate of Incorporation of  Aerogen, Inc.                                                                                                                                                                                                                                                                                    |
| 3.4   |       | (1)        |       | Amended and Restated  Bylaws of Aerogen, Inc.                                                                                                                                                                                                                                                                                                                                           |
| 3.5   |       | (6)        |       | Amendment to Rights  Agreement dated as of February 24, 2003, by and between  Aerogen, Inc. and Mellon Investor Services, LLC, as Rights Agent                                                                                                                                                                                                                                     |
| 4.1   |       | (1)        |       | Fourth Amended &  Restated Information and Registration Rights Agreement dated July 7,  2000 between Aerogen, Inc. and holders of Aerogen, Inc.  Series A, Series B, Series C, Series D, Series E,  and Series F preferred stock and holders of warrants to purchase  Aerogen, Inc. common stock or Series C preferred stock |
| 4.2   |       | (1)        |       | Warrant, dated  October 14, 1997, to purchase Series C preferred stock of  Aerogen, Inc. issued to Venture Lending & Leasing II, Inc.                                                                                                                                                                                                                           |
| 4.3   |       | (1)        |       | Warrant, dated  October 14, 1997, to purchase Series C preferred stock of  Aerogen, Inc. issued to Venture Lending & Leasing, Inc.                                                                                                                                                                                                                              |
| 4.4   |       | (9)        |       | Loan and Securities  Purchase Agreement, dated as of September 9, 2003, by and between the  Company and SF Capital Partners, Ltd. (“SF Capital”).                                                                                                                                                                                                                             |
| 4.5   |       | (9)        |       | Warrant dated as of  September 9, 2003, issued by the Company to SF Capital                                                                                                                                                                                                                                                                                                             |
| 4.6   |       | (8)        |       | Debenture dated as of  November 3, 2003, issued by the Company to SF Capital                                                                                                                                                                                                                                                                                                            |
| 4.7   |       | (8)        |       | Warrant dated as of  November 3, 2003, issued by the Company to SF Capital                                                                                                                                                                                                                                                                                                              |
| 4.8   |       | (10)       |       | Amendment to Secured  Convertible Debenture, dated January 7, 2004, by and between the Company  and SF Capital                                                                                                                                                                                                                                                                          |
| 4.9   |       | (10)       |       | Amendment No. 2 to  Secured Convertible Debenture and Consent, dated as of January 20, 2004,  by and between the Company and SF Capital                                                                                                                                                                                                                                            |
| 4.10  |       | (10)       |       | Loan and Securities  Purchase Agreement, dated as of January 23, 2004, by and between the  Company and the Carpenter 1983 Family Trust UA (the “Trust”)                                                                                                                                                                                                                       |
| 4.11  |       | (10)       |       | Debenture, dated as of  January 23, 2004, issued by the Company in favor of the Trust.                                                                                                                                                                                                                                                                                                  |
| 4.12  |       | (10)       |       | Registration Rights  Agreement, dated as of January 23, 2004, by and between the Company and  the Trust                                                                                                                                                                                                                                                                                 |
| 4.13  |       | (10)       |       | Warrant, dated as of  January 23, 2004, issued by the Company in favor of the Trust                                                                                                                                                                                                                                                                                                     |
| 4.14  |       | (11)       |       | Purchase Agreement,  dated March 11, 2004, by and between the Company, Xmark Fund L.P., Xmark  Fund, Ltd. and other investors                                                                                                                                                                                                                                                           |
| 4.15  |       | (11)       |       | Certificate of  Designations, Preferences and Rights of Series A-1 Preferred Stock of  the Company, dated March 19, 2004                                                                                                                                                                                                                                                           |
| 4.16  |       | (11)       |       | Form of Warrant                                                                                                                                                                                                                                                                                                                                                                         |
| 4.17  |       | (11)       |       | Registration Rights  Agreement, dated as of March 22, 2004, by and between the Company and  the Investors named in the Purchase Agreement                                                                                                                                                                                                                                               |
| 4.18  |       | (11)       |       | Amendment to Purchase  Agreement and Waiver, dated as of March 19, 2004, by and between the  Company and certain of the Investors named in the Purchase Agreement                                                                                                                                                                                                                       |

