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SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

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FORM 10-K

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(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, 2004

OR

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

For the transition period fromto

Commission File Number 0-19651

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GENAERA CORPORATION

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

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|                                                               |  |                                  
|-------------------------------------------------------------- |  | ---------------------------------
|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)

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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 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. ̈

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

The aggregate market value of common stock
held by non-affiliates of the registrant was approximately $220,622,228 as of June 30, 2004, 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, 2004. For purposes of this calculation only, the registrant has defined affiliates as all directors and executive officers as of June
30, 2004 and any stockholder whose ownership exceeds 10% of the common stock outstanding as of June 30, 2004. The number of shares of the registrants common stock outstanding as of June 30, 2004 was 52,529,102.

Number of shares of Common Stock outstanding as of March 14, 2005 was 57,160,399.



DOCUMENTS INCORPORATED BY REFERENCE

Portions of the Definitive Proxy Statement for the Registrants 2005 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, 2004



INDEX



|               |  |         |  |                                                                                                              |  |         
|-------------- |  | ------- |  | ------------------------------------------------------------------------------------------------------------ |  | --------
|               |  |         |  | Description                                                                                                  |  | Page No.
|Part I         |  | Item 1  |  | Business                                                                                                     |  | 1       
|               |  | Item 2  |  | Properties                                                                                                   |  | 19      
|               |  | Item 3  |  | Legal Proceedings                                                                                            |  | 20      
|               |  | Item 4  |  | Submission of Matters to a Vote of Security Holders                                                          |  | 20      
|               |  |         | 
|Part II        |  | Item 5  |  | Market for Registrants Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities |  | 21      
|               |  | Item 6  |  | Selected Financial Data                                                                                      |  | 23      
|               |  | Item 7  |  | Managements Discussion and Analysis of Financial Condition and Results of Operations                        |  | 24      
|               |  | Item 7A |  | Quantitative and Qualitative Disclosures About Market Risk                                                   |  | 31      
|               |  | Item 8  |  | Financial Statements and Supplementary Data                                                                  |  | 31      
|               |  | Item 9  |  | Changes in and Disagreements with Accountants on Accounting and Financial Disclosure                         |  | 31      
|               |  | Item 9A |  | Controls and Procedures                                                                                      |  | 32      
|               |  | Item 9B |  | Other Information                                                                                            |  | 34      
|               |  |         | 
|Part III       |  | Item 10 |  | Directors and Executive Officers of the Registrant                                                           |  | 35      
|               |  | Item 11 |  | Executive Compensation                                                                                       |  | 35      
|               |  | Item 12 |  | Security Ownership of Certain Beneficial Owners and Management                                               |  | 35      
|               |  | Item 13 |  | Certain Relationships and Related Transactions                                                               |  | 35      
|               |  | Item 14 |  | Principal Accountant Fees and Services                                                                       |  | 35      
|               |  |         | 
|Part IV        |  | Item 15 |  | Exhibits, Financial Statement Schedules                                                                      |  | 36      
|Signatures     |  | 40     
|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 particular, these include, among others, statements relating to present or anticipated scientific progress, development of potential pharmaceutical products, future revenues, capital expenditures, research and development expenditures,
future financing and collaborations, personnel, manufacturing requirements and capabilities, the impact of new accounting pronouncements and other statements regarding matters that are not historical facts or statements of current condition.



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



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 developing medicines for serious diseases from genomics (our study of genetic predisposition to
disease) and natural products. We were first incorporated in the State of Delaware in 1987 and are headquartered in Plymouth Meeting, Pennsylvania. Our research and development efforts are focused on anti-angiogenesis and respiratory diseases.
EVIZON (squalamine lactate), our lead product
candidate, is being developed to treat ophthalmic indications, specifically the wet form of age-related macular degeneration (AMD). Squalamine lactate is also being developed, as our second product candidate, for the treatment of
cancerous solid tumors. Our third product candidate, LOMUCIN (talniflumate), is being developed to treat the overproduction of mucus secretions involved in chronic respiratory disease. Our fourth product candidate, interleukin-9 (IL9) antibody, is a respiratory treatment based
on the discovery of a genetic cause of asthma. Additionally, we have a number of discovery research programs focused on the treatment of obesity, infectious diseases and inflammatory disorders.



We have no products available for sale and have incurred losses since our
inception. Because substantially all of our potential products currently are in research, preclinical development or the early or middle stages of clinical testing, revenues from sales of any products will not occur for at least the next several
years, if at all. As a result, we will need to raise substantial additional funds in the future to continue our research and development programs and to commercialize our potential 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.



CLINICAL DEVELOPMENT PROGRAMS



Squalamine Lactate



Squalamine lactate (squalamine) is a unique, first-in-class,
synthetic small molecule administered systemically that directly interrupts and reverses multiple facets of angiogenesis, a fundamental process by



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which new blood vessels are formed, and is considered an anti-angiogenic substance. Working within activated endothelial cells, squalamine
inhibits growth factor signaling including VEGF, integrin expression, and reverses cytoskeletal formation thereby resulting in endothelial cell inactivation and, in certain cases, apoptosis. The chemical structure of squalamine combines a steroid
and a polyamine, two classes of agents that are generally 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
independent laboratories.



EVIZON (squalamine lactate)



EVIZON (squalamine lactate), our lead product candidate, is currently being studied for the treatment of the wet
form of age-related macular degeneration. AMD occurs in two types: the dry form and the more severe wet form. Wet AMD is caused by the growth of abnormal blood vessels, or choroidal neovascularization, under the central part
of the retina, the macula. Dry AMD, the more common and milder form of AMD, results in varying forms of sight loss and may or may not develop into the wet form. Although the wet form of AMD accounts for a small percentage of all AMD, it is
responsible for the majority of severe vision loss associated with AMD.



In 2004, we announced that the United States Food and Drug Administration (FDA) had cleared our investigational new drug (IND) application to conduct clinical trials of EVIZON in ophthalmic indications including the treatment of wet AMD.
During 2004, we announced the initiation of three Phase II clinical trials (MSI-1256F-207, MSI-1256F-208 and MSI-1256F-209) of EVIZON for the treatment of wet AMD at multiple sites throughout the United States. MSI-1256F-207 is a pharmacokinetic and
safety trial designed to evaluate 18 patients with wet AMD at three different doses of EVIZON. MSI-1256F-209 is designed to evaluate the safety and efficacy of EVIZON as first-line therapy in 100 patients with wet AMD over a two-year period.
MSI-1256F-208, an exploratory trial, will evaluate three different doses (10mg, 20mg and 40mg) of EVIZON in combination with an initial Visudyne® treatment in 45 patients with wet AMD. Prior to 2004, we announced strong clinical results, including improved vision, for patients in our Phase I/II
clinical trial (MSI-1256F-106) designed to test EVIZON as a treatment for AMD.



Recently, the FDA selected EVIZON for participation in the Continuous Marketing Application (CMA) Pilot 2 program. The CMA Pilot 2 program provides for frequent scientific feedback and interactions during the IND
phase of new drug development based on a defined agreement between the FDA and the applicant. In October 2004, the FDA granted EVIZON Fast Track designation. Under the FDA Modernization Act of 1997, Fast Track drug development programs are designed
to expedite the review and facilitate the development of a new drug that demonstrates the potential to address unmet medical needs for the treatment of a serious life-threatening condition.



Squalamine Lactate in Cancer



We have conducted Phase II clinical trials of squalamine for the treatment
of solid tumors. Currently, we are enrolling a Phase II clinical study of squalamine for the treatment of prostate cancer. This cancer study will evaluate intravenously administered squalamine in combination with leading chemotherapeutics or
accepted interventions in this indication.



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. 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



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immune cells. Genaera has developed a patent position around IL9 having first discovered and documented a role for this cytokine in asthma. Our patent
position around IL9 includes patents licensed exclusively from the Ludwig Institute for Cancer Research (LICR) as well as patents owned jointly with LICR.



In April 2001, we entered into a collaborative agreement with MedImmune, Inc. (MedImmune), to develop and commercialize therapies related to our IL9
program. Pursuant to the agreement, MedImmune provided funding of $2.5 million for research and development activities at Genaera over a two-year period from April 2001 through April 2003. By the end of the two-year period, licensed technology had
been transferred to MedImmune, which assumed responsibility for development and commercialization efforts on the IL9 program. In addition to the research and development funding, MedImmune agreed to reimburse Genaera for certain external costs we
incur in connection with the IL9 program. Under the agreement, we received $0.5 million based on the completion of a contractual milestone and we could also receive up to $54.5 million based on the successful completion of future milestones. We are
also entitled to royalties on sales of commercial products resulting from the collaboration. As a result of our limited control over the development plan and the timing of milestones, we cannot estimate the timing or receipt of milestone payments
and do not expect to receive a substantial portion of these milestone payments within the next five years. Each party has the right to terminate the agreement upon notice to the other party.



LOMUCIN (talniflumate)



Our second genomics-based program has focused on the fundamental biology of mucus over-production in a large number of chronic respiratory patients
worldwide. Efforts to identify specific gene targets and validate these targets for therapeutic development have led to the identification of small molecules to inhibit the over-production of mucin, or mucoregulators. Our scientists have
identified hCLCA1, a chloride channel found in humans, and demonstrated a relationship between hCLCA1 and abnormal mucus production.



LOMUCIN (talniflumate) is an orally available, small molecule, inhibitor of the hCLCA1 channel and potential mucoregulator. LOMUCIN is a known compound that was discovered, developed and
marketed as an anti-inflammatory drug by Laboratorios Bago of Buenos Aires, Argentina, an independent pharmaceutical company in South America. The effects of talniflumate in blocking hCLCA1 and mucus over-production were discovered by our scientists
and we have been issued a patent protecting uses of talniflumate and certain 2-aminophenyl acetic compounds to treat diseases characterized by mucin production. We have an exclusive license with Laboratorios Bago to develop and commercialize
talniflumate as a mucoregulator drug in all major pharmaceutical markets including the United States, Europe and Japan.



Our 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. This award will be paid to us from time to time upon the achievement of certain development
milestones. Grant amounts received would become refundable to the CFFT upon marketing approval by the FDA or upon our election not to enter Phase III clinical trials or not to commercialize the product within two years of the satisfaction of
development milestones, assuming the achievement of statistically significant results. The CFFT is also due a royalty on net sales of any resultant product of up to 1% based upon the amount of funding ultimately provided by CFFT.



In October 2003, we announced that the preliminary results of our first
exploratory Phase II clinical trial of LOMUCIN for cystic fibrosis demonstrated a strong safety profile for the drug and a trend toward maintenance of existing lung function in people with cystic fibrosis receiving LOMUCIN compared to a decline in
those receiving a placebo.



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PRE-CLINICAL & RESEARCH PROGRAMS



Obesity Therapeutic Program



Trodusquemine, formerly known as trodulamine (also referred to in scientific literature as MSI-1436), is a natural aminosterol product candidate. Our
scientists have demonstrated the ability to prevent the abnormal weight gain and reduce the weight of genetically altered mice, generally very obese mice, to that of a normal healthy mouse with trodusquemine. 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, which 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.



Other Aminosterol
Programs



In addition to squalamine and trodusquemine,
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 studied 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. In February 2002, we received a Phase
II Small Business Innovative Research program grant from the National Institutes of Health (NIH) in the amount of $0.8 million to support this program. The grant extended over a two-year period, which ended in February 2004. In February 2004, we
notified the NIH of a no-cost extension to the original budget period by twelve months. As a result of the notification, the grant was extended through February 2005.



Infectious Disease Program



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. 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 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.



In February
1997, we entered into a development, supply and distribution agreement in North America with GlaxoSmithKline for LOCILEX Cream. GlaxoSmithKline paid us $10.0 million under this agreement, which we received in 1997. As a result of the FDAs
decision in July 1999 not to approve LOCILEX Cream, we 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.



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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 had an initial term of 18 months
that ended in April 2004 and has been extended to December 31, 2005. The agreement provides reimbursement to us for certain 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 $14.0 million, $7.9 million and $10.2 million for
research and development in the years ended December 31, 2004, 2003 and 2002, respectively. See ITEM 7. Managements Discussion and Analysis of Financial Condition and Results of Operations and ITEM 8. Financial Statements and
Supplementary Data for additional information.



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 potential collaborators.



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
regulates 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



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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) 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 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 typically involve 30-200 patients and are designed primarily to demonstrate safety and preliminary
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 that are intended to evaluate the overall benefit-risk relationship of the drug and to gather additional information for proper dosage and 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 more than 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. 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.



Regulation of Pharmaceutical Products Outside of the United States



The development and commercialization of our product
candidates outside of the United States is 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 as those that are encountered in the United States.



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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 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 75
patent applications and issued patents in the United States of which we own or co-own 61 and we license on an exclusive basis 14. We own, co-own or have licensed on an exclusive basis a total of 134 patent applications and issued patents in
countries other than the United States.



