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SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-K

(Mark One)

For the fiscal year ended December 31, 2002

OR

For the transition period from                                  to                                 

Commission File Number 0-19651

GENAERA CORPORATION

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

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

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

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

Common Stock, $.002 par value per share

(Title of Class)

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

Indicate by check mark whether the registrant is an accelerated filer (as defined by Rule 12b-2 of the Act). 

YES ¨ NO x

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

The aggregate market value of common stock held by non-affiliates of the registrant was approximately $41,446,000 as of June 28, 2002, 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 28, 2002. For purposes of this calculation only, the registrant has defined affiliates as all directors and executive officers as of June 28, 2002 and any stockholder whose ownership exceeds 10% of the common stock outstanding as of June 28, 2002. The number of shares of the registrant’s common stock outstanding as of June 28, 2002 was 35,626,241.

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the Definitive Proxy Statement for the Registrant’s 2003 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, 2002

INDEX

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PART I

ITEM 1.    Business

Forward-Looking Statements

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

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

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

Overview

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

Research & Development Programs

Natural Products Development Programs

Anti-Angiogenesis Program

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

Squalamine is a naturally occurring water-soluble small molecule and our lead anti-angiogenic development candidate. Squalamine was originally discovered by our founding scientist in the tissues of the dogfish shark and is one of the most abundant of a class of naturally occurring, pharmacologically active small molecules known as “aminosterols.” The shark was initially examined because of its apparent resistance to infection and cancer. The chemical structure of squalamine uniquely combines a steroid and a polyamine, two classes of systemic agents that generally are well tolerated in humans. Squalamine has exhibited reproducible anti-angiogenic properties in

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a number of in vitro and in vivo assays, including animal cancer and eye disease models, across multiple independent laboratories. Currently, our development efforts for this unique anti-angiogenic molecule are focused on serious diseases, including age-related macular degeneration and cancer.

Age-Related Macular Degeneration

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

Preclinical studies in angiogenic diseases of the eye have demonstrated that systematic squalamine administration in rodents and mammals, including primates, leads to inhibition of the development of ocular neovascularization (the growth of new vessels) and partial regression of abnormal blood vessels. Based on these results, we announced in August 2002 the initiation of a phase 1-2 clinical trial designed to test squalamine for the treatment of wet AMD. The study is an open label, dose escalation study, designed to evaluate 40 patients with AMD for safety and efficacy of squalamine treatment. Clinical testing is currently underway in patients with both classic forms of wet AMD, where verteporfin is currently the approved therapy, and in so-called “occult” forms of the disease where current therapy is less effective. In order to determine the effectiveness of squalamine in naïve, AMD patients, and to provide supporting data for proposing clinical trials comparing squalamine to current verteporfin, initial clinical studies will be performed outside the United States, in a setting where verteporfin is not commonly used. Patients enrolled will have careful angiographic and clinical documentation of their AMD at baseline. Enrollment will include AMD patients with each angiographic subtype of choroidal neovascularization, including classic, occult, and mixed angiographic abnormalities. Each patient will be treated with squalamine, once weekly for 4 weeks. Squalamine will be administered intravenously at doses of 25 or 50 mg/m². The study will be performed with leading ophthalmologists in Mexico, in consultation with several leading U.S. academic ophthalmologists. We currently anticipate completing this study by mid-year 2003.

Solid Cancers

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

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

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Squalamine is currently being evaluated in multiple Phase 2 clinical studies for the treatment of solid tumors. Specifically, we have ongoing clinical studies in non-small cell lung cancer and prostate cancer at multiple clinical sites. These cancer studies will evaluate intravenously administered squalamine in combination with leading chemotherapeutics or accepted interventions in each indication.

