##### Table of Contents

---

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549



---



FORM 10-K



---



(Mark One)

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



For the fiscal year ended December 31, 2003



OR



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



For the transition period from
 to



Commission File Number 0-27264



---



CORAUTUS GENETICS INC.

(Exact name of registrant as specified in its charter)



---



|                                                               |  |                                     
|-------------------------------------------------------------- |  | ------------------------------------
|DELAWARE                                                       |  | 33-0687976                          
|(State or other jurisdiction of incorporation or organization) |  | (I.R.S. Employer Identification no.)



75 Fifth Street, NW,
Suite 313, Atlanta, Georgia 30308

(Address of principal executive offices) (Zip code)



REGISTRANTS TELEPHONE NUMBER, INCLUDING AREA CODE:

(404) 526-6200



---



SECURITIES REGISTERED PURSUANT TO SECTION 12(B) OF THE
ACT



|                              |  |                                       
|----------------------------- |  | --------------------------------------
|Title of Class                |  | Name of Each Exchange Where Registered
|COMMON STOCK, $.001 PAR VALUE |  | AMERICAN STOCK EXCHANGE               



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

NONE



---



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



Indicate
by checkmark 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 the 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.  x



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



The aggregate market value of the registrants outstanding common stock held by nonaffiliates of the registrant computed by reference
to the price at which the common stock was last sold as of the last business day of the registrants most recently completed second fiscal quarter was $28,160,384 (based on a closing price of $2.95 per share for the registrants common
stock on the American Stock Exchange on June 30, 2003 - adjusted to reflect a one-for-seven reverse stock split effective March 10, 2003). The number of shares of the common stock of the registrant outstanding as of March 24, 2004, was 12,394,256
and the closing price on March 24, 2004 was $6.80 per share.



Documents
Incorporated by Reference: Portions of the Proxy Statement for the 2004 Annual Meeting of Stockholders to be held May 7, 2004, are incorporated by reference in Part III hereof.



---



---

##### Table of Contents

CORAUTUS GENETICS INC.



(A
DEVELOPMENT-STAGE ENTERPRISE)



FORM 10-K



TABLE OF CONTENTS



|                        |  |                                                                                                              |  |   
|----------------------- |  | ------------------------------------------------------------------------------------------------------------ |  | --
|ITEM NUMBER AND CAPTION |  | PAGE NO.                                                                                                    
|PART I                  |  |                                                                                                              |  | 1 
|ITEM 1.                 |  | BUSINESS                                                                                                     |  | 1 
|ITEM 2.                 |  | PROPERTIES                                                                                                   |  | 28
|ITEM 3.                 |  | LEGAL PROCEEDINGS                                                                                            |  | 28
|ITEM 4.                 |  | SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS                                                          |  | 28
|ITEM 4A.                |  | EXECUTIVE OFFICERS OF THE REGISTRANT                                                                         |  | 29
|                        |  |                                                                                                             
|PART II                 |  |                                                                                                              |  | 30
|                        |  |                                                                                                             
|ITEM 5.                 |  | MARKET FOR REGISTRANTS COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES |  | 30
|ITEM 6.                 |  | SELECTED FINANCIAL DATA                                                                                      |  | 32
|ITEM 7.                 |  | MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS                        |  | 33
|ITEM 7A.                |  | QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK                                                   |  | 40
|ITEM 8.                 |  | FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA                                                                  |  | 40
|ITEM 9.                 |  | CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE                         |  | 40
|ITEM 9A.                |  | CONTROLS AND PROCEDURES                                                                                      |  | 40
|                        |  |                                                                                                             
|PART III                |  |                                                                                                              |  | 41
|                        |  |                                                                                                             
|ITEM 10.                |  | DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT                                                           |  | 41
|ITEM 11.                |  | EXECUTIVE COMPENSATION                                                                                       |  | 41
|ITEM 12.                |  | SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS.              |  | 41
|ITEM 13.                |  | CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS                                                               |  | 41
|ITEM 14.                |  | PRINCIPAL ACCOUNTANT FEES AND SERVICES                                                                       |  | 41
|                        |  |                                                                                                             
|PART IV                 |  |                                                                                                              |  | 41
|                        |  |                                                                                                             
|ITEM 15.                |  | EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K                                             |  | 41



---

##### Table of Contents

CAUTIONARY FACTORS THAT MAY AFFECT FUTURE RESULTS



We believe it is important to communicate our expectations to investors. However, there
may be events in the future that we are not able to predict accurately or that we do not fully control that could cause actual results to differ materially from those expressed or implied. This annual report and the documents incorporated by
reference in this annual report may contain forward-looking statements made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. Such statements are subject to certain factors, risks and uncertainties that
may cause actual results, events and performances to differ materially from those referred to in such statements. These risks include statements that address operating performance, events or developments that we expect or anticipate will occur in
the future, such as projections about our future results of operations or our financial condition, benefits from the alliance with Boston Scientific, synergies from the merger between GenStar and Vascular Genetics, research, development and
commercialization of our product candidates, anticipated trends in our business, manufacture of sufficient and acceptable quantities of our proposed products, approval of our product candidates, meeting additional capital requirements, and other
risks that could cause actual results to differ materially. The forward-looking statements are based on information available to Corautus on the date hereof, and Corautus assumes no obligation to update any such forward-looking statements.



PART I



ITEM 1. BUSINESS



Corautus Genetics Inc. (referred
to as we, us, our or Corautus) is a biopharmaceutical company dedicated to the development of innovative gene therapy products for the treatment of cardiac and vascular disease. Corautus, formerly
known as GenStar Therapeutics Corporation and Urogen Corp., was formed as a Delaware corporation on June 30, 1995. Gene therapy is technology that uses genetic materials as therapeutic agents to treat disease. Gene therapy seeks to restore, augment
or correct gene functions either by the addition of normal genes or by neutralizing the activity of defective genes. The following discussion must be read in conjunction with, and is subject to, the risks and uncertainties set forth in Risks
and Uncertainties starting on page 16 of this report.



Recent Events



Completion of the Merger with Vascular Genetics and Related Matters



On February 5, 2003, we completed a merger with Vascular Genetics Inc.
based on a merger agreement dated as of September 12, 2002, as amended, by and among GenStar Therapeutics Corporation, Genesis Acquisition Corporation, a wholly owned subsidiary of GenStar, and Vascular Genetics. Pursuant to the merger agreement,
Genesis Acquisition Corporation was merged with and into Vascular Genetics, with Vascular Genetics surviving the merger and becoming a wholly owned subsidiary of GenStar. Upon consummation of the merger, the name of our company was changed from
GenStar Therapeutics Corporation to Corautus Genetics Inc., and the stockholders of Vascular Genetics became stockholders of Corautus.