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



The expiration date of each of these patents is subject to extension
depending upon the future research and development program timelines. We have filed several other applications across our research 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. In addition, we have licensed from the Childrens Hospital of Philadelphia the composition of
matter patent for the squalamine compound, which expires in 2012. These patents are subject to extensions by their owners depending upon the future research and development program timelines. Additionally, certain of these agreements also provide
that if we elect not to pursue the commercial development of any licensed technology, or do not adhere to an acceptable schedule of commercialization, then our exclusive rights to such technology may terminate. We also conduct or collaborate on
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



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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 LOMUCIN and are currently seeking U.S. registration of this
trademark. We also have trademark protection for the product candidate name EVIZON and 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. 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 we are targeting, including AMD, cancer and respiratory diseases. A number of major pharmaceutical companies have significant franchises in these disease areas and can be expected to invest heavily to protect their interests. With
respect to AMD, anti-angiogenic agents are under development at a number of biopharmaceutical companies, including Alcon, Inc., Bausch & Lomb, Inc., Eyetech Pharmaceuticals, Genentech, Inc., Miravant Medical Technologies, and QLT, Inc., as well
as multiple large pharmaceutical companies. For 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 other 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., Amgen, Inc., Inspire Pharmaceuticals, Inc.,
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.         |  | 51  |  | President and Chief Executive Officer                                           
|John L. Armstrong, Jr., MBA |  | 61  |  | Executive Vice President and Chief Operating Officer                            
|Michael J. Gast, M.D., PhD. |  | 56  |  | Executive Vice President and Chief Medical Officer                              
|John A. Skolas, JD, MBA     |  | 52  |  | Executive 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



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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. 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 internal medicine.



Mr. Armstrong was promoted to our Executive Vice President and Chief Operating Officer in July 2004. Prior to that,
he had served as our Executive Vice President since joining the Company in October 2003. Mr. Armstrong has over thirty-five years of increasing 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 MBA
from Century University in 1993.



Dr. Gastjoined
Genaera in February 2005 as our Executive Vice President and Chief Medical Officer. Prior to joining Genaera, Dr. Gast spent ten years at Wyeth Pharmaceuticals, most recently serving as Vice President, Scientific Affairs within Wyeth Global Medical
Affairs, where he was responsible for oversight of Phase IV clinical research programs. Previously at Wyeth, Dr. Gast served as Vice President, Womens Health Clinical Research and Development. Prior to that, Dr. Gast spent twenty-one years at
the Washington University School of Medicine. During his tenure on the faculty at the Washington University Department of Obstetrics and Gynecology, Dr. Gast served as Director of the Division of Reproductive Endocrinology and Infertility and
Director of the Endocrine Clinical Laboratories. Dr. Gast received his MD from The Ohio State University College of Medicine and his PhD in Molecular Biology from Washington University. He currently holds adjunct faculty appointments at the
Washington University School of Medicine and the University of Pennsylvania School of Medicine.



Mr. Skolas was promoted to Executive Vice President, Chief Financial Officer, General Counsel and Secretary in July 2004. Prior to that, he had
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, 2004, we had 42 full-time employees.
No employees are covered by collective bargaining agreements and we consider relations with our employees to be good.



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AVAILABLE INFORMATION



We make available free of charge on or through our internet website, 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



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



Risks Related to Our Business



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



We maintained cash, cash equivalents and short-term investments of $32.2
million at December 31, 2004. At December 31, 2004, we had current liabilities of $3.9 million and long-term liabilities of $0.6 million. In January 2004, we completed the sale of 4,950,500 shares of our common stock for gross proceeds of $20.0
million. In November 2004, we completed the sale of 4,183,422 shares of our common stock for gross proceeds of $14.4 million. We believe these resources are sufficient to sustain operations and meet our research and development goals through 2005.
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 from other parties to provide us additional funds and may be unable to obtain sufficient funding in the future on acceptable terms, if at all. If we cannot obtain funding, we will need to delay,
scale back or eliminate research and development programs or enter into collaborations with third parties to commercialize potential products or technologies that we might otherwise seek to develop or commercialize ourselves, or seek other
arrangements.



Our capital raising efforts may dilute stockholder interests.



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



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



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



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We expect to continue to incur substantial losses in the foreseeable future. We do not now have, nor have we ever had,
products available for commercial sale and we may never generate revenues or become profitable.



To date, we have engaged primarily in the research and development of drug candidates. We have not generated any revenues from product sales and have
incurred losses in each year since our inception. As of December 31, 2004, we had an accumulated deficit of $213.2 million.



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



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



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



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



Risks Related to Our Industry



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



We are dedicating substantially
all of our resources to research and development, do not have any marketed products and have not generated any product revenue. Because substantially all of our potential products currently are in research, preclinical development or the early and
middle stages of clinical testing, revenues from sales of any products will not occur for at least the next several years, if at all. Our technologies are relatively new fields and may not lead to commercially viable pharmaceutical products. Before
we can commercially introduce any products, we will likely incur substantial expense for, and devote a significant amount of time to, preclinical testing and clinical trials. We cannot apply for regulatory approval of our potential products until we
have performed additional research and 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.



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



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



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



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



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



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



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.



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



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



We currently have collaborative
agreements with three primary collaborators: MedImmune, Inc., Ludwig Institute of Cancer Research, or LICR, and Laboratorios Bago SA. We do not have control over the amount and timing of resources to be devoted to our products by our collaborative
partners. Our collaborators may not place a high priority on their contractual arrangements with us. Collaborators may develop products independently or through third parties that could compete with our proposed products. For example,
GlaxoSmithKline, a current collaborative partner, entered into an agreement with us relating to the development of LOCILEX Cream and 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 that of our competitors.



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



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



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



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do in undertaking preclinical testing and human clinical trials of new or improved therapeutic products and obtaining regulatory approvals of such products.
Some of these companies may be in advanced phases of clinical testing of various drugs that may be competitive with our proposed products.



We expect technological developments in the biopharmaceutical field to occur at a rapid rate and expect competition to intensify as advances in this field
are made. Some of these companies are currently involved in research and development activities focused on the pathogenesis of disease and the competition among companies attempting to find genes responsible for disease is intense. In addition, we
are aware that others are conducting research on compounds derived from animal host-defense systems.



Colleges, universities, governmental agencies and other public and private research organizations are becoming more active in seeking patent protection
and licensing arrangements to collect royalties for use of technology that they have developed, some of which may be directly competitive with our technology.



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



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



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



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



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



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



Patents



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



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



We cannot be certain that:



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



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



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



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



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



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



We own several patents and patent applications for the use of squalamine as
an anti-angiogenic, including methods for the treatment of cancer and neovascularization in the eye. One of these patents is to the compounds combination therapy with other anti-cancer agents and will expire in 2017 while another application
covers the treatment of age related macular degeneration, retinopathy of prematurity and diabetic retinopathy that will expire in 2015. We also own patents covering methods and intermediates in the manufacturing process of squalamine and
trodusquemine that expire in 2017 and 2018. We own a composition of matter patent for the trodusquemine compound, which expires in 2014. We also own a patent for the use of trodusquemine as an anti-obesity agent and other indications that expires in
2015. We own two patents for the use of anti-IL9 or anti-IL9 receptor antibodies for the treatment of asthma and related disorders that expire in 2016. We have recently received a U.S. patent covering methods for screening for mucoregulator
compounds. We own a patent on the use of talniflumate and related mucoregulator compounds for treating various conditions where mucous is overproduced, which expires in 2021. The expiration date of each of these patents is subject to extension
depending upon the future research and development program timelines. We have filed several other applications across our research and development programs and intend to file additional applications, as appropriate, for patents on new compounds,
products or processes discovered or developed through the application of our technology.



We have rights to several patents and patent applications under certain license agreements pursuant to which we expect to owe royalties on sales of products that incorporate issued valid patent claims. In particular,
we have licensed from the Ludwig Institute of Cancer Research specific technologies related to our IL9 program, the earliest of which expires in 2009. We have licensed from the Childrens Hospital of Philadelphia the composition of matter
patent for the squalamine compound, which expires in 2012. These patents are subject to extensions by their owners depending upon the future research and development program timelines. Additionally, certain of



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these agreements also provide that if we elect not to pursue the commercial development of any licensed technology, or do not adhere to an acceptable
schedule of commercialization, then our exclusive rights to such technology may terminate.



Third Party Intellectual Property Rights



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



Other Intellectual Property



We have trademark protection for the product candidate names EVIZON  and LOMUCIN and
are currently seeking U.S. registration of these trademarks. In order to protect our proprietary technology and processes, we also rely on trade secrets and confidentiality agreements with our employees, consultants, outside scientific
collaborators, and other advisors. We may find that these agreements have been breached or that our trade secrets have otherwise become known or independently developed or discovered by our competitors.



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



Potential Ownership Disputes



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



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



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



We depend to a considerable degree on a limited number of key personnel. Most significant responsibilities have been assigned to a relatively small number of individuals. In particular, it would be difficult to
replace our Chief Executive Officer, Roy C. Levitt, M.D., and our Chief Operating Officer, John L. Armstrong, Jr. We entered into an employment agreement with Dr. Levitt, dated May 11, 2004, that renews automatically on January 1st of each year and
is terminable by either party. We entered into an evergreen employment agreement with Mr. Armstrong, dated October 21, 2003, that is terminable by either party. Both of these employment



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agreements contain non-competition and non-solicitation clauses. All of our executive officers have executed individual employment agreements with us. We do
not maintain key man insurance on any of our employees. The loss of certain management and technical personnel could adversely affect our ability to develop and commercialize products.



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



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



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



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



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



We currently maintain primary products and completed operations liability insurance with per occurrence and aggregate coverage limits of $7.0 million. The
coverage limits of our insurance policies may be inadequate to protect us from any liabilities we might incur in connection with clinical trials, manufacturing and marketing of our products. Product liability insurance is expensive and in the future
may not be available on commercially acceptable terms, or at all. A successful claim or claims brought against us in excess of our insurance coverage could materially harm our business and financial condition.



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



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



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



Risks Related to Our Stock



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



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



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



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



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



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



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



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



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



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



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



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



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



In the past two years our stock price on the Nasdaq SmallCap Market has
fluctuated from a low of $0.23 per share on March 13, 2003 to a high of $6.17 per share on October 14, 2003. In 2004, our stock price fluctuated from $2.75 to $5.00 per share, with an average price of approximately $3.87. The volatility in our stock
price is due to the volatility of our industry in general and does not appear to be connected to any event specific to us.



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



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



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



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



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



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



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



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



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



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



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



As of December 31, 2004, there were outstanding options to purchase an aggregate of approximately 4,170,000 shares of our
common stock at prices ranging from $0.40 per share to $11.63 per share, of which options to purchase approximately 1,984,000 shares were exercisable as of such date. As of December 31, 2004, there were outstanding warrants to purchase 1,207,266
shares of our common stock. Of this total, warrants to purchase 167,166 shares of our common stock are currently exercisable at $3.33 per share, subject to adjustment under the anti-dilution provisions of the warrants. Warrants to purchase 50,000
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 (all of which has since been converted to our common stock), we issued warrants to purchase
2,000,000 shares of our common stock at an exercise price of $1.37 per share, all of which have been exercised. 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, 2004, these warrants have not yet been issued.



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



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



Our certificate of incorporation provides our board of directors the power to issue shares of preferred stock without
stockholder approval. This preferred stock could have voting rights, including voting rights that could be superior to that of our common stock. In addition, Section 203 of the Delaware General Corporation Law contains provisions that impose
restrictions on stockholder action to acquire control of us. The effect of these provisions of our certificate of incorporation and Delaware law make it more difficult to remove management and could discourage third parties from seeking to obtain
control, even 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 2005 and is subject to certain annual increases
thereafter. This lease expires in November 2007.



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##### Table of Contents

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. On February 2, 2005, the parties entered into a settlement agreement. The settlement is on terms that are not material to the Company and does not constitute an admission of wrongdoing or liability by the
Company. On February 28, 2005, the Court entered the parties stipulated order dismissing the lawsuit without prejudice.



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, 2004.



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PART II



ITEM 5. MARKET FOR REGISTRANTS COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES



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, 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
|                             |  |     
|Year Ended December 31, 2004 |  | High |      | Low
|1st Quarter                  |  | $    | 5.00 |     | $ | 3.45
|2nd Quarter                  |  | $    | 4.80 |     | $ | 3.26
|3rd Quarter                  |  | $    | 4.19 |     | $ | 2.75
|4th Quarter                  |  | $    | 4.22 |     | $ | 3.01



As of March 2, 2005,
the last reported bid price for our common stock on the Nasdaq SmallCap Market was $3.10 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 2, 2005, there were 354 stockholders of record and 16,126 beneficial owners of our common stock.