In May 2002, we released positive results on the first Phase 2 clinical trial in lung cancer, a multi-center open-label design that examined the preliminary efficacy and safety of squalamine, combined with first line standard chemotherapy of carboplatin and paclitaxel, in patients with Stage IIIB or Stage IV advanced disease. Interim results were presented previously at the May 2000 and May 2001 meetings of the American Society of Clinical Oncology. Overall, for all patients enrolled in the study, at all doses of squalamine, 27% of patients experienced an objective response (defined as a 50% or greater reduction in tumor size). Objective responses were observed in 29% of patients receiving the squalamine dose of 300 mg/m²/day for one or more cycles of therapy. In comparison, an appropriate historical benchmark objective response rate for this group of patients treated with carboplatin and paclitaxel alone is 17%, as demonstrated in the large Eastern Cooperative Oncology Group (ECOG) first published in May 2000 with a similar design and patient population. The median survival time for all patients enrolled in our study was 10.0 months (95% confidence interval, 6.6 to 12.3 months). The median survival time for patients receiving the squalamine dose of 300 mg/m²/day was 8.5 months (95% confidence interval, 6.6 to 17.8 months). In comparison, the historical benchmark objective median survival time for this group of patients treated with carboplatin and paclitaxel alone in the ECOG study was 8.1 months (95% confidence interval, 7.0 to 9.5 months). The median time to progression was 4.4 months (95% confidence interval, 3.1 to 6.9 months) for all patients in our study, 5.5 months for patients in the 300 mg/m²/day group (95% confidence interval, 3.2 to 9.4 months), and in comparison for the ECOG study was 3.1 months (95% confidence interval, 2.8 to 3.9 months). In November 2001, we commenced a Phase 2b trial in non-small cell lung cancer investigating weekly dosing of squalamine in combination with the leading chemotherapeutics. Enrollment in this study was ended in January 2003 at 45 patients to conserve capital for other ongoing programs. Further funding for the development of squalamine as a first line therapy for non-small cell lung cancer will depend on the number and quality of treatment responses from our Phase 2b clinical trial that are expected in mid-year 2003 and survival data that are expected in mid-year 2004.

In May 2002, we also released positive results on our Phase 2 clinical trial in recurrent advanced ovarian cancer, a multi-center, open label design, evaluating squalamine in combination with carboplatin. In this study, 35% of evaluable patients (9 of 26) had an objective response to the study drug regimen of squalamine and carboplatin. The best response to our therapy has included five complete responses and four partial responses. Four of the responses were in patients enrolled with measurable disease, and five were in patients enrolled with rising and elevated levels of Ca-125 tumor marker, consistent with early ovarian cancer recurrence. For this study, squalamine was dosed at 200 mg/m²/day, daily for five days, immediately following carboplatin infusion, every 3 weeks. During 2001, the U.S. Food and Drug Administration (FDA) granted squalamine Orphan Drug designation for the treatment of ovarian cancer. Orphan Drug designations are granted to applicants when the prevalence of the disease occurs in less than 200,000 patients in the United States and entitles applicants to certain exclusive marketing rights, tax credits and waivers on FDA user fees. In August 2002, we decided not to pursue additional studies of squalamine in advanced ovarian cancer in conjunction with the realignment of our operations and our intent to focus on later stage programs and reduce operating expenses.

In November 2002, we announced that a grant of $1.1 million had been awarded by the United States Department of Defense, Army Medical Research and Materiel Command, to the University of Chicago School of Medicine, for the first clinical trial of squalamine in the treatment of prostate cancer. The grant, entitled “Neoadjuvant Anti-Angiogenesis Therapy for Prostate Cancer”, will support a Phase 2 clinical trial. The trial is designed as an open-label randomized study to evaluate the activity and tolerability of squalamine in conjunction with anti-androgen therapy in patients undergoing radical prostatectomy. Up to 132 patients will receive weekly dosing of squalamine (100 mg/m²) for either 6 or 12 weeks.

