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SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549



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FORM 10-K



(Mark
One)

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

For the fiscal year ended December 31, 2003



OR



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

For the transition period from
 to



Commission File Number 0-19651





GENAERA CORPORATION

(Exact name of registrant as specified in its charter.)



|                                                               |  |                                  
|-------------------------------------------------------------- |  | ---------------------------------
|Delaware                                                       |  | 13-3445668                       
|(State or other jurisdiction of incorporation or organization) |  | (IRS Employer Identification No.)
|                                                               | 
|5110 Campus Drive, Plymouth Meeting, PA                        |  | 19462                            
|(Address of principal executive offices)                       |  | (Zip Code)                       



Registrants
telephone number, including area code: (610) 941-4020



SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:



|                      |  |                                            
|--------------------- |  | -------------------------------------------
|None                  |  | N/A                                        
|(Title of each class) |  | (Name of each exchange on which registered)



SECURITIES
REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:

Common Stock, $.002 par value per share

(Title of Class)



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



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



Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to
the best of registrants knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. ̈



The aggregate market value of common stock held by non-affiliates of the registrant was approximately $64,570,000 as of June 30, 2003, the last business day of the registrants most recently completed second fiscal quarter. Such
aggregate market value was computed by reference to the closing price of the common stock as reported on the National Market System of The Nasdaq Stock Market on June 30, 2003. For purposes of this calculation only, the registrant has defined
affiliates as all directors and executive officers as of June 30, 2003 and any stockholder whose ownership exceeds 10% of the common stock outstanding as of June 30, 2003. The number of shares of the registrants common stock outstanding as of
June 30, 2003 was 38,206,866.



Number of shares of Common Stock
outstanding as of March 24, 2004 was 52,197,102.



DOCUMENTS
INCORPORATED BY REFERENCE



Portions of the Definitive Proxy
Statement for the Registrants 2004 Annual Meeting of Stockholders to be filed within 120 days after the end of the fiscal year covered by this Annual Report on Form 10-K are incorporated by reference into Part III of this Form 10-K.



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GENAERA
CORPORATION



ANNUAL
REPORT ON FORM 10-K



FOR THE YEAR ENDED DECEMBER 31, 2003



INDEX



|               |  |                                                                                                |  |         
|-------------- |  | ---------------------------------------------------------------------------------------------- |  | --------
|               |  | Description                                                                                    |  | Page No.
|Part I         |  |                                                                                                |  |         
|               |  |                                                                                               
|Item 1         |  | Business                                                                                       |  | 3       
|               |  |                                                                                               
|Item 2         |  | Properties                                                                                     |  | 21      
|               |  |                                                                                               
|Item 3         |  | Legal Proceedings                                                                              |  | 21      
|               |  |                                                                                               
|Item 4         |  | Submission of Matters to a Vote of Security Holders                                            |  | 21      
|               |  |                                                                                               
|Part II        |  |                                                                                                |  |         
|               |  |                                                                                               
|Item 5         |  | Market for Registrants Common Equity and Related Stockholder Matters                          |  | 22      
|               |  |                                                                                               
|Item 6         |  | Selected Financial Data                                                                        |  | 24      
|               |  |                                                                                               
|Item 7         |  | Managements Discussion and Analysis of Financial Condition and Results of Operations          |  | 25      
|               |  |                                                                                               
|Item 7A        |  | Quantitative and Qualitative Disclosures About Market Risk                                     |  | 29      
|               |  |                                                                                               
|Item 8         |  | Financial Statements and Supplementary Data                                                    |  | 29      
|               |  |                                                                                               
|Item 9         |  | Changes in and Disagreements with Accountants on Accounting and Financial Disclosure           |  | 29      
|               |  |                                                                                               
|Item 9A        |  | Controls and Procedures                                                                        |  | 30      
|               |  |                                                                                               
|Part III       |  |                                                                                                |  |         
|               |  |                                                                                               
|Item 10        |  | Directors and Executive Officers of the Registrant                                             |  | 31      
|               |  |                                                                                               
|Item 11        |  | Executive Compensation                                                                         |  | 31      
|               |  |                                                                                               
|Item 12        |  | Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters |  | 31      
|               |  |                                                                                               
|Item 13        |  | Certain Relationships and Related Transactions                                                 |  | 31      
|               |  |                                                                                               
|Item 14        |  | Principal Accountant Fees and Services                                                         |  | 31      
|               |  |                                                                                               
|Part IV        |  |                                                                                                |  |         
|               |  |                                                                                               
|Item 15        |  | Exhibits, Financial Statement Schedules and Reports on Form 8-K                                |  | 32      
|               | 
|Signatures     |  | 36                                                                                            
|               | 
|Certifications |  |                                                                                               



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PART I



|ITEM 1. | BUSINESS
|------- | --------



FORWARD-LOOKING STATEMENTS



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



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



We undertake no obligation (and expressly disclaim any such obligation) to publicly update any forward-looking statements, whether as a result of new
information, future events or otherwise, except as required by law. You are advised, however, to consult any further disclosures we make on related subjects in our filings with the United States Securities and Exchange Commission (SEC), all of which
are available in the SEC EDGAR database at www.sec.gov and from us.



OVERVIEW



Genaera Corporation is a
biopharmaceutical company committed to developing medicines for serious diseases from genomics and natural products. Our research and development efforts are focused on anti-angiogenesis and respiratory diseases. We were first incorporated in the
State of Delaware in 1987 and are headquartered in Plymouth Meeting, Pennsylvania.



RESEARCH & DEVELOPMENT PROGRAMS



Natural Products Development Programs



Anti-Angiogenesis Program



Within the human
body, a network of arteries, capillaries and veins, known as the vasculature, functions to transport blood throughout the body. The basic network of the vasculature is developed through angiogenesis, a fundamental process by which new
blood vessels are formed. This embryonic vasculature is primarily developed through the first three months of fetal development. Once the general network of the blood vessels is completely developed, the balance of certain stimulatory and inhibitory
factors stabilize new blood vessel formation associated with wound healing and reproduction. Abnormal angiogenesis occurs in several common diseases, including age-related macular degeneration, diabetic retinopathy and certain forms of cancer.
Compounds that inhibit angiogenesis and that may be useful in the treatment of abnormal angiogenesis are referred to generally as anti-angiogenic substances.



Squalamine is a naturally occurring water-soluble small molecule and our lead anti-angiogenic development candidate.
Squalamine was originally discovered by our founding scientist in the tissues of the dogfish shark and is one of the most abundant of a class of naturally occurring, pharmacologically active small molecules known as aminosterols. The
shark was initially examined because of its apparent resistance to infection and cancer. The chemical structure of squalamine uniquely combines a steroid and a polyamine, two classes of systemic agents that generally are well tolerated in humans.
Squalamine has exhibited reproducible anti-angiogenic properties in a number of in vitro and in vivo assays, including animal cancer and eye disease models, across multiple independent laboratories. Currently, our development efforts
for this unique anti-angiogenic molecule are focused on serious diseases, including age-related macular degeneration and cancer.



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Age-Related Macular Degeneration



Age-related macular degeneration (AMD) is the leading cause of legal blindness among adults age 50 or older in the Western
world, affecting approximately 25 to 30 million people globally. This number is expected to triple over the next 25 years. AMD occurs in two types: the dry, or avascular, form and the more severe wet, or neovascular, form.
Dry AMD, the more common and milder form of AMD, accounts for 85% to 90% of all cases and is characterized by the collection of small, round, white-yellow, fatty deposits called drusen in the central part of the retina. Dry AMD results
in varying forms of sight loss and may or may not develop into the wet form. Currently, the more severe wet form of AMD impacts over 1 million people in the United States alone. We believe that the aging U.S. population will contribute to an
increase in the incidence and prevalence of AMD. Patients with wet AMD have a much greater chance of severe sight loss than with dry AMD. Wet AMD is caused by the growth of abnormal blood vessels, or choroidal neovascularization, under the central
part of the retina, termed the macula, which is required for fine (detailed) vision. It is responsible for 90% of severe vision loss associated with AMD. Approximately 500,000 new cases of wet AMD are diagnosed annually worldwide. In North America
alone, approximately 200,000 cases of wet AMD are diagnosed each year.



Preclinical studies in models of angiogenic diseases of the eye have demonstrated that systematic squalamine administration in rodents and mammals, including primates, leads to inhibition of the development of ocular neovascularization (the
growth of new vessels) and partial regression of abnormal blood vessels. Based on these results, we announced in August 2002 the initiation of a Phase I/II clinical trial designed to test squalamine for the treatment of wet AMD. A total of 40
patients with classic or occult angiographic abnormalities were enrolled in an open label, dose escalation study, designed to evaluate the safety and efficacy of squalamine treatment. Squalamine was administered intravenously at doses of 25 or 50
mg/m2, once weekly for 4 weeks. The principal outcome measures were visual acuity, ocular angiography, fundus
photography and safety. Visual acuity was monitored using the number of lines read correctly (gained or lost) on the ETDRS (Early Treatment Diabetic Retinopathy Study) chart. The study was performed by an internationally recognized ophthalmologist,
Dr. Hugo Quiroz-Mercado, in Mexico City with participation from Professors Charles A. Garcia (University of Texas, Houston) and Gholam Peyman (Tulane University).



In October 2003, Genaera announced strong clinical results, including improved vision, for the patients in Phase I/II
clinical trial of squalamine in AMD. Without treatment, patients with wet AMD rapidly lose vision over the first 3-6 months after diagnosis. Of patients treated with squalamine, 100% had preserved or improved vision four months after initiation of
therapy. Ten patients (26%) had three lines or greater improvement in visual acuity, and the remaining 29 patients (74%) had preserved vision. The greatest degree of improvement was eight lines, from 20/125 to 20/20 vision. Squalamine dosing in the
study consisted of four weekly doses of squalamine, with no further maintenance therapy, and follow up evaluations at two and four months. There were no withdrawals from therapy or drug related serious adverse events in the trial.



In March 2004, we submitted an Investigational New Drug Application (IND) to
the Food and Drug Administration of the United States (FDA) to conduct clinical trials of squalamine in ophthalmic indications including the treatment of wet AMD.



Solid Cancers



Cancer is the second most common cause of death in the Western world. Cancer includes many different types of uncontrolled cellular growth. Clusters of
cancer cells, referred to as tumors, may invade and destroy surrounding organs, impair physiological function and lead to death. To survive, cancer cells require oxygen and nutrients, which are received from the bodys blood supply. In order to
access this blood supply, cancer cells initiate a biochemical mechanism that stimulates angiogenesis, which provides the blood supply that nourishes the tumor. As cancer cells grow they require continuous angiogenesis. Anti-angiogenic substances are
intended to inhibit the growth of new blood vessels and thereby suppress tumor growth.



Cancer patients usually are treated with a combination of surgery, radiation therapy and chemotherapy. Surgery and radiation therapy can be particularly effective in patients in whom the disease has not yet spread to
other tissue or organs. Chemotherapy is the principal treatment for tumors that have spread from primary to secondary sites, or metastasized. Chemotherapy involves the administration of cytotoxic drugs designed to kill cancer cells, or the
administration of hormone analogues designed to either reduce the production of, or block the action of, certain hormones that affect tumor growth. Because chemotherapeutic agents generally attack rapidly dividing cells



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indiscriminately, damaging both normal and cancerous cells, chemotherapy patients often suffer serious side effects. Additionally, resistance to chemotherapy
often occurs over time.



Squalamine is currently being
evaluated in multiple Phase II clinical studies for the treatment of solid tumors. Specifically, we have ongoing clinical studies in non-small cell lung cancer and prostate cancer at multiple clinical sites. These cancer studies will evaluate
intravenously administered squalamine in combination with leading chemotherapeutics or accepted interventions in each indication.



In May 2002, we released positive results on the first Phase II clinical trial in lung cancer, a multi-center open-label design that examined the
preliminary efficacy and safety of squalamine, combined with first line standard chemotherapy of carboplatin and paclitaxel, in patients with Stage IIIB or Stage IV advanced disease. Interim results were presented previously at the May 2000 and May
2001 meetings of the American Society of Clinical Oncology. Overall, for all patients enrolled in the study, at all doses of squalamine, 27% of patients experienced an objective response (defined as a 50% or greater reduction in tumor size).
Objective responses were observed in 29% of patients receiving the squalamine dose of 300 mg/m2/day for one or more
cycles of therapy.



In comparison, an appropriate historical
benchmark objective response rate for this group of patients treated with carboplatin and paclitaxel alone is 17%, as demonstrated in the large Eastern Cooperative Oncology Group (ECOG) first published in May 2000 with a similar design and patient
population. The median survival time for all patients enrolled in our study was 10.0 months (95% confidence interval, 6.6 to 12.3 months). The median survival time for patients receiving the squalamine dose of 300 mg/m2/day was 8.5 months (95% confidence interval, 6.6 to 17.8 months). In comparison, the historical benchmark objective median
survival time for this group of patients treated with carboplatin and paclitaxel alone in the ECOG study was 8.1 months (95% confidence interval, 7.0 to 9.5 months). The median time to progression was 4.4 months (95% confidence interval, 3.1 to 6.9
months) for all patients in our study, 5.5 months for patients in the 300 mg/m2/day group (95% confidence interval,
3.2 to 9.4 months), and in comparison for the ECOG study was 3.1 months (95% confidence interval, 2.8 to 3.9 months).



In June 2003, we reported promising interim results on our Phase IIb trial in non-small cell lung cancer investigating weekly dosing of squalamine in
combination with the leading chemotherapeutics. The multi-center randomized lung cancer study is evaluating 45 patients receiving weekly dosing of squalamine, combined with weekly chemotherapy of carboplatin and paclitaxel, in patients with Stage
IIIB or Stage IV advanced disease. Two patients were withdrawn for intercurrent illness before receiving any study medication. Of the 43 patients receiving study medications, 21 received a squalamine dose of 100 mg/m2, and the 22 received a dose of 200 mg/m2. Objective responses occurred in 23% of the patients (10 of 43; 1 complete and 9 partial responses), with five responses in each of the two dose groups. An objective response is defined as a 50% or
greater reduction in tumor size, measured bi-dimensionally by CT Scan, lasting at least 4 weeks, with no new lesions appearing, as rated by the investigators and radiologists. Additional results from the study, including survival data, are maturing.



In comparison, an appropriate historical benchmark objective
response rate for this group of patients treated with carboplatin and paclitaxel alone was 17%, as demonstrated in the large Eastern Cooperative Oncology Group (ECOG) study presented at the ASCO meeting in May 2000, and updated upon publication in
the January 10, 2002 issue of the New England Journal of Medicine. The ECOG study was done with a once every three weeks carboplatin and paclitaxel dosing, at three times the dose used weekly in the current study with weekly squalamine. Also in
comparison, the objective response rate was 27% in the prior study using the dosing regimen of every three weeks carboplatin and paclitaxel, with five daily doses of squalamine every three weeks.



In May 2002, we also released positive results on our Phase II clinical trial
in recurrent advanced ovarian cancer, a multi-center, open label design, evaluating squalamine in combination with carboplatin. In this study, 35% of evaluable patients (9 of 26) had an objective response to the study drug regimen of squalamine and
carboplatin. The best response to our therapy has included five complete responses and four partial responses. Four of the responses were in patients enrolled with measurable disease, and five were in patients enrolled with rising and elevated
levels of Ca-125 tumor marker, consistent with early ovarian cancer recurrence. For this study, squalamine was dosed at 200 mg/m2/day, daily for five days, immediately following carboplatin infusion, every 3 weeks. During 2001, the FDA granted squalamine Orphan Drug designation for the treatment of ovarian cancer. Orphan Drug designations are granted to
applicants when the prevalence of the disease occurs in less than 200,000 patients in the United States and entitles applicants to certain exclusive marketing rights, tax credits and waivers on FDA user fees. In August 2002, we decided not to pursue
additional studies of squalamine in advanced ovarian cancer in conjunction with the realignment of our operations and our intent to focus on later stage programs and reduce operating expenses.



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In November 2002, we announced that a grant of $1.1 million had been awarded by the United States
Department of Defense, Army Medical Research and Materiel Command, to the University of Chicago School of Medicine, for the first clinical trial of squalamine in the treatment of prostate cancer. The grant, entitled Neoadjuvant
Anti-Angiogenesis Therapy for Prostate Cancer, will support a Phase II clinical trial. The trial is designed as an open-label randomized study to evaluate the activity and tolerability of squalamine in conjunction with anti-androgen therapy in
patients undergoing radical prostatectomy. Up to 132 patients will receive weekly dosing of squalamine (100 mg/m2)
for either 6 or 12 weeks.



In August 2003, researchers at the
University of California, Los Angeles (UCLA) Medical Center and Jonsson Comprehensive Cancer Center received a grant funding further investigation of the potential for squalamine as a treatment for breast cancer. The preclinical research at UCLA
will be led by Richard J. Pietras, PhD, MD, Associate Professor of Medicine, and funded through a $0.5 million grant over three years from the United States Department of Defense, Army Medical Research and Materiel Command (USAMRMC), Breast Cancer
Research Program.



Fibrodysplasia Ossificans Progressiva



We recently discontinued our efforts to conduct a small
Phase I clinical study in fibrodysplasia ossificans progressiva (FOP), which is a rare genetic disorder of the musculoskeletal system in which there is a poorly-understood inflammatory reaction leading to progressive formation of bone in the muscles
and other soft tissues, resulting in progressive immobility and disability. Due to difficulties with patient enrollment given the small size of the patient population, no patients were enrolled in this study.



Genomics-Based Development Programs



Respiratory Program



Since 1996, we have maintained a respiratory product development program
designed to discover and develop treatment alternatives for respiratory diseases. These respiratory diseases have in common the over-production of mucus secretions and an underlying inflammatory process. Through genomics research, we have
concentrated our efforts on determining the manner in which genes specifically impact respiratory disease. We believe that pharmaceutical products developed for use against these specific genomics-based targets have the potential for greater
effectiveness and fewer side effects than pharmaceutical products developed through more traditional processes. More than 50 million patients in the United States suffer from some form of respiratory disease, including, respiratory allergies,
asthma, chronic bronchitis, other chronic obstructive pulmonary diseases, and upper airway diseases such as chronic sinusitis.



IL9 Antibody Therapeutics



Our first genomics-based program is focused on the development of a blocking antibody to interleukin-9 (IL9) to treat a root cause of asthma. Genetic
studies to identify one or more genetic factors important to the development of asthma, in both human families and animal models, have pinpointed IL9 as a mediator of asthma. Our functional genomic studies have demonstrated the broad role of IL9 as
an etiologic agent in asthma. The IL9 gene varies in structure and function and as a result may have an important role in a genetic predisposition to asthma and allergic reactions. Our scientific studies and independent peer-reviewed publications
indicate that IL9 controls other well-known factors involved in promoting lung inflammation in asthma, including a group of proteins that modulate the growth and functional activities of immune cells. Genaera has developed a patent position around
IL9 having first discovered and documented a role for this cytokine in asthma, which is described below under Patents, Licenses and Proprietary Rights.



In April 2001, we entered into a collaborative agreement with MedImmune, Inc. relating to the development of an IL9-based
product for asthma, which is described below under Commercial Arrangements - MedImmune.



Mucoregulators



Our second genomics-based program has focused on the fundamental biology of mucus overproduction in a large number of chronic respiratory patients
worldwide. It is generally accepted that there is extensive unmet medical need for a novel therapy that can prevent abnormal mucus production. Chronic sinusitis is one of the most common



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reasons for physician visits in the United States, with approximately 35 million cases per year. It is believed that many of the symptoms of chronic
sinusitis result from excess mucus production. Among other respiratory diseases, there are up to an estimated 50 million patients with conditions exacerbated by excess mucus production to whom mucoregulator therapy may be of benefit. Mucus
overproduction and small airway plugging is one of the hallmarks of asthma and is a cause of death from asthma. Excess mucus production also is associated with chronic bronchitis, a common form of chronic obstructive pulmonary disease (COPD). Cystic
fibrosis is the most common fatal genetic disease in the United States, affecting approximately 30,000 children and young adults. Cystic fibrosis causes the body to over-produce abnormally thick, sticky mucus, due to the faulty transport of sodium
and chloride (salt) within cells lining organs such as the lungs, sinuses, and pancreas, to their outer surfaces. The thick cystic fibrosis mucus also obstructs the pancreas, preventing enzymes from reaching the intestines to help break down and
digest food. This orphan disease state is another unmet need where a mucoregulator therapy may be beneficial.



Efforts to identify specific gene targets and validate these targets for therapeutic development have led to the identification of small molecules,
believed to be drug development candidates, to inhibit the overproduction of mucin. We believe small molecule therapeutics that decrease abnormal mucin production, so-called mucoregulators, have the potential to yield novel therapeutics
for mucus overproduction in a number of chronic diseases.



In
December 2001, our scientists announced a publication regarding the discovery of hCLCA1, a chloride channel found in humans, and mCLCA3, an equivalent chloride channel found in mice. A number of studies have shown expression of hCLCA1 localized to
mucus producing cells in the respiratory epithelium. Research has further demonstrated a relationship between hCLCA1 and abnormal mucus production suggesting a mechanism for the abnormal mucus production in individuals suffering from a variety of
chronic respiratory conditions. We believe that inhibition of this mucoregulator target, which regulates abnormal mucus production, has the potential to be an important new therapeutic target strategy for a variety of respiratory conditions
including asthma, chronic bronchitis, chronic sinusitis and cystic fibrosis.