In connection with the merger with Vascular Genetics, effective as of February 5, 2003:



| |  | our authorized capital stock was increased to 105,000,000 shares, including 100,000,000 shares of common stock;
| | - | ---------------------------------------------------------------------------------------------------------------



| |  | our board of directors was increased from five to nine directors, with Peter F. Bernardoni resigning as a director and the addition of five new directors;
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Richard E. Otto and Robert T. Atwood of Vascular Genetics were appointed as Chief Executive Officer and Chief Financial Officer, respectively of Corautus; and
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | our stockholders approved and adopted a new 2002 Stock Plan.
| | - | ------------------------------------------------------------



1



---

##### Table of Contents

Corautus was created to capitalize on the complementary strengths of GenStar and Vascular Genetics to accelerate the
development of a later stage genetic therapy for cardiovascular disease. Prior to the merger with Vascular Genetics, our focus was the development of gene therapy products using viral technology to deliver genes, primarily for the treatment of
hemophilia and prostate cancer. However, as further discussed below under the heading MAX-AD FVIII License, we are no longer pursuing products related to hemophilia and prostate cancer. Rather, the focus of our efforts and resources will
be the clinical development of gene therapy products using a vascular growth factor gene known as Vascular Endothelial Growth Factor 2, or VEGF-2, for the treatment of severe cardiovascular disease.



Pursuant to the rules of the Securities Exchange Act of 1934, much of the information
contained in this Form 10-K is a review of Corautus for the period beginning January 1, 2003 and ending December 31, 2003. We have included the required disclosures for such period, which during the period of January 1, 2003 to February 5, 2003,
Corautus was operating under the name GenStar Therapeutics Corporation. Since the completion of the merger with Vascular Genetics, there have been many changes at Corautus, and we have included certain additional information in this Form 10-K to
reflect our operations on a going forward basis after such merger, such as our emphasis on the development of the VEGF-2 products and the new management team that will be guiding Corautus in 2004.



Reverse Stock Split for Our Common Stock



On March 10, 2003, we completed a reverse stock split for our common stock pursuant to which
each seven shares of common stock were converted into one share of common stock. No fractional shares were issued as a result of the reverse stock split. However, record holders of our common stock at the effective time of the reverse stock split
received cash in lieu of fractional shares. The closing price of our common stock on the American Stock Exchange, or AMEX, on March 10, 2003 immediately preceding the reverse stock split was $0.29. The closing price of our common stock on AMEX on
March 24, 2004 was $6.80. The share and per share amounts for our common stock included in this report have been adjusted to reflect the reverse stock split for all periods presented.



Conversion of Our Series A and Series B Preferred Stock



In connection with the merger with Vascular Genetics in February 2003, the outstanding shares of our Series B preferred stock (all of which
was owned by Baxter Healthcare Corporation) were converted into shares of our common stock. After giving effect to the reverse stock split on March 10, 2003, the 12,890 outstanding shares of Series B preferred stock were converted into 287,274
shares of common stock. In addition, on March 7, 2003, the outstanding shares of our Series A preferred stock (all of which was owned by Baxter Healthcare) were converted into shares of our common stock. After giving effect to the reverse stock
split on March 10, 2003, the 5,830 outstanding shares of Series A preferred stock were converted into 832,857 shares of common stock.



Baxter Healthcare Corporation



In July 1998, we executed various agreements with Baxter Healthcare Corporation pursuant to which we acquired certain rights and assets from Baxter Healthcare in
connection with the MAX-AD FVIII product for hemophilia. As of July 10, 2003, and consistent with our previous announcements to focus on VEGF-2 and cardiovascular disease, we transferred our rights to certain intellectual property licensed from
Baxter Healthcare Corporation to Magnum Therapeutics Corporation, an entity controlled by Dr. Sobol. With Baxters consent we also transferred to Magnum certain agreements we had with Baxter relating to the hemophilia product. We no longer have
any rights to use or develop products related to the MAX-AD FVIII product for hemophilia, and all agreements relating to the MAX-AD FVIII product for hemophilia have been either assigned to Magnum or terminated.



Baxter Healthcare owns all 2,000 shares of our outstanding Series C Preferred Stock, which is
convertible into common stock, at the option of the holder, upon the earlier of (a) the approval by the FDA of our hemophilia product or (b) June 13, 2010. Since we have transferred the rights to, and are no longer pursuing the approval of, the
hemophilia product, the earliest date of conversion of the Series C Preferred Stock into common stock will be June 13, 2010. In the event Baxter Healthcare elects to convert the Series C Preferred Stock into common stock on or after the conversion
date, each share of Series C Preferred Stock is convertible into a number of shares of common



2



---

##### Table of Contents

stock equal to (a) $1,000 divided by (b) 110% of the fair market value of the common stock on the conversion date.
Assuming a fair market value of $6.80 per share on the conversion date of June 13, 2010 ($6.80 was the closing price on March 24, 2004), the 2,000 shares of Series C Preferred Stock would be convertible into approximately 267,380 shares of common
stock.



Collaborative Efforts with Boston Scientific Corporation



On July 30, 2003, Corautus entered into a strategic alliance with Boston
Scientific Corporation to develop and commercialize Vascular Endothelial Growth Factor 2 (VEGF-2) gene therapy products to treat cardiovascular disease. Boston Scientific made a $9,000,000 investment in exchange for 1,385,377 shares of Series D
Preferred Stock, which was convertible into 1,396,116 shares of common stock as of March 24, 2004, subject to adjustment. Additionally, Boston Scientific paid a $1,000,000 license fee for certain intellectual property, which is being recognized as
revenue over the anticipated term of the license of 12 years. Boston Scientific has committed to purchasing up to $15 million of convertible debt from Corautus based on achievement of certain milestones. Boston Scientific has obtained exclusive
rights to market, distribute and sell Corautus VEGF-2 gene products, if and when regulatory approval is obtained.



As part of its commitment to purchase $15 million of convertible debt, Boston Scientific purchased $2.5 million of convertible debt from Corautus in December 2003. The
$2.5 million of convertible debt bears interest at the rate of six percent per year and is repayable in three equal annual payments of interest and principal beginning on December 31, 2008, with the final payment of principal and interest due on
December 31, 2010. In the event of certain change of control events, the outstanding principal amount of the $2.5 million convertible debt may, at the option of the holder, be converted into a maximum of 250,012 shares of common stock, subject to
adjustment.



Certain Lease Obligations



During the first quarter of 2003, Corautus decided to abandon its manufacturing facility
located at Barnes Canyon Road in San Diego, California and move operations to a smaller facility which had previously been subleased by Corautus to a third party. Due to this decision, all tenant improvements related to the manufacturing facility
and certain equipment specifically related to the building were identified as having no future use. A charge of $1,358,000, net of an estimated salvage value of $12,500, was taken during the first quarter of 2003, and an additional charge of
$456,000 net of an estimated salvage value of $200,000 was taken during the second quarter of 2003 related to the disposal of excess furniture and equipment. Additionally, Corautus has forfeited the deposit on the manufacturing facility of $700,000.