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Fibrodysplasia Ossificans Progressiva

We also are conducting a small Phase 1 clinical study in fibrodysplasia ossificans progressiva (FOP), which is a rare genetic disorder of the musculoskeletal system in which there is a poorly-understood inflammatory reaction leading to progressive formation of bone in the muscles and other soft tissues, resulting in progressive immobility and disability. Similar to cancer, this growth in the swollen tissues is nourished by a network of newly formed primitive blood vessels resulting from active angiogenesis in the lesions. There are no preclinical animal models of FOP. However, we believe that because squalamine has exhibited the ability to block the angiogenic process, it has the potential to inhibit the abnormal growth of bone in muscles and soft tissues of patients with FOP. Due to difficulties with patient enrollment given the small size of the patient population, no patients have been enrolled to date in this study.

Genomics-Based Development Programs

Respiratory Program

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

IL9 Antibody Therapeutics

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

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

Mucoregulators

Our second genomics-based program has focused on the fundamental biology of mucus overproduction in a large number of chronic respiratory patients worldwide. It is generally accepted that there is extensive unmet medical need for a novel therapy that can prevent abnormal mucus production. Chronic sinusitis is one of the most common reasons for physician visits in the United States, with approximately 35 million cases per year. It is believed that many of the symptoms of chronic sinusitis result from excess mucus production. Among other respiratory diseases, there are up to an estimated 50 million patients with conditions exacerbated by excess mucus production to whom mucoregulator therapy may be of benefit. Mucus overproduction and small airway plugging is one of the hallmarks of asthma and is a cause of death from asthma. Excess mucus production also is associated with chronic bronchitis, a common form of chronic obstructive pulmonary disease (COPD). Cystic fibrosis is the most common fatal genetic disease in the United States, affecting approximately 30,000 children and young adults. Cystic fibrosis causes the body to produce abnormally thick, sticky mucus, due to the faulty transport of sodium and chloride (salt) within cells lining organs such as the lungs, sinuses, and pancreas, to their outer surfaces. The thick cystic fibrosis mucus also obstructs the pancreas, preventing enzymes from reaching the

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intestines to help break down and digest food. This orphan disease state is another unmet need where a mucoregulator therapy may be beneficial.

Efforts to identify specific gene targets, validate these targets for therapeutic development, and build an intellectual property position on these assets remain an important focus for our second genomics-based program. Our efforts led to the identification of small molecules, believed to be drug development candidates, to inhibit the overproduction of mucin. We believe small molecule therapeutics that decrease abnormal mucin production, so-called “mucoregulators,” have the potential to yield novel therapeutics for mucus overproduction in a number of chronic diseases. We are also exploring biologics-based therapeutics, including antibodies, as mucoregulators.

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

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

The first clinical trial for LOMUCIN^™ in asthma, entitled “A Phase 4 Open-label, Randomized Gastrointestinal Tolerability Study of Talniflumate compared to Ibuprofen in Patients with Stable Chronic Persistent Asthma”, was initiated in Mexico City during August 2001. The open-label, single-center, randomized study evaluated 63 patients with chronic asthma, to assess the gastrointestinal and respiratory tolerance of LOMUCIN^™ oral tablets in patients with chronic asthma, as well as measure the preliminary effects on symptoms and pulmonary functions. The trial treated 42 patients with LOMUCIN^™ and 21 with ibuprofen. Results of this study were announced in October 2002. As the primary outcome of the trial, LOMUCIN^™ was well tolerated in asthma patients, with a trend of improved gastrointestinal tolerance compared to ibuprofen, and no serious adverse events. There were no significant effects on asthma symptoms compared to ibuprofen. A positive efficacy trend was observed among patients with moderate asthma treated with LOMUCIN^™, indicated by increased residual volume at baseline (indicative of gas trapping in the lung). In these patients (half of the patients enrolled in the study) LOMUCIN^™ significantly decreased residual volume by 28%, compared to 13% with ibuprofen. This efficacy trend may be due to LOMUCIN^™ mucoregulator activity leading to decreased mucus production and the opening of small airways, allowing more air to be exhaled from the lung.

In October 2002, we announced that we had received regulatory approval from the Irish Medicines Board to begin a Phase 2 clinical trial for LOMUCIN^™, its oral mucoregulator treatment, in patients with cystic fibrosis.