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##### Table of Contents

Equity Compensation Plan Information



The following table provides aggregate information as of December 31, 2004, regarding our equity compensation plans,
including the 2004 Stock-Based Incentive Compensation Plan, 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, warrantsand rights andlapse of restrictionson
restricted 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     |  | 4,490,625                                                                                                                         |  | $                                                                        | 4.00 |                                                                                                                                        | 3,502,875
|Equity compensation plans not approved by security holders |  |                                                                                                                                  |  |                                                                          |     |                                                                                                                                        |         
|                                                           |  |                                                                                                                                   |  |                                                                          |      |                                                                                                                                        |          
|Total                                                      |  | 4,490,625                                                                                                                         |  | $                                                                        | 4.00 |                                                                                                                                        | 3,502,875
|                                                           |  |                                                                                                                                   |  |                                                                          |      |                                                                                                                                        |          

|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 and 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,                  |        
|                                                                                                               |  | 2004                                     |         |   | 2003 |   |         | 2002 |  |   | 2001    |   |  | 2000 |        
|                                                                                                               |  | (In thousands, except per share amounts) |        
|Statement of Operations Data:                                                                                  |  |                                          |         |   |      |   |         |      |  |   |         |   |  |      |         |   |  |   |         |  
|                                                                                                               |  |                                          |         |   |     
|Revenues:                                                                                                      |  |                                          |         |   |      |   |         |      |  |   |         |   |  |      |         |   |  |   |         |  
|Collaborative research agreement and grant revenues                                                            |  | $                                        | 873     |   |      | $ | 1,113   |      |  | $ | 1,517   |   |  | $    | 1,038   |   |  | $ |        |  
|                                                                                                               |  |                                          |         |   |      |   |         |      |  |   |         |   |  |      |         |   |  |   |         |  
|Costs and expenses:                                                                                            |  |                                          |         |   |      |   |         |      |  |   |         |   |  |      |         |   |  |   |         |  
|Research and development                                                                                       |  |                                          | 14,004  |   |      |   | 7,922   |      |  |   | 10,216  |   |  |      | 11,019  |   |  |   | 10,074  |  
|General and administrative                                                                                     |  |                                          | 4,951   |   |      |   | 2,864   |      |  |   | 3,560   |   |  |      | 3,536   |   |  |   | 2,583   |  
|                                                                                                               |  |                                          |         |   |      |   |         |      |  |   |         |   |  |      |         |   |  |   |         |  
|                                                                                                               |  |                                          | 18,955  |   |      |   | 10,786  |      |  |   | 13,776  |   |  |      | 14,555  |   |  |   | 12,657  |  
|                                                                                                               |  |                                          |         |   |      |   |         |      |  |   |         |   |  |      |         |   |  |   |         |  
|Loss from operations                                                                                           |  |                                          | (18,082 | ) |      |   | (9,673  | )    |  |   | (12,259 | ) |  |      | (13,517 | ) |  |   | (12,657 | )
|Interest income                                                                                                |  |                                          | 329     |   |      |   | 88      |      |  |   | 260     |   |  |      | 849     |   |  |   | 883     |  
|Interest expense                                                                                               |  |                                          | (2      | ) |      |   | (65     | )    |  |   | (157    | ) |  |      | (244    | ) |  |   | (605    | )
|Gain (loss) on sale of fixed assets                                                                            |  |                                          | (118    | ) |      |   | 257     |      |  |   |        |   |  |      |        |   |  |   |        |  
|                                                                                                               |  |                                          |         |   |      |   |         |      |  |   |         |   |  |      |         |   |  |   |         |  
|Net loss                                                                                                       |  |                                          | (17,873 | ) |      |   | (9,393  | )    |  |   | (12,156 | ) |  |      | (12,912 | ) |  |   | (12,379 | )
|Dividends on preferred stock including amount attributable to beneficial conversion feature of $3,050 for 2003 |  |                                          |        |   |      |   | (3,085  | )    |  |   | (73     | ) |  |      | (111    | ) |  |   | (45     | )
|                                                                                                               |  |                                          |         |   |      |   |         |      |  |   |         |   |  |      |         |   |  |   |         |  
|Net loss applicable to common stockholders                                                                     |  | $                                        | (17,873 | ) |      | $ | (12,478 | )    |  | $ | (12,229 | ) |  | $    | (13,023 | ) |  | $ | (12,424 | )
|                                                                                                               |  |                                          |         |   |      |   |         |      |  |   |         |   |  |      |         |   |  |   |         |  
|Net loss applicable to common stockholders per sharebasic and diluted                                         |  | $                                        | (0.34   | ) |      | $ | (0.32   | )    |  | $ | (0.35   | ) |  | $    | (0.40   | ) |  | $ | (0.42   | )
|                                                                                                               |  |                                          |         |   |      |   |         |      |  |   |         |   |  |      |         |   |  |   |         |  
|Weighted average shares outstandingbasic and diluted                                                          |  |                                          | 52,839  |   |      |   | 38,634  |      |  |   | 34,894  |   |  |      | 32,711  |   |  |   | 29,375  |  
|                                                                                                               |  |                                          |         |   |      |   |         |      |  |   |         |   |  |      |         |   |  |   |         |  



|                                                  |  |                |          |   |      |   |          |      |  |   |          |   |  |      |          |   |  |   |          |  
|------------------------------------------------- |  | -------------- | -------- | - | ---- | - | -------- | ---- |  | - | -------- | - |  | ---- | -------- | - |  | - | -------- | -
|                                                  |  | December 31,   |         
|                                                  |  | 2004           |          |   | 2003 |   |          | 2002 |  |   | 2001     |   |  | 2000 |         
|                                                  |  | (In thousands) |         
|Balance Sheet Data:                               |  |                |          |   |      |   |          |      |  |   |          |   |  |      |          |   |  |   |          |  
|                                                  |  |                |          |   |     
|Cash, cash equivalents and short-term investments |  | $              | 32,151   |   |      | $ | 13,135   |      |  | $ | 9,400    |   |  | $    | 16,078   |   |  | $ | 19,033   |  
|Total assets                                      |  |                | 33,548   |   |      |   | 14,553   |      |  |   | 11,191   |   |  |      | 17,816   |   |  |   | 20,701   |  
|Long-term liabilities                             |  |                | 580      |   |      |   | 1,048    |      |  |   | 1,704    |   |  |      | 1,579    |   |  |   | 2,010    |  
|Redeemable convertible preferred stock            |  |                |         |   |      |   |         |      |  |   | 1,117    |   |  |      | 1,044    |   |  |   | 1,233    |  
|Accumulated deficit                               |  |                | (213,171 | ) |      |   | (195,298 | )    |  |   | (182,819 | ) |  |      | (170,591 | ) |  |   | (157,568 | )
|Stockholders equity                              |  |                | 29,082   |   |      |   | 10,622   |      |  |   | 4,511    |   |  |      | 9,610    |   |  |   | 11,473   |  
|                                                  |  |                |          |   |     
|Other Data:                                       |  |                |          |   |      |   |          |      |  |   |          |   |  |      |          |   |  |   |          |  
|                                                  |  |                |          |   |     
|Working capital                                   |  |                | 28,867   |   |      |   | 10,516   |      |  |   | 5,727    |   |  |      | 10,713   |   |  |   | 13,393   |  



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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. Research and
development efforts are focused on anti-angiogenesis and respiratory diseases. We have four products in development addressing substantial unmet medical needs in major pharmaceutical markets.



Since commencing operations in 1988, we have not generated any revenue from
product sales. We have funded operations primarily from the proceeds of public and private placements of securities, 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, 2004, our accumulated deficit was $213.2 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, 2004. The 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 U.S. generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in our financial
statements and accompanying notes. Actual results could differ materially from those estimates. The following are critical accounting policies important to our financial condition and results of operations presented in our financial statements that
require management to make judgments, assumptions and estimates that are inherently uncertain.



Revenue Recognition



Contract revenue for research and development is recorded as earned based on the performance requirements of the contract. Non-refundable contract fees for which no further performance obligations exist, and for which there is no continuing
involvement by us, are recognized 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 patient



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enrollment or the passage of time. At the initiation of certain contracts, we must make an estimate as to the duration and expected completion date of the
contract, which may require a change due to accelerations, delays or other adjustments to the contract period or work performed. Changes in these estimates could have a significant effect on the amount of research and development costs in a specific
period.



Stock-Based Compensation



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



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



RESULTS
OF OPERATIONS2004 vs. 2003



Revenues



We have received no revenues to date from product sales.
Revenues recorded to date have consisted principally of revenues recognized under collaborations with third parties. In April 2001, we entered into a research collaboration and licensing agreement with MedImmune, Inc., to develop and commercialize
therapies related to our IL9 program. MedImmune provided funding of $2.5 million, payable in eight equal quarterly installments through April 2003 (the R&D Funding), plus it funds external cost reimbursements for our research and
development activities. We could also receive up to $54.5 million based on successful completion of future milestones. In August 2004, we received the first of such milestone payments as a result of the initiation of Phase I clinical trials. For the
year ended December 31, 2004, we recognized $0.8 million as revenue related to external cost reimbursements ($0.3 million) and milestone payments ($0.5 million). For the year ended December 31, 2003, we recognized $0.7 million as revenue related to
the R&D Funding ($0.4 million) and external cost reimbursements ($0.3 million).



In February 2002, the Company received a Phase II Small Business Innovative Research program grant from the NIH in the amount of $0.8 million to support its aminosterol research program. The grant extended over a
two-year period, which ended in February 2004. In February 2004, the Company notified the NIH of a no-cost extension of the original budget period by twelve months. As a result of the notification, the grant was extended through February 2005. The
Company recognized no revenue related to this grant for the year ended December 31, 2004. The Company recognized $0.4 million as revenue related to this grant in year ended December 31, 2003.



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Research and Development Expenses



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



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

---

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



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



We recognized research and development expenses of $14.0 million and $7.9 million in 2004 and 2003, respectively. The following table illustrates research and development expenses (in thousands) incurred during the
years ended December 31, 2004 and 2003 for our significant groups of research and development projects.



|                            |  |                          |        |      |   |      
|--------------------------- |  | ------------------------ | ------ | ---- | - | -----
|                            |  | Years ended December 31,
|                            |  | 2004                     |        | 2003
|Squalamine program expenses |  | $                        | 10,097 |      | $ | 4,254
|LOMUCIN program expenses   |  |                          | 545    |      |   | 944  
|IL9 program expenses        |  |                          | 241    |      |   | 426  
|Other program expenses      |  |                          | 267    |      |   | 238  
|Indirect expenses           |  |                          | 2,854  |      |   | 2,060
|                            |  |                          |        |      |   |      
|                            |  | $                        | 14,004 |      | $ | 7,922
|                            |  |                          |        |      |   |      



Research and
development expenses have increased in the year ended December 31, 2004, as compared to the same period a year ago, due primarily to increases in third-party contract research ($1.5 million), manufacturing ($1.7 million) and clinical trial costs
($0.7 million) and an increase in costs for research and development supplies ($0.2 million) related to our squalamine program for the treatment of age-related macular degeneration, as well as resulting increases in personnel costs ($2.2 million).
In addition, indirect expenses increased ($0.8 million) as a result of increased overhead, such as utilities, insurance and general facilities costs related to additional personnel and increased research, clinical and manufacturing efforts. These
increases were partially offset by decreases in our LOMUCINTM($0.4 million) and IL9 program ($0.2 million) expenses
due to the conclusion of our Phase II clinical trial of LOMUCIN in patients with cystic fibrosis in 2003 and the transfer of responsibility for development and commercialization efforts on the IL9 program to MedImmune in



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April of 2003, as well as a decrease in consulting costs ($0.4 million) related to our squalamine program for the treatment of age-related macular
degeneration.



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



The level of research and development expenses in future periods will depend principally upon the progress of our research and development programs and
our capital resources. Due to the significant risks and uncertainties inherent in the preclinical and clinical studies associated with each of our research and development programs, the cost to complete such programs, as well as the period in which
net cash inflows from significant programs are expected to commence, are not reasonably estimable. Preclinical and clinical studies may yield varying results that could delay, limit or prevent a programs advancement through the various stages
of product development and significantly impact the costs to be incurred and the time involved in bringing a program to completion. Such delays, limitations or prevention of a programs advancement could harm our financial condition and
operating results and inhibit our ability to raise additional funds to support ongoing operations.



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



General and Administrative Expenses



We recognized general and administrative expenses of $5.0 million and $2.9
million in 2004 and 2003, respectively. General and administrative expenses consist principally of personnel costs, professional fees and public company expenses. General and administrative costs increased in the year ended December 31, 2004, as
compared to the same period a year ago, due principally to increases in personnel as a result of our expanded development efforts ($1.2 million), increased professional fees ($0.8 million), partially due to maintaining compliance with the
Sarbanes-Oxley Act of 2002, and increases in investor relations expenses ($0.2 million).



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Interest Income and Expense



We recognized interest income of $0.3 million and $88 thousand in 2004 and 2003, respectively. We recognized interest
expense of $2,000 and $65,000 in 2004 and 2003, 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 Merrill Lynch Bank
USA (Merrill Lynch). Interest income increased during the year ended December 31, 2004, as compared to the same period a year ago, due to higher average investment balances. Interest expense decreased during the year ended December 31, 2004, as
compared to the prior year, due to the repayment of our indebtedness to Merrill Lynch. (See NOTE 6. Note Payable for additional information.) We recognized a loss on the write-off of fixed assets of $0.1 million for the year ended
December 31, 2004 and a gain on the sale of fixed assets of $0.3 million in the year ended December 31, 2003 as a result of the sale of excess research equipment.



RESULTS OF OPERATIONS2003 vs. 2002



Revenues



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 it 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 $0.3 million, respectively, related to external cost reimbursements.



In February 2002, the Company received a Phase II Small Business Innovative
Research program grant from the NIH in the amount of $0.8 million to support our aminosterol research program. The grant extended over a two-year period, which ended in February 2004 and was subsequently extended through February 2005. The Company
recognized $0.4 million as revenue related to this grant in the year ended December 31, 2003.