In May 2003, Corautus entered into an agreement to terminate the lease for its
manufacturing facility and to surrender possession of such facility without prejudice to any remedies of the landlord for the recovery of rent. As of the date of such termination, future payments due under this operating lease for the remaining
eight year term were approximately $16.5 million. We have entered into a settlement and release agreement with the landlord, dated as of November 7, 2003, for the settlement of the remaining payments that would have been due for the original term of
such lease. Pursuant to the settlement and release agreement, Corautus is obligated to pay or deliver to the landlord the following:



| |  | a warrant to acquire 100,000 shares of Corautus common stock at an exercise price of $4.50 per share with a term of seven years;
| | - | --------------------------------------------------------------------------------------------------------------------------------



| |  | $650,000 in cash on or before April 15, 2004, in one or more installments;
| | - | --------------------------------------------------------------------------



| |  | an aggregate of $550,000 in cash in twenty-two equal consecutive monthly installments beginning February 2004;
| | - | --------------------------------------------------------------------------------------------------------------



| |  | for twenty-four months beginning November 2003, that number of shares of Corautus common stock which on the first day of each such month shall have a trading value of $50,000; and
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | $681,000 in cash on or before January 5, 2006, subject to reduction for certain amounts received by the landlord prior to December 1, 2004 from re-leasing the property.
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------



3



---

##### Table of Contents

Corautus delivered to the landlord a standby letter of credit for $681,000, securing a portion of its obligations under
the agreement. Corautus agreed to file a registration statement to register the shares delivered to the landlord, including the shares underlying the warrants, pursuant to the Securities Act of 1933, on or before June 1, 2004. Such registration
statement was filed on January 27, 2004, as further discussed below under the heading Private Placement/Registration of Stock. Effective with the delivery of the $650,000 cash payment due on or before April 15, 2004, Corautus will be
released from its obligations under the lease.



The net present value of this
settlement amount of $3.4 million was charged to expense in 2003. The estimated fair value of the warrants of $490,000 was recorded to additional paid in capital and as of December 31, 2003, approximately $1,128,000 is included in current
liabilities and approximately $1,815,000 is included in long-term liabilities.



Additionally, due to our restrained cash situation prior to receiving $10 million from Boston Scientific related to an investment in Series D Preferred Stock and a license payment, we discontinued making payments on a capital lease
obligation. Subsequent to receiving the funds from Boston Scientific, we paid the originally scheduled amounts due on the capital lease obligation and are currently negotiating with the lender regarding terms for security and repayment of the
remaining balance. Until such negotiations are complete, the remaining balance of approximately $376,000 has been classified on the balance sheet as a current liability.



Private Placement/Registration of Stock



In December 2003, we completed the funding of a private transaction to three investors in the amount of $2,150,000 and issued 541,690 shares of our common stock and
warrants to purchase 108,338 shares of common stock at $5.4375 per share, which is 20% warrant coverage. The price of our common stock was $3.97 per share, which at the time the contract was entered into was a 10% discount to then current market
price of the common stock. The exercise price of the common stock under the warrants was at 125% of the market value of the common stock on the date of the closing. In January 2004, we completed the second part of this private transaction in the
amount of $1,000,000 and issued 251,950 shares of our common stock and warrants to purchase 50,390 shares of common stock at $6.7625 per share. As with the first part of this transaction, the price of the common stock was at $3.97 per share, which
at the time the contract was entered into was a 10% discount to then current market price. The exercise price of the common stock under the warrants was also at 125% of the market value on the date of the closing. The warrant coverage was also 20%.



In January 2004, we completed the funding of a second private transaction to
two institutional investors in the amount of $5,260,680 and issued 1,200,000 shares of our common stock and warrants to purchase 240,000 shares of common stock at $6.72 per share, which is 20% warrant coverage. In this transaction, the price of the
common stock was $4.3819 per share, which at the time the contract was entered into was a 10% discount to the then current market price of the common stock. The exercise price of the common stock under the warrants was 120% of the market price of
the common stock on the date of the closing.



Pursuant to the purchase
agreements executed through the private placements, we were obligated to file a registration statement with the Securities and Exchange Commission to register the shares sold thereunder within 30 days of the issuance. On January 27, 2004, we filed a
registration statement on Form S-3 to register an aggregate of 4,185,318 shares of common stock, which included: (i) 2,424,699 shares issued or issuable pursuant to the private placements, (ii) 366,664 shares issued or issuable to PMSI Barnes Canyon
LLC pursuant to the settlement and release agreement (see Certain Lease Obligations above for a discussion on the settlement), and (iii) 1,393,955 shares issuable upon conversion of the Series D Preferred Stock. The registration
statement of Form S-3, as amended on February 2, 2004, was declared effective on February 6, 2004.



In March 2004, we completed the funding of a third private transaction to two institutional investors in the amount of $2,249,984 and issued 376,000 shares of our common stock and warrants to purchase 18,800 shares of
common stock at $8.375 per share, which is 5% warrant coverage. In this transaction the price of the common stock was



4



---

##### Table of Contents

$5.9835 per share, which at the time the contract was entered into was a 12% discount to the then current market price of
the common stock. The exercise price of the common stock under the warrants was 125% of the market price of the common stock on the date of the closing.



Our Core Technology  Vascular Endothelial Growth Factor 2, or VEGF-2



Our core technology is based upon the pioneering research of the late Dr. Jeffrey Isner of St. Elizabeths Medical Center of Boston
utilizing gene transfer therapy to effect therapeutic angiogenesis, the process of formation or growth of new blood vessels, utilizing a gene known as Vascular Endothelial Growth Factor 2, or VEGF-2. The gene was discovered and isolated by Human
Genome Sciences, Inc. Preclinical laboratory studies have shown that the VEGF-2 gene may promote the growth of new blood vessels in ischemic, or oxygen deprived, heart and peripheral vascular tissue. Thus, VEGF-2 may have potential as a treatment
for certain vascular diseases, including coronary artery disease and peripheral artery disease.



Through our subsidiary, Vascular Genetics, we hold an exclusive, worldwide license from Human Genome Sciences to make, use and sell products utilizing its VEGF-2 technology in the field of gene therapy for the
treatment of vascular disease. Vascular Genetics also holds a license from Caritas St. Elizabeths Medical Center of Boston, Inc. relating to the injection of a gene into ischemic tissue and a license from Vical Incorporated to use certain gene
therapy delivery methods to directly inject VEGF-2 products as naked plasmid DNA into a patients vascular tissue using a catheter or hypodermic needle. We have also entered into a collaboration agreement with Boston Scientific to utilize a
proprietary catheter developed by Boston Scientific to deliver the VEGF-2 plasmid DNA directly to the affected cardiac muscle in clinical trials.