Based on the role of the hCLCA1 chloride channel in a variety of respiratory disorders characterized by mucus overproduction, we undertook the screening of known compounds that might potentially represent safe oral
mucoregulator therapeutics for clinical development. This preliminary screening effort led to the identification of LOMUCIN (talniflumate) as an orally available small molecule inhibitor of the hCLCA1 channel and potential mucoregulator. In
testing, LOMUCIN demonstrated a dose-dependent inhibition of mucin production, yet its toxicity was the lowest reported for the various compounds tested. While talniflumate is used commercially as a non-steroidal anti-inflammatory (NSAIDs),
other popular NSAIDs for example, ibuprofen or diclofenac, are not mucoregulators. LOMUCIN is a known compound, which was discovered, developed and marketed as an anti-inflammatory drug by Laboratorios Bago of Buenos Aires, Argentina, a
leading independent pharmaceutical company in South America. Talniflumate has been approved and marketed for almost 20 years in Argentina, and selected other countries excluding the United States, Europe, and Japan. The effects of talniflumate in
blocking hCLCA1 and mucus overproduction were discovered by Genaera scientists who have submitted patent applications protecting the novel uses of talniflumate as a mucoregulator. Genaera has an exclusive agreement with Laboratorios Bago to develop
and commercialize talniflumate as a new chemical entity and mucoregulator drug in all major pharmaceutical markets including the United States, Europe, and Japan.



Clinical development of LOMUCIN is focused on cystic fibrosis and is supported by program-specific funding through an
initial Therapeutics Development Grant of up to $1.7 million from Cystic Fibrosis Foundation Therapeutics (CFFT), the nonprofit drug development affiliate of the Cystic Fibrosis Foundation (CFF). Our arrangement with CFF is described below under
Commercial Arrangements - Cystic Fibrosis Foundation.



In October 2002, we announced that we had received regulatory approval from the Irish Medicines Board to begin a Phase II clinical trial for LOMUCIN, its oral mucoregulator treatment, in patients with cystic fibrosis. The double
blind, placebo controlled, randomized study evaluated 55 patients with cystic fibrosis. The study assessed the preliminary safety and efficacy of LOMUCIN oral tablets by evaluating the effects of LOMUCIN on respiratory symptoms and
pulmonary function. In the trial, 36 individuals were randomized to LOMUCIN and 19 to placebo. The trial finished enrolling in the fourth quarter of 2003 and the preliminary results demonstrated a strong safety profile for the drug, and
maintenance of existing lung function in people with cystic fibrosis receiving LOMUCIN compared to a decline in those receiving placebo.



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Other Programs



Obesity Therapeutic Program



Trodusquemine, formerly known as trodulamine (also referred to in scientific literature as MSI-1436), is another natural aminosterol product candidate.
Our scientists have demonstrated the ability to reduce the weight of genetically altered mice, generally very obese mice about 10 times their normal size, to that of a normal healthy mouse. Body weights of healthy animals, including animals with
diet-induced obesity, also have been reduced through the administration of trodusquemine. Our researchers have shown preclinical efficacy with trodusquemine, and demonstrated that animal food intake can be regulated in a reversible manner, leading
to changes in body weight. Preclinical data on trodusquemine demonstrate it is a potent appetite suppressant with the ability to normalize fasting blood sugar, as well as high blood cholesterol levels, resulting from weight loss in obese animals.
With trodusquemine, we are targeting the approximately 10 to 12 million Americans who are classified medically as significantly obese. While the trodusquemine molecule is very different in function, it has a similar chemical structure to squalamine,
and thus would enable us to make more efficient use of internal and external resources already utilized for squalamine in its development. Preclinical results with trodusquemine suggest that additional work on formulation and delivery of this
compound in a safer and more convenient fashion would be the next milestones for development, if a business partnership or program-specific funding can be obtained. Further preclinical development work will be needed before an IND application can be
filed with the FDA. Due to the limitations of our current resources, we do not intend to actively pursue the development of this product candidate at this time but we continue to seek new opportunities that will enable us to capitalize on our past
development efforts in this program.



Other Aminosterol
Programs



In addition to squalamine, our discovery of
natural aminosterols has been complemented by a combinatorial chemistry and biology program that has produced many synthetic aminosterols. These natural aminosterols and their synthetic analogues are being developed as a class of agents that are
able to block cellular activation in specific cell types. Our lead compounds have demonstrated sufficient efficacy in preclinical models to encourage our pursuit of additional research that could lead to the development of a new treatment for
inflammatory disorders. These anti-inflammatory aminosterols represent a novel class of compounds with significant potential for a wide range of systemic and topical anti-inflammatory indications. This research is supported in part by our Phase II
Small Business Innovation Research program grant of $800,000 from the National Institutes of Health covering a two-year period beginning in February 2002.



Infectious Disease Program



We have conducted research and development in infectious diseases over many years. The magainin class of compounds, originally discovered in frogs, has
been shown to have activity against a variety of pathogens, including bacteria, amoebae, fungi and parasites. Magainins are peptides. A peptide is a chain of 2 to 50 molecules, known as amino acids, which are considered to be one of the basic
building blocks of the human body. Chains of more than 50 amino acids are referred to as proteins. We have modified natural peptides by rearranging the order and combination of amino acids, by substituting additional amino acids, and by deleting
amino acids to produce magainins having a broader spectrum of therapeutic activity and improved potency.



Antibiotic resistance is the process by which antibiotics lose their effectiveness over time because bacteria, through mutation, develop the means to
produce enzymes capable of diminishing the utility of an antibiotic. We have not noted the development of any antibiotic resistance to the magainins. We believe this is due to the unique mechanism of action of the magainins; magainins puncture the
cell membrane and break down the integrity of the cell, killing bacteria differently than traditional antibiotics.



Prior to 2000, LOCILEX Cream, a topical cream antibiotic for the treatment of infection in diabetic foot ulcers, had been our lead product development
candidate in the peptide program. LOCILEX Cream did not obtain approval from the FDA in July 1999, and we have since terminated our manufacturing agreements required to further develop this product candidate and refocused our near-term product
development efforts on our other programs. Near-term commercialization of LOCILEX Cream will not occur, and we will generate no revenues from LOCILEX Cream in



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the near future. We continue to seek new opportunities that will enable us to capitalize on our past development efforts in this program and related
programs.



Other



In prior years, we have conducted feasibility studies in a number of other
areas, including animal-host defense systems and uses for magainin peptides other than in infectious diseases. In November 2002, we announced that we and E.I. du Pont de Nemours entered into an option agreement for certain of our antimicrobial
peptide intellectual property. The agreement has an initial term of 18 months ending in April 2004 and may extend for additional periods, but no later than October 2005. The agreement provides reimbursement to us for patent-related expenses. We no
longer conduct significant research and development activities in these areas as a result of a reprioritization of our corporate goals. Any of these programs could become more significant over the next 12 months; however, there can be no assurance
that any of these or our other programs will generate viable product opportunities.



RESEARCH AND DEVELOPMENT COSTS



We have
incurred costs of $8.1 million, $10.7 million and $11.1 million for research and development in the years ended December 31, 2003, 2002 and 2001, respectively.



COMMERCIAL ARRANGEMENTS



We believe collaborations allow us to leverage our scientific and financial resources and gain access to markets and technologies that would not otherwise
be available to us. In the long term, development and marketing arrangements with established companies in the markets in which our potential products will compete may provide us with more efficient development and marketing abilities and may,
accordingly, conserve our resources. We expect that we will seek additional development and marketing arrangements for most of the products we may develop. From time to time, we hold discussions with various potential collaborators.



MedImmune



In April 2001, we entered into a research collaboration and licensing
agreement with MedImmune, Inc. to develop and commercialize therapies related to our IL9 program. The companies also will collaborate on the creation of specific assays and respiratory disease models for use in assessing product candidates developed
by MedImmune. MedImmune will be responsible for development, manufacturing, clinical testing, and marketing of any resulting product. MedImmune has funded $2.5 million, plus external cost reimbursements, for research and development activities at
Genaera through April 2003. In addition to the research and development funding, MedImmune also will reimburse Genaera for certain external costs we incur in connection with the IL9 program. Under the agreement, we could receive up to $55.0 million
if future milestones are successfully achieved, plus royalties on any product resulting from this agreement. As a result of our limited control over the development plan and the timing of the milestones, we do not expect to complete a substantial
portion of those milestones within the next five years. Each party has the right to terminate the agreement upon notice to the other party.



Cystic Fibrosis Foundation



In September 2001, we received a contingent award of up to $1.7 million from an affiliate of the Cystic Fibrosis Foundation under their Therapeutics
Development Program to support early clinical evaluation of LOMUCIN involving patients with cystic fibrosis. This award has been granted and shall be paid to us from time to time upon the achievement of certain development milestones. Grant
amounts received are refundable to the CFF upon marketing approval by the FDA or upon our election not to enter Phase III clinical trials or to commercialize the product within two years of milestone completion, assuming efficacy is demonstrated.
The CFF is also due a royalty on net sales of any resultant product up to 1% based upon the amount of funding ultimately provided by the CFF through this award.



Laboratorios Bago



We have an exclusive agreement with Laboratorios Bago of Buenos Aires, Argentina, a leading independent pharmaceutical company in South America, to
develop and commercialize LOMUCINTMas a new chemical entity and mucoregulator drug in all major pharmaceutical
markets including the United States, Europe, and Japan.



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GlaxoSmithKline



In February 1997, we entered into a development, supply and distribution agreement in North America with GlaxoSmithKline for
LOCILEX Cream. GlaxoSmithKline paid us $10 million under this agreement, which we received in 1997. At that time, we had hoped to commercialize LOCILEX Cream in the near-term. However, as a result of the FDAs decision in July 1999 not to
approve LOCILEX Cream, near-term commercialization of LOCILEX Cream will not occur, and we will generate no revenues from LOCILEX Cream in the near future. We have terminated our manufacturing agreements required to further develop this product
candidate. The GlaxoSmithKline agreement also gives GlaxoSmithKline rights to terminate the arrangement, and, under certain conditions, the right to negotiate for rights to another Genaera product development candidate. GlaxoSmithKline remains our
exclusive sales, marketing and distribution partner for the North American territory for LOCILEX Cream.



CONTRACT MANUFACTURING



We have no current plans to establish a commercial manufacturing facility. We depend upon various contract manufacturers for clinical trial manufacturing of our proposed products and expect to continue to rely on third parties for any
commercial-scale manufacturing. We require all of our third-party manufacturers to produce our active pharmaceutical ingredients and finished products in accordance with all applicable regulatory standards.



GOVERNMENT REGULATION



Our development, manufacture, and potential sale of therapeutics are subject to extensive regulation by United States and
foreign governmental authorities.



Regulation of
Pharmaceutical Products in the United States



The FDA may
regulate our product candidates currently being developed as drugs or biologics in the United States. New drugs are subject to regulation under the Federal Food, Drug, and Cosmetic Act, and biological products, in addition to being subject to
certain provisions of that Act, are regulated under the Public Health Service Act. Both statutes and the regulations promulgated thereunder govern, among other things, the testing, manufacturing, safety, efficacy, labeling, storage, record keeping,
and advertising and other promotional practices involving biologics or new drugs, as the case may be. FDA approval or other clearances must be obtained before clinical testing, and before manufacturing and marketing of new biologics and drugs.



Obtaining FDA approval historically has been a costly and
time-consuming process. Generally, in order to gain FDA premarket approval, a developer first must conduct preclinical studies in the laboratory and in animal model systems to gain preliminary information on an agents effectiveness and to
identify any safety problems. The results of these studies are submitted as a part of an IND for a drug or biologic which the FDA must review before human clinical trials of an investigational drug or device can begin. The IND includes a detailed
description of the clinical investigations to be undertaken.



In order to commercialize any products, we or our collaborators must sponsor and file an IND and be responsible for initiating and overseeing the clinical studies to demonstrate the safety, effectiveness, and quality that are necessary to
obtain FDA approval of any such products. For INDs sponsored by us or our collaborators, we or our collaborators will be required to select qualified investigators (usually physicians within medical institutions) to supervise the administration of
the products, and ensure that the investigations are conducted and monitored in accordance with FDA regulations, including the general investigational plan and protocols contained in the IND.



Clinical trials of drugs normally are done in three phases, although the
phases may overlap. Phase I trials are concerned primarily with the safety and preliminary effectiveness of the drug, involve a small group typically ranging from 1540 subjects, and may take from six months to over one year to complete. Phase
II trials normally involve 30200 patients and are designed primarily to demonstrate effectiveness in treating or diagnosing the disease or condition for which the drug is intended, although short-term side effects and risks in people whose
health is impaired may also be examined. Phase III trials are expanded clinical trials with larger numbers of patients which are intended to evaluate the overall benefit-risk relationship of the drug and to gather additional information for proper
dosage and



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labeling of the drug. Phase III clinical trials generally take two to five years to complete, but may take longer. The FDA receives reports on the progress
of each phase of clinical testing, and it may require the modification, suspension, or termination of clinical trials if it concludes that an unwarranted risk is presented to patients, or, in Phase II and III, if it concludes that the study
protocols are deficient in design to meet their stated objectives.



If clinical trials of a new product are completed successfully, the sponsor of the product may seek FDA marketing approval. If the product is regulated as a biologic, the FDA will require the submission and approval of a Biologics License
Application (BLA) before commercial marketing of the biologic. If the product is classified as a new drug, an applicant must file a New Drug Application (NDA) with the FDA and receive approval before commercial marketing of the drug. The BLA or NDA
must include detailed information about the product and its manufacture and the results of product development, preclinical studies and clinical trials.



The testing and approval processes require substantial time and effort and there can be no assurance that any approval will be granted on a timely basis,
if at all. BLAs, and NDAs submitted to the FDA can take up to one to two years to receive approval. If questions arise during the FDA review process, approval can take more than five years. Notwithstanding the submission of relevant data, the FDA
may ultimately decide that the BLA or NDA does not satisfy its regulatory criteria for approval and deny approval, require additional clinical studies, or require demonstration of compliance with Good Manufacturing Practices (GMPs). In addition, the
FDA may condition marketing approval on the conduct of specific post-marketing studies to further evaluate safety and effectiveness. Even if FDA regulatory clearances are obtained, a marketed product is subject to continual regulatory requirements
and review relating to GMPs, adverse event reporting, promotion and advertising, and other matters, and later discovery of previously unknown problems or failure to comply with the applicable regulatory requirements may result in restrictions on the
marketing of a product or withdrawal of the product from the market as well as possible civil or criminal sanctions.



Orphan Drug Designation



During 2001, the FDA granted squalamine orphan drug designation for the treatment of ovarian cancer. We may request orphan drug designation for several
indications for our other product candidates under development. Orphan drug designation may be granted to those products developed to treat diseases or conditions that affect fewer than 200,000 persons in the United States or that affect more than
200,000 persons in the United States and for which there is no reasonable expectation that the cost of developing and making a drug in the United States for such disease or condition will be recovered from sales in the United States of such drug.
Under the law, the developer of an orphan drug may be entitled to seven years of market exclusivity following the approval of the product by the FDA, exemption from user fee payments to the FDA and a tax credit for the amount of money spent on human
clinical trials. However, we must be the first to receive FDA marketing approval to receive market exclusivity under the orphan drug statute should there be a competitor with a similar molecular entity pursuing the same intended clinical use.
Although we may get market exclusivity under the Orphan Drug Act, the FDA will allow the sale of a molecularly equivalent drug, which is clinically superior to or a molecular entity different from another approved orphan drug, although for the same
indication, during the seven-year exclusive marketing period. It is also possible that a competitor might try to undermine any exclusivity provided by promoting a product for an off-label use that is the otherwise protected product. We cannot be
sure that any of our other product candidates under development will ultimately receive orphan drug designation, or that the benefits currently provided by this designation, if we were to receive it, will not subsequently be amended or eliminated.
Orphan drug designation does not convey any advantage in, or shorten the duration of, the regulatory review and approval process.



Regulation of Pharmaceutical Products Outside of the United States



The development and commercialization of our product candidates outside of the United States are subject to foreign local and national regulatory
requirements. The requirements that we must satisfy to obtain regulatory approval by governmental agencies in other countries prior to commercialization of our products in such countries can be as rigorous, costly and uncertain.



Other



In addition to the foregoing, our business is and will be subject to regulation under various state and federal
environmental laws, including the Occupational Safety and Health Act, the Resource Conservation and Recovery Act and the Toxic Substance Control Act. These and other laws govern our use, handling and disposal of various biological, chemical and
radioactive substances used in and wastes generated by our operations. We cannot predict



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whether state or federal regulators and agencies will impose new regulatory restrictions on the marketing of biotechnology products.



PATENTS, LICENSES AND PROPRIETARY RIGHTS



We actively seek to protect our product candidates and proprietary
information by means of United States and foreign patents, trademarks and contractual arrangements. Our success depends, in part, on our ability to develop and maintain a strong patent position for our products and technologies both in the United
States and certain other countries where patent laws are enforced and pharmaceutical markets are deemed to be meaningful to us and our current and future collaborators. As with most biotechnology and pharmaceutical companies, our patent position is
highly uncertain and involves complex legal and factual questions.



To date, we own, co-own or have licensed on an exclusive basis a total of 73 patent applications and issued patents in the United States of which we own or co-own 59 and we license on an exclusive basis 14. We own, co-own or have licensed
on an exclusive basis a total of 102 patent applications and issued patents in countries other than the United States.



We own several patents for the use of squalamine as an anti-angiogenic, including the patent to the compounds combination therapy with other
anti-cancer agents, the earliest of which expires in 2017. We also own a patent regarding a specific component of the manufacturing process of squalamine and trodusquemine that expires in 2017. We own a composition of matter patent for the
trodusquemine compound, which expires in 2014. We also own a patent for the use of trodusquemine as an anti-obesity agent and other indications that expires in 2015. We own a patent for the use of anti-IL9 antibodies for the treatment of asthma and
related disorders, which expires in 2016. We have recently received a notice of allowance for a patent covering methods for screening for mucoregulator compounds.



The expiration date of each of these patents is subject to extension depending upon the future research and development
program timelines. We have filed several other applications across our research and development programs and intend to file additional applications, as appropriate, for patents on new compounds, products or processes discovered or developed through
the application of our technology.



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



In addition, we rely on unpatented proprietary technologies, unpatentable skills, knowledge and experience of our scientific and technical personnel, as well as those of our advisors, consultants and other contractors
and other intellectual property (know-how) in the development of our product candidates. To help protect our proprietary know-how that is not patentable, and for inventions for which patents may be difficult to enforce, we rely on trade
secret protection and confidentiality agreements to protect our interests. To this end, we require employees, consultants and advisors to enter into agreements that prohibit the disclosure of confidential information and, where applicable, require
disclosure and assignment to us of the ideas, developments, discoveries and inventions that arise from their activities for us. These confidentiality agreements require that our employees, consultants and advisors do not bring to us, or use without
proper authorization, any third partys proprietary technology.



We have trademark protection for the product candidate name LOMUCINTMand are currently seeking U.S.
registration of this trademark.



COMPETITION



The pharmaceutical industry is characterized by intense competition. Many
companies, research institutions and universities are conducting research and development activities in a number of areas similar to our fields of interest.



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Most of these entities have substantially greater financial, technical, manufacturing, marketing, distribution and other resources. We also may face
competition from companies using different or advanced techniques that could render our products obsolete.



We expect technological developments in the biopharmaceutical field to occur at a rapid rate and expect competition to intensify as advances in this field
are made. Colleges, universities, governmental agencies and other public and private research organizations are becoming more active in seeking patent protection and licensing arrangements to collect royalties for use of technology that they have
developed, some of which may be directly competitive with our technology. In addition, these institutions, along with pharmaceutical and specialized biotechnology companies, can be expected to compete with us in recruiting highly qualified
scientific personnel.



Many companies are working to develop
and market products intended for the disease areas being targeted by us, including cancer, AMD, and respiratory diseases. A number of major pharmaceutical companies have significant franchises in these disease areas, and can be expected to invest
heavily to protect their interests. With respect to cancer, anti-angiogenic agents are under development at a number of biopharmaceutical companies, including EntreMed, Inc., Genentech, Inc., and Imclone Systems, Inc., as well as multiple large
pharmaceutical companies. For AMD, anti-angiogenic agents are under development at a number of biopharmaceutical companies, including Alcon, Inc., Bausch & Lomb, Inc., Eyetech Pharmaceuticals, Genentech, Inc., Miravant Medical Technologies, and
QLT, Inc., as well as multiple large pharmaceutical companies. In the respiratory field, other biopharmaceutical companies also have reported the discovery of genes relating to asthma and other respiratory diseases, including Genentech, Inc.,
Immunex Corporation, and Vertex Pharmaceuticals, Inc., as well as multiple large pharmaceutical companies.



EXECUTIVE OFFICERS



Our
current executive officers are as follows:



|                         |  |     |  |                                                                                    
|------------------------ |  | --- |  | -----------------------------------------------------------------------------------
|Name                     |  | Age |  | Position                                                                           
|Roy C. Levitt, M.D.      |  | 50  |  | President and Chief Executive Officer                                              
|Kenneth J. Holroyd, M.D. |  | 45  |  | Executive Vice President and Chief Operating Officer                               
|John L. Armstrong, Jr.   |  | 60  |  | Executive Vice President                                                           
|Angeline K. Shashlo      |  | 45  |  | Senior Vice President, Regulatory Affairs, Quality Assurance and Project Management
|John A. Skolas           |  | 51  |  | Senior Vice President, Chief Financial Officer, General Counsel and Secretary      



Dr. Levitt has
served as our President and Chief Executive Officer since November 2000. Prior to that, Dr. Levitt had served as our Executive Vice President and Chief Operating Officer since August 1998. Dr. Levitt was appointed our head of Research and
Development and a Director in August 1997. Prior to joining us on a full-time basis in January 1996, Dr. Levitt served as a consultant to a number of biotechnology companies, including Genaera, beginning in 1995. Dr. Levitt served as a faculty
member at Johns Hopkins University in the Department of Anesthesiology and Critical Care Medicine, from 1986 to 1995, in Neurological Surgery from 1995 to 1996 and in the Department of Environmental Health Sciences in the Johns Hopkins School of
Public Health and Hygiene from 1988 to 1996. Dr. Levitt completed his residency training in internal medicine and anesthesiology and critical care medicine at the John Hopkins Medical Institutions and genetics training at the National Institutes of
Health. He is board certified in anesthesiology and critical care medicine and internal medicine.