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| 4.19    |   | (11) |   | Amendment No. 2 to Rights Agreement, dated as  of March 19, 2004, by and between the Company and Mellon Investor  Services LLC as Rights Agent                       |
|---------|--------|------|--------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 4.20    |   | (11) |   | Amendment to Secured  Convertible Debentures, dated as of March 1, 2004, by and between the  Company and SF Capital                                                       |
| 4.21    |   | (11) |   | Amendment No. 1 to  Secured Convertible Debenture and Consent, dated as of March 1, 2004, by  and between the Company and the Carpenter Trust                        |
| 4.22    |   | (11) |   | Secured Debenture, dated  March 12, 2004, issued by the Company to SF Capital                                                                                             |
| 4.23    |   | (11) |   | Amendment No. 1 to  Security Agreement, dated as of March 11, 2004, by and between the  Company and SF Capital                                                       |
| 4.24    |   | (11) |   | Amendment  No. 1 to IP Security Agreement, dated as of March 11, 2004, by and  between the Company and SF Capital                                                    |
| 10.1    |   | (1)  |   | Form of Indemnity  Agreement                                                                                                                                              |
| 10.2    |   | (3)  |   | Amended and Restated  1994 Stock Option Plan                                                                                                                                   |
| 10.4    |   | (2)  |   | 2000 Equity Incentive  Plan                                                                                                                                                    |
| 10.5    |   | (2)  |   | 2000 Non-Employee  Directors’ Stock Option Plan                                                                                                                           |
| 10.6    |   | (2)  |   | 2000 Employee Stock  Purchase Plan                                                                                                                                             |
| 10.10   |   | (2)  |   | Amended and Restated  1996 Stock Option Plan                                                                                                                                   |
| 10.11   |   | (4)  |   | Aerogen, Inc.  Restated Executive Severance Benefit Plan                                                                                                                  |
| 10.12   |   | (5)  |   | Form of lease  agreement between EOP-Shoreline Technology Park, L.L.C. and Aerogen, Inc.  for the premises located at 2071 Stierlin Court, Mountain View, California |
| 10.12.1 |   | (13) |   | Lease amendment, dated  November 6, 2003, between CA-Shoreline Technology Park, LP and Aerogen.                                                                           |
| 10.12.2 |   | (13) |   | Lease amendment, dated  March 9, 2004, between CA-Shoreline Technology Park, LP and Aerogen.                                                                              |
| 10.17   |   | (8)* |   | Distribution and supply  agreement, dated as of September 30, 2003, between the Company and  Medical Industries America, Inc.                                        |
| 21.1    |   | (12) |   | Subsidiaries of  Aerogen, Inc.                                                                                                                                            |
| 23.1    |   | (14) |   | Consent of Independent  Registered Public Accounting Firm                                                                                                                      |
| 31.1    |   | (14) |   | Certification required  by Rule 13a-14(a) or Rule 15d-14(a) of the Securities  Exchange Act of 1934, as amended                                            |
| 31.2    |   | (14) |   | Certification required  by Rule 13a-14(a) or Rule 15d-14(a) of the Securities Exchange  Act of 1934, as amended                                            |
| 32.1    |   | (14) |   | Certification of Chief  Executive Officer and Chief Financial Officer pursuant to Section 906 of  the Sarbanes-Oxley Act of 2002                                          |

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(1)          Incorporated byreference to Aerogen’s Registration Statement on Form S-1 No. 333-44470as filed with the Securities and Exchange Commission on August 25, 2000.

(2)          Incorporated byreference to Aerogen’s Amendment No. 1 to Registration Statement on Form S-1No. 333-44470 as filed with the Securities and Exchange Commission on October 5,2000.

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(3)          Incorporated byreference to Aerogen’s Form 10-K for the year ended December 31, 2000as filed with the Securities and Exchange Commission on March 28, 2001.

(4)          Incorporated byreference to Aerogen’s Form 10-Q for the quarter ended June 30, 2001as filed with the Securities and Exchange Commission on August 14, 2001.

(5)          Incorporated byreference to Aerogen’s Form 10-Q for the quarter ended September 30,2001 as filed with the Securities and Exchange Commission on November 13,2001.

(6)          Incorporated byreference to Aerogen’s Current Report on Form 8-K as filed with theSecurities and Exchange Commission on February 25, 2003.

(7)          Incorporated byreference to Aerogen’s Form 10-Q for the quarter ended June 30, 2002as filed with the Securities and Exchange Commission on August 13, 2002.

(8)          Incorporated byreference to Aerogen’s Form 10-Q for the quarter ended September 30,2003 as filed with the Securities and Exchange Commission on November 14,2003.

(9)          Incorporated byreference to the Company’s Current Report on Form 8-K filed on October 7,2003.

(10)   Incorporated by reference tothe Company’s Current Report on Form 8-K filed on February 5, 2004.

(11)   Incorporated by reference tothe Company’s Current Report on Form 8-K filed on March 26, 2004.

(12)   Previously filed with theCompany’s Form 10-K for the year ended December 31, 2003.

(13)   Previously filed with theCompany’s Form 10-K/A for the year ended December 31, 2003.

(14)   Filed herewith.

*                    Previouslyrequested confidential treatment as to specific portions, which portions wereomitted and filed separately with the Securities and Exchange Commission.

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