We are currently developing two product candidate applications using the VEGF-2 material, one for the treatment of coronary artery disease and the other for the treatment
of peripheral artery disease. Our gene therapy treatment and product candidates are comprised of three primary elements:



| |  | the VEGF-2 gene and DNA plasmid agents using the VEGF-2 gene;
| | - | -------------------------------------------------------------



| |  | the delivery of the VEGF-2 gene; and
| | - | ------------------------------------



| |  | the gene therapy methods for therapeutic angiogenesis.
| | - | ------------------------------------------------------



The product candidate for the treatment of coronary artery disease has completed Phase I/II clinical trials utilizing a surgical procedure and a randomized,
placebo-controlled Phase I/II clinical trial employing a percutaneous catheter-based method to deliver the VEGF-2 plasmid DNA directly to the heart muscle. The Phase I/II clinical trials provided preliminary data which we believe supports the safety
of the product candidate and its delivery method. In the clinical trial process, the next step is a later Phase II, or Phase IIb, clinical trial to further evaluate the safety and effectiveness of this product candidate. We submitted a protocol to
the FDA in the third quarter of 2003 for that trial, and we are continuing written and verbal communications with the FDA. The FDA must approve our submissions before we may proceed with this Phase IIb clinical trial and that approval has not been
obtained. The FDAs determination of when to permit the trials to proceed is more complex than a typical product candidate because our clinical trials will also involve the investigation of injection catheters supplied by a third party for gene
transfer. We expect further direction from the FDA in the near term and the commencement of our Phase IIb clinical trial in early 2004.



Our product candidate for the peripheral vascular disease market has completed an early Phase I clinical trial for the treatment of critical limb ischemia. The clinical
data from this study has not yet been evaluated, and we have not yet prepared a protocol for further clinical trials for this product candidate. In 2004, we expect to consider the possibility of filing a revised protocol investigational new drug
amendment for further clinical trials for this product candidate.



5



---

##### Table of Contents

Vascular and Cardiovascular Disease: Markets and Current Treatments



Cardiovascular Disease, Including Coronary Artery Disease and Angina



Cardiovascular disease is the leading cause of death in the United States, causing
approximately 38.5% of all deaths in the United States in 2001. The American Heart Association estimates that more than 64 million Americans have one or more types of cardiovascular disease and that the current annual direct and indirect costs of
treatment for cardiovascular disease, including stroke, in the United States is approximately $368.4 billion.



More than one of every five deaths in the United States in 2001 were due to coronary artery disease. The coronary arteries carry blood to the heart. Coronary artery disease is a condition characterized by a narrowing
of the coronary arteries and reduced blood flow, and therefore oxygen, to the heart. The narrowing of the coronary arteries is often caused by arteriosclerosis, a disease in which the inner layers of the artery walls become thick and irregular due
to deposits of fat, cholesterol and other substances. The lack of blood flow and oxygen to an organ is referred to as ischemia, and myocardial ischemia refers to the lack of blood flow and oxygen to the heart muscle. The American Heart Association
estimates that more than 13 million Americans have coronary artery disease and that more than $10 billion was paid to Medicare beneficiaries in 1999 for the treatment of coronary artery disease.



The primary symptoms of coronary artery disease and myocardial ischemia include heart attack
and angina, the medical term for chest pain or discomfort due to myocardial ischemia. Angina may be categorized as either stable angina or unstable angina. People with stable angina have episodes of chest pain or discomfort that are usually
predictable and occur during exertion or under mental or emotional stress. People with unstable angina have unexpected chest pain or discomfort that usually occurs at rest. The Canadian Cardiovascular Society proposed a grading system of angina in
1972 that has since been used to classify stable angina. This grading system identifies four classes of angina. Class III angina is characterized by a marked limitation of ordinary physical activity. The most severe class of angina, Class IV, is
characterized by an inability to carry on any physical activity without discomfort.



Current treatments for coronary artery disease and angina include drug therapies and invasive techniques that help restore adequate blood flow to ischemic, or oxygen deprived, regions of the heart. The primary drug therapy treatments,
including nitroglycerin tablets, dilate the coronary vessels increasing the blood supply to heart muscle. However, these treatments have limitations, and their effectiveness is diminished when the coronary blood vessels are severely narrowed by
arteriosclerosis. The current invasive techniques include stent procedures, balloon and laser angioplasty, and bypass surgery. The American Heart Association estimates that approximately 1,051,000 angioplasty and/or stent procedures and 516,000
coronary artery bypass graft procedures are performed annually in the United States. In general, these invasive procedures seek to clear or bypass diseased coronary blood vessels to increase blood flow to the heart muscle. However, the effectiveness
of these procedures is limited when the coronary blood vessels are diffusely narrowed by arteriosclerosis or when the blocked blood vessel is in an area that is difficult to access.



The American Heart Association estimates that approximately 6,800,000 patients in the United States are classified as angina pectoris
patients. Of these patients with angina pectoris, approximately 150,000 to 250,000 refractory coronary artery disease patients annually cannot be successfully treated with conventional cardiovascular therapies. In most cases, these patients have
undergone multiple invasive procedures and/or surgeries that have been unsuccessful. We have targeted this critical patient population as the initial candidates for our VEGF-2 gene therapy treatment. We believe that the potential market in the
United States for VEGF-2 gene therapy of severe coronary artery disease is at least $1 billion per year.



Peripheral Vascular Disease, Including Critical Limb Ischemia



Peripheral vascular disease refers to diseases of the blood vessels outside of the heart and brain and is often a narrowing of the vessels carrying blood to leg and arm muscles. The American Heart Association
estimates that peripheral vascular disease affects 8 to 12 million people in the United States. Critical limb ischemia is an advanced form of peripheral artery disease. Patients with critical limb ischemia often experience excruciating pain and may
be afflicted by skin lesions that are difficult to heal because of reduced blood flow to the area. In severe cases, peripheral vascular disease may lead to gangrene and amputation of patients limbs.



6



---

##### Table of Contents

A primary objective in treating patients with critical limb ischemia is to increase blood flow to the affected limb.
Current treatments for peripheral vascular disease include drug treatments such as anti-thrombotics to prevent the blood from clotting and intrusive techniques such as bypass surgery and a type of angioplasty to dilate narrowed peripheral arteries.



Gene Therapy and Therapeutic Angiogenesis



Gene Therapy



Each persons DNA is comprised of segments called genes that contain the specific sequences of information responsible for particular
physiological traits and processes. Each gene is comprised of a sequence of nucleotides that provide precise genetic instructions to create, or express, a protein. Proteins are the primary building blocks of a humans physiological
characteristics. A typical human cell contains thousands of different proteins essential to its structure, growth and function.