Dr. Holroyd was promoted to our Executive Vice President and Chief Operating Officer in February 2002. Prior to that, he had served as our
Executive Vice President and Chief Business Officer since November 2000. Prior to that, Dr. Holroyd had served as our Senior Vice President, Clinical Research and Regulatory Affairs since June 1998. Dr. Holroyd has held various positions, including
Vice President of Respiratory Discovery Research, Product Development and Business Development, since joining us in February 1997. Prior to joining us, Dr. Holroyd was a faculty member and head of respiratory care services at Johns Hopkins
University School of Medicine and Hospital in the Departments of Medicine and Anesthesiology and Critical Care Medicine. Dr. Holroyd earned his M.D. and M.B.A. from Johns Hopkins in 1984 and 2000, respectively, and completed his residency training
at Johns Hopkins and at the National Heart, Lung and Blood Institute.



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Mr. Armstrong has served as our Executive Vice President since joining the Company in October
2003. Mr. Armstrong has over thirty-four years of executive responsibility in the pharmaceutical industry, with a manufacturing emphasis. Prior to Genaera, he served as CEO of Mills Biopharmaceuticals, a subsidiary of UroCor, Inc., and as Vice
President of Business Development at UroCor from December 1999 to November 2001. Prior to that, Mr. Armstrong served as President and Chief Operating Officer at Oread, Inc. from February 1998 to August 1999. Mr. Armstrong spent from 1991 to 1998
with the DuPont Merck Pharmaceutical Company where he served in various executive positions, including as President of ENDO Laboratories, and President of the global manufacturing/quality division. Prior to that Mr. Armstrong served in numerous
roles of increasing responsibility in manufacturing operations at Merck, Sharp and Dohme, Stuart Pharmaceuticals and Marion Merrell Dow. Mr. Armstrong earned his M.B.A from Century University in 1993.



Ms. Shashlo has served as our Senior Vice President, Regulatory
Affairs, Quality Assurance and Project Management since December 2002. Prior to that, Ms. Shashlo served as our Vice President, Regulatory Affairs and Project Management since joining us in June 2002. Prior to Genaera, Ms. Shashlo served as a
worldwide regulatory consultant from September 2001 to May 2002, including a brief tenure as Vice President, Regulatory Affairs for Medinox, Inc. From May 2000 to August 2001, Ms. Shashlo served as Vice President, Regulatory Affairs and Quality
Assurance for Vitagen Incorporated. Prior to that, Ms. Shashlo served as Director, Regulatory Affairs and Compliance at Ligand Pharmaceuticals, Inc. from August 1997 to May 2000. From September 1993 to August 1997, Ms. Shashlo held the position of
Associate Director International Regulatory Affairs, Worldwide Regulatory Affairs Division for Wyeth-Ayerst Research. Ms. Shashlo received her B.S. Pharmacy degree from the University of Michigan and is a registered pharmacist licensed by the State
of Michigan.



Mr. Skolas has served as our Senior Vice
President, Chief Financial Officer, General Counsel and Secretary since October 2003. Prior to that, Mr. Skolas served as a consultant and acting chief financial officer for early stage biotechnology companies. From 2000 through 2001, Mr. Skolas was
Chief Financial Officer of Valigen, a privately held genomics company. From 1999 through 2000, Mr. Skolas served as Chief Financial Officer of Coelacanth Corporation (now the pharmaceuticals division of Lexicon Genetics). From 1997 until 1999, Mr.
Skolas served as Chief Financial Officer and General Counsel of Phytoworks, Inc. From 1988 until 1997, Mr. Skolas served in various executive positions with EMI Group, PLC, including five years as President and General Counsel of its subsidiary EMI
Group Inc. Mr. Skolas early career included law practice as a partner in Muchin, Muchin, Bendix & Skolas S.C. and accounting practice as a Tax Specialist for Coopers & Lybrand, CPA. Mr. Skolas obtained a CPA certificate from the State
of Iowa in 1976. He earned an MBA from Harvard Business School in 1988 and a JD from the University of Wisconsin in 1977.



Officers are elected or appointed by the board of directors to serve until the appointment or election and qualification of their successors or their
earlier termination or resignation.



EMPLOYEES



As of December 31, 2003, we had 31 full-time employees. No employees are
covered by collective bargaining agreements, and we consider relations with our employees to be good.



AVAILABLE INFORMATION



We make available free of charge on or through our internet website at www.genaera.com our Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and amendments to these reports filed or furnished pursuant
to Section 13(a) or 15(d) of the Securities Exchange Act of 1934 as soon as reasonably practicable after we electronically file such material with, or furnish it to, the United States Securities and Exchange Commission.



RISK FACTORS RELATED TO OUR BUSINESS



Any investment in shares of our common stock involves a high degree of risk.
You should carefully consider the following risk factors, together with the other information presented in this Annual Report on Form 10-K.



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



We maintained cash and investments of $13.1 million at December 31, 2003.
At December 31, 2003, we had current liabilities of $2.9 million, and long-term liabilities of $1.0 million. In January 2004, we completed the sale of 4,950,500 shares of our common stock for gross proceeds of approximately $20.0 million. We believe
these resources



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are sufficient to meet our research and development goals and sustain operations at least through 2004. However, we will need to raise substantial additional
funds in the future to continue our research and development programs and to commercialize our potential products. If we are unable to raise additional funds, we may be unable to complete our development activities for any of our proposed products.



We regularly explore alternative means of financing our
operations and seek funding through various sources, including public and private securities offerings, collaborative arrangements with third parties and other strategic alliances and business transactions. We currently do not have any commitments
to provide us additional funds, and may be unable to obtain sufficient funding in the future on acceptable terms, if at all. If we cannot obtain funding, we will need to delay, scale back or eliminate research and development programs or enter into
collaborations with third parties to commercialize potential products or technologies that we might otherwise seek to develop or commercialize ourselves, or seek other arrangements. If we raise additional capital by issuing equity or securities
convertible into equity, our stockholders may experience dilution and our share price may decline. Any debt financing may result in restrictions on spending or payment of dividends. If we engage in collaborations, we will receive lower consideration
upon commercialization of such products than if we had not entered into such arrangements, or if we entered into such arrangements at later stages in the product development process.



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



To date, we have engaged primarily in the research and
development of drug candidates. We have not generated any revenues from product sales and have incurred losses in each year since our inception. As of December 31, 2003, we had an accumulated deficit of approximately $195.3 million.



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



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



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



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



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



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



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penny stocks. Prior to the transaction, a broker-dealer must provide a disclosure schedule relating to the penny stock market. In
addition, the broker-dealer must disclose the following:



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



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



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



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



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



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



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



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



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



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



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



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



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



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



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



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



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



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



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



We currently do
not have the resources, facilities, or technical capabilities to manufacture any of our proposed products in the quantities and quality required for commercial sale. We have no plans to establish a manufacturing facility. We expect to depend upon
contract manufacturers for commercial scale manufacturing of our proposed



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products in accordance with regulatory standards. For example, we are currently working with outside contractors for the chemical production of squalamine.
This dependence on contract manufacturers may restrict our ability to develop and deliver products on a timely, profitable and competitive basis especially because the number of companies capable of producing our proposed products is limited. These
contract manufacturers generally have multiple projects and they may give ours a lower priority. As a result of contract manufacture mishaps, our product could be lost or delivered late delaying our clinical and preclinical programs, or may not be
produced in accordance with all current applicable regulatory standards. Products not produced in accordance with all current applicable regulatory standards may lead to adverse outcomes for patients and/or product recalls. Furthermore, the
development of a robust, low-cost manufacturing process for the commercial production of squalamine and other proposed products will require significant time and expenditure by us. We may be unable to maintain arrangements with qualified outside
contractors to manufacture materials at costs that are affordable to us, if at all.



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



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



Patents



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



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



We cannot be certain that:



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



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



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



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



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



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



Third Party Intellectual Property Rights



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



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Other Intellectual Property



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



Certain of our exclusive rights to patents,
patent applications and other technology are governed by contract. Generally, these contracts require that we undertake certain obligations including the payment of royalties on sales of any products that are covered by patent claims. If we do not
meet those obligations, we may lose our rights. Additionally, some of these agreements also require that we develop the licensed technology or meet certain milestones within a given timeframe. If we do not adhere to an acceptable schedule of
commercialization, we may lose our rights.



We are currently
attempting to register as a trademark the Genaera name in certain jurisdictions throughout the world. There can be no assurance that trademarks will be issued, or that our issued trademarks will protect our name. If the Genaera name
conflicts with the rights of a pre-existing trademark owner in a jurisdiction, we may need to operate under a different name in such jurisdiction, which could result in a loss of goodwill associated with that name.



Potential Ownership Disputes



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



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



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



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



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



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



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



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



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



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



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



In both the United States and elsewhere, the availability of reimbursement from third-party payers, such as government health administration authorities, private health insurers and other organizations, can impact
prescription pharmaceutical sales. These organizations are increasingly challenging the prices charged for medical products and services, particularly where they believe that there is only an incremental therapeutic benefit that does not justify the



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additional cost. If any of our products ever obtain marketing approval, coverage and reimbursement may not be available for these products, or, if available,
may not be adequate. Without insurance coverage, many patients may be unable to afford our products, in which case sales of the products would be adversely affected.



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



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



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



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



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



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



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



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



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



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



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



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



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



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



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



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



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



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



As of December 31, 2003, there were outstanding
options to purchase an aggregate of approximately 4,038,000 shares of our common stock at prices ranging from $0.40 per share to $11.63 per share, of which options to purchase approximately 2,510,000 shares were exercisable as of such date. As of
December 31, 2003, there were outstanding warrants to purchase 417,166 shares of our common stock, of which warrants to purchase 167,166 shares of our common stock are currently exercisable at $3.38 per share, subject to adjustment under the
anti-dilution provisions of the warrants, and warrants to purchase 50,000 shares are currently exercisable at $3.79 per share. In May 2003, in connection with a private placement of our Series C convertible preferred stock, we issued warrants to
purchase 2,000,000 shares of our common stock at an exercise price of $1.37 per share, of which 1,800,000 have been exercised and 200,000 are exercisable 18 months after issuance beginning on November 23, 2004 and may be exercised immediately if the
holder elects to receive, without the payment by the holder of any additional consideration, a number of shares of our common stock equal to the value of the warrants, also know as net exercise provisions. In January 2004, in connection with a
private placement of our common stock, we issued warrants to purchase 990,100 shares of our common stock at an exercise price of $5.38 per share. In connection with an April 2002 private placement of our common stock, we granted to the placement
agent warrants to purchase 100,000 shares of our common stock at an exercise price of $2.75 per share. As of December 31, 2003, these warrants have not yet been issued.



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



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



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



|ITEM 2. | PROPERTIES
|------- | ----------



We lease approximately 21,000 square feet of office and laboratory space in a single building in Plymouth Meeting, Pennsylvania. This lease provides for
minimum annual payments of approximately $0.4 million in 2004 and is subject to certain annual increases thereafter. This lease expires in November 2007.



|ITEM 3. | LEGAL PROCEEDINGS
|------- | -----------------



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



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



No matters were submitted to a vote of our stockholders during the last quarter of the year ended December 31, 2003.



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PART II



|ITEM 5. | MARKET FOR REGISTRANTS COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
|------- | ---------------------------------------------------------------------



Our common stock currently trades on the National Association of Securities Dealers Automated Quotation System (Nasdaq)
SmallCap Market under the symbol GENR. From December 12, 1991, the date of our initial public offering, until March 9, 2001 our common stock was included for quotation on the Nasdaq National Market under the symbol MAGN. On
March 9, 2001, we changed our name to Genaera Corporation and, on March 12, 2001, our common stock began inclusion for quotation on the Nasdaq National Market under the symbol GENR. Our common stock was included for quotation under the
Nasdaq National Market through October 30, 2002, when we elected to begin trading on the Nasdaq SmallCap Market effective with the opening of trading on October 31, 2002.



The quarterly ranges of high and low closing bid prices per share of our common stock are shown below.



|                             |  |      |      |     |   |     
|---------------------------- |  | ---- | ---- | --- | - | ----
|Year Ended December 31, 2002 |  | High |      | Low
|1st Quarter                  |  | $    | 3.90 |     | $ | 2.50
|2nd Quarter                  |  | $    | 3.18 |     | $ | 1.78
|3rd Quarter                  |  | $    | 1.90 |     | $ | 0.46
|4th Quarter                  |  | $    | 0.68 |     | $ | 0.32
|                             |  |     
|Year Ended December 31, 2003 |  | High |      | Low
|1st Quarter                  |  | $    | 0.61 |     | $ | 0.23
|2nd Quarter                  |  | $    | 2.48 |     | $ | 0.32
|3rd Quarter                  |  | $    | 5.17 |     | $ | 1.62
|4th Quarter                  |  | $    | 6.17 |     | $ | 3.15



As of March 19, 2004,
the last reported bid price for our common stock on the Nasdaq SmallCap Market was $4.62 per share.



Dividends



We have not
paid any cash dividends on our common stock since our inception, and we do not anticipate paying any cash dividends on our common stock in the foreseeable future. It is the present policy of the board of directors to retain all earnings, if any, to
finance the development of our business.



Number of Holders of Common Stock



At March 19, 2004, there were 362 stockholders of record
and approximately 16,867 beneficial owners of our common stock.



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Equity Compensation Plan Information



The following table provides aggregate information as of December 31, 2003, regarding our equity compensation plans,
including the Amended 1998 Equity Compensation Plan and the 1992 Stock Option Plan (the 1992 Plan). As a result of the expiration of the 1992 Plan in 2002, no additional option grants will be made under the 1992 Plan.



|                                                           |  |                                                                                                                                   |  |                                                                          |      |                                                                                                                                        |        
|---------------------------------------------------------- |  | --------------------------------------------------------------------------------------------------------------------------------- |  | ------------------------------------------------------------------------ | ---- | -------------------------------------------------------------------------------------------------------------------------------------- | -------
|                                                           |  | (a)                                                                                                                               |  | (b)                                                                      |      | (c)                                                                                                                                   
|                                                           |  | Number ofsecurities to beissued uponexercise ofoutstandingoptions,
warrants andrights and lapse ofrestrictions onrestricted stock |  | Weighted-averageexercise price ofoutstandingoptions, warrantsand rights1 |      | Number of securitiesremaining available forfuture issuances underequity compensationplans (excludingsecurities reflected incolumn
(a))
|Equity compensation plans approved by security holders     |  | 4,136,250                                                                                                                         |  | $                                                                        | 3.88 |                                                                                                                                        | 326,375
|Equity compensation plans not approved by security holders |  |                                                                                                                                  |  |                                                                          |     |                                                                                                                                        |       
|                                                           |  |                                                                                                                                   |  |                                                                          |      |                                                                                                                                        |        
|Total                                                      |  | 4,136,250                                                                                                                         |  | $                                                                        | 3.88 |                                                                                                                                        | 326,375
|                                                           |  |                                                                                                                                   |  |                                                                          |      |                                                                                                                                        |        



|1 | Does not include restricted stock as exercise price is determined on date of issuance, not
date of grant.
|- | ---------------------------------------------------------------------------------------------------------



See ITEM 8. Financial Statements and Supplementary Data, NOTE 10. Common Stock Options and Restricted Common Stock
Awards for additional information regarding the Companys equity compensation plans.



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##### Table of Contents

|ITEM 6. | SELECTED FINANCIAL DATA
|------- | -----------------------



The following tables summarize certain selected financial data and are derived from our audited financial statements. The selected financial data below
should be read in conjunction with our financial statements and notes thereto, Managements Discussion and Analysis of Financial Condition and Results of Operations and the other financial information included herein.



|                                                                       |  |                                          |         |   |      |   |         |      |  |   |         |   |  |      |         |   |  |   |         |  
|---------------------------------------------------------------------- |  | ---------------------------------------- | ------- | - | ---- | - | ------- | ---- |  | - | ------- | - |  | ---- | ------- | - |  | - | ------- | -
|                                                                       |  | Year Ended December 31,                  |        
|                                                                       |  | 2003                                     |         |   | 2002 |   |         | 2001 |  |   | 2000    |   |  | 1999 |        
|                                                                       |  | (In thousands, except per share amounts) |        
|Statement of Operations Data:                                          |  |                                          |         |   |      |   |         |      |  |   |         |   |  |      |         |   |  |   |         |  
|Revenues:                                                              |  |                                          |         |   |      |   |         |      |  |   |         |   |  |      |         |   |  |   |         |  
|Collaborative research agreement                                       |  | $                                        | 1,113   |   |      | $ | 1,517   |      |  | $ | 1,038   |   |  | $    |        |   |  | $ |        |  
|                                                                       |  |                                          |         |   |      |   |         |      |  |   |         |   |  |      |         |   |  |   |         |  
|Costs and expenses:                                                    |  |                                          |         |   |      |   |         |      |  |   |         |   |  |      |         |   |  |   |         |  
|Research and development                                               |  |                                          | 8,092   |   |      |   | 10,691  |      |  |   | 11,132  |   |  |      | 10,074  |   |  |   | 9,876   |  
|General and administrative                                             |  |                                          | 2,437   |   |      |   | 3,085   |      |  |   | 3,423   |   |  |      | 2,583   |   |  |   | 2,870   |  
|                                                                       |  |                                          |         |   |      |   |         |      |  |   |         |   |  |      |         |   |  |   |         |  
|                                                                       |  |                                          | 10,529  |   |      |   | 13,776  |      |  |   | 14,555  |   |  |      | 12,657  |   |  |   | 12,746  |  
|                                                                       |  |                                          |         |   |      |   |         |      |  |   |         |   |  |      |         |   |  |   |         |  
|Loss from operations                                                   |  |                                          | (9,416  | ) |      |   | (12,259 | )    |  |   | (13,517 | ) |  |      | (12,657 | ) |  |   | (12,746 | )
|Interest income                                                        |  |                                          | 88      |   |      |   | 260     |      |  |   | 849     |   |  |      | 883     |   |  |   | 755     |  
|Interest expense                                                       |  |                                          | (65     | ) |      |   | (157    | )    |  |   | (244    | ) |  |      | (605    | ) |  |   | (225    | )
|                                                                       |  |                                          |         |   |      |   |         |      |  |   |         |   |  |      |         |   |  |   |         |  
|Net loss                                                               |  |                                          | (9,393  | ) |      |   | (12,156 | )    |  |   | (12,912 | ) |  |      | (12,379 | ) |  |   | (12,216 | )
|Dividends on preferred stock                                           |  |                                          | 3,085   |   |      |   | 73      |      |  |   | 111     |   |  |      | 45      |   |  |   |        |  
|                                                                       |  |                                          |         |   |      |   |         |      |  |   |         |   |  |      |         |   |  |   |         |  
|Net loss applicable to common stockholders                             |  | $                                        | (12,478 | ) |      | $ | (12,229 | )    |  | $ | (13,023 | ) |  | $    | (12,424 | ) |  | $ | (12,216 | )
|                                                                       |  |                                          |         |   |      |   |         |      |  |   |         |   |  |      |         |   |  |   |         |  
|Net loss applicable to common stockholders per share-basic and diluted |  | $                                        | (0.32   | ) |      | $ | (0.35   | )    |  | $ | (0.40   | ) |  | $    | (0.42   | ) |  | $ | (0.52   | )
|                                                                       |  |                                          |         |   |      |   |         |      |  |   |         |   |  |      |         |   |  |   |         |  
|Weighted average shares outstanding-basic and diluted                  |  |                                          | 38,634  |   |      |   | 34,894  |      |  |   | 32,711  |   |  |      | 29,375  |   |  |   | 23,706  |  
|                                                                       |  |                                          |         |   |      |   |         |      |  |   |         |   |  |      |         |   |  |   |         |  



|                                       |  |                |          |   |      |   |          |      |  |   |          |   |  |      |          |   |  |   |          |  
|-------------------------------------- |  | -------------- | -------- | - | ---- | - | -------- | ---- |  | - | -------- | - |  | ---- | -------- | - |  | - | -------- | -
|                                       |  | December 31,   |         
|                                       |  | 2003           |          |   | 2002 |   |          | 2001 |  |   | 2000     |   |  | 1999 |         
|                                       |  | (In thousands) |         
|Balance Sheet Data:                    |  |                |          |   |      |   |          |      |  |   |          |   |  |      |          |   |  |   |          |  
|Cash and investments                   |  | $              | 13,135   |   |      | $ | 9,400    |      |  | $ | 16,078   |   |  | $    | 19,033   |   |  | $ | 10,644   |  
|Total assets                           |  |                | 14,553   |   |      |   | 11,191   |      |  |   | 17,816   |   |  |      | 20,701   |   |  |   | 12,731   |  
|Long-term liabilities                  |  |                | 1,048    |   |      |   | 1,704    |      |  |   | 1,579    |   |  |      | 2,010    |   |  |   | 3,015    |  
|Redeemable convertible preferred stock |  |                |         |   |      |   | 1,117    |      |  |   | 1,044    |   |  |      | 1,233    |   |  |   |         |  
|Accumulated deficit                    |  |                | (195,298 | ) |      |   | (182,819 | )    |  |   | (170,591 | ) |  |      | (157,568 | ) |  |   | (145,144 | )
|Stockholders equity                   |  |                | 10,622   |   |      |   | 4,511    |      |  |   | 9,610    |   |  |      | 11,473   |   |  |   | 6,552    |  
|                                       |  |                |          |   |     
|Other Data:                            |  |                |          |   |      |   |          |      |  |   |          |   |  |      |          |   |  |   |          |  
|Working capital                        |  |                | 10,516   |   |      |   | 5,727    |      |  |   | 10,713   |   |  |      | 13,393   |   |  |   | 7,608    |  



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|ITEM 7. | MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
|------- | -------------------------------------------------------------------------------------



OVERVIEW



Genaera Corporation is a biopharmaceutical company committed to developing medicines for serious diseases from genomics and
natural products. Our research and development efforts are focused on anti-angiogenesis and respiratory diseases.



Since commencing operations in 1988, we have not generated any revenue from product sales, and we have funded operations primarily from the proceeds of
public and private placements of securities and research and development collaboration payments and related equity investments. We have incurred a loss in each year since our inception, and we expect to incur substantial additional losses for at
least the next several years. We expect that losses may fluctuate, and that such fluctuations may be substantial. At December 31, 2003, our accumulated deficit was approximately $195.3 million. We will need to raise additional funds in the future to
continue our operations.