Research and Development Expenses



We recognized research and development expenses of $7.9 million and $10.2 million in 2003 and 2002, respectively. The following table illustrates research and development expenses (in thousands) incurred during the
years ended December 31, 2003 and 2002 for our significant groups of research and development projects.



|                            |  |                          |       |      |   |       
|--------------------------- |  | ------------------------ | ----- | ---- | - | ------
|                            |  | Years ended December 31,
|                            |  | 2003                     |       | 2002
|Squalamine program expenses |  | $                        | 4,254 |      | $ | 3,333 
|LOMUCIN program expenses   |  |                          | 944   |      |   | 1,902 
|IL9 program expenses        |  |                          | 426   |      |   | 886   
|Other program expenses      |  |                          | 238   |      |   | 482   
|Indirect expenses           |  |                          | 2,060 |      |   | 3,613 
|                            |  |                          |       |      |   |       
|                            |  | $                        | 7,922 |      | $ | 10,216
|                            |  |                          |       |      |   |       



Research and
development expenses decreased in the year ended December 31, 2003, as compared to the same period the year before, due primarily to 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 a reduction of overall indirect costs ($0.8 million) such as recruiting, supplies and facilities costs as a result of our cost containment efforts and reduced headcount. In addition, costs
associated with our LOMUCIN program, squalamine
program, IL9 program and other programs decreased as a result of the conclusion of our Phase II clinical study of LOMUCIN in patients with cystic fibrosis in 2003 ($1.0 million), a decrease in manufacturing efforts in squalamine program for cancer ($0.9 million), the
transfer of responsibility for development and commercialization efforts on the IL9 program to MedImmune in April of 2003 ($0.5 million) and the decrease in



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research and development efforts in trodulamine ($0.2 million). These reductions were partially offset by increased research and clinical development efforts
and consulting expenses ($1.8 million) related to our squalamine program for the treatment of age-related macular degeneration.



General and Administrative Expenses



We recognized general and administrative expenses of $2.9 million and $3.6 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 the year before, due principally to reduced payroll
and related costs associated with our realignment of operations in 2002 ($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.



Interest Income and Expense



We recognized interest income of $88 thousand and $0.3 million in 2003 and 2002, respectively. We recognized interest expense of $65 thousand 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 Merrill Lynch. 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 Merrill Lynch.



LIQUIDITY AND CAPITAL RESOURCES



Cash, cash
equivalents and short-term investments were $32.2 million at December 31, 2004 as compared to $13.1 million at December 31, 2003. The primary use of cash was to finance our research and development operations.



Since inception, we have funded our operations primarily from the proceeds of
public and private placements of our securities totaling approximately $207.1 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 2002, 2003
and 2004:



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



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



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



| |  |  | $ 19.9 millionJanuary 2004; and
| | - |  | --------------------------------



| |  |  | $ 13.5 millionNovember 2004.
| | - |  | -----------------------------



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 increased by $1.0
million from $2.9 million at December 31, 2003 to $3.9 million at December 31, 2004, due primarily to an increase in accounts payable and accrued expenses resulting from the



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timing and magnitude of our current development contracts. Prior to 1999, we had an agreement with Abbott Laboratories (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 was payable and paid to Abbott on March 1, 2004. As a result of the Companys financing activities during 2004, the remaining liability of $0.6
million is due and payable to Abbott on March 1, 2005 and is included in short-term liabilities as of December 31, 2004.



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, 2004.



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 2004 and 2003, funding of $0.9 million and $0.7 million, respectively, was received from MedImmune. Of the amount received in 2003, $0.4 million
was specifically related to the $2.5 million research and development funding with the remainder comprised of external cost reimbursements. Of the amount received in 2004, $0.5 million was payment for the achievement of a contractual milestone and
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.



In January 2004, we completed the sale of 4,950,500 shares of our common stock for gross proceeds of $20.0 million. In November 2004, we completed the
sale of 4,183,422 shares of our common stock for gross proceeds of $14.4 million. We believe that the proceeds of these offerings, in addition to our current cash, cash equivalents and short-term investments at December 31, 2004, are sufficient to
meet our research and development goals and sustain operations through 2005.



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Contractual Cash Obligations



The table below sets forth our contractual obligations at December 31, 2004 (in thousands):



|                                                        |  |       |       |                             |   |           |  |           |     |               |   |   |  |   |  
|------------------------------------------------------- |  | ----- | ----- | --------------------------- | - | --------- |  | --------- | --- | ------------- | - | - |  | - | -
|                                                        |  |       |       | Cash Payments Due by Period
|Contractual Cash Obligations                            |  | Total |       | Less than 1 year            |   | 1-3 years |  | 4-5 years |     | After 5 years
|Abbott settlement1                                      |  | $     | 563   |                             | $ | 563       |  | $         |    |               | $ |  |  | $ | 
|Operating lease on building2                            |  |       | 1,156 |                             |   | 383       |  |           | 773 |               |   |  |  |   | 
|Operating leases and maintenance contracts on equipment |  |       | 128   |                             |   | 65        |  |           | 63  |               |   |  |  |   | 
|R&D contracts                                           |  |       | 316   |                             |   | 284       |  |           | 32  |               |   |  |  |   | 
|Clinical trial contracts                                |  |       | 221   |                             |   | 221       |  |           |    |               |   |  |  |   | 
|Manufacturing contracts                                 |  |       | 357   |                             |   | 357       |  |           |    |               |   |  |  |   | 
|                                                        |  |       |       |                             |   |           |  |           |     |               |   |   |  |   |  
|Total contractual cash obligations                      |  | $     | 2,741 |                             | $ | 1,873     |  | $         | 868 |               | $ |  |  | $ | 
|                                                        |  |       |       |                             |   |           |  |           |     |               |   |   |  |   |  

---

|1 | 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.
|- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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



As of December 31, 2004, our portfolio investments consisted of $14.2 million in cash and cash equivalents and $17.9 million in U.S. Treasury or U.S. government agency debt instruments having a maturity of less than
one year. Due to the nature of our investment portfolio, management believes that a sudden change in interest rates would not have a material effect on the value of the portfolio. Management estimates that if the average annualized yield of our
investments had decreased by 100 basis points, our interest income for the year ended December 31, 2004 would have decreased by approximately $0.3 million. This estimate assumes that the decrease occurred on the first day of 2004 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, 2004 would have increased
by $0.3 million. This estimate assumes that the increase occurred on the first day of 2004 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 Financial Statements beginning on page F-1.



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



None.



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ITEM 9A. CONTROLS AND PROCEDURES



Evaluation of Disclosure Controls and Procedures



For the year ended December 31, 2004, we carried out an evaluation, under the supervision and with the participation of our management, including our President and Chief Executive Officer and our Executive 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-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the
Exchange Act). Based upon this evaluation, our President and Chief Executive Officer and our Executive Vice President and Chief Financial Officer concluded that, as of December 31, 2004, our disclosure controls and procedures have been
designed and are being operated in a manner that provides reasonable assurance that the information required to be disclosed by the Company in reports filed 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. A control system, no matter how well designed and operated, cannot provide assurance that the objectives of the control system are being met, and no evaluation of
controls can provide absolute assurance that all control issues and instances of fraud, if any, within a company have been detected.



Managements Report on Internal Control over Financial Reporting



The management of Genaera Corporation is responsible for establishing and maintaining adequate internal control over
financial reporting as defined in Rule 13a-15(f) or 15d-15(f) promulgated under the Securities and Exchange Act of 1934, as amended. Genaeras internal control system was designed to provide reasonable assurance to the Companys management
and board of directors regarding the preparation and fair presentation of published financial statements.



All internal control systems, no matter how well designed, have inherent limitations. Therefore, even those systems determined to be effective can only
provide reasonable assurance with respect to financial statement preparation and presentation.



Genaeras management assessed the effectiveness of the Companys internal control over financial reporting as of December 31, 2004. In making this assessment, it used the criteria set forth by the Committee
on Sponsoring Organizations of the Treadway Commission (COSO) in Internal Control-Integrated Framework. Based on our assessment we believe that, as of December 31, 2004, the Companys internal control over financial reporting is effective based
on those criteria.



Genaeras independent registered
public accounting firm has issued an audit report on our assessment of the Companys internal control over financial reporting. Their report appears below.



Changes in Internal Control over Financial Reporting



There have not been any changes in our internal control over financial reporting during the quarter ended December 31, 2004 that have materially affected,
or are reasonably likely to materially affect, our internal control over financial reporting.



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Report of Independent Registered Public Accounting Firm



The Board of Directors and Stockholders

Genaera Corporation:



We have audited managements assessment, included in the accompanying Managements Report on Internal Control over Financial Reporting, that
Genaera Corporation maintained effective internal control over financial reporting as of December 31, 2004, based on the criteria established in Internal ControlIntegrated Framework issued by the Committee of Sponsoring Organizations of the
Treadway Commission (COSO). Genaera Corporations management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting. Our
responsibility is to express an opinion on managements assessment and an opinion on the effectiveness of the Companys internal control over financial reporting based on our audit.



We conducted our audit in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our
audit included obtaining an understanding of internal control over financial reporting, evaluating managements assessment, testing and evaluating the design and operating effectiveness of internal control, and performing such other procedures
as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.



A companys internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial
reporting and the preparation of financial statements for external purposes in accordance with U.S. generally accepted accounting principles. A companys internal control over financial reporting includes those policies and procedures that (1)
pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit
preparation of financial statements in accordance with U.S. generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company;
and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the companys assets that could have a material effect on the financial statements.



Because of its inherent limitations, internal control over financial
reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance
with the policies or procedures may deteriorate.



In our
opinion, managements assessment that Genaera Corporation maintained effective internal control over financial reporting as of December 31, 2004, is fairly stated, in all material respects, based on criteria established in Internal
ControlIntegrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Also, in our opinion, Genaera Corporation maintained, in all material respects, effective internal control over financial
reporting as of December 31, 2004, based on the criteria established in Internal ControlIntegrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO).



We also have audited, in accordance with the standards of the Public Company
Accounting Oversight Board (United States), the balance sheets of Genaera Corporation as of December 31, 2004 and 2003, and the related 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, 2004, and our report dated March 15, 2005 expressed an unqualified opinion on those financial statements.



/s/ KPMG LLP



Philadelphia, Pennsylvania

March 15, 2005



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ITEM 9B. OTHER INFORMATION



None.



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##### Table of Contents

PART III



This Part incorporates certain information from our Proxy Statement for the 2005 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 2005 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 2005 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 Annual Report.



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 2005 Annual Meeting of Stockholders.



ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT



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 2005 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 2005 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 2005 Annual Meeting of Stockholders.



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PART IV



ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES



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



1. Index to Financial Statements



|                                                                     |  |     
|-------------------------------------------------------------------- |  | ----
|                                                                     |  | Page
|Report of Independent Registered Public Accounting Firm              |  | F-2 
|Balance Sheets                                                       |  | F-3 
|Statements of Operations                                             |  | F-4 
|Statements of Changes in Stockholders Equity and Comprehensive Loss |  | F-5 
|Statements of Cash Flows                                             |  | F-6 
|Notes to 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 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 Magainin Pharmaceuticals, Inc. 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)                                                                                       



36



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##### Table of Contents

|            |  |                                                                                                                                                                                                                                    
|----------- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit No. |  |                                                                                                                                                                                                                                    
|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)                                
|            | 
|10.3#       |  | 2004 Stock-Based Incentive Plan (Incorporated by reference to Exhibit 10.0 filed with the Companys Quarterly Report on Form 10-Q for June 30, 2004)                                                                               
|            | 
|10.4#       |  | 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)                                                        
|            | 
|10.5#       |  | 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)                               
|            | 
|10.6#+      |  | 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)                                                               
|            | 
|10.7#       |  | 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)                                                        
|            | 
|10.8#       |  | 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)                                                         
|            | 
|10.9#       |  | 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)                                                           
|            | 
|10.10#      |  | 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)                                                                 
|            | 
|10.11#      |  | Employment Agreement with John A. Skolas (Incorporated by reference to Exhibit 10.35 filed with the Companys Annual Report on Form 10-K for December 31, 2003)                                                                    
|            | 
|10.12#      |  | Employment Agreement with John L. Armstrong, Jr. (Incorporated by reference to Exhibit 10.36 filed with the Companys Annual Report on Form 10-K for December 31, 2003)                                                            
|            | 
|10.13#      |  | Employment Agreement with Roy C. Levitt, M.D. (Incorporated by reference to Exhibit 10.2 filed with the Companys Quarterly Report on Form 10-Q for June 30, 2004)                                                                 
|            | 
|10.14#      |  | 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)                                                       
|            | 
|10.15#      |  | Change in Control Agreement with Roy C. Levitt, M.D. (Incorporated by reference to Exhibit 10.1 filed with the Companys Quarterly Report on Form 10-Q for September 30,
2004)                                                     
|            | 
|10.16#      |  | Change in Control Agreement with John L. Armstrong, Jr. (Incorporated by reference to Exhibit 10.2 filed with the Companys Quarterly Report on Form 10-Q for September 30,
2004)                                                  
|            | 
|10.17#      |  | Change in Control Agreement with John A. Skolas (Incorporated by reference to Exhibit 10.3 filed with the Companys Quarterly Report on Form 10-Q for September 30, 2004)                                                          
|            | 
|10.18       |  | 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)    
|            | 
|10.19       |  | 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)