Gene therapy is an approach to the treatment of disease in which genes are inserted into a patients cells for the purpose of inducing such cells to express
therapeutic proteins or to replace defective or missing genes. In addition, gene therapy may allow the localized expression of therapeutic proteins at the site of the disease or disorder. Gene therapy methods are currently being developed and tested
to treat and/or cure a number of diseases or disorders, including cancer, hemophilia, cardiovascular and vascular diseases, and cystic fibrosis.



Therapeutic Angiogenesis



The human body has a natural biological process called angiogenesis for the formation and growth of new blood vessels, often collateral blood vessels, to help
compensate for reduced blood flow in a persons major arteries. The administration of genetic material or other drugs to copy this natural process and induce the formation and growth of new blood vessels is a clinical strategy referred to as
therapeutic angiogenesis. Some pre-clinical laboratory studies have shown that certain genes and proteins, called growth factors, may stimulate angiogenesis in ischemic, or oxygen-deprived, tissue. These growth factors include vascular
endothelial growth factors, or VEGF, and fibroblast growth factors, or FGF.



Our Gene Therapy Treatment for Therapeutic Angiogenesis



Delivery and Gene Therapy Methods for Therapeutic Angiogenesis



Our proposed products use a plasmid, or small piece of DNA, containing the VEGF-2 gene. The VEGF-2 gene and its expressed VEGF-2 protein have shown some promise in laboratory studies, and our proposed gene therapy treatment relies upon a
method of delivering the VEGF-2 plasmid DNA to the targeted cells within a patient in what we believe will be shown to be a safe and effective manner. When simply injected into the bloodstream, plasmid DNA may be impeded by cell walls or otherwise
rapidly degrade in circulating blood. Therefore, some gene therapy methods for vascular and other diseases have used a delivery vehicle, or vector, that encapsulates a therapeutic gene for delivery to cells. For example, some gene therapy trials,
including our previous MAXIMUM-AD Phase I clinical trial for hemophilia, have used a viral vector that incorporates the genetic material into a virus, which is then injected into the patient for delivery via the bloodstream.



Our proposed gene therapy treatment relies upon the non-viral delivery of a naked VEGF-2
plasmid DNA directly to the ischemic tissue by injection, where the gene transfer takes place. This VEGF-2 plasmid is referred to as naked because it contains no accessory packaging, such as encapsulation within viruses or liposomes. We believe that
the non-viral delivery of the naked VEGF-2 DNA plasmid may achieve a biological effect while minimizing the toxicity associated with viral vectors.



7



---

##### Table of Contents

While we believe the plasmid DNA may be injected directly with a hypodermic needle into skeletal muscles for the
treatment of peripheral vascular disease in certain circumstances, the heart muscle is less accessible than skeletal muscles for the direct injection of naked plasmid DNA. In its prior clinical trials, Vascular Genetics utilized both a surgical
procedure and a percutaneous catheter-based method to deliver the VEGF-2 plasmid directly to the heart muscle. We have secured a license from Caritas St. Elizabeths Medical Center of Boston, Inc. relating to the injection of a gene into
ischemic tissue, and we have secured a license from Vical Incorporated to utilize certain gene delivery technologies to deliver the naked VEGF-2 plasmid DNA directly into skeletal muscles using a hypodermic needle and directly into the hearts
muscle tissue using a hypodermic needle or catheter. Additionally, we have secured a license from Boston Scientific, during such time as it has exclusive distribution rights, to develop and commercialize our VEGF-2 product for the treatment of
vascular disease under all patents owned, or licensed to and sublicenseable, by Boston Scientific and necessary for development or commercialization of such product.



In the surgical procedure, the VEGF-2 plasmid is injected into the heart muscle by a hypodermic needle following a limited thoracotomy, or
surgical incision of the chest wall. This procedure is invasive and requires general anesthesia.



Because of the invasive nature of the surgical procedure, we are developing and testing a catheter-based delivery of the VEGF-2 plasmid that may be performed percutaneously, or through the skin. The percutaneous
catheter-based delivery of the VEGF-2 plasmid to the heart muscle does not require surgery and may be performed in facilities employed for standard cardiac catheter procedures. In this treatment, a catheter is inserted percutaneously into blood
vessels in the leg and then advanced into the heart.



Once the catheter is
properly positioned, the VEGF-2 plasmid is injected through a retractable needle into the diseased heart muscle. The injected VEGF-2 plasmid DNA may then result in the expression of the VEGF-2 protein to stimulate the production of new blood vessels
in the ischemic heart muscle.



For the next phase of our clinical trials,
expected to commence in early 2004, we will utilize a proprietary catheter developed by Boston Scientific, known as the Stiletto catheter, to deliver the VEGF-2 plasmid directly to the affected cardiac muscle.



Clinical Trials for Our VEGF-2 Product Candidates



Clinical Trials for Gene Therapy Products and Treatments Generally



Our product candidates and their delivery methods must be tested in human clinical trials to determine whether they are both safe and
effective. Traditionally, clinical trials are performed in three phases. Phase I clinical trials mark the first time a new drug or treatment is administered to humans and are normally conducted to determine the safety profile of a new drug or
treatment. Phase II clinical trials are conducted in order to determine the preliminary effectiveness and optimal dosage of a new drug or treatment and to confirm its safety profile. Phase III clinical trials are often large scale, multi-center
studies conducted to evaluate the overall safety and effectiveness and to compare a new drug or treatment with a currently approved therapy. At times a single trial may incorporate elements from different phases of development. For example, a
clinical trial may be designed to determine both the safety and initial efficacy of a new drug or treatment. Such a trial may be referred to as a Phase I/II clinical trial.



A clinical trial is based on a protocol, or study plan, designed to safeguard the health of patients enrolled in the trial as well as answer
specific research questions. The protocol for a clinical trial typically describes the patients who may participate in the trial, the schedule of tests, procedures, medications and dosages and the length of the study. The protocol may also provide
for the evaluation of different doses of the drug under study.



Many protocols
require a placebo-controlled study in which the patients receiving the actual drug under study are compared with a control group of patients that receive a placebo. A placebo is an inactive treatment that is often designed to look exactly like the
actual drug under study. Because a patients beliefs and hopes about treatment may have a significant biochemical effect, many protocols require a blinded or double-blinded clinical trial for a more complete evaluation of the drugs
effectiveness and possible adverse reactions without the bias of a placebo effect. A clinical trial is blinded when the patient in the study does not know if he is receiving the actual drug or a placebo.



8



---

##### Table of Contents

In a double-blinded clinical trial, both the patient and the administrator of the drug do not know if the patient is
receiving the actual drug or a placebo. In addition, the protocol may require a process referred to as randomization for assigning patients in the study to the experimental groups in the trial, including the control group. This process seeks to
ensure an even distribution of patient characteristics in the clinical trial.



Clinical Trials of Our Product Candidate for Coronary Artery Disease



Our product candidate for the treatment of coronary artery disease has completed both a Phase I clinical trial using a surgical procedure to deliver the VEGF-2 plasmid directly to the heart muscle and a Phase I/II clinical trial for the
percutaneous catheter delivery of the VEGF-2 plasmid directly to the heart muscle.