The following discussion is
included to describe our financial position and results of operations for each of the previous three years in the period ended December 31, 2003. The Consolidated Financial Statements and Notes thereto contain detailed information that should be
referred to in conjunction with this discussion.



CRITICAL ACCOUNTING
POLICIES AND ESTIMATES



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



Revenue Recognition



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



Research and Development Expenses



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



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##### Table of Contents

Stock-Based Compensation



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



RESULTS OF OPERATIONS  2003 vs. 2002



Revenues



We have received no revenues to date from product sales. Revenues recorded
to date have consisted principally of revenues recognized under collaborations with third parties. In April 2001, we entered into a research collaboration and licensing agreement with MedImmune, Inc. to develop and commercialize therapies related to
our IL9 program. MedImmune provided funding of $2.5 million, payable in eight equal quarterly installments through April 2003, plus funds external cost reimbursements for our research and development activities. For the years ended December 31, 2003
and 2002, we recognized $0.7 million and $1.5 million, respectively, in revenue related to this agreement, of which $0.3 million and $0.2 million, respectively, related to external cost reimbursements.



In February 2002, the Company received a Phase II Small Business Innovative
Research program grant from the National Institutes of Health in the amount of $800,000 to support our aminosterol research program. The grant extends over the two-year period beginning in February 2002. The Company recognized $412,000 as revenue
related to this grant in the periods ending December 31, 2003.



Research and Development Expenses



We
recognized research and development expenses of $8.1 million and $10.7 million in 2003 and 2002, respectively. Research and development expenses consist principally of personnel costs, contract research, development and manufacturing costs and
facility costs. Research and development expenses have decreased in the year ended December 31, 2003, as compared to the same period a year ago, due to reduced manufacturing efforts ($1.0 million), the absence of a one time accrual of severance and
related costs associated with our realignment of operations in August and November of 2002 ($0.7 million), as well as reduced continuing payroll and related costs associated with our realignment of operations in 2002 ($2.7 million). These reductions
were partially offset by increased development efforts in squalamine ($1.8 million). The level of research and development expenses in future periods will depend principally upon the progress of our research and development programs and our capital
resources.



General and Administrative Expenses



We recognized general and administrative expenses of $2.4
million and $3.1 million in 2003 and 2002, respectively. General and administrative expenses consist principally of personnel costs, professional fees and public company expenses. General and administrative costs decreased in the year ended December
31, 2003, as compared to the same period a year ago, due principally to reduced payroll and related costs associated with our realignment of operations in 2002 ($0.3 million), gains from the sale of excess research equipment ($0.3 million), the
absence of a one time accrual of severance and related costs associated with our realignment of operations in August and November of 2002 ($0.2 million), as well as continuing cost containment initiatives. These reductions were partially offset by
small increases in several categories of general corporate expenses.



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##### Table of Contents

Interest Income and Expense



We recognized interest income of $0.1 million and $0.3 million in 2003 and 2002, respectively. We recognized interest
expense of $0.1 million and $0.2 million in 2003 and 2002, respectively. Interest income is primarily comprised of income generated from cash and investments. Interest expense is primarily comprised of expense related to our indebtedness to a bank.
Interest income decreased during the year ended December 31, 2003, as compared to the same period a year ago, due to declining investment interest yields and lower average investment balances. Interest expense decreased during the year ended
December 31, 2003, as compared to the prior year due to the repayment of our indebtedness to a bank.



RESULTS OF OPERATIONS  2002 vs. 2001



Revenues



We received
no revenues from product sales for the years ended December 31, 2002 and 2001. Revenues recorded have consisted principally of revenues recognized under collaborations with third parties. In April 2001, we entered into a research collaboration and
licensing agreement with MedImmune, Inc. to develop and commercialize therapies related to our IL9 program. MedImmune provided funding of $2.5 million, payable in eight equal quarterly installments through April 2003, plus funds external cost
reimbursements for our research and development activities. For the years ended December 31, 2002 and 2001, we recognized $1.5 million and $1.0 million, respectively, in revenue related to this agreement, of which $0.2 million and $0.1 million,
respectively, related to external cost reimbursements.



Research and Development Expenses



We
recognized research and development expenses of $10.7 million and $11.1 million in 2002 and 2001, respectively. Research and development expenses consist principally of personnel costs, contract research, development and manufacturing costs and
facility costs. Research and development expenses have decreased marginally in the year ended December 31, 2002, as compared to the prior year, due to reduced squalamine manufacturing and trodusquemine development efforts. These reductions were
partially offset by the $498,000 and $183,000 accruals of research and development employee severance and related costs associated with our realignment of operations in August and November of 2002, respectively.



General and Administrative Expenses



We recognized general and administrative expenses of $3.1 million and $3.4
million in 2002 and 2001, respectively. General and administrative expenses consist principally of personnel costs, professional fees and public company expenses. Such expenses decreased in the year ended December 31, 2002, as compared to the prior
year, due principally to decreases in personnel related to general corporate activities. These reductions were partially offset by the $8,000 and $134,000 accruals of general and administrative employee severance and related costs associated with
our realignment of operations in August and November of 2002, respectively.



Interest Income and Expense



We recognized interest income of $0.3 million and $0.8 million in 2002 and 2001, respectively. We recognized interest expense of $0.2 million in 2002 and 2001. Interest income is primarily comprised of income generated from cash and
investments. Interest expense is primarily comprised of expense related to our indebtedness to a bank. Interest income decreased during the year ended December 31, 2002, as compared to the prior year, due to declining investment interest yields and
lower average investment balances.



LIQUIDITY AND CAPITAL RESOURCES



Cash and investments were $13.1 million at December 31,
2003 as compared to $9.4 million at December 31, 2002. The primary use of cash was to finance our research and development operations.



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Since inception, we have funded our operations primarily from the proceeds of public and private
placements of our securities totaling approximately $173.7 million since our initial public offering in December 1991 and including the proceeds from the following private placements of our securities, net of costs, in 2001, 2002 and 2003:



| |  | $ 9.9 million  April 2001;
| | - | ---------------------------



| |  | $ 6.9 million  April 2002;
| | - | ---------------------------



| |  | $ 4.9 million  May 2003; and
| | - | -----------------------------



| |  | $ 7.9 million  November 2003.
| | - | ------------------------------



In addition to the above, we have funded our operations from contract and grant revenues, research and development expense reimbursements, interest
income, lease financing and debt financing.



Our goal is to
conduct significant research, pre-clinical development, clinical testing and manufacturing activities over the next several years. We expect that these activities, together with projected general and administrative expenses, will result in continued
and significant losses.



Current liabilities decreased by $1.0
million from $3.9 million at December 31, 2002 to $2.9 million at December 31, 2003, due primarily to the maturity and payment of the Companys $2.5 million note payable in June of 2003. The decrease in current liabilities was partially offset
by the reclassification of $1.0 million of long-term liability payable to Abbot to short-term liabilities, as well as an increase in accounts payable and accrued expenses resulting from the timing and magnitude of our current development contracts.
Prior to 1999, we had an agreement with Abbott providing for the purchase of approximately $10.0 million of bulk drug substance for LOCILEX Cream. As FDA approval of LOCILEX Cream did not occur, we renegotiated this agreement with Abbott in 1999,
paying Abbott $4.2 million and receiving partial delivery of material. An additional $3.4 million was due to Abbott and payable if we receive in excess of $10.0 million of additional funds in any year beginning in 2000, in which case 15% of such
excess over $10.0 million shall be payable to Abbott. We have no further purchase commitments to Abbott, and Abbott has no further supply requirements to us. As a result of the Companys financing activities during 2000 and 2001 and other cash
inflows, $1.4 million and $0.5 million of this liability was payable and paid to Abbott on March 1, 2001 and 2002, respectively. No portion of the liability was payable to Abbott on March 1, 2003 as the Company did not receive in excess of $10.0
million of cash inflows during 2002. As a result of the Companys financing activities during 2003 and other cash inflows, $1.0 million of the remaining liability is due and payable to Abbott on March 1, 2004 and is included in short-term
liabilities as of December 31, 2003. The remaining amount of $0.6 million is included in long-term liabilities as of December 31, 2003.



Our capital expenditure requirements will depend upon numerous factors, including the progress of our research and development programs, the time and cost
required to obtain regulatory approvals, our ability to enter into additional collaborative arrangements, the demand for products based on our technology, if and when such products are approved, and possible acquisitions of products, technologies
and companies. We had no significant capital commitments as of December 31, 2003.



In April 2001, we entered into a research collaboration and licensing agreement and a preferred stock purchase agreement with MedImmune pursuant to which we received $10.0 million. MedImmune has funded $2.5 million
plus external cost reimbursements for our research and development activities through April 2003. During 2003 and 2002, funding of $0.7 million and $1.5 million, respectively, had been received from MedImmune. Of that amount, $0.4 million and $1.3
million during 2003 and 2002, respectively, was specifically related to the $2.5 million research and development funding, with the remainder comprised of external cost reimbursements.



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



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In January 2004, we completed the sale of 4,950,500 shares of our common stock for gross proceeds of
approximately $20.0 million. We believe that the proceeds of this offering in addition to our current cash and investments at December 31, 2003, are sufficient to meet our research and development goals and sustain operations at least through 2004.



Contractual Cash Obligations



The table below sets forth our contractual obligations at December 31, 2003
(in thousands):



|                                                        |  |       |       |                             |   |           |  |           |       |              |   |   |  |   |  
|------------------------------------------------------- |  | ----- | ----- | --------------------------- | - | --------- |  | --------- | ----- | ------------ | - | - |  | - | -
|                                                        |  |       |       | Cash Payments Due by Period
|Contractual Cash Obligations                            |  | Total |       | Less than 1 year            |   | 1-3 years |  | 4-5 years |       | After5 years
|Abbott settlement1                                      |  |       | 1,529 |                             |   | 966       |  |           | 563   |              |   |  |  |   | 
|Operating lease on building2                            |  |       | 1,527 |                             |   | 371       |  |           | 1,156 |              |   |  |  |   | 
|Operating leases and maintenance contracts on equipment |  |       | 230   |                             |   | 144       |  |           | 86    |              |   |  |  |   | 
|R&D contracts                                           |  |       | 541   |                             |   | 509       |  |           | 32    |              |   |  |  |   | 
|Clinical trial contracts                                |  |       | 413   |                             |   | 413       |  |           |      |              |   |  |  |   | 
|Manufacturing contracts                                 |  |       | 60    |                             |   | 60        |  |           |      |              |   |  |  |   | 
|                                                        |  |       |       |                             |   |           |  |           |       |              |   |   |  |   |  
|Total contractual cash obligations                      |  | $     | 4,300 |                             | $ | 2,463     |  | $         | 1,837 |              | $ |  |  | $ | 
|                                                        |  |       |       |                             |   |           |  |           |       |              |   |   |  |   |  

---

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



|2 | The lease provides for escalations relating to increases in the Consumer Price Index not to exceed 7% but no less than 3.5% beginning in December 2002. We have
assumed a minimum lease payment escalation of 3.5% for the purposes of this table.
|- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|ITEM 7A. | QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
|-------- | ----------------------------------------------------------



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



As of December 31,
2003, our portfolio investments consisted of $6.6 million in cash and $6.5 million in U.S. government or U.S. government agency debt instruments having a maturity of less than one year. Due to the nature of our investment portfolio, management
believes that a sudden change in interest rates would not have a material effect on the value of the portfolio. Management estimates that if the average annualized yield of our investments had decreased by 100 basis points, our interest income for
the year ended December 31, 2003 would have decreased by approximately $88,000. This estimate assumes that the decrease occurred on the first day of 2003 and reduced the annualized yield of each investment instrument by 100 basis points.
Correspondingly, if the average annualized yield of our investments had increased by 100 basis points, our interest income for the year ended December 31, 2003 would have increased by $94,000. This estimate assumes that the increase occurred on the
first day of 2003 and increased the annualized yield of each investment instrument by 100 basis points. The impact on our future interest income will depend largely on the gross amount of our investment portfolio.



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



|ITEM 8. | FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
|------- | -------------------------------------------



See the Consolidated Financial Statements beginning on page F-1.



|ITEM 9. | CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
|------- | ------------------------------------------------------------------------------------



Not applicable.



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##### Table of Contents

|ITEM 9A. | CONTROLS AND PROCEDURES
|-------- | -----------------------



(a) Evaluation of disclosure controls and procedures: For the quarterly period ended December 31, 2003, we carried out an evaluation, under the
supervision and with the participation of our management, including our President and Chief Executive Officer and our Senior Vice President and Chief Financial Officer (the principal finance and accounting officer), of the effectiveness of the
design and operation of our disclosure controls and procedures pursuant to Rules 13a-14 and 15d-14 under the Securities Exchange Act of 1934, as amended (the Exchange Act). Based upon this evaluation, our President and Chief Executive
Officer and our Senior Vice President and Chief Financial Officer concluded that, as of December 31, 2003, our disclosure controls and procedures were adequate to ensure that information required to be disclosed by us in the reports filed or
submitted by us under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the rules and forms of the Securities and Exchange Commission.



(b) Internal control over financial reporting: No change in our internal control over financial reporting (as defined in
Rules 13a-15(f) and 15d-15(f) under the Exchange Act) occurred during the fiscal quarter ended December 31, 2003 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.



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##### Table of Contents

PART III



This Part incorporates certain information from our Proxy Statement for the 2004 Annual Meeting of Stockholders to be filed with the Securities and
Exchange Commission not later than 120 days after the end of the fiscal year covered by this Annual Report on Form 10-K. Notwithstanding such incorporation, the sections of our 2004 Proxy Statement entitled Report of the Compensation
Committee and Performance Graph shall not be deemed to be filed as part of this Annual Report.



|ITEM 10. | DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
|-------- | --------------------------------------------------



Information required by this item concerning our directors is incorporated herein by reference to the section entitled
Nominees for Election and Corporate Governance in our Proxy Statement for the 2004 Annual Meeting of Stockholders. Information required by this item concerning our executive officers is included in Part I of this Annual
Report.



The Company adopted a corporate code of ethics in
December 2003. This code of ethics applies to all of the Companys employees and directors and includes the code of ethics for the Companys principal executive officer, principal financial officer, principal accounting officer or
controller within the meaning of the SEC regulations adopted under the Sarbanes-Oxley Act of 2002. The Companys corporate code of ethics is posted under the Investor Relations section of its website at www.genaera.com. Please note that none of
the information on the Companys website is incorporated by reference in this proxy statement.



|ITEM 11. | EXECUTIVE COMPENSATION
|-------- | ----------------------



Information required by this item is incorporated herein by reference to the section entitled Compensation of Executive Officers and Directors
in our Proxy Statement for the 2004 Annual Meeting of Stockholders.



|ITEM 12. | SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS
|-------- | ----------------------------------------------------------------------------------------------



Information required by this item is incorporated herein by reference to the
section entitled Security Ownership of Certain Beneficial Owners and Management in our Proxy Statement for the 2004 Annual Meeting of Stockholders.



|ITEM 13. | CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
|-------- | ----------------------------------------------



Information required by this item is incorporated herein by reference to the section entitled Certain Relationships and Related Transactions
in our Proxy Statement for the 2004 Annual Meeting of Stockholders.



|ITEM 14. | PRINCIPAL ACCOUNTANT FEES AND SERVICES
|-------- | --------------------------------------



Information required by this item is incorporated herein by reference to the section entitled Principal Accountant Fees and Services in our
Proxy Statement for the 2004 Annual Meeting of Stockholders.



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PART IV



|ITEM 15. | EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
|-------- | ---------------------------------------------------------------



(a) The following documents are filed as a part of this Annual Report:



|1. | Index to Consolidated Financial Statements
|-- | ------------------------------------------



|                                                                                  |  |     
|--------------------------------------------------------------------------------- |  | ----
|                                                                                  |  | Page
|Independent Auditors Report                                                      |  | F-2 
|Consolidated Balance Sheets                                                       |  | F-3 
|Consolidated Statements of Operations                                             |  | F-4 
|Consolidated Statements of Changes in Stockholders Equity and Comprehensive Loss |  | F-5 
|Consolidated Statements of Cash Flows                                             |  | F-6 
|Notes to Consolidated Financial Statements                                        |  | F-7 



|2. | Financial Statement Schedules
|-- | -----------------------------



All schedules have been omitted because they are not applicable or not required or the information is shown in the Consolidated Financial Statements or
Notes thereto.



|3. | Exhibits
|-- | --------



The following is a list of exhibits filed as part of this Annual Report on Form 10-K. Where so indicated, exhibits that were previously filed are
incorporated by reference. For exhibits incorporated by reference, the location of the exhibit in the previous filing is indicated parenthetically.



|            |  |                                                                                                                                                                                                                                                                                                 
|----------- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit No. |  |                                                                                                                                                                                                                                                                                                 
|            | 
|3.1         |  | Third Restated Certificate of Incorporation of Genaera Corporation (Incorporated by reference to Exhibit 3.1 filed with the Companys Quarterly Report on Form 10-Q for June 30,
2003)                                                                                                          
|            | 
|3.2         |  | Certificate of Designations, Preferences and Rights of Series A Preferred Stock of Genaera Corporation dated May 8, 2000 (Incorporated by reference to Exhibit 10.2 filed with the
Companys Quarterly Report on Form 10-Q for June 30, 2000)                                                   
|            | 
|3.3         |  | Certificate of Ownership and Merger Merging M Merger Sub, Inc. with and into Magainin Pharmaceuticals Inc. dated March 9, 2001 (Incorporated by reference to Exhibit 3.5 filed with the
Companys Quarterly Report on Form 10-Q for March 31, 2001)                                             
|            | 
|3.4         |  | Certificate of Designations, Preferences and Rights of Series B Preferred Stock of Genaera Corporation dated April 19, 2001 (Incorporated by reference to Exhibit 3.7 filed with the
Companys Quarterly Report on Form 10-Q for March 31, 2001)                                                
|            | 
|3.5         |  | By-laws of Genaera Corporation, as Amended and Restated on May 16, 2002 (Incorporated by reference to Exhibit 3.2 filed with the Companys Quarterly Report on Form 10-Q for June 30,
2002)                                                                                                     
|            | 
|3.6         |  | Amended and Restated Certificate of Designations, Preferences and Rights for the Series C-1 Preferred Stock dated June 9, 2003 (Incorporated by reference to Exhibit 3.1 filed with the
Companys Current Report on Form 8-K filed with the Securities and Exchange Commission on June 12, 2003)
|            | 
|3.7         |  | Amended and Restated Certificate of Designations, Preferences and Rights for the Series C-2 Preferred Stock dated June 9, 2003 (Incorporated by reference to Exhibit 3.2 filed with the
Companys Current Report on Form 8-K filed with the Securities and Exchange Commission on June 12, 2003)
|            | 
|4.1         |  | Specimen copy of stock certificate for shares of Common Stock of Genaera Corporation (Incorporated by reference to Exhibit 4.1 filed with the Companys Quarterly Report on Form 10-Q for
March 31, 2001)                                                                                       
|            | 
|10.1 #      |  | 1992 Stock Option Plan of the Registrant, as amended (Incorporated by reference to Exhibit A filed with the Companys Proxy Statement for the 1996 Annual Meeting of
Stockholders)                                                                                                              
|            | 
|10.2 #      |  | Amended 1998 Equity Compensation Plan, as Amended and Restated on July 22, 2002 (Incorporated by reference to Exhibit 3.2 filed with the Companys Quarterly Report on Form 10-Q for June
30, 2002)                                                                                             