37



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##### Table of Contents

|            |  |                                                                                                                                                                                                                                                                                                              
|----------- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit No. |  |                                                                                                                                                                                                                                                                                                              
|10.20       |  | 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)                                                                                                                                  
|            | 
|10.21       |  | 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)                                                                                                         
|            | 
|10.22+      |  | Assignment Agreement between Magainin Pharmaceuticals, Inc., 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)                                                                                  
|            | 
|10.23+      |  | 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)                                                                
|            | 
|10.24       |  | 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)
|            | 
|10.25       |  | Registration Rights Agreement between Magainin Pharmaceuticals, Inc. 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)                                                                           
|            | 
|10.26+      |  | Amended License Agreement between Magainin Pharmaceuticals, Inc. 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)                                                      
|            | 
|10.27+      |  | Second Research Agreement between Magainin Pharmaceuticals, Inc. 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)                                                      
|            | 
|10.28+      |  | 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)                                            
|            | 
|10.29       |  | 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)                                                                                              
|            | 
|10.30+      |  | 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)                                                                               
|            | 
|10.31       |  | 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)                                                             
|            | 
|10.32       |  | 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)                                                                                
|            | 
|10.33       |  | 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)                                                                         



38



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##### Table of Contents

|            |  |                                                                                                                                                                                                                                                                                                                                     
|----------- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit No. |  |                                                                                                                                                                                                                                                                                                                                     
|10.34       |  | 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)                                                
|            | 
|10.35+      |  | 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)                                                                                                 
|            | 
|10.36       |  | 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)                                                    
|            | 
|10.37       |  | 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)
|            | 
|10.38       |  | 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)                                                                              
|            | 
|10.39       |  | 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)                                                          
|            | 
|10.40       |  | 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)                                                                                                     
|            | 
|10.41       |  | 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)                                                                                                       
|            | 
|10.42*#     |  | Employment Agreement with Michael J. Gast, M.D.                                                                                                                                                                                                                                                                                     
|            | 
|12.1*       |  | Schedule of Ratio of Fixed Charges to Earnings                                                                                                                                                                                                                                                                                      
|            | 
|23.1*       |  | Consent of KPMG LLP, Independent Registered Public Accounting Firm                                                                                                                                                                                                                                                                  
|            | 
|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                                                                                                      
|            | 
|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.
|- | ------------------------------------------------------------------------------------------------------------------------------------------------------------



39



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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.



|                     |  |                     |  |                                                                    
|-------------------- |  | ------------------- |  | -------------------------------------------------------------------
|                     |  | GENAERA CORPORATION
|                     |  |                    
|Date: March 15, 2005 |  | By:                 |  | /s/    ROY C.
LEVITT                                               
|                     |  |                     |  | Roy 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 15, 2005
|                                                   |  |                                                                                                
|/s/    ZOLA P.
HOROVITZZola P. Horovitz,
Ph.D.     |  | Director                                                                                        |  | March 15, 2005
|                                                   |  |                                                                                                
|/s/    OSAGIE O.
IMASOGIEOsagie O.
Imasogie        |  | Director                                                                                        |  | March 15, 2005
|                                                   |  |                                                                                                
|/s/    ROY C. LEVITTRoy C. Levitt, M.D.            |  | President, Chief Executive Officerand Director(Principal Executive Officer)                     |  | March 15, 2005
|                                                   |  |                                                                                                
|/s/    ROBERT F. SHAPIRORobert F. Shapiro          |  | Director                                                                                        |  | March 15, 2005
|                                                   |  |                                                                                                
|/s/    JOHN A. SKOLASJohn A. Skolas                |  | Executive Vice President andChief Financial Officer(Principal Financial and Accounting Officer) |  | March 15, 2005
|                                                   |  |                                                                                                
|/s/    JAMES B.
WYNGAARDENJames B. Wyngaarden,
M.D |  | Director                                                                                        |  | March 15, 2005



40



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##### Table of Contents

GENAERA CORPORATION



INDEX TO FINANCIAL STATEMENTS



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



F-1



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##### Table of Contents

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM



The Board of Directors and Stockholders

Genaera Corporation:



We have
audited the accompanying balance sheets of Genaera Corporation as of December 31, 2004 and 2003, and the related 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, 2004. These financial statements are the responsibility of the Companys management. Our responsibility is to express an opinion on these financial statements based on our audits.



We conducted our audits in accordance with the standards of the Public
Company Accounting Oversight Board (United States). 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 financial statements referred to above present fairly, in all material respects, the financial position of Genaera Corporation as of December 31, 2004 and 2003, and the results of its operations
and its cash flows for each of the years in the three-year period ended December 31, 2004, in conformity with U.S. generally accepted accounting principles.



We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the effectiveness of Genaera
Corporations internal control over financial reporting as of December 31, 2004, based on criteria established in Internal ControlIntegrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO),
and our report dated March 15, 2005 expressed an unqualified opinion on managements assessment of, and the effective operation of, internal control over financial reporting.





/s/    KPMG LLP



Philadelphia, Pennsylvania

March 15, 2005



F-2



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##### Table of Contents

GENAERA CORPORATION



BALANCE
SHEETS

(In thousands, except per share amounts)



|                                                                                                                                                    |  |              |          |   |      |   |          |  
|--------------------------------------------------------------------------------------------------------------------------------------------------- |  | ------------ | -------- | - | ---- | - | -------- | -
|                                                                                                                                                    |  | December 31, |         
|                                                                                                                                                    |  | 2004         |          |   | 2003 |  
|ASSETS                                                                                                                                              |  |              |          |   |      |   |          |  
|Current assets:                                                                                                                                     |  |              |          |   |      |   |          |  
|Cash and cash equivalents                                                                                                                           |  | $            | 14,217   |   |      | $ | 6,625    |  
|Short-term investments (NOTES 3 and 6)                                                                                                              |  |              | 17,934   |   |      |   | 6,510    |  
|Prepaid expenses and other current assets                                                                                                           |  |              | 602      |   |      |   | 264      |  
|                                                                                                                                                    |  |              |          |   |      |   |          |  
|Total current assets                                                                                                                                |  |              | 32,753   |   |      |   | 13,399   |  
|                                                                                                                                                    |  |             
|Fixed assets, net (NOTE 4)                                                                                                                          |  |              | 736      |   |      |   | 1,095    |  
|Other assets                                                                                                                                        |  |              | 59       |   |      |   | 59       |  
|                                                                                                                                                    |  |              |          |   |      |   |          |  
|Total assets                                                                                                                                        |  | $            | 33,548   |   |      | $ | 14,553   |  
|                                                                                                                                                    |  |              |          |   |      |   |          |  
|LIABILITIES AND STOCKHOLDERS EQUITY                                                                                                                |  |              |          |   |      |   |          |  
|Current liabilities:                                                                                                                                |  |              |          |   |      |   |          |  
|Accounts payable and accrued expenses (NOTE 5)                                                                                                      |  | $            | 3,323    |   |      | $ | 1,917    |  
|Accrued development expenseshort-term (NOTE 15)                                                                                                    |  |              | 563      |   |      |   | 966      |  
|                                                                                                                                                    |  |              |          |   |      |   |          |  
|Total current liabilities                                                                                                                           |  |              | 3,886    |   |      |   | 2,883    |  
|Accrued development expenselong-term (NOTE 15)                                                                                                     |  |              |         |   |      |   | 563      |  
|Other liabilities (NOTE 12)                                                                                                                         |  |              | 580      |   |      |   | 485      |  
|                                                                                                                                                    |  |             
|Commitments, contingencies and other matters (NOTE 15)                                                                                              |  |              |          |   |      |   |          |  
|                                                                                                                                                    |  |             
|Stockholders equity:                                                                                                                               |  |              |          |   |      |   |          |  
|Preferred stock$.001 par value; 9,211 shares authorized; none issued and outstanding at December 31, 2004 and 2003 (NOTE
7)                        |  |              |         |   |      |   |         |  
|Common stock$.002 par value; 75,000 shares authorized; 57,072 and 47,024 shares issued and outstanding at December 31, 2004 and 2003,
respectively |  |              | 114      |   |      |   | 94       |  
|Additional paid-in capital                                                                                                                          |  |              | 242,145  |   |      |   | 205,826  |  
|Accumulated other comprehensive lossunrealized loss on investments                                                                                 |  |              | (6       | ) |      |   |         |  
|Accumulated deficit                                                                                                                                 |  |              | (213,171 | ) |      |   | (195,298 | )
|                                                                                                                                                    |  |              |          |   |      |   |          |  
|Total stockholders equity                                                                                                                          |  |              | 29,082   |   |      |   | 10,622   |  
|                                                                                                                                                    |  |              |          |   |      |   |          |  
|Total liabilities and stockholders equity                                                                                                          |  | $            | 33,548   |   |      | $ | 14,553   |  
|                                                                                                                                                    |  |              |          |   |      |   |          |  



See accompanying notes
to financial statements.



F-3



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##### Table of Contents

GENAERA CORPORATION



STATEMENTS
OF OPERATIONS

(In thousands, except per share amounts)



|                                                                                                       |  |                         |         |   |      |   |         |      |  |   |         |  
|------------------------------------------------------------------------------------------------------ |  | ----------------------- | ------- | - | ---- | - | ------- | ---- |  | - | ------- | -
|                                                                                                       |  | Year Ended December 31, |        
|                                                                                                       |  | 2004                    |         |   | 2003 |   |         | 2002 | 
|Collaborative research agreement and grant revenues                                                    |  | $                       | 873     |   |      | $ | 1,113   |      |  | $ | 1,517   |  
|                                                                                                       |  |                         |         |   |      |   |         |      |  |   |         |  
|Costs and expenses:                                                                                    |  |                         |         |   |      |   |         |      |  |   |         |  
|Research and development                                                                               |  |                         | 14,004  |   |      |   | 7,922   |      |  |   | 10,216  |  
|General and administrative                                                                             |  |                         | 4,951   |   |      |   | 2,864   |      |  |   | 3,560   |  
|                                                                                                       |  |                         |         |   |      |   |         |      |  |   |         |  
|                                                                                                       |  |                         | 18,955  |   |      |   | 10,786  |      |  |   | 13,776  |  
|                                                                                                       |  |                         |         |   |      |   |         |      |  |   |         |  
|Loss from operations                                                                                   |  |                         | (18,082 | ) |      |   | (9,673  | )    |  |   | (12,259 | )
|Interest income                                                                                        |  |                         | 329     |   |      |   | 88      |      |  |   | 260     |  
|Interest expense                                                                                       |  |                         | (2      | ) |      |   | (65     | )    |  |   | (157    | )
|Gain (loss) on sale of fixed assets                                                                    |  |                         | (118    | ) |      |   | 257     |      |  |   |        |  
|                                                                                                       |  |                         |         |   |      |   |         |      |  |   |         |  
|Net loss                                                                                               |  |                         | (17,873 | ) |      |   | (9,393  | )    |  |   | (12,156 | )
|Dividends on preferred stock, including $3,050 attributable to a beneficial conversion feature in 2003 |  |                         |        |   |      |   | (3,085  | )    |  |   | (73     | )
|                                                                                                       |  |                         |         |   |      |   |         |      |  |   |         |  
|Net loss applicable to common stockholders                                                             |  | $                       | (17,873 | ) |      | $ | (12,478 | )    |  | $ | (12,229 | )
|                                                                                                       |  |                         |         |   |      |   |         |      |  |   |         |  
|Net loss applicable to common stockholders per sharebasic and diluted                                 |  | $                       | (0.34   | ) |      | $ | (0.32   | )    |  | $ | (0.35   | )
|                                                                                                       |  |                         |         |   |      |   |         |      |  |   |         |  
|Weighted average shares outstandingbasic and diluted                                                  |  |                         | 52,839  |   |      |   | 38,634  |      |  |   | 34,894  |  
|                                                                                                       |  |                         |         |   |      |   |         |      |  |   |         |  





See accompanying notes to financial statements.



F-4



---

##### Table of Contents

GENAERA CORPORATION



STATEMENTS
OF CHANGES IN STOCKHOLDERS

EQUITY AND COMPREHENSIVE LOSS

(In thousands)



|                                                                                                              |  |                 |  |                          |     |  |                                               |         |   |                    |   |     |                            |  |   |          |   |  |   |         |  
|------------------------------------------------------------------------------------------------------------- |  | --------------- |  | ------------------------ | --- |  | --------------------------------------------- | ------- | - | ------------------ | - | --- | -------------------------- |  | - | -------- | - |  | - | ------- | -
|                                                                                                              |  | Common Stock    |  | AdditionalPaid-inCapital |     |  | AccumulatedOther Compre- hensiveIncome (Loss) |         |   | AccumulatedDeficit |   |     | TotalStock- holdersEquity | 
|                                                                                                              |  | Numberof Shares |  | Amount                   |     |  |                                               |        
|Balance at January 1, 2002                                                                                    |  | 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 convertible preferred stock                                                          |  | 2,500           |  |                          | 5   |  |                                               | (5      | ) |                    |   |    |                            |  |   |         |   |  |   |        |  
|Conversion of Series C-2 convertible 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 redeemable convertible preferred stock                                                 |  | 541             |  |                          | 1   |  |                                               | 1,150   |   |                    |   |    |                            |  |   |         |   |  |   | 1,151   |  
|Dividends on Series A redeemable convertible preferred stock                                                  |  |                |  |                          |    |  |                                               |        |   |                    |   |    |                            |  |   | (35      | ) |  |   | (35     | )
|Amortization of beneficial conversion feature                                                                 |  |                |  |                          |    |  |                                               | 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  |  
|Exercise of stock options and compensation expense under option grants and stock awards                       |  | 714             |  |                          | 1   |  |                                               | 2,634   |   |                    |   |    |                            |  |   |         |   |  |   | 2,635   |  
|Common stock issued pursuant to private placement                                                             |  | 9,134           |  |                          | 18  |  |                                               | 33,412  |   |                    |   |    |                            |  |   |         |   |  |   | 33,430  |  
|Exercise of common stock warrants issued pursuant to May 2003 private placement                               |  | 200             |  |                          | 1   |  |                                               | 273     |   |                    |   |    |                            |  |   |         |   |  |   | 274     |  
|Comprehensive loss:                                                                                           |  |                 |  |                          |     |  |                                               |         |   |                    |   |     |                            |  |   |          |   |  |   |         |  
|Net loss                                                                                                      |  |                |  |                          |    |  |                                               |        |   |                    |   |    |                            |  |   | (17,873  | ) |  |   | (17,873 | )
|Carrying value adjustment                                                                                     |  |                |  |                          |    |  |                                               |        |   |                    |   | (6  | )                          |  |   |         |   |  |   | (6      | )
|                                                                                                              |  |                 |  |                          |     |  |                                               |         |   |                    |   |     |                            |  |   |          |   |  |   |         |  
|Total comprehensive loss                                                                                      |  |                 |  |                          |     |  |                                               |         |   |                    |   |     |                            |  |   |          |   |  |   | (17,879 | )
|                                                                                                              |  |                 |  |                          |     |  |                                               |         |   |                    |   |     |                            |  |   |          |   |  |   |         |  
|Balance at December 31, 2004                                                                                  |  | 57,072          |  | $                        | 114 |  | $                                             | 242,145 |   |                    | $ | (6  | )                          |  | $ | (213,171 | ) |  | $ | 29,082  |  
|                                                                                                              |  |                 |  |                          |     |  |                                               |         |   |                    |   |     |                            |  |   |          |   |  |   |         |  



See accompanying notes
to financial statements.