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The double blind, placebo controlled, randomized study will evaluate 60 patients with cystic fibrosis. The study will assess the preliminary safety and efficacy of LOMUCIN^™ oral tablets by evaluating the effects of LOMUCIN^™ on respiratory symptoms and pulmonary function. Clinical development of LOMUCIN^™ for cystic fibrosis is supported by program-specific funding through an initial Therapeutics Development Grant of up to $1.7 million from Cystic Fibrosis Foundation Therapeutics (CFFT), the nonprofit drug development affiliate of the Cystic Fibrosis Foundation (CFF). Our arrangement with CFF is described below under “Commercial Arrangements—Cystic Fibrosis Foundation.” We anticipate reporting results from this trial in mid-year 2003. Genaera currently expects to focus its future clinical development efforts for LOMUCIN^™ on the treatment of cystic fibrosis.

Other Development Programs

Obesity Therapeutic Program

Trodulamine, formerly known as produlestan, is another natural aminosterol product candidate. Our scientists have demonstrated the ability to reduce the weight of genetically altered mice, generally very obese mice about 10 times their normal size, to that of a normal healthy mouse. Body weights of healthy animals, including animals with diet-induced obesity, also have been reduced through the administration of trodulamine. Our researchers have shown preclinical efficacy with trodulamine, and demonstrated that animal food intake can be regulated in a reversible manner, leading to changes in body weight. Preclinical data on trodulamine 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 trodulamine, we are targeting the approximately 10 to 12 million Americans who are classified medically as significantly obese. While the trodulamine molecule is very different in function, it has a similar chemical structure to squalamine, and thus would enable us to make more efficient use of internal and external resources already utilized for squalamine in its development. Preclinical results with trodulamine 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 Investigational New Drug application can be filed with the FDA. Due to the limitations of our current resources, we do not intend to actively pursue the development of this product candidate at this time but we continue to seek new opportunities that will enable us to capitalize on our past development efforts in this program.

Other Aminosterol Programs

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

Infectious Disease Program

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

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

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

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 a 3-year option agreement for certain of our antimicrobial peptide intellectual property. The agreement provides reimbursement to us for patent-related expenses. We no longer conduct significant research and development activities in these areas as a result of a reprioritization of our corporate goals. Any of these programs could become more significant over the next 12 months; however, there can be no assurance that any of these or our other programs will generate viable product opportunities.

Research and Development Costs

We have incurred costs of $10.7 million, $11.1 million and $10.1 million for research and development in the years ended December 31, 2002, 2001 and 2000, respectively.

Commercial Arrangements

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

MedImmune

In April 2001, we entered into a research collaboration and licensing agreement with MedImmune, Inc. to develop and commercialize therapies related to our IL9 program. The companies also will collaborate on the creation of specific assays and respiratory disease models for use in assessing product candidates developed by MedImmune. MedImmune will be responsible for development, manufacturing, clinical testing, and marketing of any resulting product. Upon execution of the agreement, MedImmune purchased 10,000 shares of our Series B preferred stock in exchange for $10 million. MedImmune is expected to further fund at least $2.5 million, payable in eight quarterly installments, plus external cost reimbursements, for research and development activities at Genaera from April 2001 through April 2003. In addition to the research and development funding, MedImmune also will reimburse us for certain external costs we incur in connection with the IL9 research plan. Under the agreement, we could receive up to $55.0 million if future milestones are successfully achieved, plus royalties on any product resulting from this agreement. As result of our lack of control over the development plan and the timing of the milestones, we do not expect to complete a substantial portion of those milestones within the next five years. Each party has the right to terminate the agreement upon notice to the other party.

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Cystic Fibrosis Foundation

In September 2001, we received a contingent award of up to $1.7 million from an affiliate of the Cystic Fibrosis Foundation under their Therapeutics Development Program to support early clinical evaluation of LOMUCIN^™ involving patients with cystic fibrosis. This award has been granted and shall be paid to us from time to time upon the achievement of certain development milestones. Grant amounts received are refundable to the CFF upon marketing approval by the FDA or upon our election not to enter Phase 3 clinical trials or to commercialize the product within two years of milestone completion, assuming efficacy is demonstrated. The CFF is also due a royalty on net sales of any resultant product up to 1% based upon the amount of funding ultimately provided by the CFF through this award.