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|            |  |                                                                                                                                                                                                                                                                                                             
|----------- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit No. |  |                                                                                                                                                                                                                                                                                                             
|            | 
|10.3 #      |  | Form of Stock Option Agreement under Stock Option Plans (Incorporated by reference to Exhibit 4.6 filed with the Companys Registration Statement No. 33-43579 on Form
S-1)                                                                                                                                 
|            | 
|10.4 #      |  | Amended and Restated Consulting Agreement with Michael A. Zasloff, M.D., Ph.D. (Incorporated by reference to Exhibit 10.5 filed with the Companys Annual Report on Form 10-K for December
31, 2001)                                                                                                        
|            | 
|10.5 #+     |  | Employment Agreement with Roy C. Levitt, M.D. (Incorporated by reference to Exhibit 10.24 filed with the Companys Annual Report on Form 10-K for December 31, 1995)                                                                                                                                        
|            | 
|10.6 #      |  | Employment Agreement with Kenneth J. Holroyd, M.D. (Incorporated by reference to Exhibit 10.12 filed with the Companys Annual Report on Form 10-K/A for December 31,
1998)                                                                                                                                 
|            | 
|10.7 #      |  | Employment Agreement with Christopher P. Schnittker (Incorporated by reference to Exhibit 10.13 filed with the Companys Annual Report on Form 10-K for December 31,
2000)                                                                                                                                  
|            | 
|10.8 #      |  | Employment Agreement with Sean M. Johnston, Ph.D. (Incorporated by reference to Exhibit 10.14 filed with the Companys Annual Report on Form 10-K for December 31, 2000)                                                                                                                                    
|            | 
|10.9 #      |  | Employment Agreement with Angeline K. Shashlo (Incorporated by reference to Exhibit 10.3 filed with the Companys Quarterly Report on Form 10-Q for June 30, 2002)                                                                                                                                          
|            | 
|10.10 #     |  | Form and Schedule of Stock Awards to Executive Officers (Incorporated by reference to Exhibit 4.7 filed with the Companys Registration Statement No. 333-62073 on Form
S-8)                                                                                                                                
|            | 
|10.11       |  | Lease with respect to Plymouth Meeting, Pennsylvania office and laboratory space dated December 13, 2001 (Incorporated by reference to Exhibit 10.12 filed with the Companys Annual
Report on Form 10-K for December 31, 2001)                                                                             
|            | 
|10.12       |  | Amended Patent License Agreement and Sponsored Research Agreement with The Childrens Hospital of Philadelphia (Incorporated by reference to Exhibit 10.1 filed with the Companys
Quarterly Report on Form 10-Q for June 30, 2003)                                                                         
|            | 
|10.13       |  | License Agreement with Multiple Peptide Systems, Inc. (Incorporated by reference to Exhibit 10.12 filed with the Companys Registration Statement No. 33-43579 on Form
S-1)                                                                                                                                 
|            | 
|10.14       |  | Second Amendment to License Agreement with Multiple Peptide Systems, Inc. (Incorporated by reference to Exhibit 10.30 filed with the Companys Quarterly Report on Form 10-Q for September
30, 1996)                                                                                                        
|            | 
|10.15 +     |  | Assignment Agreement between Genaera Corporation, Roy C. Levitt, M.D. and GeneQuest, Inc. (Incorporated by reference to Exhibit 10.25 filed with the Companys Annual Report on Form 10-K
for December 31, 1995)                                                                                            
|            | 
|10.16 +     |  | Development, Supply and Distribution Agreement, effective as of February 12, 1997, with SmithKline Beecham Corporation (Incorporated by reference to Exhibit 10.29 filed with the
Companys Annual Report on Form 10-K for December 31, 1996)                                                               
|            | 
|10.17       |  | Settlement and Termination Agreement between Abbott Laboratories Inc. and Magainin Pharmaceuticals Inc., effective September 8, 1999 (Incorporated by reference to Exhibit 99.1 filed with the
Companys Current Report on Form 8-K filed with the Securities and Exchange Commission on September 28, 1999)
|            | 
|10.18       |  | Registration Rights Agreement between Genaera Corporation and Genentech, Inc. dated April 28, 2000 (Incorporated by reference to Exhibit 10.4 filed with the Companys Quarterly Report on
Form 10-Q for June 30, 2000)                                                                                     
|            | 
|10.19 +     |  | Amended License Agreement between Genaera Corporation and Ludwig Institute for Cancer Research dated December 20, 1999 (Incorporated by reference to Exhibit 10.1 filed with the Companys
Quarterly Report on Form 10-Q for March 31, 2001)                                                                
|            | 
|10.20 +     |  | Second Research Agreement between Genaera Corporation and Ludwig Institute for Cancer Research dated December 20, 1999 (Incorporated by reference to Exhibit 10.2 filed with the Companys
Quarterly Report on Form 10-Q for March 31, 2001)                                                                
|            | 
|10.21 +     |  | Notice of Renewal of Second Research Agreement between Genaera Corporation and Ludwig Institute for Cancer Research dated October 31, 2001 (Incorporated by reference to Exhibit 10.22 filed
with the Companys Annual Report on Form 10-K for December 31, 2001)                                           



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|            |  |                                                                                                                                                                                                                                                                                                                                     
|----------- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit No. |  |                                                                                                                                                                                                                                                                                                                                     
|            | 
|10.22       |  | Settlement Agreement between Genaera Corporation and Genentech, Inc. dated April 18, 2001 (Incorporated by reference to Exhibit 10.3 filed with the Companys Quarterly Report on Form
10-Q for March 31, 2001)                                                                                                                     
|            | 
|10.23 +     |  | Collaboration and License Agreement between Genaera Corporation and MedImmune, Inc. dated April 19, 2001 (Incorporated by reference to Exhibit 10.4 filed with the Companys Quarterly
Report on Form 10-Q for March 31, 2001)                                                                                                      
|            | 
|10.24       |  | Amendment to Collaboration and License Agreement between Genaera Corporation and MedImmune, Inc. effective April 19, 2001 (Incorporated by reference to Exhibit 10.25 filed with the
Companys Annual Report on Form 10-K for December 31, 2001)                                                                                    
|            | 
|10.25       |  | Preferred Stock Purchase Agreement between Genaera Corporation and MedImmune, Inc. dated April 19, 2001 (Incorporated by reference to Exhibit 10.5 filed with the Companys Quarterly
Report on Form 10-Q for March 31, 2001)                                                                                                       
|            | 
|10.26       |  | Warrants to purchase shares of Genaera Corporation Common Stock by Ladenburg Thalmann dated December 12, 2001 (Incorporated by reference to Exhibit 10.27 filed with the Companys Annual
Report on Form 10-K for December 31, 2001)                                                                                                
|            | 
|10.27       |  | Placement Agency Agreement dated April 5, 2002 by and between Genaera Corporation and Wells Fargo Securities, LLC (Incorporated by reference to Exhibit 10.1 filed with the Companys
Current Report on Form 8-K filed with the Securities and Exchange Commission on April 8, 2002)                                                
|            | 
|10.28 +     |  | License, Development and Commercialization Agreement Between Genaera Corporation and Laboratorios Bago SA (Incorporated by reference to Exhibit 10.1 filed with the Companys Quarterly
Report on Form 10-Q for September 30, 2002)                                                                                                 
|            | 
|10.29       |  | Placement Agency Agreement between Genaera Corporation and Fortis Securities Inc. dated as of November 11, 2003 (Incorporated by reference to Exhibit 99.2 with the Companys Current
Report on Form 8-K filed with the Securities and Exchange Commission on November 14, 2003)                                                    
|            | 
|10.30       |  | Consent Agreement to Amend and Restate the Certificates of Designations, Preferences and Rights for the Series C-1 Preferred Stock and Series C-2 Preferred Stock (Incorporated by reference to
Exhibit 10.1 filed with the Companys Current Report on Form 8-K filed with the Securities and Exchange Commission on June 12, 2003)
|            | 
|10.31       |  | Series C-1 and C-2 Preferred Stock and Warrant Purchase Agreement dated May 23, 2003 (Incorporated by reference to Exhibit 10.1 filed with the Companys Current Report on Form 8-K filed
with the Securities and Exchange Commission on May 28, 2003)                                                                              
|            | 
|10.32       |  | Amendment No. 1 to Series C-1 and C-2 Preferred Stock and Warrant Purchase Agreement dated June 9, 2003 (Incorporated by reference to Exhibit 10.2 filed with the Companys Current Report
on Form 8-K filed with the Securities and Exchange Commission on June 12, 2003)                                                          
|            | 
|10.33       |  | Form of Warrants to Purchase 1,500,000 Shares of Common Stock (Incorporated by reference to Exhibit 10.2 filed with the Companys Current Report on Form 8-K filed with the Securities and
Exchange Commission on May 28, 2003)                                                                                                     
|            | 
|10.34       |  | Form of Warrants to Purchase 500,000 Shares of Common Stock (Incorporated by reference to Exhibit 10.3 filed with the Companys Current Report on Form 8-K filed with the Securities and
Exchange Commission on May 28, 2003)                                                                                                       
|            | 
|10.35 *     |  | Employment Agreement with John A. Skolas                                                                                                                                                                                                                                                                                            
|            | 
|10.36 *     |  | Employment Agreement with John L. Armstrong, Jr.                                                                                                                                                                                                                                                                                    
|            | 
|23.1 *      |  | Consent of KPMG LLP                                                                                                                                                                                                                                                                                                                 
|            | 
|24.1 *      |  | Power of Attorney (Included on signature page of this Annual Report on Form 10-K)                                                                                                                                                                                                                                                   
|            | 
|31.1 *      |  | Certification of Chief Executive Officer pursuant to Rules 13a-14(a) and 15d-14(a) promulgated under the Securities and Exchange Act of 1934, as amended, as adopted pursuant to section 302 of
the Sarbanes-Oxley Act of 2002                                                                                                      



34



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##### Table of Contents

|       |  |                                                                                                                                                                                                                               
|------ |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|       | 
|31.2 * |  | Certification of Chief Financial Officer pursuant to Rules 13a-14(a) and 15d-14(a) promulgated under the Securities and Exchange Act of 1934, as amended, as adopted pursuant to section 302 of
the Sarbanes-Oxley Act of 2002
|       | 
|32.1 * |  | Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to section 906 of the Sarbanes-Oxley Act of 2002                                                                             
|       | 
|32.2 * |  | Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to section 906 of the Sarbanes-Oxley Act of 2002                                                                             

---

Explanation of Footnotes to Listing of Exhibits:



|* | Filed herewith.
|- | ---------------



|# | Compensation plan or arrangement in which directors or executive officers are eligible to participate.
|- | ------------------------------------------------------------------------------------------------------



|+ | Portions of this Exhibit were omitted and filed separately with the Securities and Exchange Commission pursuant to an order granting confidential treatment.
|- | ------------------------------------------------------------------------------------------------------------------------------------------------------------



(b) Reports on Form 8-K:



We filed a Current Report on Form 8-K on October 2, 2003 regarding the
conversion by the holders of all of the Series C-2 convertible preferred stock into common stock of the Company.



We filed a Current Report on Form 8-K on October 7, 2003 incorporating a press release announcing the updated results for its Phase I/II clinical trial of
squalamine for the treatment of age-related macular degeneration.



We filed a Current Report on Form 8-K on October 8, 2003 regarding the conversion by the holder of all of the Series B convertible preferred stock into common stock of the Company.



We filed a Current Report on Form 8-K on October 17, 2003 incorporating two
press releases regarding Phase II Clinical Trial Results of Lomucin in Cystic Fibrosis and the Lomucin Preclinical Presentation on Gastrointestinal Benefits in Cystic Fibrosis Distal Intestinal Obstruction Syndrome.



We filed a Current Report on Form 8-K on October 23, 2003 incorporating a press release announcing that John A. Skolas joined the Company as Senior Vice
President, Chief Financial Officer, General Counsel and Secretary.



We filed a Current Report on Form 8-K on October 29, 2003 incorporating a press release announcing that John L. Armstrong, Jr. joined the Company as Executive Vice President.



We filed a Current Report on Form 8-K on November 4, 2003 incorporating a press release announcing that Richard J. Pietras,
PhD, MD would present preclinical research on squalamine at the XVII FIGO World Congress of Gynecology and Obstetrics.



We filed a Current Report on Form 8-K on November 11, 2003 incorporating a press release announcing the acceptance of subscriptions from unaffiliated
institutional investors for the purchase of an aggregate of 2,050,000 shares of our common stock in a registered direct offering.



We filed a Current Report on Form 8-K on November 14, 2003 incorporating a press release announcing the close of the registered direct offering.



35



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##### Table of Contents

SIGNATURES



Pursuant to the
requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.



Date: March 25, 2004



GENAERA CORPORATIONBy:

/s/    ROY C. LEVITTRoy C. Levitt, M.D. President, Chief Executive Officer and Director




Pursuant to the
requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant in the capacities and on the dates indicated.



Each person whose signature appears below in so signing also makes, constitutes and appoints Roy C. Levitt, President and
Chief Executive Officer, his true and lawful attorney-in-fact, in his name, place and stead to execute and cause to be filed with the Securities and Exchange Commission any or all amendments to this report.



|                                                    |  |                                                                                                |  |               
|--------------------------------------------------- |  | ---------------------------------------------------------------------------------------------- |  | --------------
|Signature                                           |  | Title                                                                                          |  | Date          
|                                                    |  |                                                                                               
|/s/    R. FRANK
ECOCKR. Frank Ecock                 |  | Director                                                                                       |  | March 25, 2004
|                                                    |  |                                                                                               
|/s/    ZOLA P.
HOROVITZZola P. Horovitz,
Ph.D.      |  | Director                                                                                       |  | March 25, 2004
|                                                    |  |                                                                                               
|/s/    OSAGIE O.
IMASOGIEOsagie O.
Imasogie         |  | Director                                                                                       |  | March 25, 2004
|                                                    |  |                                                                                               
|/s/    ROY C.
LEVITTRoy C. Levitt,
M.D.             |  | President, Chief Executive Officer and Director (Principal Executive Officer)                  |  | March 25, 2004
|                                                    |  |                                                                                               
|/s/    ROBERT F.
SHAPIRORobert F. Shapiro           |  | Director                                                                                       |  | March 25, 2004
|                                                    |  |                                                                                               
|/s/    JOHN A.
SKOLASJohn A. Skolas                 |  | Senior Vice President and Chief Financial Officer (Principal Financial and Accounting Officer) |  | March 25, 2004
|                                                    |  |                                                                                               
|/s/    JAMES B.
WYNGAARDENJames B. Wyngaarden,
M.D. |  | Director                                                                                       |  | March 25, 2004



36



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##### Table of Contents



GENAERA CORPORATION



INDEX TO CONSOLIDATED FINANCIAL STATEMENTS



|                                                                                  |  |     
|--------------------------------------------------------------------------------- |  | ----
|                                                                                  |  | Page
|                                                                                  | 
|Independent Auditors Report                                                      |  | F-2 
|                                                                                  | 
|Consolidated Balance Sheets                                                       |  | F-3 
|                                                                                  | 
|Consolidated Statements of Operations                                             |  | F-4 
|                                                                                  | 
|Consolidated Statements of Changes in Stockholders Equity and Comprehensive Loss |  | F-5 
|                                                                                  | 
|Consolidated Statements of Cash Flows                                             |  | F-6 
|                                                                                  | 
|Notes to Consolidated Financial Statements                                        |  | F-7 



F-1



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##### Table of Contents

INDEPENDENT AUDITORS REPORT



The Board of
Directors and Stockholders

Genaera Corporation:



We have audited the accompanying consolidated balance sheets of Genaera Corporation and subsidiary as of December 31, 2003 and 2002, and the related
consolidated statements of operations, changes in stockholders equity and comprehensive loss, and cash flows for each of the years in the three-year period ended December 31, 2003. These consolidated financial statements are the responsibility
of the Companys management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.



We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An
audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.



In our opinion, the consolidated financial statements referred
to above present fairly, in all material respects, the financial position of Genaera Corporation and subsidiary as of December 31, 2003 and 2002, and the results of their operations and their cash flows for each of the years in the three-year period
ended December 31, 2003, in conformity with accounting principles generally accepted in the United States of America.



/s/ KPMG LLP



Princeton, New Jersey

February 13, 2004



F-2



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##### Table of Contents

GENAERA CORPORATION AND SUBSIDIARY



CONSOLIDATED BALANCE SHEETS

(In thousands, except per share amounts)



|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 |  |              |          |   |      |   |          |  
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ------------ | -------- | - | ---- | - | -------- | -
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 |  | December 31, |         
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 |  | 2003         |          |   | 2002 |  
|ASSETS                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           |  |              |          |   |      |   |          |  
|Current assets:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  |  |              |          |   |      |   |          |  
|Cash and cash equivalents                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |  | $            | 6,625    |   |      | $ | 1,368    |  
|Short-term investments (NOTES 3 and 6)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           |  |              | 6,510    |   |      |   | 8,032    |  
|Prepaid expenses and other current assets                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |  |              | 264      |   |      |   | 186      |  
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 |  |              |          |   |      |   |          |  
|Total current assets                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             |  |              | 13,399   |   |      |   | 9,586    |  
|Fixed assets, net (NOTE 4)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |  |              | 1,095    |   |      |   | 1,541    |  
|Other assets                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     |  |              | 59       |   |      |   | 64       |  
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 |  |              |          |   |      |   |          |  
|Total assets                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     |  | $            | 14,553   |   |      | $ | 11,191   |  
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 |  |              |          |   |      |   |          |  
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 |  |             
|LIABILITIES AND STOCKHOLDERS EQUITY                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             |  |              |          |   |      |   |          |  
|Current liabilities:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             |  |              |          |   |      |   |          |  
|Accounts payable and accrued expenses (NOTE 5)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   |  | $            | 1,917    |   |      | $ | 1,302    |  
|Notes payable (NOTE 6)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           |  |              |         |   |      |   | 2,500    |  
|Accrued development expense  short-term (NOTE 15)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               |  |              | 966      |   |      |   |         |  
|Other current liabilities                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |  |              |         |   |      |   | 57       |  
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 |  |              |          |   |      |   |          |  
|Total current liabilities                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |  |              | 2,883    |   |      |   | 3,859    |  
|Accrued development expense - long-term (NOTE 15)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                |  |              | 563      |   |      |   | 1,529    |  
|Other liabilities                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                |  |              | 485      |   |      |   | 175      |  
|Series A redeemable convertible preferred stock (liquidation value of $1,117 at December 31, 2002) (NOTE 7)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      |  |              |         |   |      |   | 1,117    |  
|Commitments, contingencies and other matters (NOTE 15)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           |  |              |          |   |      |   |          |  
|Stockholders equity:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            |  |              |          |   |      |   |          |  
|Preferred stock - $.001 par value; 9,211 shares authorized; none and 0.888 shares issued and outstanding as Series A redeemable convertible
preferred stock at December 31, 2003 and 2002, respectively; none and 10.0 shares issued and outstanding as Series B convertible preferred stock at December 31, 2003 and 2002, respectively (liquidation value of $10,000 at December 31, 2002); none
issued and outstanding as Series C-1 convertible preferred stock at December 31, 2003 and December 31, 2002; none issued and outstanding as Series C-2 convertible preferred stock at December 31, 2003 and December 31, 2002 |  |              |         |   |      |   |         |  
|Common stock - $.002 par value; 75,000 shares authorized; 47,024 and 35,666 shares issued and outstanding at December 31, 2003 and 2002,
respectively                                                                                                                                                                                                                                                                                                                                                                                                                                                                            |  |              | 94       |   |      |   | 71       |  
|Additional paid-in capital                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |  |              | 205,826  |   |      |   | 187,258  |  
|Accumulated other comprehensive incomeunrealized gain on investments                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            |  |              |         |   |      |   | 1        |  
|Accumulated deficit                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              |  |              | (195,298 | ) |      |   | (182,819 | )
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 |  |              |          |   |      |   |          |  
|Total stockholders equity                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |  |              | 10,622   |   |      |   | 4,511    |  
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 |  |              |          |   |      |   |          |  
|Total liabilities and stockholders equity                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |  | $            | 14,553   |   |      | $ | 11,191   |  
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 |  |              |          |   |      |   |          |  



See accompanying notes
to financial statements.



F-3



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##### Table of Contents

GENAERA CORPORATION AND SUBSIDIARY



CONSOLIDATED STATEMENTS OF OPERATIONS

(In thousands, except per share amounts)



|                                                                                                                  |  |                         |         |   |      |   |         |      |  |   |         |  
|----------------------------------------------------------------------------------------------------------------- |  | ----------------------- | ------- | - | ---- | - | ------- | ---- |  | - | ------- | -
|                                                                                                                  |  | Year Ended December 31, |        
|                                                                                                                  |  | 2003                    |         |   | 2002 |   |         | 2001 | 
|Collaborative research agreement and grant revenues                                                               |  | $                       | 1,113   |   |      | $ | 1,517   |      |  | $ | 1,038   |  
|                                                                                                                  |  |                         |         |   |      |   |         |      |  |   |         |  
|Costs and expenses:                                                                                               |  |                         |         |   |      |   |         |      |  |   |         |  
|Research and development                                                                                          |  |                         | 8,092   |   |      |   | 10,691  |      |  |   | 11,132  |  
|General and administrative                                                                                        |  |                         | 2,437   |   |      |   | 3,085   |      |  |   | 3,423   |  
|                                                                                                                  |  |                         |         |   |      |   |         |      |  |   |         |  
|                                                                                                                  |  |                         | 10,529  |   |      |   | 13,776  |      |  |   | 14,555  |  
|                                                                                                                  |  |                         |         |   |      |   |         |      |  |   |         |  
|Loss from operations                                                                                              |  |                         | (9,416  | ) |      |   | (12,259 | )    |  |   | (13,517 | )
|Interest income                                                                                                   |  |                         | 88      |   |      |   | 260     |      |  |   | 849     |  
|Interest expense                                                                                                  |  |                         | (65     | ) |      |   | (157    | )    |  |   | (244    | )
|                                                                                                                  |  |                         |         |   |      |   |         |      |  |   |         |  
|Net loss                                                                                                          |  |                         | (9,393  | ) |      |   | (12,156 | )    |  |   | (12,912 | )
|Dividends on preferred stock, including amount attributable to a beneficial conversion feature of $3,050 for 2003 |  |                         | 3,085   |   |      |   | 73      |      |  |   | 111     |  
|                                                                                                                  |  |                         |         |   |      |   |         |      |  |   |         |  
|Net loss applicable to common stockholders                                                                        |  | $                       | (12,478 | ) |      | $ | (12,229 | )    |  | $ | (13,023 | )
|                                                                                                                  |  |                         |         |   |      |   |         |      |  |   |         |  
|Net loss applicable to common stockholders per sharebasic and diluted                                            |  | $                       | (0.32   | ) |      | $ | (0.35   | )    |  | $ | (0.40   | )
|                                                                                                                  |  |                         |         |   |      |   |         |      |  |   |         |  
|Weighted average shares outstandingbasic and diluted                                                             |  |                         | 38,634  |   |      |   | 34,894  |      |  |   | 32,711  |  
|                                                                                                                  |  |                         |         |   |      |   |         |      |  |   |         |  



See accompanying notes
to financial statements.