F-5



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##### Table of Contents

GENAERA CORPORATION



STATEMENTS
OF CASH FLOWS

(In thousands)



|                                                                                                       |  |                         |         |   |      |   |         |      |  |   |         |  
|------------------------------------------------------------------------------------------------------ |  | ----------------------- | ------- | - | ---- | - | ------- | ---- |  | - | ------- | -
|                                                                                                       |  | Year Ended December 31, |        
|                                                                                                       |  | 2004                    |         |   | 2003 |   |         | 2002 | 
|Cash Flows From Operating Activities:                                                                  |  |                         |         |   |      |   |         |      |  |   |         |  
|Net loss                                                                                               |  | $                       | (17,873 | ) |      | $ | (9,393  | )    |  | $ | (12,156 | )
|Adjustments to reconcile net loss to net cash used in operating activities:                            |  |                         |         |   |      |   |         |      |  |   |         |  
|Depreciation and amortization                                                                          |  |                         | 344     |   |      |   | 489     |      |  |   | 510     |  
|Amortization of investment discounts/premiums                                                          |  |                         | (149    | ) |      |   | (67     | )    |  |   | (232    | )
|Compensation expense on option grants and equity awards                                                |  |                         | 841     |   |      |   | 211     |      |  |   | 204     |  
|(Gain) loss on sale of fixed assets                                                                    |  |                         | 118     |   |      |   | (257    | )    |  |   |        |  
|Changes in operating assets and liabilities:                                                           |  |                         |         |   |      |   |         |      |  |   |         |  
|Prepaid expenses and other assets                                                                      |  |                         | (338    | ) |      |   | (75     | )    |  |   | 32      |  
|Accounts payable and accrued expenses                                                                  |  |                         | 1,406   |   |      |   | 616     |      |  |   | (1,219  | )
|Accrued development expenses                                                                           |  |                         | (966    | ) |      |   |        |      |  |   | (480    | )
|Other liabilities                                                                                      |  |                         | 95      |   |      |   | 253     |      |  |   | 100     |  
|                                                                                                       |  |                         |         |   |      |   |         |      |  |   |         |  
|Net cash used in operating activities                                                                  |  |                         | (16,522 | ) |      |   | (8,223  | )    |  |   | (13,241 | )
|                                                                                                       |  |                         |         |   |      |   |         |      |  |   |         |  
|Cash Flows From Investing Activities:                                                                  |  |                         |         |   |      |   |         |      |  |   |         |  
|Purchase of investments                                                                                |  |                         | (37,781 | ) |      |   | (19,762 | )    |  |   | (26,967 | )
|Proceeds from maturities of investments                                                                |  |                         | 26,500  |   |      |   | 21,350  |      |  |   | 33,250  |  
|Proceeds from sales of fixed assets                                                                    |  |                         |        |   |      |   | 257     |      |  |   |        |  
|Capital expenditures                                                                                   |  |                         | (103    | ) |      |   | (43     | )    |  |   | (595    | )
|                                                                                                       |  |                         |         |   |      |   |         |      |  |   |         |  
|Net cash (used in) provided by investing activities                                                    |  |                         | (11,384 | ) |      |   | 1,802   |      |  |   | 5,688   |  
|                                                                                                       |  |                         |         |   |      |   |         |      |  |   |         |  
|Cash Flows From Financing Activities:                                                                  |  |                         |         |   |      |   |         |      |  |   |         |  
|Payments on notes payable                                                                              |  |                         |        |   |      |   | (2,500  | )    |  |   |        |  
|Net proceeds from issuance of Series C-1 and C-2 convertible preferred stock and common stock warrants |  |                         |        |   |      |   | 4,922   |      |  |   |        |  
|Net proceeds from issuance of common stock                                                             |  |                         | 33,430  |   |      |   | 7,893   |      |  |   | 6,943   |  
|Proceeds from exercise of options and warrants                                                         |  |                         | 2,068   |   |      |   | 1,363   |      |  |   | 5       |  
|                                                                                                       |  |                         |         |   |      |   |         |      |  |   |         |  
|Net cash provided by financing activities                                                              |  |                         | 35,498  |   |      |   | 11,678  |      |  |   | 6,948   |  
|                                                                                                       |  |                         |         |   |      |   |         |      |  |   |         |  
|Net increase (decrease) in cash and cash equivalents                                                   |  |                         | 7,592   |   |      |   | 5,257   |      |  |   | (605    | )
|Cash and cash equivalents at beginning of year                                                         |  |                         | 6,625   |   |      |   | 1,368   |      |  |   | 1,973   |  
|                                                                                                       |  |                         |         |   |      |   |         |      |  |   |         |  
|Cash and cash equivalents at end of year                                                               |  | $                       | 14,217  |   |      | $ | 6,625   |      |  | $ | 1,368   |  
|                                                                                                       |  |                         |         |   |      |   |         |      |  |   |         |  
|Supplemental Cash Flow Information:                                                                    |  |                         |         |   |      |   |         |      |  |   |         |  
|Cash paid during the period for interest                                                               |  | $                       | 2       |   |      | $ | 76      |      |  | $ | 160     |  
|                                                                                                       |  |                         |         |   |      |   |         |      |  |   |         |  
|Conversion of Series A redeemable convertible preferred stock into common stock                        |  | $                       |        |   |      | $ | 1,117   |      |  | $ |        |  
|                                                                                                       |  |                         |         |   |      |   |         |      |  |   |         |  



See accompanying notes
to financial statements.



F-6



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##### Table of Contents

GENAERA CORPORATION



NOTES TO
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.



In
September 2000, the Company formed a subsidiary, M Merger Sub, Inc. The subsidiary transacted no business and had no assets, but was required to file state and federal tax returns. In March 2001, the Companys subsidiary was merged into Genaera
Corporation. In 2002 and 2003, the Company was required to file income tax returns on behalf of the subsidiary in Pennsylvania. The subsidiarys obligation to file income tax returns was terminated at the end of 2003 by filing withdrawal
documents with the Pennsylvania Department of Revenue and the Companys financial statements no longer refer to a consolidated subsidiary.



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 U.S. generally accepted accounting principles 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 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 using 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



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##### Table of Contents

GENAERA CORPORATION



NOTES TO FINANCIAL STATEMENTS(Continued)



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 subject to amortization, such as fixed assets, are reviewed for impairment whenever events or changes in
circumstances indicate that the carrying amount of the asset may not be recoverable. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of the asset to the estimated undiscounted future cash flows
expected to be generated by the asset. If the carrying amount of the asset exceeds its estimated future cash flows, an impairment charge is recognized in 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 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 and liabilities of a disposal group classified
as held-for-sale would be presented separately in the appropriate asset and liability sections of the balance sheet.



Revenue RecognitionIn accordance with Staff Accounting Bulletin (SAB) No. 101, Revenue Recognition in Financial Statements
(SAB 101) 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. Prior to the issuance of SAB 101 in December 1999, the Company recognized up-front fees in the period in which they were received.



In December 2003, the staff of the United States Securities and Exchange
Commission (SEC) issued SAB No. 104, Revenue Recognition(SAB 104). SAB 104 updated the guidance in 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. The
adoption of EITF 00-21 did not impact the Companys historical financial position or results of operations, but could affect the timing pattern of revenue recognition for future collaborative research and/or licensing agreements.



In January 2002, the EITF issued EITF 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 statements of operations for all periods presented.



Research and DevelopmentResearch and development (R&D) expenses include related salaries, facility costs, 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 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.



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##### Table of Contents

GENAERA CORPORATION



NOTES TO FINANCIAL STATEMENTS(Continued)



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 Financial Accounting Standards Board
(FASB) Interpretation No. 44, Accounting for Certain Transactions involving Stock Compensation, issued in March 2000. Under this method, compensation cost is recorded on the date of grant only if the current market price of the
underlying stock exceeded the exercise price. 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 Issue No. 96-18, Accounting for Equity Instruments that are Issued to Other
Than Employees for Acquiring, or in Conjunction with Selling, Goods or Services, and other related interpretations. Under this method, the equity-based instrument is valued at the fair value of either the consideration received or the equity
instrument issued on the date of grant. The resulting compensation cost is recognized and charged to operations over the service period, which is usually the vesting period. 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).



|                                                                                                                            |  |      |         |   |      |   |         |      |  |   |         |  
|--------------------------------------------------------------------------------------------------------------------------- |  | ---- | ------- | - | ---- | - | ------- | ---- |  | - | ------- | -
|                                                                                                                            |  | 2004 |         |   | 2003 |   |         | 2002 | 
|Net loss applicable to common stockholders, as reported                                                                     |  | $    | (17,873 | ) |      | $ | (12,478 | )    |  | $ | (12,229 | )
|Add: Stock-based employee compensation expense included in reported net loss applicable to common stockholders              |  |      | 729     |   |      |   | 176     |      |  |   | 95      |  
|Deduct: Total stock-based employee compensation expense determined under fair-value-based method for all stock-based awards |  |      | (1,561  | ) |      |   | (1,692  | )    |  |   | (2,386  | )
|                                                                                                                            |  |      |         |   |      |   |         |      |  |   |         |  
|Pro forma net loss applicable to common stockholders                                                                        |  | $    | (18,705 | ) |      | $ | (13,994 | )    |  | $ | (14,520 | )
|                                                                                                                            |  |      |         |   |      |   |         |      |  |   |         |  
|Net loss applicable to common stockholders per sharebasic and diluted:                                                     |  |      |         |   |      |   |         |      |  |   |         |  
|As reported                                                                                                                 |  | $    | (0.34   | ) |      | $ | (0.32   | )    |  | $ | (0.35   | )
|                                                                                                                            |  |      |         |   |      |   |         |      |  |   |         |  
|Pro forma                                                                                                                   |  | $    | (0.35   | ) |      | $ | (0.36   | )    |  | $ | (0.42   | )
|                                                                                                                            |  |      |         |   |      |   |         |      |  |   |         |  



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:



|                                                               |  |           |  |           |  |          
|-------------------------------------------------------------- |  | --------- |  | --------- |  | ---------
|                                                               |  | 2004      |  | 2003      |  | 2002     
|Range of risk free interest rates                              |  | 3.0%-4.0% |  | 3.6%-3.9% |  | 3.6%-4.9%
|Dividend yield                                                 |  | 0%        |  | 0%        |  | 0%       
|Volatility factor                                              |  | 121%      |  | 121%      |  | 110%     
|Weighted average expected life of options (in years)           |  | 6.0       |  | 6.0       |  | 7.5      
|Weighted average fair value of options granted during the year |  | $3.21     |  | $2.84     |  | $0.99    



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



F-9



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##### Table of Contents

GENAERA CORPORATION



NOTES TO FINANCIAL STATEMENTS(Continued)



differences between the financial reporting and tax bases of assets and liabilities, and net operating losses and credit carryforwards. Deferred tax assets
and liabilities are measured using the enacted tax rates and laws that will be in effect when the temporary 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 statement of operations. 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, 2004, options and warrants to purchase 5,376,641 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.



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 U.S. generally accepted accounting principles, 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On December 16, 2004, the FASB published SFAS No. 123 (Revised 2004), Share-Based Payment (SFAS 123R). SFAS 123R requires that compensation cost related to share-based payment transactions be recognized in
the financial statements. Share-based payment transactions within the scope of SFAS 123R include stock options, restricted stock plans, performance-based awards, stock appreciation rights and employee share purchase plans. The provisions of SFAS
123R are effective as of the first interim period that begins after June 15, 2005. Accordingly, the Company will implement the revised standard in the third quarter of fiscal year 2005. The implications of this revised standard will materially
impact the Companys results of operations in the third quarter of fiscal year 2005 and thereafter. If the Company had applied the provisions of SFAS 123R to the financial statements for the year ended December 31, 2004, net loss attributed to
common stockholders would have increased by approximately $2,041,000.