In the Phase I clinical trial using the surgical procedure, the naked VEGF-2 plasmid was directly injected into the heart muscle through a limited thoracotomy surgical procedure in 30 patients. The patients enrolled in the study were
considered no option patients with stable class III or IV angina despite the use of conventional revascularization procedures. The study was conducted at five medical centers in the United States, including St. Elizabeths Medical
Center of Boston, and was led by Dr. Jeffrey Isner as the principal investigator.



This Phase I clinical trial was a dose-escalating study in which 10 patients each received 200, 800 or 2000 microgram doses of the VEGF-2 plasmid. The patients were followed for one year after treatment. Of the 30 patients enrolled in this
Phase I study, a single death occurred during the year after treatment. This death was unrelated to the product candidate in the opinion of the investigator. The investigators observed a subjective improvement in patients following the VEGF-2 gene
transfer.



Although this Phase I study had some encouraging results, the study
is limited by the absence of a control population for comparison of the VEGF-2 plasmid against placebos. Some studies have indicated that the use of placebos may have a positive effect on patients in this class. Because of the invasive nature of the
surgical procedure, this Phase I study could not be conducted to preclude randomization against a placebo.



Based upon the encouraging results and limitations of the initial Phase I surgical study, a Phase I/II clinical trial was then performed to investigate the safety and effectiveness of a percutaneous catheter-based
delivery of the naked VEGF-2 plasmid directly to the heart muscle. This clinical trial, which was sponsored by Vascular Genetics, was designed as a prospective, randomized, double-blind, placebo-controlled, dose-escalating study of 27 patients with
chronic myocardial ischemia.



Nineteen patients were enrolled in the study
when, in February 2000, the study was placed on clinical hold by the FDA. Following the death of an 18-year old patient enrolled in an unrelated gene therapy study using a viral vector to deliver the genetic material, the FDA undertook extensive
reviews of gene therapy clinical trials in the United States to evaluate compliance with clinical trial monitoring procedures. Vascular Genetics was required to cease further patient enrollment and the administration of its product candidates in the
clinical trials while it provided data and information to allow the FDA to assess the risks to patients in Vascular Genetics clinical trials. Because of limited capital resources, Vascular Genetics was unable to provide adequate data to the
FDA and respond to the FDAs inquiries for some time. In October 2001, after Vascular Genetics obtained additional funding and responded to the FDAs inquiries, the FDA removed the Phase I/II study from clinical hold.



The 19 patients enrolled in the study suffered from multi-vessel coronary artery disease that
was not suitable for angioplasty or bypass surgery. In addition, all patients were classified as having class III or IV angina refractory, or resistant, to maximum medical therapy prior to the clinical trial. These patients were randomized in a
double-blind fashion to receive injections of a placebo or the VEGF-2 plasmid in doses of either 200, 800, or 2000 micrograms. Seven patients were randomized to receive six injections each of the placebo, and 12 patients were randomized to receive
six injections each of the VEGF-2 plasmid. Because enrollment was limited to 19 patients rather than the 27 proposed, the doses of the VEGF-2 plasmid in the trial were pooled. Of the 12 patients randomized to receive injections of the VEGF-2
plasmid, six patients received doses of 200 micrograms and six patients received doses of 800 micrograms.



9



---

##### Table of Contents

In a subsequent publication, the investigators reported that the preliminary data from this Phase I/II clinical trial
supported both the safety of the VEGF-2 product candidate at certain doses and the safety of the catheter-based injections performed in the study. The investigators further reported a statistically significant improvement in symptoms of angina,
including decreases in angina class and frequency of angina episodes, during follow-up for patients that received the VEGF-2 plasmid treatment. Finally, the investigators concluded in their report that a larger Phase II/III clinical trial was
warranted.



We submitted a protocol to the FDA in the third quarter of 2003 and
are continuing written and verbal communications with the FDA for a later Phase II, or Phase IIb, clinical trial with larger patient populations to further evaluate the safety and effectiveness of this product candidate using a percutaneous
catheter-based injection for cardiovascular disease. We anticipate that the trial will be a national, multi-center, randomized, double-blind, dose ranging and placebo-controlled trial of approximately 404 patients with Class III and Class IV angina.
The FDA must approve our submissions before we may proceed with this Phase IIb clinical trial and that approval has not been obtained. The FDAs determination of when to permit the trials to proceed is more complex than a typical product
candidate because our clinical trials will also involve the investigation of injection catheters supplied by a third party for gene transfer. We expect further direction from the FDA in the near term and the commencement of our Phase IIb clinical
trial in early 2004. If the FDA permits our clinical trial to proceed, we anticipate that it will take between four to six years for our VEGF-2 product for severe cardiovascular disease to complete clinical trials and, if the trials are successful,
to be approved by the FDA.



There is no assurance that the FDA will permit us
to proceed with our clinical trials or that the data from further trials will support a marketing application.



Clinical Trials of Our Product Candidate for Peripheral Vascular Disease



Our product candidate for the peripheral vascular disease market has completed an early Phase I clinical trial for the treatment of critical limb ischemia. The clinical
data from this study has not been evaluated, and we have not yet prepared a protocol for further clinical trials for this product candidate. In 2004, we expect to consider the possibility of filing a revised protocol investigational new drug
amendment for further clinical trials for this product candidate. However, there is no assurance that the data from the initial trial will support further trials or that the FDA will permit further trials to proceed.



Our Other Technologies and Potential Products  MAXIMUM-AD, DUAL-AD AND IL-3



Prior to the merger with Vascular Genetics, our core technology was the
MAXIMUM-AD system, which is based on a common-cold adenoviral vector system that facilitates therapeutic DNA delivery. MAXIMUM-AD has been bio-engineered from a common cold adenovirus, with all viral genes removed to provide improved safety and
capacity for gene delivery. Working with our research partner, Baxter Healthcare Corporation, we also developed a gene delivery system called MAX-AD FVIII, which is based on our MAXIMUM-AD technology, for the treatment of Hemophilia A. In June 2001,
we commenced a Phase I clinical study to evaluate the MAX-AD FVIII product for the treatment of Hemophilia A. However, only one patient was ever enrolled in the study.



As of July 10, 2003, and consistent with our previous announcements to focus on VEGF-2 and cardiovascular disease, we transferred our rights
to certain intellectual property licensed from Baxter Healthcare Corporation to Magnum Therapeutics Corporation, an entity controlled by a former Corautus executive officer. We no longer have any rights to use or develop products related to the
MAX-AD FVIII product for hemophilia.