F-4



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##### Table of Contents

GENAERA CORPORATION AND SUBSIDIARY



CONSOLIDATED STATEMENTS OF CHANGES IN

STOCKHOLDERS EQUITY AND COMPREHENSIVE LOSS

(In thousands)



|                                                                                                              |  |                 |  |                          |    |  |                                            |         |   |                    |   |     |                           |  |   |          |   |  |   |         |  
|------------------------------------------------------------------------------------------------------------- |  | --------------- |  | ------------------------ | -- |  | ------------------------------------------ | ------- | - | ------------------ | - | --- | ------------------------- |  | - | -------- | - |  | - | ------- | -
|                                                                                                              |  | Common Stock    |  | AdditionalPaid-inCapital |    |  | AccumulatedOtherComprehensiveIncome (Loss) |         |   | AccumulatedDeficit |   |     | TotalStock-holdersEquity | 
|                                                                                                              |  | Numberof Shares |  | Amount                   |    |  |                                            |        
|Balance at December 31, 2000                                                                                  |  | 32,393          |  |                          | 65 |  |                                            | 168,967 |   |                    |   | 9   |                           |  |   | (157,568 | ) |  |   | 11,473  |  
|Exercise of stock options and compensation expense under option grants and stock awards                       |  | 471             |  |                          | 1  |  |                                            | 1,237   |   |                    |   |    |                           |  |   |         |   |  |   | 1,238   |  
|Convertible preferred stock issued                                                                            |  |                |  |                          |   |  |                                            | 9,908   |   |                    |   |    |                           |  |   |         |   |  |   | 9,908   |  
|Dividends on preferred stock                                                                                  |  |                |  |                          |   |  |                                            |        |   |                    |   |    |                           |  |   | (111     | ) |  |   | (111    | )
|Comprehensive loss:                                                                                           |  |                 |  |                          |    |  |                                            |         |   |                    |   |     |                           |  |   |          |   |  |   |         |  
|Net loss                                                                                                      |  |                |  |                          |   |  |                                            |        |   |                    |   |    |                           |  |   | (12,912  | ) |  |   | (12,912 | )
|Carrying value adjustment                                                                                     |  |                |  |                          |   |  |                                            |        |   |                    |   | 14  |                           |  |   |         |   |  |   | 14      |  
|                                                                                                              |  |                 |  |                          |    |  |                                            |         |   |                    |   |     |                           |  |   |          |   |  |   |         |  
|Total comprehensive loss                                                                                      |  |                |  |                          |   |  |                                            |        |   |                    |   |    |                           |  |   |         |   |  |   | (12,898 | )
|                                                                                                              |  |                 |  |                          |    |  |                                            |         |   |                    |   |     |                           |  |   |          |   |  |   |         |  
|Balance at December 31, 2001                                                                                  |  | 32,864          |  |                          | 66 |  |                                            | 180,112 |   |                    |   | 23  |                           |  |   | (170,591 | ) |  |   | 9,610   |  
|Exercise of stock options and compensation expense under option grants and stock awards                       |  | 43              |  |                          |   |  |                                            | 208     |   |                    |   |    |                           |  |   |         |   |  |   | 208     |  
|Common stock issued pursuant to private placement                                                             |  | 2,759           |  |                          | 5  |  |                                            | 6,938   |   |                    |   |    |                           |  |   |         |   |  |   | 6,943   |  
|Dividends on preferred stock                                                                                  |  |                |  |                          |   |  |                                            |        |   |                    |   |    |                           |  |   | (72      | ) |  |   | (72     | )
|Comprehensive loss:                                                                                           |  |                 |  |                          |    |  |                                            |         |   |                    |   |     |                           |  |   |          |   |  |   |         |  
|Net loss                                                                                                      |  |                |  |                          |   |  |                                            |        |   |                    |   |    |                           |  |   | (12,156  | ) |  |   | (12,156 | )
|Carrying value adjustment                                                                                     |  |                |  |                          |   |  |                                            |        |   |                    |   | (22 | )                         |  |   |         |   |  |   | (22     | )
|                                                                                                              |  |                 |  |                          |    |  |                                            |         |   |                    |   |     |                           |  |   |          |   |  |   |         |  
|Total comprehensive loss                                                                                      |  |                |  |                          |   |  |                                            |        |   |                    |   |    |                           |  |   |         |   |  |   | (12,178 | )
|                                                                                                              |  |                 |  |                          |    |  |                                            |         |   |                    |   |     |                           |  |   |          |   |  |   |         |  
|Balance at December 31, 2002                                                                                  |  | 35,666          |  |                          | 71 |  |                                            | 187,258 |   |                    |   | 1   |                           |  |   | (182,819 | ) |  |   | 4,511   |  
|Exercise of stock options and compensation expense under option grants and stock awards                       |  | 275             |  |                          | 1  |  |                                            | 752     |   |                    |   |    |                           |  |   |         |   |  |   | 753     |  
|Common stock issued pursuant to private placement                                                             |  | 2,050           |  |                          | 4  |  |                                            | 7,889   |   |                    |   |    |                           |  |   |         |   |  |   | 7,893   |  
|Series C-1 and C-2 convertible preferred stock and common stock warrants issued pursuant to private placement |  |                |  |                          |   |  |                                            | 4,922   |   |                    |   |    |                           |  |   |         |   |  |   | 4,922   |  
|Beneficial conversion feature related to the issuance of Series C-1 and C-2 convertible preferred stock       |  |                |  |                          |   |  |                                            | 3,050   |   |                    |   |    |                           |  |   |         |   |  |   | 3,050   |  
|Discount on Series C-1 and C-2 convertible preferred stock                                                    |  |                |  |                          |   |  |                                            | (3,050  | ) |                    |   |    |                           |  |   |         |   |  |   | (3,050  | )
|Conversion of Series B preferred stock                                                                        |  | 2,000           |  |                          | 4  |  |                                            | (4      | ) |                    |   |    |                           |  |   |         |   |  |   |        |  
|Conversion of Series C-1 preferred stock                                                                      |  | 2,500           |  |                          | 5  |  |                                            | (5      | ) |                    |   |    |                           |  |   |         |   |  |   |        |  
|Conversion of Series C-2 preferred stock                                                                      |  | 2,500           |  |                          | 5  |  |                                            | (5      | ) |                    |   |    |                           |  |   |         |   |  |   |        |  
|Exercise of common stock warrants issued pursuant to May 2003 private placement                               |  | 1,492           |  |                          | 3  |  |                                            | 819     |   |                    |   |    |                           |  |   |         |   |  |   | 822     |  
|Conversion of Series A preferred stock                                                                        |  | 541             |  |                          | 1  |  |                                            | 1,150   |   |                    |   |    |                           |  |   |         |   |  |   | 1,151   |  
|Dividends on Series A preferred stock                                                                         |  |                |  |                          |   |  |                                            |        |   |                    |   |    |                           |  |   | (35      | ) |  |   | (35     | )
|Amortization of beneficial conversion                                                                         |  |                |  |                          |   |  |                                            | 3,050   |   |                    |   |    |                           |  |   | (3,050   | ) |  |   |        |  
|Comprehensive loss:                                                                                           |  |                 |  |                          |    |  |                                            |         |   |                    |   |     |                           |  |   |          |   |  |   |         |  
|Net loss                                                                                                      |  |                |  |                          |   |  |                                            |        |   |                    |   |    |                           |  |   | (9,393   | ) |  |   | (9,393  | )
|Carrying value adjustment                                                                                     |  |                |  |                          |   |  |                                            |        |   |                    |   | (1  | )                         |  |   |         |   |  |   | (1      | )
|                                                                                                              |  |                 |  |                          |    |  |                                            |         |   |                    |   |     |                           |  |   |          |   |  |   |         |  
|Total comprehensive loss                                                                                      |  |                |  |                          |   |  |                                            |        |   |                    |   |    |                           |  |   |         |   |  |   | (9,394  | )
|                                                                                                              |  |                 |  |                          |    |  |                                            |         |   |                    |   |     |                           |  |   |          |   |  |   |         |  
|Balance at December 31, 2003                                                                                  |  | 47,024          |  | $                        | 94 |  | $                                          | 205,826 |   |                    | $ |    |                           |  | $ | (195,298 | ) |  | $ | 10,622  |  
|                                                                                                              |  |                 |  |                          |    |  |                                            |         |   |                    |   |     |                           |  |   |          |   |  |   |         |  



See accompanying notes
to financial statements.



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GENAERA CORPORATION AND SUBSIDIARY



CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands)



|                                                                                |  |                         |         |   |      |   |         |      |  |   |         |  
|------------------------------------------------------------------------------- |  | ----------------------- | ------- | - | ---- | - | ------- | ---- |  | - | ------- | -
|                                                                                |  | Year Ended December 31, |        
|                                                                                |  | 2003                    |         |   | 2002 |   |         | 2001 | 
|Cash Flows From Operating Activities:                                           |  |                         |         |   |      |   |         |      |  |   |         |  
|Net loss                                                                        |  | $                       | (9,393  | ) |      | $ | (12,156 | )    |  | $ | (12,912 | )
|Adjustments to reconcile net loss to net cash used in operating activities:     |  |                         |         |   |      |   |         |      |  |   |         |  
|Depreciation and amortization                                                   |  |                         | 489     |   |      |   | 510     |      |  |   | 838     |  
|Amortization of investment discounts/premiums                                   |  |                         | (67     | ) |      |   | (232    | )    |  |   | (663    | )
|Compensation expense on option grants and equity awards                         |  |                         | 211     |   |      |   | 204     |      |  |   | 373     |  
|Receipt and retirement of Series A redeemable convertible preferred stock       |  |                         |        |   |      |   |        |      |  |   | (300    | )
|Gain on sale of fixed assets                                                    |  |                         | (257    | ) |      |   |        |      |  |   |        |  
|Changes in operating assets and liabilities:                                    |  |                         |         |   |      |   |         |      |  |   |         |  
|Prepaid expenses and other assets                                               |  |                         | (75     | ) |      |   | 32      |      |  |   | 242     |  
|Accounts payable and accrued expenses                                           |  |                         | 616     |   |      |   | (1,219  | )    |  |   | 428     |  
|Accrued development expenses                                                    |  |                         |        |   |      |   | (480    | )    |  |   | (1,350  | )
|Other liabilities                                                               |  |                         | 253     |   |      |   | 100     |      |  |   | 89      |  
|                                                                                |  |                         |         |   |      |   |         |      |  |   |         |  
|Net cash used in operating activities                                           |  |                         | (8,223  | ) |      |   | (13,241 | )    |  |   | (13,255 | )
|                                                                                |  |                         |         |   |      |   |         |      |  |   |         |  
|Cash Flows From Investing Activities:                                           |  |                         |         |   |      |   |         |      |  |   |         |  
|Purchase of investments                                                         |  |                         | (19,762 | ) |      |   | (26,967 | )    |  |   | (34,173 | )
|Proceeds from maturities of investments                                         |  |                         | 21,350  |   |      |   | 33,250  |      |  |   | 39,179  |  
|Proceeds from sales of fixed assets                                             |  |                         | 257     |   |      |   |        |      |  |   |        |  
|Capital expenditures                                                            |  |                         | (43     | ) |      |   | (595    | )    |  |   | (1,150  | )
|                                                                                |  |                         |         |   |      |   |         |      |  |   |         |  
|Net cash provided by investing activities                                       |  |                         | 1,802   |   |      |   | 5,688   |      |  |   | 3,856   |  
|                                                                                |  |                         |         |   |      |   |         |      |  |   |         |  
|Cash Flows From Financing Activities:                                           |  |                         |         |   |      |   |         |      |  |   |         |  
|Payments on notes payable                                                       |  |                         | (2,500  | ) |      |   |        |      |  |   |        |  
|Net proceeds from issuance of Series B convertible preferred stock              |  |                         |        |   |      |   |        |      |  |   | 9,908   |  
|Net proceeds from issuance of Series C-1 and C-2 convertible preferred stock    |  |                         | 4,922   |   |      |   |        |      |  |   |        |  
|Net proceeds from issuance of common stock                                      |  |                         | 7,893   |   |      |   | 6,943   |      |  |   |        |  
|Proceeds from exercise of options and warrants                                  |  |                         | 1,363   |   |      |   | 5       |      |  |   | 865     |  
|                                                                                |  |                         |         |   |      |   |         |      |  |   |         |  
|Net cash provided by financing activities                                       |  |                         | 11,678  |   |      |   | 6,948   |      |  |   | 10,773  |  
|                                                                                |  |                         |         |   |      |   |         |      |  |   |         |  
|Net increase (decrease) in cash and cash equivalents                            |  |                         | 5,257   |   |      |   | (605    | )    |  |   | 1,374   |  
|Cash and cash equivalents at beginning of period                                |  |                         | 1,368   |   |      |   | 1,973   |      |  |   | 599     |  
|                                                                                |  |                         |         |   |      |   |         |      |  |   |         |  
|Cash and cash equivalents at end of period                                      |  | $                       | 6,625   |   |      | $ | 1,368   |      |  | $ | 1,973   |  
|                                                                                |  |                         |         |   |      |   |         |      |  |   |         |  
|Supplemental Cash Flow Information:                                             |  |                         |         |   |      |   |         |      |  |   |         |  
|Cash paid during the period for interest                                        |  | $                       | 76      |   |      | $ | 160     |      |  | $ | 208     |  
|                                                                                |  |                         |         |   |      |   |         |      |  |   |         |  
|Conversion of Series A redeemable convertible preferred stock into common stock |  | $                       | 1,117   |   |      | $ |        |      |  | $ |        |  
|                                                                                |  |                         |         |   |      |   |         |      |  |   |         |  



See accompanying notes
to financial statements.



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##### Table of Contents

GENAERA CORPORATION AND SUBSIDIARY



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS



NOTE 1. The Company



Genaera Corporation
(Genaera or the Company), a Delaware corporation, was incorporated on June 29, 1987. Genaera is a biopharmaceutical company committed to developing medicines for serious diseases from genomics and natural products. The
Companys research and development efforts are focused on anti-angiogenesis and respiratory diseases. On March 9, 2001, the Company changed its name from Magainin Pharmaceuticals Inc. to Genaera Corporation.



The Company is managed and operated as one business. A single management team
that reports to the Chief Executive Officer comprehensively manages the entire business. Accordingly, the Company does not prepare discrete financial information with respect to separate product areas or by location, and does not have separately
reportable segments as defined by Statement of Financial Accounting Standards (SFAS) No. 131, Disclosures about Segments of an Enterprise and Related Information.



NOTE 2. Summary of Significant Accounting Policies



Use of Estimates - The preparation of financial statements in conformity with accounting principles generally
accepted in the United States of America requires management to make estimates and assumptions that affect the amounts reported in the financial statements and related notes. Actual results could differ from those estimates



Cash and Cash Equivalents - The Company considers all highly liquid
investment instruments purchased with a maturity of three months or less to be cash equivalents.



Investments - Investments purchased with a maturity of more than three months, and that mature less than twelve months from the balance sheet date,
are classified as short-term investments. Long-term investments are those with maturities greater than twelve months from the balance sheet date. The Company generally holds investments to maturity; however, since the Company may, from time to time,
sell securities to meet cash requirements, the Company classifies its investments as available-for-sale as defined by SFAS No. 115, Accounting for Certain Investments in Debt and Equity Securities. Available-for-sale securities are carried at
market value with unrealized gains and losses, which are temporary, reported as a separate component of stockholders equity. Gross realized gains and losses on the sales of investment securities are determined on the specific identification
method.



Fixed Assets and Depreciation - Fixed assets
are recorded at cost and depreciated using the straight-line method over the estimated useful lives of the assets including: three (3) years for computers and software, five (5) years for laboratory and office equipment, and seven (7) years for
furniture and fixtures. Leasehold improvements are amortized using the straight-line method over the term of the respective lease, or their estimated useful lives, whichever is shorter. Expenditures for maintenance and repairs are charged to expense
as incurred.



Impairment of Long-Lived Assets - The
Company adopted SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets, (SFAS 144) as of January 1, 2002. SFAS 144 provides a single accounting model for long-lived assets to be disposed of. It also changes
the criteria for classifying an asset as held for sale and broadens the scope of businesses to be disposed of that qualify for reporting as discontinued operations and changes the timing of recognizing losses on such operations. The adoption of SFAS
144 did not affect the Companys financial statements.



In
accordance with SFAS 144, long-lived assets, such as property, plant, and equipment, software costs and purchased intangibles subject to amortization are reviewed for impairment whenever events or changes in circumstances indicate that the carrying
amount of an asset may not be recoverable. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of an asset to the estimated undiscounted future cash flows expected to be generated by the asset. If the
carrying amount of an asset exceeds its estimated future cash flows, an impairment charge is recognized by the amount by which the carrying amount of the asset exceeds the fair value of the asset. Assets to be disposed of would be separately
presented in the consolidated balance sheet and reported at the lower of the carrying amount or fair value less costs to sell, and are no longer depreciated. The assets



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GENAERA CORPORATION AND SUBSIDIARY



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS



and liabilities of a disposal group classified as held for sale would be presented separately in the appropriate asset and liability sections of the
consolidated balance sheet.



Revenue Recognition - In
December 2003, the staff of the United States Securities and Exchange Commission (SEC) issued Staff Accounting Bulletin (SAB) No. 104, Revenue Recognition(SAB 104). SAB 104 updates the guidance in SAB No.
101, Revenue Recognition in Financial Statements (SAB 101) and requires companies to identify separate units of accounting based on the consensus reached in Emerging Issues Task Force (EITF) Issue No. 00-21, Revenue
Arrangements with Multiple Deliverables(EITF 00-21). EITF 00-21 provides guidance on how to determine when an arrangement involving multiple revenue-generating activities or deliverables should be divided into separate units of
accounting for revenue recognition purposes, and if this division is required, how the arrangement consideration should be allocated among the separate units of accounting. EITF 00-21 is effective for revenue arrangements entered into in quarters
beginning after June 15, 2003. If the deliverables in a revenue arrangement constitute separate units of accounting according to the EITFs separation criteria, the revenue-recognition policy must be determined for each identified unit. If the
arrangement is a single unit of accounting under the separation criteria, the revenue-recognition policy must be determined for the entire arrangement. The adoption of EITF 00-21 did not impact the Companys historical consolidated financial
position or results of operations, but could affect the timing pattern of revenue recognition for future collaborative research and/or licensing agreements. In previous years, prior to SAB 104, any revenues from research and development arrangements
are recognized in accordance with the terms of the related agreements, either as services are performed or as milestones are achieved. Revenues related to up-front fees are deferred and recognized over specified future performance periods.



In January 2002, the EITF issued Emerging Issues Task Force
No. 01-14, Income Statement Characterization of Reimbursements Received for Out-of-Pocket Expenses Incurred, (EITF 01-14). In accordance with EITF 01-14 reimbursements received for out-of-pocket expenses are
characterized as revenue in the accompanying consolidated statements of operations for all periods presented.



Research and Development - Research and development (R&D) expenses include related salaries, contractor fees, and facility costs.
R&D expenses consist of independent R&D contract costs, contract manufacturing costs and costs associated with collaborative R&D arrangements. In addition, the Company funds R&D at other research institutions under agreements that
are generally cancelable. R&D expenses also include external activities such as investigator-sponsored trials. All such costs are charged to R&D expense systematically as incurred, which may be measured by contract milestones, patient
enrollment or the passage of time.



Patent Costs -
Patent-related costs, including professional fees and filing fees, are expensed as incurred.



Lease Expense - Expense related to the facility lease is recorded on a straight-line basis over the lease term. The difference between rent expense incurred and the amount paid is recorded as deferred rent and
is classified under Other Liabilities on the balance sheet.



Stock-Based Compensation - The Company accounts for its fixed-plan stock options under the intrinsic-value-based method set forth by Accounting Principles Board (APB) Opinion No. 25, Accounting for Stock Issued to
Employees, (APB 25), and related interpretations including FASB Interpretation No. 44, Accounting for Certain Transactions involving Stock Compensation, an interpretation of APB No. 25, issued in March 2000. Under this method,
compensation expense is recorded on the date of grant only if the current market price of the underlying stock exceeded the exercise price. SFAS No. 123, Accounting for Stock-Based Compensation,(SFAS 123) established accounting
and disclosure requirements using a fair-value-based method of accounting for stock-based employee compensation. Stock or other equity-based compensation for non-employees must be accounted for under the fair value-based method as required by SFAS
123 and EITF No. 96-18, Accounting for Equity Instruments that are Issued to Other Than Employees for Acquiring, or in Conjunction with Selling, Goods or Services, and other related interpretations. Under this method, the equity-based
instrument is valued at either the fair value of the consideration received or the equity instrument issued on the date of grant. The resulting compensation cost is recognized and charged to operations over the service period, which is usually the
vesting period. As allowed by SFAS 123, the Company has elected to continue to apply the intrinsic-value-based method of accounting described above, and has adopted only the disclosure requirements of SFAS 123. The following table illustrates the
effect on net loss applicable to common stockholders if the fair-value-based method had been applied to all outstanding and unvested stock-based awards in each period (in thousands, except per share amounts).



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GENAERA CORPORATION AND SUBSIDIARY



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS



|                                                                                                                                                        |  |      |         |   |      |   |         |      |  |   |         |  
|------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ---- | ------- | - | ---- | - | ------- | ---- |  | - | ------- | -
|                                                                                                                                                        |  | 2003 |         |   | 2002 |   |         | 2001 | 
|Net loss applicable to common stockholders, as reported                                                                                                 |  | $    | (12,478 | ) |      | $ | (12,229 | )    |  | $ | (13,023 | )
|Add: Stock-based employee compensation expense included in reported net loss applicable to common stockholders, net of related tax
effects              |  |      | 211     |   |      |   | 204     |      |  |   | 373     |  
|Deduct: Total stock-based employee compensation expense determined under fair-value-based method for all stock-based awards, net of related
tax effects |  |      | (1,727  | ) |      |   | (2,495  | )    |  |   | (3,149  | )
|                                                                                                                                                        |  |      |         |   |      |   |         |      |  |   |         |  
|Pro forma net loss applicable to common stockholders                                                                                                    |  | $    | (13,994 | ) |      | $ | (14,520 | )    |  | $ | (15,799 | )
|                                                                                                                                                        |  |      |         |   |      |   |         |      |  |   |         |  
|Net loss applicable to common stockholders per share  basic and diluted:                                                                               |  |      |         |   |      |   |         |      |  |   |         |  
|As reported                                                                                                                                             |  | $    | (0.32   | ) |      | $ | (0.35   | )    |  | $ | (0.40   | )
|                                                                                                                                                        |  |      |         |   |      |   |         |      |  |   |         |  
|Pro forma                                                                                                                                               |  | $    | (0.36   | ) |      | $ | (0.42   | )    |  | $ | (0.48   | )
|                                                                                                                                                        |  |      |         |   |      |   |         |      |  |   |         |  



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



|                                                               |  |             |  |             |  |            
|-------------------------------------------------------------- |  | ----------- |  | ----------- |  | -----------
|                                                               |  | 2003        |  | 2002        |  | 2001       
|Range of risk free interest rates                              |  | 3.6% - 3.9% |  | 3.6% - 4.9% |  | 4.2% - 5.2%
|Dividend yield                                                 |  | 0%          |  | 0%          |  | 0%         
|Volatility factor                                              |  | 121%        |  | 110%        |  | 100%       
|Weighted average expected life of options (in years)           |  | 6.0         |  | 7.5         |  | 7.0        
|Weighted average fair value of options granted during the year |  | $2.84       |  | $0.99       |  | $2.81      



On April 22, 2003, the
FASB determined that stock-based compensation should be recognized as a cost in the financial statements and that such cost should be measured according to the fair value of the stock options. The FASB has not as yet finalized the methodology for
calculating fair value and plans to issue an exposure draft in early 2004. The Company will continue to monitor communications on this subject from the FASB in order to determine the impact on the Companys financial statements.