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



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, 2004, the Company had $13,939,000 and $3,995,000 invested in U.S. Treasury securities and U.S. government agency securities, respectively. The Company had unrealized losses of $6,000 at December
31, 2004 and unrealized gains of $1,000 at December 31, 2002. The Company realized $1,000 of gains on its investments during the year ended December 31, 2003.



F-10



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##### Table of Contents

GENAERA CORPORATION



NOTES TO FINANCIAL STATEMENTS(Continued)



NOTE 4. Fixed Assets



Fixed assets are summarized as follows (in thousands):



|                                               |  |                  |        |   |                  |   |        |  
|---------------------------------------------- |  | ---------------- | ------ | - | ---------------- | - | ------ | -
|                                               |  | December 31,2004 |        |   | December 31,2003 |  
|Laboratory and office equipment                |  | $                | 744    |   |                  | $ | 4,363  |  
|Leasehold improvements                         |  |                  | 1,137  |   |                  |   | 1,873  |  
|                                               |  |                  |        |   |                  |   |        |  
|                                               |  |                  | 1,881  |   |                  |   | 6,236  |  
|Less accumulated depreciation and amortization |  |                  | (1,145 | ) |                  |   | (5,141 | )
|                                               |  |                  |        |   |                  |   |        |  
|                                               |  | $                | 736    |   |                  | $ | 1,095  |  
|                                               |  |                  |        |   |                  |   |        |  



Depreciation expense
for the years ended December 31, 2004, 2003 and 2002 was $344,000, $489,000 and $510,000, respectively. During the year ended December 31, 2004, the Company removed approximately $4,100,000 of fully depreciated fixed assets from its records.



NOTE 5. Accounts Payable and Accrued Expenses



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



|                                |  |                  |       |                  |   |      
|------------------------------- |  | ---------------- | ----- | ---------------- | - | -----
|                                |  | December 31,2004 |       | December 31,2003
|Accounts payable                |  | $                | 1,233 |                  | $ | 579  
|Employee compensation           |  |                  | 693   |                  |   | 179  
|Manufacturing development costs |  |                  | 357   |                  |   | 60   
|Professional fees               |  |                  | 298   |                  |   | 195  
|Preclinical costs               |  |                  | 284   |                  |   | 93   
|Clinical and regulatory costs   |  |                  | 221   |                  |   | 746  
|Other                           |  |                  | 237   |                  |   | 65   
|                                |  |                  |       |                  |   |      
|                                |  | $                | 3,323 |                  | $ | 1,917
|                                |  |                  |       |                  |   |      



NOTE 6. Note Payable



In the second quarter of 2002, the Company refinanced its
$2,500,000 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 and 2002 was $61,000 and $150,000, 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



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##### Table of Contents

GENAERA CORPORATION



NOTES TO FINANCIAL STATEMENTS(Continued)



determine these voting rights. As of December 31, 2004, the Companys board of directors has designated 80,000 shares of preferred stock as Series A
redeemable convertible preferred stock (the Series A Preferred Stock), 10,000 shares of preferred stock as Series B convertible preferred stock (the Series B Preferred Stock), 2,500 shares of preferred stock as Series C-1
convertible preferred stock (the Series C-1 Preferred Stock), and 2,500 shares of preferred stock as Series C-2 convertible preferred stock (the Series C-2 Preferred Stock) (the Series C-1 Preferred Stock and the Series
C-2 Preferred Stock are collectively referred to as the Series C Preferred Stock). During 2003, each of the holders of Series A Preferred Stock, Series B Preferred Stock and Series C Preferred Stock elected to convert all of their
outstanding and issued convertible preferred stock into shares of the Companys common stock. Pursuant to the terms of the certificate of designation for each series of preferred stock, all the previously issued shares of Series A Preferred
Stock, Series B Preferred Stock and Series C Preferred Stock have reverted to the status of authorized shares of preferred stock undesignated as to series or other terms. As a result of these transactions, no shares of convertible preferred stock
were outstanding at December 31, 2004 or 2003 and all of the 9,211,031 shares of preferred stock authorized under the Companys Certificate of Incorporation are undesignated and unissued.



In 2003, the Company sold shares of Series C Preferred Stock and warrants.
The preferred stock had a conversion price that was below the quoted market price of the Companys common stock at the time of sale. The Company calculated a beneficial conversion feature of $3,050,000, which represents the excess of the fair
value of the preferred stock issued over the proceeds allocable to the preferred stock. 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 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 was first known to be convertible. All of the preferred stock became convertible before the end of the
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.



NOTE 8. Common Stock



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.



On January 21, 2004, the Company sold 4,950,500 shares of its common stock to four institutional investors in a private placement at a purchase price of
$4.04 per share. Net proceeds to the Company from the offering totaled approximately $19,930,000 after offering costs of approximately $70,000. The share price was calculated based on a 10% discount to the five-day moving average of the closing
price of the Companys common stock on the Nasdaq SmallCap Market on January 20, 2004. In addition, an aggregate of 990,100 warrants to purchase 990,100 shares of the Companys common stock were issued to the institutional investors (See
NOTE 9. Common Stock Warrants).



On November 8,
2004, the Company completed the sale of 4,183,422 shares of its common stock, to unaffiliated institutional investors in a registered direct offering, at a purchase price of $3.45 per share for aggregate proceeds of approximately $13,500,000 after
offering expenses ($66,000) and placement agency fees ($866,000). The shares were offered through a prospectus supplement pursuant to the Companys effective shelf registration statement. The share price represents a 13% discount to the closing
price on the Nasdaq SmallCap Market on November 1, 2004.



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##### Table of Contents

GENAERA CORPORATION



NOTES TO FINANCIAL STATEMENTS(Continued)



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 $3.33 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 is vested. 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 the vesting provisions. Compensation expense related to this warrant for the year
ended December 31, 2002 was $72,000, and was determined using a Black-Scholes valuation model. All 50,000 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 five 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. These warrants expire on May 23, 2008 and contain certain provisions under which the holder may elect to receive, without the payment by the holder of any additional consideration, a number of shares of
the Companys common stock equal to the value of the warrant, also known as net exercise provisions. Of this total, warrants to purchase 1,500,000 shares were exercisable immediately. The remaining warrants to purchase 500,000 shares were
generally exercisable after 18 months from issuance, or beginning on November 23, 2004, or prior to November 23, 2004 if the holder exercised the warrants on a net exercise basis. In August 2003, Ziff Asset Management, L.P. exercised its 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 $822,000. In October 2003, Biotechnology Value Fund LP and
associated entities and Ziff Asset Management, L.P. exercised their warrants to purchase 1,200,000 shares of the Companys common stock under the net exercise provisions of these warrants resulting in the issuance of 892,361 shares of common
stock. In December 2004, Ziff Asset Management, L.P. exercised their remaining warrants to purchase 200,000 shares of the Companys common stock at an exercise price of $1.37 per share, pursuant to these warrants. Proceeds to the Company from
the exercise of this warrant were $274,000. As a result of these transactions, no warrants under this grant were outstanding as of December 31, 2004.



In connection with its January 21, 2004 private placement, the Company granted warrants to purchase 990,100 shares of its common stock. The warrants have
an exercise price of $5.38 per share and expire on January 23, 2009. The exercise price and the number of shares that may be purchased upon exercise of the warrants may be adjusted from time to time as a result of stock dividend, split or
subdivision of shares, as well as a combination of shares or merger or consolidation.



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GENAERA CORPORATION



NOTES TO FINANCIAL STATEMENTS(Continued)



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. In May 2004, the stockholders approved the 2004 Stock-Based Incentive Compensation Plan (the 2004 Plan), which provides for the granting of options
and stock awards of up to 4,500,000 shares of common stock.



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 ten 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, the 1998 Plan and the 2004 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, 2004, 2003 and 2002, and changes during the years ended on those dates, is presented below (in thousands, except per share data):



|                                 |  |        |   |      |                                |      |        |       |   |                                |   |        |  |       |                                |  |   |     
|-------------------------------- |  | ------ | - | ---- | ------------------------------ | ---- | ------ | ----- | - | ------------------------------ | - | ------ |  | ----- | ------------------------------ |  | - | ----
|                                 |  | 2004   |   | 2003 |                                | 2002
|                                 |  | Shares |   |      | Weighted AverageExercise Price |      | Shares |       |   | Weighted AverageExercise Price |   | Shares |  |       | Weighted AverageExercise Price
|Outstanding at beginning of year |  | 4,038  |   |      | $                              | 3.88 |        | 4,214 |   |                                | $ | 3.77   |  | 3,745 |                                |  | $ | 4.62
|Granted                          |  | 1,380  |   |      | $                              | 3.66 |        | 591   |   |                                | $ | 3.66   |  | 1,306 |                                |  | $ | 1.12
|Exercised                        |  | (662   | ) |      | $                              | 2.71 |        | (261  | ) |                                | $ | 2.07   |  | (3    | )                              |  | $ | 1.88
|Forfeited                        |  | (586   | ) |      | $                              | 3.85 |        | (506  | ) |                                | $ | 3.65   |  | (834  | )                              |  | $ | 3.42
|                                 |  |        |   |      |                                |      |        |       |   |                                |   |        |  |       |                                |  |   |     
|Outstanding at end of year       |  | 4,170  |   |      | $                              | 4.00 |        | 4,038 |   |                                | $ | 3.88   |  | 4,214 |                                |  | $ | 3.77
|                                 |  |        |   |      |                                |      |        |       |   |                                |   |        |  |       |                                |  |   |     
|Exercisable at end of year       |  | 1,984  |   |      | $                              | 4.86 |        | 2,510 |   |                                | $ | 4.74   |  | 2,422 |                                |  | $ | 5.19
|                                 |  |        |   |      |                                |      |        |       |   |                                |   |        |  |       |                                |  |   |     



The following table
summarizes information about stock options outstanding and exercisable as of December 31, 2004 (in thousands, except per share data and years):



|                         |  |                     |  |                                           |  |                                |       |                   |       |                                |   |      
|------------------------ |  | ------------------- |  | ----------------------------------------- |  | ------------------------------ | ----- | ----------------- | ----- | ------------------------------ | - | -----
|                         |  | Options Outstanding |  | Options Exercisable                      
|Range of Exercise Prices |  | SharesOutstanding   |  | Weighted AverageRemainingContractual Life |  | Weighted AverageExercise Price |       | SharesExercisable |       | Weighted AverageExercise Price
|$0.40  $ 1.56           |  | 717                 |  | 7.1 Years                                 |  | $                              | 0.90  |                   | 370   |                                | $ | 0.92 
|$1.97  $ 3.35           |  | 928                 |  | 7.1 Years                                 |  | $                              | 2.99  |                   | 466   |                                | $ | 3.00 
|$3.47  $ 5.00           |  | 1,762               |  | 8.5 Years                                 |  | $                              | 3.90  |                   | 460   |                                | $ | 4.11 
|$5.10  $ 5.75           |  | 170                 |  | 6.6 Years                                 |  | $                              | 5.37  |                   | 95    |                                | $ | 5.58 
|$7.13  $8.25            |  | 183                 |  | 2.0 Years                                 |  | $                              | 7.35  |                   | 183   |                                | $ | 7.35 
|$9.13                    |  | 150                 |  | 0.9 Years                                 |  | $                              | 9.13  |                   | 150   |                                | $ | 9.13 
|$10.00  $11.63          |  | 260                 |  | 1.6 Years                                 |  | $                              | 10.68 |                   | 260   |                                | $ | 10.68
|                         |  |                     |  |                                           |  |                                |       |                   |       |                                |   |      
|$0.40  $11.63           |  | 4,170               |  | 6.9 Years                                 |  | $                              | 4.00  |                   | 1,984 |                                | $ | 4.86 
|                         |  |                     |  |                                           |  |                                |       |                   |       |                                |   |      



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GENAERA CORPORATION



NOTES TO FINANCIAL STATEMENTS(Continued)



The 1998 Plan provides for the issuance of common stock awards, up to a maximum of 375,000 shares.
The 2004 Plan provides for the issuance of common stock awards with no restriction as to the percentage of shares issued as stock awards in relation to the maximum shares allowable under the plan. 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, 2004, 574,125 and 26,875 shares have been awarded
under the 1998 Plan and 2004 Plan, respectively. The cost of these awards will be recognized as expense over the vesting periods, which range from two to four years. The following table provides information as of December 31, 2004 regarding the
number of restricted stock awards granted, issued, and outstanding.



|              |  |               |  |                 |  |              |  |                   
|------------- |  | ------------- |  | --------------- |  | ------------ |  | ------------------
|Year of Grant |  | SharesGranted |  | SharesCancelled |  | SharesIssued |  | Shares Outstanding
|1998          |  | 146,000       |  | 25,000          |  | 121,000      |  |                  
|1999          |  | 32,500        |  | 2,500           |  | 30,000       |  |                  
|2000          |  | 27,500        |  | 3,750           |  | 23,750       |  |                  
|2003          |  | 95,000        |  |                |  | 23,750       |  | 71,250            
|2004          |  | 300,000       |  | 50,000          |  |             |  | 250,000           
|              |  |               |  |                 |  |              |  |                   
|Total         |  | 601,000       |  | 81,250          |  | 198,500      |  | 321,250           
|              |  |               |  |                 |  |              |  |                   



Compensation expense
related to these stock awards for the years ended December 31, 2004, 2003 and 2002 was $503,000, $48,000 and $144,000, 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 2004, 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 and 2002 was $35,000 and $37,000, 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 $32,000 and $128,000 for the years ended December 31, 2004 and 2003, 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, 2004, the Company has $154,895,000 of net operating loss (NOL) carryforwards for federal income tax purposes (expiring in
years 2005 through 2024). In addition, the Company has NOL carryforwards for state income tax purposes of $122,253,000 (expiring in years 2005 through 2024). 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 $6,886,000 of research and development tax credits carryforwards available to offset future federal income tax liability (expiring in years 2005
through 2024). 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, 2004, approximately $3,300,000 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
stockholders equity.