Manufacturing



The manufacturing and production of our product candidates must comply with good
manufacturing practices established by the FDA. For Vascular Genetics prior clinical trials, the formulated product candidate consisted of a naked plasmid DNA encoding for VEGF-2 that was produced by Human Genome Sciences pursuant to a
manufacturing agreement between such parties. In February 2001, the manufacturing agreement was terminated, and Human Genome Sciences and Vascular Genetics entered into an agreement for transitioning the manufacturing of the VEGF-2 plasmid to
another manufacturer.



10



---

##### Table of Contents

In 2003, we completed the production of the VEGF-2 plasmid for our Phase II(b) clinical trials, which will be used when
such study is permitted to proceed by the FDA. In addition, we have recently entered into an agreement with a third-party manufacturer for the production of the VEGF-2 plasmid for future clinical trials and the initial sale of our products after
marketing approval, if such events occur. However, we may not be able to establish relationships with manufacturers on commercially acceptable terms. In addition, there is no assurance that other manufacturers will be able to manufacture sufficient
quantities of the product under good manufacturing practices and on a cost-effective basis to permit us to continue clinical trials.



Licenses and Intellectual Property



We have established a portfolio of licensed patents and technologies relating to the development and use of the VEGF-2 technology for the gene therapy treatment of
cardiovascular disease and vascular disease. We do not own any of the patents or patent applications relating to our core VEGF-2 technology but hold exclusive licenses (through our subsidiary, Vascular Genetics) from Human Genome Sciences, Vical,
and Boston Scientific to certain United States patents, pending United States patent applications, and associated non-U.S. patents filings covering aspects of such technology. There is no assurance that any patents applications licensed to us will
issue as patents or, if issued, will cover any technology utilized by us.



Human Genome Sciences License for VEGF-2



In October 1997,
Vascular Genetics secured an exclusive, worldwide license from Human Genome Sciences to make, use and sell products covered by certain patents and patent applications owned by Human Genome Sciences, or otherwise using the VEGF-2 technology, in the
gene therapy treatment of vascular disease. The license agreement requires us to make royalty payments to Human Genome Sciences based on certain percentages of net revenue we derive from sales of products covered by the licensed technologies and
from sublicensing of the licensed technologies. In addition, the license agreement requires us to reimburse Human Genome Sciences for 50% of all reasonable expenses Human Genome Sciences incurs for the preparation, filing, prosecution and
maintenance of the licensed patents and patent applications. We must also indemnify Human Genome Sciences for all liabilities, losses and expenses in connection with claims arising out of any theory of product liability concerning any product,
process or service made, used or sold pursuant to the license.



The license
agreement with Human Genome Science requires us to meet certain milestones within specified time periods for the commercialization of the licensed technologies as follows:



| |  | we must initiate a Phase IIb or Phase III clinical trial within 3 months of validating that we have VEGF-2 material acceptable for such clinical trial, but in no event later than
June 30, 2004;
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | we must have an official end of Phase II meeting with the FDA no later than September 30, 2005;
| | - | -----------------------------------------------------------------------------------------------



| |  | if both a Phase IIb and Phase III clinical trial are required by the FDA, we must initiate the Phase III clinical trial no later than 6 months after the end of the Phase II meeting,
but no later than March 31, 2006; and
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | we must file a biological license application with the FDA for at least one licensed product no later than December 31, 2009.
| | - | -----------------------------------------------------------------------------------------------------------------------------



In the event we fail to meet any of these milestones, Human Genome Sciences may immediately
terminate the license if, after Human Genome Sciences gives notice to us, we still fail to meet the milestone within 60 days after such notice. In addition, if Human Genome Sciences terminates the license for failure to meet any milestone, we must
grant Human Genome Sciences an exclusive license to all data and information generated by us under the agreement to develop, use and sell products.



The license agreement with Human Genome Sciences will terminate when all patent rights licensed under the agreement expire. Human Genome Sciences may also terminate the
license if, after Human Genome Sciences gives



11



---

##### Table of Contents

notice to us, we fail to make a payment, fail to maintain specified insurance, incur specified financial problems or
breach any of our obligations under the agreement. We may terminate the license by giving 30 days advance written notice to Human Genome Sciences.



Vical License for Gene Therapy Delivery Methods



In February 2000, Vascular Genetics obtained an exclusive, worldwide license from Vical Incorporated to develop, make, use and sell products using VEGF-2 and covered by
certain patents and patent applications owned by Vical, relating to gene therapy delivery methods, for the treatment or prevention of disease in humans using gene therapy.



Under the terms of the license agreement, Vical owns all patentable or unpatentable inventions and discoveries regarding Vicals
licensed technology which result from the use of such licensed technology, excluding inventions and discoveries regarding a formulation or combination of the VEGF-2 gene and its delivery vehicle. We have a non-exclusive, royalty-free, perpetual and
worldwide license from Vical to use such improvements.



The license agreement
requires us to make royalty payments to Vical based on a percentage of net revenue we derive from sales of products covered by the licensed technologies and from sublicensing of the licensed technologies. We must also indemnify Vical for all
liabilities, losses and expenses in connection with claims arising out of the development, manufacture, possession, distribution, use, testing or sale of licensed products by us or our sublicensees.



The license agreement with Vical will terminate when all patent rights licensed under the
agreement expire. Vical may also terminate the license if, after Vical gives notice to us, we fail to make a payment, fail to use commercially reasonable efforts to commercialize at least one licensed product in a major market, or breach any of our
other obligations under the agreement. We may terminate the license if, after we give notice to Vical, Vical fails to make a payment or breaches any of its other obligations under the agreement.



Biosense Webster Collaboration Agreement



In May 1999, Vascular Genetics entered into a collaboration agreement with Biosense Webster,
a Johnson & Johnson company. Pursuant to the agreement, Vascular Genetics and Biosense Webster agreed to collaborate on obtaining regulatory approval for the marketing of Vascular Genetics gene therapy products in conjunction with Biosense
Websters catheter products and catheter-based cardiac mapping system, or NOGA Cardiac Navigation System.



On July 18,
2003, Vascular Genetics and Biosense Webster terminated the collaboration agreement.



Boston Scientific Development Agreement



In July, 2003,
Corautus and Boston Scientific Corporation entered into a development agreement. Pursuant to the development agreement, we are required to design and sponsor clinical trials and research and development activities, in the United States and other
jurisdictions for which the parties agree, for products using VEGF-2 with an injection catheter or hypodermic needle for the treatment of cardiovascular or vascular disease. In this regard, we have agreed to use commercially reasonable efforts to
initiate a Phase IIb trial not later than September 30, 2004, initiate a Phase III clinical trial, if needed, not later than March 31, 2006, and file a marketing application for at least one product no later than December 31, 2008.



Boston Scientific has granted to us a non-exclusive, non-transferable and royalty free
license under all patents owned or licensed and sublicensable by Boston Scientific that are necessary for the development of our VEGF-2 products. This license is limited to the development of our VEGF-2 products and does not extend to the sale or
distribution of such products, if such products are ultimately approved for sale. A license for the sale and distribution of our VEGF-2 products is included in the distribution agreement, discussed below. Boston Scientific has also agreed to supply
injection catheters for our clinical studies under the development agreement and to assist in clinical activities necessary to support the use of the injection catheters, including training of investigators.