Income TaxesThe Company accounts for income taxes using the
asset and liability method as prescribed by SFAS No. 109, Accounting for Income Taxes. Deferred tax assets and liabilities are determined based on differences between the financial reporting and tax bases of assets and liabilities, and are
measured using the enacted tax rates and laws that will be in effect when the differences are expected to reverse. The measurement of deferred tax assets is reduced, if necessary, by a valuation allowance for any tax benefits that are not expected
to be realized. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in the period in which tax rate changes are enacted.



Loss Per ShareThe Company calculates loss per share under the provisions of SFAS No. 128, Earnings Per Share,(SFAS 128).
SFAS 128 requires a dual presentation of basic and diluted loss per share on the face of the income statement. Basic loss per share is computed by dividing the net loss applicable to common stockholders by the weighted
average number of shares of common stock outstanding during each period. Diluted loss per share includes the dilutive effect, if any, from the potential exercise or conversion of securities, such as stock options and warrants, which would result in
the issuance of shares of common stock. For the year ended December 31, 2003, options and warrants to purchase 4,555,291 shares of the Companys common stock were not included in the calculation of the diluted per share amounts as their effect
was anti-dilutive. Basic and diluted loss per share amounts are the same as the Company reported a loss for all periods presented.



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GENAERA CORPORATION AND SUBSIDIARY



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS



Comprehensive Income - SFAS No. 130, Reporting Comprehensive Income, establishes
standards for the reporting of comprehensive income and its components. Comprehensive income consists of reported net income or loss and other comprehensive income (i.e., other gains and losses affecting stockholders equity that,
under accounting principles generally accepted in the United States of America, are excluded from net income or loss as reported on the statement of operations). With regard to the Company, other comprehensive income consists of unrealized gains and
losses on marketable securities.



New Accounting
Pronouncements



In June 2002, the FASB issued SFAS No.
146, Accounting for Costs Associated with Exit or Disposal Activities, (SFAS 146). This statement addresses financial accounting and reporting for costs associated with exit or disposal activities and nullifies Emerging Issues
Task Force Issue No. 94-3, Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring), (EITF 94-3). This statement requires that a
liability for a cost associated with an exit or disposal activity be recognized when the liability is incurred. Under EITF 94-3, a liability for an exit cost, as defined, was recognized at the date of an entitys commitment to an exit plan. The
provisions of this statement are effective for exit or disposal activities that are initiated after December 31, 2002 as the Company did not elect to adopt it earlier.



NOTE 3. Investments



The Company invests in securities of the U.S. Treasury and U.S. government agencies. Excess cash is invested on a short-term basis in U.S.
government-based money market funds. At December 31, 2003, the Company had $2.5 million and $4.0 million invested in U.S. Treasury securities and U.S. government agency securities, respectively. The Company had unrealized gains of $1,000 at December
31, 2002. The Company has not realized any losses on its investments during the years ended December 31, 2003, 2002 or 2001.



NOTE 4. Fixed Assets



Fixed assets are summarized as follows (in thousands):



|                                               |  |                  |        |   |                  |   |        |  
|---------------------------------------------- |  | ---------------- | ------ | - | ---------------- | - | ------ | -
|                                               |  | December 31,2003 |        |   | December 31,2002 |  
|Laboratory and office equipment                |  | $                | 4,363  |   |                  | $ | 4,239  |  
|Leasehold improvements                         |  |                  | 1,873  |   |                  |   | 1,471  |  
|Construction in progress                       |  |                  |       |   |                  |   | 483    |  
|                                               |  |                  |        |   |                  |   |        |  
|                                               |  |                  | 6,236  |   |                  |   | 6,193  |  
|Less accumulated depreciation and amortization |  |                  | (5,141 | ) |                  |   | (4,652 | )
|                                               |  |                  |        |   |                  |   |        |  
|                                               |  | $                | 1,095  |   |                  | $ | 1,541  |  
|                                               |  |                  |        |   |                  |   |        |  



NOTE 5. Accounts Payable and
Accrued Expenses



Accounts payable and accrued expenses
consist of the following (in thousands):



|                                |  |                  |       |                  |   |      
|------------------------------- |  | ---------------- | ----- | ---------------- | - | -----
|                                |  | December 31,2003 |       | December 31,2002
|Accounts payable                |  | $                | 579   |                  | $ | 159  
|Clinical and regulatory costs   |  |                  | 746   |                  |   | 622  
|Professional fees               |  |                  | 195   |                  |   | 183  
|Employee compensation           |  |                  | 179   |                  |   | 27   
|Preclinical costs               |  |                  | 93    |                  |   | 101  
|Manufacturing development costs |  |                  | 60    |                  |   | 16   
|Other                           |  |                  | 65    |                  |   | 19   
|Realignment costs (NOTE 16)     |  |                  |      |                  |   | 175  
|                                |  |                  |       |                  |   |      
|                                |  | $                | 1,917 |                  | $ | 1,302
|                                |  |                  |       |                  |   |      



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GENAERA CORPORATION AND SUBSIDIARY



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS



NOTE 6. Note Payable



In the second quarter of 2002, the Company refinanced its $2.5 million note payable with Merrill Lynch Bank USA. Under the terms of this note payable,
the Company made monthly interest-only payments at an annual rate of 5.346%, with principal due in June 2003. In June 2003, the Companys note payable matured and was not refinanced. The Company used its collateralized cash (which amounted to
approximately $2,800,000 as of December 31, 2002) to satisfy the outstanding balance of $2,500,000 plus $6,000 of accrued but unpaid interest through maturity. Interest expense related to this note payable for the years ended December 31, 2003, 2002
and 2001 was $61,000, $150,000 and $196,000, respectively.



NOTE 7.
Preferred Stock



The Companys certificate of
incorporation provides the board of directors the power to issue shares of preferred stock without stockholder approval. This preferred stock could have voting rights, including voting rights that could be superior to that of the Companys
common stock, and the board of directors has the power to determine these voting rights. As of December 31, 2003, the Companys board of directors has designated 80,000 shares of preferred stock as Series A redeemable convertible preferred
stock (the Series A Preferred Stock), 888 shares of which were issued to Genentech, Inc., (Genentech), 10,000 shares of preferred stock as Series B convertible preferred stock (the Series B Preferred Stock), all
of which were issued to MedImmune, Inc. (MedImmune), 2,500 shares of preferred stock as Series C-1 convertible preferred stock (the Series C-1 Preferred Stock), and 2,500 shares of preferred stock as Series C-2 convertible
preferred stock (the Series C-2 Preferred Stock) (the Series C-1 Preferred Stock and the Series C-2 Preferred Stock collectively the Series C Preferred Stock). All 5,000 shares of the Series C Preferred Stock were issued to
Biotechnology Value Fund and associated entities and to Ziff Asset Management, L.P. The issuances to both Genentech and MedImmune were in connection with collaborative agreements (see NOTE 12. Collaborative Agreements). The Series B
Preferred Stock was purchased by MedImmune in April 2001 for $10.0 million. The Series C Preferred stock was purchased by Biotechnology Value Fund and associated entities and by Ziff Asset Management, L.P. in a private placement in May 2003 for
gross proceeds of $5.0 million (net proceeds of $4.9 million).



The Series A Preferred Stock is convertible, in whole or in part, at the Companys (subject to defined limitations) or holders option, into shares of the Companys common stock at a conversion rate determined by dividing the
original issue price of $1,000 per share (Original Issue Price) by the 5-day average closing price of the common stock as of the conversion date. Shares of the Series A Preferred Stock issued before May 10, 2005 are convertible at any
one date during the six-month period beginning on May 10, 2005. Shares of the Series A Preferred Stock issued on or after May 10, 2005 are convertible at any one date during the six-month period beginning on December 31, 2008. In addition, the
Series A Preferred Stock is convertible at the holders option (1) in the event of a merger, consolidation or sale of substantially all of the assets of the Company or (2) at any time following the first date when the total number of common
shares outstanding, on a fully-diluted and as-converted basis, multiplied by the preceding 10-day average closing price of such date, is less than 500% of the aggregate Original Issue Price plus accrued and unpaid cumulative dividends on the Series
A Preferred Stock. In any event, the aggregate number of common shares issued upon conversion of the shares of Series A Preferred Stock shall not exceed 5,388,595 shares nor shall such aggregate conversions result in Genentech beneficially owning
more than 10% of the Companys common stock. In the event of a conversion that would exceed these limits, the Company would be required to redeem such shares at a cash redemption price of $1,000 per share plus accrued and unpaid cumulative
dividends to the date of conversion. The Series A Preferred Stock may also be redeemed, in whole or in part, at any time at the Companys option at a cash redemption price of $1,000 per share plus accrued and unpaid cumulative dividends to the
date of redemption. The Series A Preferred Stock ranks senior to the Companys common stock as to liquidation and dividend rights. In the event of any liquidation, dissolution or winding up of the Company, the Series A Preferred Stock has a
liquidation preference of $1,000 per share plus accumulated and unpaid cumulative dividends to the date of liquidation. Cumulative preferred dividends under the Series A Preferred Stock are payable in arrears on a quarterly basis at an annual rate
of the prime rate plus 2%. Holders of the Series A Preferred Shares have limited voting rights and generally do not have the right to vote on matters submitted to the holders of the Companys common stock.



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



The Series B Preferred Stock is convertible prior to April 19, 2006, in whole or in part, at the holders option, into shares of the Companys common stock at a conversion rate of 200 shares of common stock
for each share of Series B Preferred Stock. The maximum aggregate number of common shares issued upon a conversion of all of the shares of Series B Preferred Stock before April 19, 2006 is 2,000,000 shares. The Series B Preferred Stock is
convertible after April 19, 2006, in whole or in part, at the Companys or holders option, into shares of the Companys common stock at a conversion rate determined by dividing the original issue price of $1,000 per share by the
lesser of (i) $5.00 or (ii) the 20-day average closing price of the common stock as of the conversion date (the Post-April 19, 2006 Conversion Rate). However, the Company may not exercise its option to convert if the closing price of the
common stock is less than $2.15 per share on the day prior to notice of conversion. In addition, the Series B Preferred Stock shall be automatically convertible at any time in the event of a merger, consolidation or sale of substantially all of the
assets of the Company (a Merger Event), at the Post-April 19, 2006 Conversion Rate. The maximum aggregate number of common shares issued upon conversion of all of the shares of Series B Preferred Stock after April 19, 2006 or at any time
as a result of a Merger Event is 4,642,741 shares of common stock. The Series B Preferred Stock may also be redeemed, in whole or in part, at any time at the Companys option at a cash redemption price of $1,000 per share plus accrued and
unpaid cumulative dividends to the date of redemption. Holders of the Series B Preferred Stock have no rights to dividends other than the right to participate in any dividends that may be declared on the Companys common stock based on the
conversion of such Series B Preferred Stock shares into common stock. With respect to liquidation and dividend rights, the Series B Preferred Stock ranks senior to the Companys common stock and junior to the Companys Series A Preferred
Stock. In the event of any liquidation, dissolution or winding up of the Company, the Series B Preferred Stock has a liquidation preference of $1,000 per share plus accrued and unpaid cumulative dividends to the date of liquidation. Holders of the
Series B Preferred Shares have limited voting rights and generally do not have the right to vote on matters submitted to the holders of the Companys common stock.



On October 8, 2003, MedImmune, Inc., the sole holder of the Series B Convertible Preferred Stock, elected to convert its
outstanding and issued 10,000 shares of Series B Convertible Preferred Stock into 2,000,000 shares of newly-issued common stock of the Company. As a result of this transaction, no shares of Series B convertible preferred stock are outstanding.



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



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GENAERA CORPORATION AND SUBSIDIARY



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS



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



In May 2003, the Company completed the sale of a total of 5,000 shares of Series C Preferred Stock (consisting of 2,500
shares of Series C-1 Preferred Stock and 2,500 shares of Series C-2 Preferred Stock) and warrants to purchase 2,000,000 shares of the Companys common stock at an exercise price per share of $1.37 to Biotechnology Value Fund LP and associated
entities and to Ziff Asset Management L.P. in a private placement pursuant to a purchase agreement (the Preferred Stock and Warrant Purchase Agreement) for gross proceeds of $5,000,000, before offering costs of approximately $78,000. The
Preferred Stock and Warrant Purchase Agreement was subsequently amended and the Certificate of Designations, Preferences and Rights of each of the Series C-1 Preferred Stock and Series C-2 Preferred Stock was amended and restated in June 2003 to
amend one of the conversion factors and clarify voting rights and the distribution of certain shares among the investors. Due to the sale of the shares of Series C Preferred Stock with a conversion price that was below the quoted market price of the
Companys common stock at the time of sale and the issuance of warrants, the Company calculated a beneficial conversion feature of $3,050,000 which represents the excess of the fair value of the preferred stock issued ($6,850,000) over the
proceeds allocable to the preferred stock ($3,800,000). The value of the preferred stock issued was estimated based on the conversion feature and the value of the warrants issued was estimated using a Black-Scholes model and the amount of the
proceeds allocable to the Series C Preferred Stock and warrants was based on the relative fair values of the securities. The proceeds allocable to the warrants were $1,200,000. The Company was amortizing the value of the beneficial conversion
feature as a preferred stock dividend over the 18-month period from the date of issuance of the Series C Preferred Stock to the date on which the Series C Preferred Stock is first known to be convertible. All of the preferred stock became
convertible before the end of this 18-month period as the Companys stock price met defined thresholds, therefore the entire amount of the beneficial conversion feature was recognized as a dividend in 2003.



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



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



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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS



NOTE 8. Common Stock



In April 2002, the Company sold 2,758,855 shares of its common stock, through a private placement, at $2.75 per share. The shares were sold to three of
its institutional shareholders: Wellington Management Company, LLC, the State of Wisconsin Investment Board (SWIB), and Caxton Associates, LLC. Wells Fargo Securities, LLC acted as a placement agent for 1,813,400 of the shares sold. Net
proceeds to the Company from the offering were $6,943,000 after offering costs. Also, the Company is required to issue warrants to the placement agent (See NOTE 9. Warrants). As a condition of SWIBs purchase of its shares, the
Company amended its outstanding stock option plans and its corporate by-laws to, in general, prohibit the Company from, among other things, issuing options with exercise prices below fair market value, from reducing the exercise price of issued
options, from canceling and re-granting options at lower exercise prices and from issuing certain convertible securities, each without requisite stockholder approval.



In November 2003, the Company sold 2,050,000 shares of its common stock, through a private placement, at a price of $4.15
per share. Net proceeds to the Company from the offering totaled $7,893,000, after offering costs, which included a cash fee paid to the placement agent.



NOTE 9. Common Stock Warrants



In connection with its August 2000 private placement, the Company granted to the placement agent warrants to purchase 167,166 shares of the Companys
common stock at an exercise price of $3.38 per share. These warrants expire on August 17, 2007 and are subject to adjustment under certain circumstances. Such circumstances include the issuance of shares of common stock by the Company for a
consideration per share less than the exercise price of the warrants, and the issuance by the Company of securities convertible into shares of common stock for which the exercise or conversion price, when added to the purchase price of such
convertible securities, is less than the exercise price of the warrants. All such warrants are currently outstanding and exercisable.



In connection with the execution of an agreement with an investment bank to provide future financing to the Company, on December 12, 2001, the Company
granted to the investment bank two separate warrants to purchase 50,000 shares and 200,000 shares of the Companys common stock at an exercise price of $3.79 per share. The warrant to purchase 50,000 shares vests either (i) equally in four
installments on the first through fourth 3-month anniversaries of the date of grant or (ii) entirely upon the closing of a financing with aggregate gross proceeds of not less than $15.0 million. The warrant to purchase 200,000 shares was cancelled
without vesting subsequent to December 31, 2001 as a result of the investment banks termination by the Company. The warrant to purchase 50,000 shares of common stock expires on December 12, 2006. The compensation expense for the warrant to
purchase 50,000 shares of common stock granted to this investment bank was recognized over the respective service period in accordance with vesting provisions. Compensation expense related to this warrant for the years ended December 31, 2002 and
2001 was $72,000 and $13,000, respectively, determined using a Black-Scholes valuation model. All such warrants are currently outstanding and exercisable.



In connection with its April 2002 private placement, the Company granted to the placement agent warrants to purchase 100,000 shares of the Companys
common stock at an exercise price of $2.75 per share. When issued, these warrants will be fully exercisable and have a term of 5 years from the date of the transaction.



In connection with its May 2003 private placement, the Company granted warrants to purchase 2,000,000 shares of its common
stock at an exercise price of $1.37 per share. The warrants expire on May 23, 2008 and contain certain provisions under which the holder may elect to receive, without the payment by the holder of any additional consideration, a number of shares of
the Companys common stock equal to the value of the warrant, also known as net exercise provisions. Of this total, warrants to purchase 1.5 million shares are exercisable immediately. The remaining warrants to purchase 500,000 shares are
generally exercisable after 18 months from issuance, or beginning on November 23, 2004, or prior to November 23, 2004 if the holder exercises the warrants on a net exercise basis. On August 26, 2003, Ziff Asset Management, L.P., exercised its
warrants to purchase 600,000 shares of the Companys common stock at an exercise price of $1.37 per share, pursuant to these warrants. Proceeds to the Company from the exercise of this warrant were approximately $822,000. On October 23, 2003,
Biotechnology Value Fund LP and associated entities and Ziff Asset Management L.P. exercised their warrants to purchase 1,200,000 shares of the Companys common stock under the net exercise provisions of these warrants resulting in the



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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS



issuance of 892,361 shares of common stock. As of December 31, 2003, 200,000 of such warrants are outstanding at an exercise price of $1.37 per share.



NOTE 10. Common Stock Options and Restricted Common Stock Awards



In May 1996, the stockholders approved the amended 1992
Stock Option Plan (the 1992 Plan), which provides for the granting of options for the purchase of up to 2,500,000 shares of common stock. The 1992 Plan expired in May 2002. In May 1998, the stockholders approved the 1998 Equity
Compensation Plan (the 1998 Plan), which provides for the granting of options and stock awards of up to 1,500,000 shares of common stock. In May 2001, the stockholders approved an amendment to the Companys Amended 1998 Equity
Compensation Plan to increase the number of shares of common stock issuable thereunder to 3,500,000 shares.



The plans provide for the granting of incentive stock options and nonqualified stock options and are administered by a committee of the Companys
board of directors. The committee has the authority to determine the term during which an option may be exercised (provided that no option may have a term of more than 10 years), the exercise price of an option, and the rate at which options may be
exercised. Incentive stock options may be granted only to employees of the Company. Nonqualified stock options may be granted to employees, directors or consultants of the Company. The exercise price of options under the 1992 Plan and the 1998 Plan
cannot be less than the fair market value of the underlying common stock on the date of the grant.