Laboratorios Bago

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

GlaxoSmithKline

In February 1997, we entered into a development, supply and distribution agreement in North America with GlaxoSmithKline for LOCILEX^™ Cream. GlaxoSmithKline paid us $10 million under this agreement, which we received in 1997. At that time, we had hoped to commercialize LOCILEX^™ Cream in the near-term. However, as a result of the FDA’s decision in July 1999 not to approve LOCILEX^™ Cream, near-term commercialization of LOCILEX^™ Cream will not occur, and we will generate no revenues from LOCILEX^™ Cream in the near future.

We have terminated our manufacturing agreements required to further develop this product candidate. The GlaxoSmithKline agreement also gives GlaxoSmithKline rights to terminate the arrangement, and, under certain conditions, the right to negotiate for rights to another Genaera product development candidate. GlaxoSmithKline remains our exclusive sales, marketing and distribution partner for the North American territory for LOCILEX^™ Cream.

Contract Manufacturing

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

Government Regulation

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

Regulation of Pharmaceutical Products in the United States

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

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

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

Clinical trials of drugs normally are done in three phases, although the phases may overlap. Phase 1 trials are concerned primarily with the safety and preliminary effectiveness of the drug, involve a small group typically ranging from 15 – 40 subjects, and may take from six months to over one year to complete. Phase 2 trials normally involve 30 – 200 patients and are designed primarily to demonstrate effectiveness in treating or diagnosing the disease or condition for which the drug is intended, although short-term side effects and risks in people whose health is impaired may also be examined. Phase 3 trials are expanded clinical trials with larger numbers of patients which are intended to evaluate the overall benefit-risk relationship of the drug and to gather additional information for proper dosage and labeling of the drug. Phase 3 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 2 and 3, if it concludes that the study protocols are deficient in design to meet their stated objectives.

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

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

Orphan Drug Designation

During 2001, the FDA granted squalamine orphan drug designation for the treatment of ovarian cancer. We may request orphan drug designation for several indications for our other product candidates under development. Orphan drug designation may be granted to those products developed to treat diseases or conditions that affect fewer than 200,000 persons in the United States or that affect more than 200,000 persons in the United States and

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

Regulation of Pharmaceutical Products Outside of the United States

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

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 76 patent applications and issued patents in the United States of which we own or co-own 60 and we license on an exclusive basis 16. We own, co-own or have licensed on an exclusive basis a total of 150 patent applications and issued patents in countries other than the United States.

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

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

We have rights to several patents and patent applications under certain license agreements pursuant to which we expect to owe royalties on sales of products that incorporate issued valid patent claims. In particular, we have licensed from the Ludwig Institute of Cancer Research specific technologies related to our IL9 program, the earliest of which expires in 2009, and have licensed from the Children’s Hospital of Philadelphia the composition of matter patent for the squalamine compound, which expires in 2010. These patents are subject to extensions by their owners depending upon the future research and development program timelines. Additionally, certain of these agreements also provide that if we elect not to pursue the commercial development of any licensed technology, or do not adhere to an acceptable schedule of commercialization, then our exclusive rights to such technology may terminate. We also fund research at certain institutions, and these relationships may provide us with technology that is owned, licensed or for which we have an option to license.

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

We have trademark protection for the product candidate names LOMUCIN^TM and LOCILEX^TM and are currently seeking U.S. registration of these trademarks.