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GENAERA CORPORATION



NOTES TO FINANCIAL STATEMENTS(Continued)



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 and NOL and
credit carryforwards. 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 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, 2004 and 2003. The net change in the valuation allowance for deferred tax assets at December 31, 2004 and 2003 was an increase of $8,211,000
and $3,922,000, 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, 2004
and 2003 consist of the following (in thousands):



|                                     |  |      |         |   |      |   |         |  
|------------------------------------ |  | ---- | ------- | - | ---- | - | ------- | -
|                                     |  | 2004 |         |   | 2003 |  
|Deferred tax assets:                 |  |      |         |   |      |   |         |  
|Net operating losses                 |  | $    | 62,152  |   |      | $ | 52,868  |  
|Research credits                     |  |      | 6,886   |   |      |   | 6,684   |  
|Capitalized research and development |  |      | 23,849  |   |      |   | 25,904  |  
|Accrued expenses, reserves and other |  |      | 388     |   |      |   | 436     |  
|Depreciation and amortization        |  |      | 700     |   |      |   |        |  
|                                     |  |      |         |   |      |   |         |  
|Total gross deferred tax assets      |  |      | 93,975  |   |      |   | 85,892  |  
|                                     |  |      |         |   |      |   |         |  
|Deferred tax liabilities:            |  |      |         |   |      |   |         |  
|Depreciation and amortization        |  |      |        |   |      |   | (129    | )
|                                     |  |      |         |   |      |   |         |  
|Total gross deferred tax liabilities |  |      |        |   |      |   | (129    | )
|                                     |  |      | 93,975  |   |      |   | 85,763  |  
|Valuation allowance                  |  |      | (93,975 | ) |      |   | (85,763 | )
|                                     |  |      |         |   |      |   |         |  
|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 $10,000,000 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,



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GENAERA CORPORATION



NOTES TO FINANCIAL STATEMENTS(Continued)



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. (Genentech) 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 $5,000,000 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, Inc. (MedImmune) to develop and commercialize therapies related to the Companys IL9 program. Pursuant to the agreement, MedImmune provided
funding of $2,500,000 to the Company for research and development activities at the Company over a two-year period from April 2001 to April 2003 (the R&D Funding). The R&D Funding was paid in eight quarterly installments and
recognized by the Company as revenue on a straight-line basis over the two-year period. By the end of that two-year period, licensed technology had been transferred to MedImmune and MedImmune assumed responsibility for development and
commercialization efforts on the IL9 program. In addition to the R&D Funding, MedImmune also agreed to reimburse the Company for certain external costs incurred by the Company in connection with the IL9 research plan, which will be recognized by
the Company as revenues when the related expenses are incurred. In August 2004, the Company received a milestone payment as a result of the initiation of Phase I clinical trials. For the year ended December 31, 2004, the Company recognized $848,000
as revenue from the milestone payment ($500,000) and external cost reimbursements ($348,000). For the year ended December 31, 2003, the Company recognized $701,000 as revenue related to the R&D Funding ($370,000) and external cost reimbursements
($331,000). For the year ended December 31, 2002, the Company recognized $1,517,000 as revenue related to the R&D Funding ($1,250,000) and external cost reimbursements ($267,000). No revenue related to milestone payments was recognized during
the years ended December 31, 2003 and 2002. The Company could also receive up to $54,500,000 based on successful completion of future milestones. The Company is also entitled to royalties on sales of commercial products resulting from the
collaboration. Receipt of future milestones and royalties is dependent upon favorable results in the future from clinical trials being conducted by MedImmune, MedImmune continuing to conduct the research and development activities required to
commercialize the product and the commercial success of the product if and when it is approved for marketing by the United States Food and Drug Administration (FDA).



In September 2001, the Company received a contingent award of up to $1,700,000 from Cystic Fibrosis Foundation Therapeutics
(CFFT), an affiliate of the Cystic Fibrosis Foundation, to support early clinical evaluation of LOMUCIN involving patients with cystic fibrosis. 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, $513,000 and $296,000 had been received as of December 31, 2004 and December 31, 2003, respectively, and was recorded as a long-term liability. The Company did not recognize this amount as revenue as it would
become refundable to the CFFT upon marketing approval by the FDA or if the Company elects not to enter Phase III clinical trials or



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GENAERA CORPORATION



NOTES TO FINANCIAL STATEMENTS(Continued)



not to commercialize the product within two years of the satisfaction of development milestones, assuming the achievement of statistically significant
results. CFFT is also due a royalty on net sales of any resultant product of up to 1% based upon the amount of funding ultimately provided by CFFT.



In February 2002, the Company received a Phase II Small Business Innovative Research (SBIR) program grant from the National Institutes of
Health (NIH) in the amount of $800,000 to support its aminosterol research program. The grant extended over a two-year period, which ended in February 2004. In February 2004, the Company notified the NIH of a no-cost extension of the
original budget period by twelve months. As a result of the notification, the grant was extended to February 2005. The Company recognized no revenue related to this grant in the year ended December 31, 2004. The Company recognized $412,000 as
revenue related to this grant for the year ended December 31, 2003.



In April 2004, the Company received a Phase I SBIR program grant from the National Institute of Diabetes and Digestive and Kidney Diseases of the NIH in the amount of $100,000 to support its trodusquemine (formerly trodulamine) program. The
grant extends over a one-year period ending in March 2005. The Company recognized no revenue related to this grant during the year ended December 31, 2004.



In September 2004, the Company received a Phase I SBIR program grant from the National Eye Institute of the NIH in the amount of $100,000 to support its
aminosterols for age-related macular degeneration program. The grant extends over a one-year period ending in August 2005. The Company recognized no revenue related to this grant during the year ended December 31, 2004.



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, 2004, 2003 or 2002.



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, short-term investments 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, |  |  
|2005                    |  | $ | 383  
|2006                    |  |   | 397  
|2007                    |  |   | 376  
|                        |  |   |      
|                        |  | $ | 1,156
|                        |  |   |      



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GENAERA CORPORATION



NOTES TO FINANCIAL STATEMENTS(Continued)



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, the lease anniversary date. Rent expense, which includes the cost of
common area maintenance and other building operating expenses paid to the landlord, was $441,000, $460,000 and $425,000 for the years ended December 31, 2004, 2003 and 2002, 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, |  |  
|2005                    |  | $ | 65 
|2006                    |  |   | 39 
|2007                    |  |   | 22 
|2008                    |  |   | 2  
|                        |  |   |    
|                        |  | $ | 128
|                        |  |   |    



Equipment rental
expense was $128,000, $181,000 and $185,000 for the years ended December 31, 2004, 2003 and 2002, respectively.



Employment Agreements



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



During
the year ended December 31, 2004, two executives ceased employment with the Company. As a result, the Company recorded $654,000 of continuing compensation and stock compensation expense for the year ended December 31, 2004.



Manufacturing



In January 1999 and prior, the Company entered into several agreements with Abbott Laboratories (Abbott) providing for the
purchase of approximately $10,000,000 of bulk drug substance to be used in the manufacturing process for LOCILEX Cream. As the FDA did not approve LOCILEX Cream in July 1999, the Company renegotiated this agreement with Abbott in September 1999,
paying Abbott $4,200,000 at that time and receiving partial delivery of material. An additional $3,400,000 was due to Abbott and payable if the Company received in excess of $10,000,000 of additional funds (as defined in the agreement) in any year
beginning in 2000, in which case the Company must pay 15% of such excess over $10,000,000 to Abbott. The Company recorded this conditional obligation as a liability in 1999 at its then estimated present value. As a result of the Companys
financing activities during 2000 and 2001 and other cash inflows, $1,392,000 and $480,000 of this liability was payable and paid to Abbott on March 1, 2001 and 2002, respectively. No portion of the liability was payable to Abbott on March 1, 2003,
as the Company did not receive in excess of $10,000,000 of cash inflows during 2002. As a result of the Companys financing activities during 2003 and other cash inflows, $966,000 of the remaining liability was payable and paid to Abbott on
March 1, 2004. The remaining amount of $563,000 is included in short-term liabilities as of December 31, 2004, as it is due and payable to Abbott on March 1, 2005 as a result of the Companys financing activities during the year ended December
31, 2004.



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GENAERA CORPORATION



NOTES TO FINANCIAL STATEMENTS(Continued)



Liquidity



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



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



In January 2004, the Company completed the sale of 4,950,500
shares of its common stock for gross proceeds of $20,000,000. In November 2004, the Company completed the sale of 4,183,422 shares of its common stock for gross proceeds of $14,433,000. The Company believes that the proceeds of these offerings in
addition to its current cash and investments at December 31, 2004 are sufficient to meet its research and development goals and sustain operations through 2005.



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. On February 2, 2005, the parties entered into a settlement agreement. The settlement is on terms
that are not material to the Company, and does not constitute an admission of wrongdoing or liability by the Company. On February 28, 2005, the Court entered the parties stipulated order dismissing the lawsuit without prejudice.



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 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%,



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##### Table of Contents

GENAERA CORPORATION



NOTES TO FINANCIAL STATEMENTS(Continued)



or 11 employees. All of the employees affected by the workforce reduction were offered severance and outplacement support. The Company recorded a 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. Quarterly Results (Unaudited)



The following tables contain selected unaudited
information for each quarter of the fiscal years ended December 31, 2004 and 2003 (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.



|                                                      |  |                              |        |   |               |   |        |              |  |   |               |   |  |   |        |  
|----------------------------------------------------- |  | ---------------------------- | ------ | - | ------------- | - | ------ | ------------ |  | - | ------------- | - |  | - | ------ | -
|                                                      |  | Year Ended December 31, 2004 |       
|                                                      |  | FirstQuarter                 |        |   | SecondQuarter |   |        | ThirdQuarter |  |   | FourthQuarter |  
|Collaborative research agreement and grant revenues   |  | $                            | 136    |   |               | $ | 36     |              |  | $ | 672           |   |  | $ | 29     |  
|                                                      |  |                              |        |   |               |   |        |              |  |   |               |   |  |   |        |  
|Net loss                                              |  | $                            | (4,363 | ) |               | $ | (3,957 | )            |  | $ | (4,690        | ) |  | $ | (4,863 | )
|                                                      |  |                              |        |   |               |   |        |              |  |   |               |   |  |   |        |  
|Net loss per sharebasic and diluted                  |  | $                            | (.09   | ) |               | $ | (.08   | )            |  | $ | (.09          | ) |  | $ | (.08   | )
|                                                      |  |                              |        |   |               |   |        |              |  |   |               |   |  |   |        |  
|Weighted average shares outstandingbasic and diluted |  |                              | 51,027 |   |               |   | 52,396 |              |  |   | 52,607        |   |  |   | 55,303 |  
|                                                      |  |                              |        |   |               |   |        |              |  |   |               |   |  |   |        |  



|                                                                          |  |                              |        |   |               |   |        |              |  |   |               |   |  |   |        |  
|------------------------------------------------------------------------- |  | ---------------------------- | ------ | - | ------------- | - | ------ | ------------ |  | - | ------------- | - |  | - | ------ | -
|                                                                          |  | Year Ended December 31, 2003 |       
|                                                                          |  | FirstQuarter                 |        |   | SecondQuarter |   |        | ThirdQuarter |  |   | FourthQuarter |  
|Collaborative research agreement and grant revenues                       |  | $                            | 487    |   |               | $ | 389    |              |  | $ | 124           |   |  | $ | 113    |  
|                                                                          |  |                              |        |   |               |   |        |              |  |   |               |   |  |   |        |  
|Net loss(1)                                                               |  | $                            | (1,584 | ) |               | $ | (1,402 | )            |  | $ | (2,071        | ) |  | $ | (4,337 | )
|                                                                          |  |                              |        |   |               |   |        |              |  |   |               |   |  |   |        |  
|Net loss applicable to common stockholders                                |  | $                            | (1,602 | ) |               | $ | (1,523 | )            |  | $ | (5,016        | ) |  | $ | (4,337 | )
|                                                                          |  |                              |        |   |               |   |        |              |  |   |               |   |  |   |        |  
|Net loss applicable to common stockholders per sharebasic and diluted(1) |  | $                            | (.04   | ) |               | $ | (.04   | )            |  | $ | (.13          | ) |  | $ | (.10   | )
|                                                                          |  |                              |        |   |               |   |        |              |  |   |               |   |  |   |        |  
|Weighted average shares outstandingbasic and diluted                     |  |                              | 35,666 |   |               |   | 35,691 |              |  |   | 37,453        |   |  |   | 45,629 |  
|                                                                          |  |                              |        |   |               |   |        |              |  |   |               |   |  |   |        |  

---

|(1) | Amounts do not add to the year end amount due to rounding.
|--- | ----------------------------------------------------------



F-21