A summary of the status of the Companys stock options as of December 31, 2003, 2002 and 2001, and changes during the years ended on those dates, is
presented below (in thousands, except per share data):



|                                 |  |        |   |      |                                |      |        |       |   |                                |   |        |  |       |                                |  |   |     
|-------------------------------- |  | ------ | - | ---- | ------------------------------ | ---- | ------ | ----- | - | ------------------------------ | - | ------ |  | ----- | ------------------------------ |  | - | ----
|                                 |  | 2003   |   | 2002 |                                | 2001
|                                 |  | Shares |   |      | Weighted AverageExercise Price |      | Shares |       |   | Weighted AverageExercise Price |   | Shares |  |       | Weighted AverageExercise Price
|Outstanding at beginning of year |  | 4,214  |   |      | $                              | 3.77 |        | 3,745 |   |                                | $ | 4.62   |  | 3,680 |                                |  | $ | 4.51
|Granted                          |  | 591    |   |      | $                              | 3.66 |        | 1,306 |   |                                | $ | 1.12   |  | 832   |                                |  | $ | 3.36
|Exercised                        |  | (261   | ) |      | $                              | 2.07 |        | (3    | ) |                                | $ | 1.88   |  | (424  | )                              |  | $ | 2.05
|Forfeited                        |  | (506   | ) |      | $                              | 3.65 |        | (834  | ) |                                | $ | 3.42   |  | (343  | )                              |  | $ | 3.63
|                                 |  |        |   |      |                                |      |        |       |   |                                |   |        |  |       |                                |  |   |     
|Outstanding at end of year       |  | 4,038  |   |      | $                              | 3.88 |        | 4,214 |   |                                | $ | 3.77   |  | 3,745 |                                |  | $ | 4.62
|                                 |  |        |   |      |                                |      |        |       |   |                                |   |        |  |       |                                |  |   |     
|Exercisable at end of year       |  | 2,510  |   |      | $                              | 4.74 |        | 2,422 |   |                                | $ | 5.19   |  | 2,057 |                                |  | $ | 5.70
|                                 |  |        |   |      |                                |      |        |       |   |                                |   |        |  |       |                                |  |   |     



The following table
summarizes information about stock options outstanding and exercisable as of December 31, 2003 (in thousands, except per share data):



|                         |  |                     |  |                                           |  |                                |       |                   |       |                                |   |      
|------------------------ |  | ------------------- |  | ----------------------------------------- |  | ------------------------------ | ----- | ----------------- | ----- | ------------------------------ | - | -----
|                         |  | Options Outstanding |  | Options Exercisable                      
|Range of Exercise Prices |  | SharesOutstanding   |  | Weighted AverageRemainingContractual Life |  | Weighted AverageExercise Price |       | SharesExercisable |       | Weighted AverageExercise Price
|$0.40 - $ 1.56           |  | 1,034               |  | 8.2 Years                                 |  | $                              | 0.88  |                   | 386   |                                | $ | 0.97 
|$1.97 - $ 3.35           |  | 1,017               |  | 6.7 Years                                 |  | $                              | 2.96  |                   | 640   |                                | $ | 3.04 
|$3.47 - $ 5.00           |  | 1,078               |  | 6.2 Years                                 |  | $                              | 4.07  |                   | 675   |                                | $ | 4.08 
|$5.10 - $ 5.75           |  | 250                 |  | 6.6 Years                                 |  | $                              | 5.45  |                   | 150   |                                | $ | 5.69 
|$7.13 - $8.25            |  | 249                 |  | 3.0 Years                                 |  | $                              | 7.48  |                   | 249   |                                | $ | 7.48 
|$9.13 -                  |  | 150                 |  | 1.9 Years                                 |  | $                              | 9.13  |                   | 150   |                                | $ | 9.13 
|$10.00 - $11.63          |  | 260                 |  | 2.6 Years                                 |  | $                              | 10.68 |                   | 260   |                                | $ | 10.68
|                         |  |                     |  |                                           |  |                                |       |                   |       |                                |   |      
|$0.40 - $11.63           |  | 4,038               |  | 6.3 Years                                 |  | $                              | 3.88  |                   | 2,510 |                                | $ | 4.74 
|                         |  |                     |  |                                           |  |                                |       |                   |       |                                |   |      



The 1998 Plan also
provides for the issuance of common stock awards, up to a maximum of 375,000 shares. Such awards shall be made subject to such performance requirements, vesting provisions, transfer restrictions or other restrictions and conditions as a committee of
the Companys board of directors may determine. As of December 31, 2003, a total of 301,000 shares have been awarded under the 1998 Plan, vesting over a four-year period from the award date. The cost of these awards will be recognized as
expense over the vesting period. The



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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS



following table provides information as of December 31, 2003 regarding the number of restricted stock awards granted, issued, and outstanding.



|              |  |                |  |               |  |                   
|------------- |  | -------------- |  | ------------- |  | ------------------
|Year of Grant |  | Shares Granted |  | Shares Issued |  | Shares Outstanding
|1998          |  | 146,000        |  | 121,000       |  |                  
|1999          |  | 32,500         |  | 30,000        |  |                  
|2000          |  | 27,500         |  | 20,625        |  | 3,125             
|2003          |  | 95,000         |  |              |  | 95,000            
|              |  |                |  |               |  |                   
|Total         |  | 301,000        |  | 171,625       |  | 98,125            
|              |  |                |  |               |  |                   



Compensation expense
related to these stock awards for the years ended December 31, 2003, 2002 and 2001 was $48,000, $144,000 and $209,000, respectively.



The Company granted options to purchase 20,000 and 25,000 shares of the Companys common stock to consultants in the years ended December 31, 2002
and 2000, respectively. No options were granted to consultants in 2003 or 2001. The compensation expense for options granted to consultants is recognized over the respective service periods ranging up to one year or in accordance with vesting
provisions. Compensation expense related to these options for the years ended December 31, 2003, 2002 and 2001 was $35,000, $37,000 and $95,000, respectively. In 2000 and 2003, the Company entered into consulting contracts with former officers of
the Company subsequent to their employment. As a result of these contracts, the former officers retained unvested options to purchase 97,500 and 190,000 shares of the Companys common stock, respectively, after their transition to non-employee
status. The Company recorded additional compensation expense of $128,000 and $56,000 for the years ended December 31, 2003 and 2001, respectively, and a reduction to compensation expense of $49,000 for the year ended December 31, 2002 related to
these options.



NOTE 11. Income Taxes



As of December 31, 2003, the Company has $132,909,000 of net operating loss
(NOL) carryforwards for federal income tax purposes (expiring in years 2004 through 2023). In addition, the Company has NOL carryforwards for state income tax purposes of $97,787,000 (expiring in years 2005 through 2013). Pennsylvania
has a $2,000,000 annual limitation on the utilization of NOL carryforwards, thus the Company is not likely to utilize most of its state NOL carryforwards. The Company also has $6,684,000 of research and development tax credits carryforwards
available to offset future federal income tax liability (expiring in years 2005 through 2023). The NOL carryforward differs from the accumulated deficit principally due to differences in the recognition of certain expenses between financial and
federal tax reporting. As of December 31, 2003, approximately $2.6 million of the Companys gross deferred tax assets, for which no tax benefits have been recognized, are attributable to stock option deductions. To the extent that such tax
benefits are recognized in the future, the benefit would be credited directly to stockholders equity.



Under the Tax Reform Act of 1986, the utilization of a corporations NOL carryforward and research and development tax credits are limited following
a change in ownership of greater than 50% within a three-year period. Due to the Companys prior equity transactions, the Companys net operating loss and tax credit carryforwards may be subject to an annual limitation generally determined
by multiplying the market value of the Company on the date of the ownership change by the federal long-term tax-exempt rate. Any amount exceeding the annual limitation may be carried forward to future years for the balance of the NOL and tax credit
carryforward period.



Deferred income taxes reflect the net tax
effects of temporary differences between carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. In assessing the realizability of deferred tax assets, management considers whether it
is more likely than not that some portion or all of the deferred tax assets will not be realized. The ultimate realization of deferred tax assets is dependent upon generation of future taxable income during the periods in which temporary differences
representing net future



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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS



deductible amounts become deductible. Due to the uncertainty of the Companys ability to realize the benefit of the deferred tax asset, the deferred tax
assets are fully offset by a valuation allowance at December 31, 2003 and 2002. The net change in the valuation allowance for deferred tax assets at December 31, 2003 and 2002 was an increase of $3,922,000 and $3,095,000, respectively. The expected
tax benefit calculated using a federal statutory tax rate of 35% has been reduced to an actual benefit of zero due primarily to the aforementioned valuation allowance.



Significant components of the net deferred tax assets as of December 31, 2003 and 2002 consist of the following (in
thousands):



|                                     |  |      |         |   |      |   |         |  
|------------------------------------ |  | ---- | ------- | - | ---- | - | ------- | -
|                                     |  | 2003 |         |   | 2002 |  
|Deferred tax assets:                 |  |      |         |   |      |   |         |  
|Net operating losses                 |  | $    | 52,868  |   |      | $ | 46,116  |  
|Research credits                     |  |      | 6,684   |   |      |   | 6,934   |  
|Capitalized research and development |  |      | 25,904  |   |      |   | 27,860  |  
|Accrued expenses, reserves and other |  |      | 436     |   |      |   | 870     |  
|Depreciation                         |  |      |        |   |      |   | 61      |  
|                                     |  |      |         |   |      |   |         |  
|Total gross deferred tax assets      |  |      | 85,892  |   |      |   | 81,841  |  
|                                     |  |      |         |   |      |   |         |  
|Deferred tax liabilities:            |  |      |         |   |      |   |         |  
|Depreciation                         |  |      | (129    | ) |      |   |        |  
|                                     |  |      |         |   |      |   |         |  
|Total gross deferred tax liabilities |  |      | (129    | ) |      |   |        |  
|                                     |  |      | 85,763  |   |      |   | 81,841  |  
|Valuation allowance                  |  |      | (85,763 | ) |      |   | (81,841 | )
|                                     |  |      |         |   |      |   |         |  
|Deferred tax assets, net             |  | $    |        |   |      | $ |        |  
|                                     |  |      |         |   |      |   |         |  



NOTE 12. Collaborative Arrangements



In February 1997, the Company entered into a development,
supply and distribution agreement in North America with GlaxoSmithKline for LOCILEX Cream (the GlaxoSmithKline Agreement). GlaxoSmithKline has paid the Company $10.0 million under this agreement. The Company had hoped to commercialize
LOCILEX Cream in the near-term. However, with the FDAs decision not to approve LOCILEX Cream, near-term commercialization will not occur, and the Company will generate no revenues from LOCILEX Cream in the near future. The GlaxoSmithKline
Agreement also gives GlaxoSmithKline rights to terminate the arrangement, and, under certain conditions, the right to negotiate for rights to another Genaera product development candidate. GlaxoSmithKline remains the Companys exclusive sales,
marketing and distribution partner for the North American territory for LOCILEX Cream.



In May 2000, the Company entered into a research, development and commercialization collaboration agreement with Genentech Inc. related to the Companys IL9 antibody development program and related respiratory
technology (the Genentech Agreement), which replaced a December 1998 collaboration agreement. The Company and Genentech simultaneously executed a Stock Purchase Agreement (the Stock Purchase Agreement) pursuant to which the
Company received from Genentech $5.0 million in exchange for the issuance of 1,085,973 shares of its common stock and $500,000 for the issuance of 500 shares of its Series A Preferred Stock. In November 2000, the Company issued 688 of its Series A
Preferred Stock to Genentech for $688,000, which represented further development funding. In December 2000, Genentech provided notice to the Company of its election to terminate the Genentech Agreement. In April 2001, Genentech and the Company
executed a settlement agreement pursuant to which all licensed technology under the Genentech Agreement was returned to the Company. At that time, $300,000 in development expenditures owed to the Company by Genentech was settled by the return to the
Company and cancellation of 300 shares of the Series A Preferred Stock previously issued to Genentech. This $300,000 was accounted for as a reduction to research and development expenses for the year ended December 31, 2001.



In April 2001, the Company entered into a research collaboration and
licensing agreement with MedImmune to develop and commercialize therapies related to the Companys IL9 program. The companies also will collaborate on the creation of specific assays and respiratory disease models for use in assessing product
candidates developed by MedImmune. MedImmune will be responsible for development, manufacturing, clinical testing, and marketing of any resulting product. MedImmune provided funding of $2.5 million for research and development activities at the



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GENAERA CORPORATION AND SUBSIDIARY



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS



Company through April 2003 (the R&D Funding), which has been recognized by the Company as revenues on a straight-line basis over the two-year
period. In addition to the R&D Funding, MedImmune will also reimburse the Company for certain external costs incurred by the Company in connection with the IL9 research plan, which will be recognized by the Company as revenues when the related
expenses are incurred. For the years ended December 31, 2003, 2002, and 2001, the Company recognized $701,000, $1,517,000, and $1,038,000, respectively, as revenue related to this agreement, which approximated the Companys costs to obtain that
revenue, of which $331,000, $267,000, and $158,000, respectively, relates to external cost reimbursements. The Company could receive up to $55.0 million if future milestones are successfully achieved, plus royalties on any product resulting from
this agreement.



In September 2001, the Company received a
contingent award of up to $1.7 million from an affiliate of the Cystic Fibrosis Foundation (CFF) to support early clinical evaluation of LOMUCIN involving patients with cystic fibrosis. This award has been granted and shall be paid to the Company from time to time upon the achievement
of certain development milestones. Of this grant, $296,000 and $125,000 was received as of December 31, 2003 and 2002, respectively, and was recorded as a long-term liability. The Company did not recognize these amounts as revenue as they are
refundable to the CFF upon marketing approval by the FDA or if the Company elects not to enter Phase III clinical trials or to commercialize the product within two years of the satisfaction of development milestones. The CFF is also due a royalty on
net sales of any resultant product up to 1% based upon the amount of funding ultimately provided by the CFF.



In February 2002, the Company received a Phase II Small Business Innovative Research program grant from the National Institutes of Health in the amount of
$800,000 to support its aminosterol research program. The grant extends over the two-year period beginning in February 2002. The Company recognized $412,000 as revenue related to this grant for the year ended December 31, 2003.



NOTE 13. 401(k) Plan



The Company maintains a 401(k) retirement plan available to all full-time, eligible employees. Employee contributions are
voluntary and are determined on an individual basis, limited to the maximum amount allowable under federal tax regulations. The Company, at its discretion, may make certain contributions to the plan. No such Company contributions have been made
during the years ended December 31, 2003, 2002 or 2001.



NOTE 14. Fair Value
of Financial Instruments



The following disclosures of
estimated fair value were determined by management, using available market information and valuation methodologies. Considerable judgment is necessary to interpret market data and develop estimated fair market value. Accordingly, the estimates
presented herein are not necessarily indicative of the amounts the Company could realize on disposition of the financial instruments. The use of different market assumptions or estimation methodologies may have an effect on the estimated fair value
amounts.



Cash equivalents and accounts payable are carried at
amounts that reasonably approximate their fair values due to the short-term nature of these instruments.



NOTE 15. Commitments, Contingencies and Liquidity



Facility Lease



The
Company has entered into an operating lease for its laboratory and corporate office facilities, which expires in December 2007. Minimum annual rent payments through 2007 are as follows (in thousands):



|                        |  |   |      
|----------------------- |  | - | -----
|Year Ended December 31, |  |  
|2004                    |  |   | 371  
|2005                    |  |   | 383  
|2006                    |  |   | 397  
|2007                    |  |   | 376  
|                        |  |   |      
|                        |  | $ | 1,527
|                        |  |   |      



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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS



The lease provides for rent escalations relating to increases in the Consumer Price Index not to
exceed 7% but no less than 3.5%. For the purposes of the above table, the Company has assumed a minimum lease payment escalation of 3.5% for all future periods after November 2004. Rent expense, which includes the cost of common area maintenance and
other building operating expenses paid to the landlord, was $460,000, $425,000 and $362,000 for the years ended December 31, 2003, 2002 and 2001, respectively.



Equipment Leases and Maintenance Contracts



The Company has entered into multiple operating leases and maintenance contracts for its laboratory and corporate office equipment. Minimum annual lease
payments through 2008 are as follows (in thousands):



|                        |  |   |    
|----------------------- |  | - | ---
|Year Ended December
31, |  |  
|2004                    |  |   | 144
|2005                    |  |   | 68 
|2006                    |  |   | 15 
|2007                    |  |   | 3  
|2008                    |  |   |   
|                        |  |   |    
|                        |  | $ | 230
|                        |  |   |    



Equipment rental
expense was $181,000, $185,000, and $240,000 for the years ended December 31, 2003, 2002 and 2001, respectively.



Employment Agreements



The Company has employment agreements with certain officers and employees. Employees covered under employment contracts who are terminated not for
cause are entitled to receive from the Company continuation of base pay and health benefits for a period of twelve months in the case of the President and Executive Vice Presidents or six months in the case of the Senior Vice Presidents. In
either case, continuation of pay and heath benefits will cease upon the attainment of full time employment elsewhere.



Manufacturing



In January 1999 and prior, the Company entered into several agreements with Abbott Laboratories providing for the purchase of approximately $10.0 million
of bulk drug substance to be used in the manufacturing process for LOCILEX Cream. As the FDA did not approve LOCILEX Cream, the Company renegotiated this agreement with Abbott in September 1999, paying Abbott $4.2 million at that time and receiving
partial delivery of material. An additional $3.4 million was due to Abbott and payable if the Company receives in excess of $10.0 million of additional funds (as defined in the agreement) in any year beginning in 2000, in which case the Company must
pay 15% of such excess over $10.0 million to Abbott. The Company recorded this conditional obligation as a liability in 1999 at its then present value. As a result of the Companys financing activities during 2000 and 2001 and other cash
inflows, $1,392,000 and $480,000 of this liability was payable and paid to Abbott on March 1, 2001 and 2002, respectively. No portion of the liability was payable to Abbott on March 1, 2003 as the Company did not receive in excess of $10.0 million
of cash inflows during 2002. As a result of the Companys financing activities during 2003 and other cash inflows, $966,000 of the remaining liability is due and payable to Abbott on March 1, 2004 and is included in short-term liabilities as of
December 31, 2003. The remaining amount of $563,000 is included in long-term liabilities as of December 31, 2003.



Liquidity



The Company has not generated any revenues from product sales and has funded operations primarily from the proceeds of public and private placements of
its securities. Substantial additional financing will be required by the Company in the near-term to fund its continuing research and development activities. No assurance can be given that any such financing will be available when needed or that the
Companys research and development efforts will be successful.



The Company regularly explores alternative means of financing its operations and seeks funding through various sources, including public and private securities offerings and collaborative arrangements with third parties. The



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GENAERA CORPORATION AND SUBSIDIARY



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS



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



In January 2004, we completed the sale of 4,950,500 shares of our common stock for gross proceeds of approximately $20.0 million. We believe that the
proceeds of this offering in addition to our current cash and investments at December 31, 2003, are sufficient to meet our research and development goals and sustain operations at least through 2004.



Litigation



On August 4, 2003, a lawsuit was filed against the Company by Perceptive
Life Sciences Master Fund, LTD in the United States District Court for the Eastern District of Pennsylvania alleging the existence and subsequent breaches of certain contractual obligations by the Company in connection with its sale of shares of
Series C Preferred Stock in May 2003. The plaintiff is seeking monetary damages from the Company or a judgment by the court that the Company should specifically perform the terms of an alleged agreement related to such sale. The Company believes
that this lawsuit is without merit and intends to defend it vigorously. The Company does not believe that a loss from this matter is probable and therefore has not recognized a liability.



NOTE 16. Realignment of Operations



On August 14, 2002, the Company announced that it implemented a realignment of operations intended to focus resources on its most advanced product
development programs and reduce expenses. Under the realignment plan, the Company reduced its headcount by approximately 35%, or 23 employees, primarily impacting unsupported preclinical research programs. All of the employees affected by the
workforce reduction were offered severance and outplacement support. The Company recorded a nonrecurring charge of $506,000 in 2002, of which $498,000 and $8,000 are recorded in Research and Development Expense and General and Administrative
Expense, respectively. As of December 31, 2003, the Company had paid $499,000 in cash severance and outplacement support against this accrual. The remaining accrual of $7,000 was reversed during 2003 because all cash severance and outplacement
support payments had been satisfied.



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



NOTE 17. Subsequent Events



On January 21, 2004, the Company sold 4,950,500 shares of its common stock, to four institutional investors in a private placement, at a purchase price of
$4.04 per share for aggregate gross proceeds of approximately $20.0 million (net proceeds of $19.9 million). The share price was calculated based on a 10% discount to the five day moving average of the closing price of Genaeras common stock on
the Nasdaq SmallCap Market on January 20, 2004. In addition, an aggregate of 990,100 warrants to purchase 990,100 shares of the Companys common stock were issued to the institutional investors. The warrants have an exercise price of $5.38 per
share and expire on January 23, 2009.



NOTE 18. Quarterly Results
(Unaudited)



The following tables contain selected
unaudited Statement of Operations information for each quarter of the fiscal years ended December 31, 2003 and 2002 (in thousands, except per share amounts). The Company believes that the following information reflects all normal recurring
adjustments necessary for a fair presentation of the information for the periods presented. The operating results for any quarter are not necessarily indicative of results for any future period.



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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS



|                                                                       |  |                              |        |   |                |   |        |               |  |   |                |   |  |   |        |  
|---------------------------------------------------------------------- |  | ---------------------------- | ------ | - | -------------- | - | ------ | ------------- |  | - | -------------- | - |  | - | ------ | -
|                                                                       |  | Year Ended December 31, 2003 |       
|                                                                       |  | First Quarter                |        |   | Second Quarter |   |        | Third Quarter |  |   | Fourth Quarter |  
|Collaborative research agreement and grant revenues                    |  | $                            | 487    |   |                | $ | 389    |               |  | $ | 124            |   |  | $ | 113    |  
|                                                                       |  |                              |        |   |                |   |        |               |  |   |                |   |  |   |        |  
|Net loss                                                               |  | $                            | (1,584 | ) |                | $ | (1,402 | )             |  | $ | (2,071         | ) |  | $ | (4,336 | )
|                                                                       |  |                              |        |   |                |   |        |               |  |   |                |   |  |   |        |  
|Net loss applicable to common stockholders                             |  | $                            | (1,602 | ) |                | $ | (1,523 | )             |  | $ | (5,016         | ) |  | $ | (4,336 | )
|                                                                       |  |                              |        |   |                |   |        |               |  |   |                |   |  |   |        |  
|Net loss applicable to common stockholders per sharebasic and diluted |  | $                            | (.04   | ) |                | $ | (.04   | )             |  | $ | (.13           | ) |  | $ | (.10   | )
|                                                                       |  |                              |        |   |                |   |        |               |  |   |                |   |  |   |        |  
|Weighted average shares outstandingbasic and diluted                  |  |                              | 35,666 |   |                |   | 35,691 |               |  |   | 37,453         |   |  |   | 45,629 |  
|                                                                       |  |                              |        |   |                |   |        |               |  |   |                |   |  |   |        |  
|                                                                       | 
|                                                                       |  | Year Ended December 31, 2002 |       
|                                                                       |  | First Quarter                |        |   | Second Quarter |   |        | Third Quarter |  |   | Fourth Quarter |  
|Collaborative research agreement and grant revenues                    |  | $                            | 436    |   |                | $ | 417    |               |  | $ | 349            |   |  | $ | 315    |  
|                                                                       |  |                              |        |   |                |   |        |               |  |   |                |   |  |   |        |  
|Net loss                                                               |  | $                            | (4,053 | ) |                | $ | (3,313 | )             |  | $ | (2,969         | ) |  | $ | (1,821 | )
|                                                                       |  |                              |        |   |                |   |        |               |  |   |                |   |  |   |        |  
|Net loss applicable to common stockholders                             |  | $                            | (4,071 | ) |                | $ | (3,330 | )             |  | $ | (2,988         | ) |  | $ | (1,840 | )
|                                                                       |  |                              |        |   |                |   |        |               |  |   |                |   |  |   |        |  
|Net loss applicable to common stockholders per sharebasic and diluted |  | $                            | (.12   | ) |                | $ | (.09   | )             |  | $ | (.08           | ) |  | $ | (.05   | )
|                                                                       |  |                              |        |   |                |   |        |               |  |   |                |   |  |   |        |  
|Weighted average shares outstandingbasic and diluted                  |  |                              | 32,866 |   |                |   | 35,353 |               |  |   | 35,652         |   |  |   | 35,666 |  
|                                                                       |  |                              |        |   |                |   |        |               |  |   |                |   |  |   |        |  



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