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 being targeted by us, including cancer, AMD, and respiratory diseases. A number of major pharmaceutical companies have significant franchises in these disease areas, and can be expected to invest heavily to protect their interests. With respect to cancer, anti-angiogenic agents are under development at a number of biopharmaceutical companies, including EntreMed, Inc., Genentech, Inc., and Imclone Systems, Inc., as well as multiple large pharmaceutical companies. For AMD, anti-angiogenic agents are under development at a number of biopharmaceutical companies, including Alcon, Inc., Bausch & Lomb, Inc., Eyetech Pharmaceuticals, Genentech, Inc., Miravant Medical Technologies, and QLT, Inc., as well as multiple large pharmaceutical companies. In the respiratory

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field, other biopharmaceutical companies also have reported the discovery of genes relating to asthma and other respiratory diseases, including Genentech, Inc., Immunex Corporation, and Vertex Pharmaceuticals, Inc., as well as multiple large pharmaceutical companies.

Executive Officers

Our current executive officers are as follows:

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

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

Mr. Schnittker has served as our Senior Vice President and Chief Financial Officer since December 2002. Prior to that, Mr. Schnittker served as Vice President and Chief Financial Officer since joining us in June 2000. Prior to joining us, Mr. Schnittker served as Director of Finance from August 1999 to May 2000 and Controller from December 1997 to August 1999 at Global Sports, Inc. From June 1995 to December 1997, Mr. Schnittker held the positions of Manager, Finance Policies and Procedures and Senior Accountant, External Reporting at Rhône-Poulenc Rorer, Inc. Prior to that, Mr. Schnittker held various positions at Price Waterhouse LLP (now PricewaterhouseCoopers LLP) from 1990 to 1995. Mr. Schnittker is a certified public accountant.

Ms. Shashlo has served as our Senior Vice President, Regulatory Affairs, Quality Assurance and Project Management since December 2002. Prior to that, Ms. Shashlo served as our Vice President, Regulatory Affairs and Project Management since joining us in June 2002. Prior to Genaera, Ms. Shashlo served as a worldwide regulatory consultant from September 2001 to May 2002, including a brief tenure as Vice President, Regulatory Affairs for Medinox, Inc. From May 2000 to August 2001, Ms. Shashlo served as Vice President, Regulatory

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Affairs and Quality Assurance for Vitagen Incorporated. Prior to that, Ms. Shashlo served as Director, Regulatory Affairs and Compliance at Ligand Pharmaceuticals, Inc. from August 1997 to May 2000. From September 1993 to August 1997, Ms. Shashlo held the position of Associate Director International Regulatory Affairs, Worldwide Regulatory Affairs Division for Wyeth-Ayerst Research. Ms. Shashlo received her B.S. Pharmacy degree from the University of Michigan and is a registered pharmacist licensed by the State of Michigan.

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, 2002, we had 22 full-time employees. No employees are covered by collective bargaining agreements, and we consider relations with our employees to be good.

Available Information

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

Risk Factors Related To Our Business

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

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

We maintained cash and investments of $9.4 million at December 31, 2002. At December 31, 2002, we had current liabilities of $3.9 million, long-term liabilities of $1.7 million and redeemable convertible preferred stock of $1.1million. We believe these resources are sufficient to meet our research and development goals and sustain operations through 2003. 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 such funds, we may be unable to complete our development activities for any of our proposed products.

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

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

To date, we have engaged primarily in the research and development of drug candidates. We have not generated any revenues from product sales and have incurred losses in each year since our inception. As of December 31, 2002, we had an accumulated deficit of approximately $182.8 million.

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

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

Our common stock is currently listed on the Nasdaq SmallCap Market. There are several requirements that we must satisfy in order for our common stock to continue to be listed on the Nasdaq SmallCap Market. These requirements include, but are not limited to, maintaining a minimum per share price on our common stock of one dollar. The per share price of our common stock does not currently satisfy requirements to remain listed on the Nasdaq SmallCap Market. We have received notification from The Nasdaq Stock Market, Inc. that our common stock will be delisted from the Nasdaq SmallCap Market unless the stock closes at or above one dollar per share for at least ten consecutive days by September 18, 2003. In addition, in the future we may not comply with other listing requirements, which might result in the delisting of our common stock. Delisting from the Nasdaq SmallCap Market could also adversely affect the liquidity and the price of our common stock and could have a long-term adverse impact on our ability to raise future capital through a sale of our common stock.

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

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