12



---

##### Table of Contents

Although the development agreement does not extend to the development of our potential VEGF-2 products using delivery
technologies other than an injection catheter or hypodermic needle, the parties are required to discuss the joint funding and development of such products in good faith. In any event, we are prohibited from using injection catheters provided by
third parties in any clinical trials for development of VEGF-2 products.



Boston Scientific Distribution Agreement



In July, 2003,
Corautus and Boston Scientific Corporation entered into a distribution agreement. Pursuant to the distribution agreement, we have granted Boston Scientific the exclusive right to market, distribute and sell our VEGF-2 products worldwide, if and when
such products receive regulatory approval in each jurisdiction.



Boston
Scientific will purchase our VEGF-2 products, if and when such products receive regulatory approval, at a wholesale price based on a percentage of the net revenues received by Boston Scientific for its sales of such products, which wholesale price
may not in any event be less than a minimum price designed to recover our costs of production. However, in the event of any sale of our VEGF-2 business, including a merger or other transaction, to certain competitors designated by Boston Scientific
from time to time, the percentage upon which the wholesale price is based will be reduced.



During the time that Boston Scientific has exclusive distribution rights to our VEGF-2 products, Boston Scientific has granted to us a non-exclusive and non-transferable license under all patents owned or licensed and
sublicensable by Boston Scientific that are necessary for the commercialization of our VEGF-2 products. For such license, we are required to pay Boston Scientific a royalty equal to a percentage of the wholesale price that Boston Scientific pays us
for our VEGF-2 products, when and if such sales are made. However, in the event certain patent licenses to Boston Scientific are terminated, we may elect to terminate this license from Boston Scientific and the corresponding obligation to pay
royalties.



Boston Scientific Patent Sublicense Agreement



Through our wholly-owned subsidiary Vascular Genetics Inc., we hold a non-exclusive license
from Caritas St. Elizabeths Medical Center of Boston, Inc. under certain patents relating to the injection of a gene into ischemic tissue. Pursuant to a patent sublicense agreement, we have granted a sublicense of our rights to Boston
Scientific and have agreed not to issue other sublicenses of such rights to any third parties. In turn, Boston Scientific has granted a non-exclusive, non-sublicensable and royalty-free sublicense of such rights back to us.



In consideration of the sublicense, Boston Scientific has paid us a fee of $1 million. No
royalties are payable by Boston Scientific under such sublicense for its sale of our VEGF-2 products under the distribution agreement, if and when such products are approved. However, royalties are payable to us, in an amount equivalent to our
royalty obligations to Caritas St. Elizabeths Medical Center of Boston, in the event of sales of licensed products by sublicensees of Boston Scientific or in the event of sales of licensed products by Boston Scientific other than our VEGF-2
products under the distribution agreement.



Government Regulation



New drugs and biologics, including gene therapy products, are subject to
regulation under the Federal Food, Drug, and Cosmetic Act. In addition to being subject to certain provisions of that Act, biologics are also regulated under the Public Health Service Act. We believe that the pharmaceutical products being developed
by us will be regulated either as biological products or as new drugs. Both statutes and their corresponding regulations govern, among other things, the testing, manufacturing, distribution, safety, efficacy, labeling, storage, record keeping,
advertising and other promotional practices involving biologics or new drugs. FDA approval or other clearances must be obtained before clinical testing, and before manufacturing and marketing, of biologics and drugs. Obtaining FDA approval has
historically been a costly and time-consuming process.



In addition, any gene
therapy products developed by us will require regulatory approvals prior to human trials and additional regulatory approvals prior to marketing. New human gene therapy products are subject to extensive regulation by the FDA and the Center for
Biological Evaluation and Research and comparable agencies in other



13



---

##### Table of Contents

countries. Currently, each human-study protocol is reviewed by the FDA and, in some instances, the National Institutes of
Health, on a case-by-case basis. The FDA and the National Institutes of Health have published guidance documents with respect to the development and submission of gene therapy protocols.



In order to commercialize our proposed products, we must sponsor and file an investigational new drug application and be responsible for
initiating and overseeing the human studies to demonstrate the safety and efficacy and, for a biologic product, the potency, which are necessary to obtain FDA approval of any such products. For Corautus-sponsored investigational new drug
applications, we will be required to select qualified investigators (usually physicians within medical institutions) to supervise the administration of the products, and we will be required to ensure that the investigations are conducted and
monitored in accordance with FDA regulations and the general investigational plan and protocols contained in the investigational new drug application.



We submitted a protocol to the FDA in the third quarter of 2003 and are currently continuing written and verbal communications with the FDA for a later Phase II, or Phase
IIb, clinical trial to further evaluate the safety and effectiveness of the percutaneous, catheter-based delivery of our VEGF-2 product candidate for the treatment of severe cardiovascular disease. The FDA must approve our submissions before we may
proceed with this Phase IIb clinical trial and that approval has not been obtained. The FDAs determination of when to permit the trials to proceed is more complex than a typical product candidate because our clinical trials will also involve
the investigation of injection catheters supplied by a third party for gene transfer. We currently anticipate further directions from the FDA in the near term and the commencement of our Phase IIb clinical trials in early 2004. If the FDA permits
our clinical trial to proceed, we anticipate that it will take between four to six years for our VEGF-2 product for severe cardiovascular disease to complete clinical trials and, if the trials are successful, to be approved by the FDA.



The FDA receives reports on the progress of each phase of testing, and it may require the
modification, suspension, or termination of trials if an unwarranted risk is presented to patients. If the FDA imposes a clinical hold, trials may not recommence without FDA authorization and then only under terms authorized by the FDA. The
investigational new drug application process can thus result in substantial delay and expense. Human gene therapy products, which is the primary area in which we are seeking to develop products, are a new category of therapeutics. Because this is a
relatively new and expanding area of novel therapeutic interventions, there can be no assurance as to the length of the trial period, the number of patients the FDA will require to be enrolled in the trials in order to establish the safety, efficacy
and potency of human gene therapy products, or that the data generated in these studies will be acceptable to the FDA to support marketing approval.



After the completion of trials of a new drug or biologic product, FDA marketing approval must be obtained. If the product is regulated as a biologic, the Center for
Biological Evaluation and Research will require the submission and approval, depending on the type of biologic, of either a biologic license application or a product license application and an establishment license application before commercial
marketing of the biologic. If the product is classified as a new drug, we must file a new drug application with the Center for Drug Evaluation and Research and receive approval before commercial marketing of the drug. The new drug application or
biologic license applications must include results of product development, laboratory, animal and human studies, and manufacturing information. The testing and approval processes require substantial time and effort and there can be no assurance that
the FDA will accept the new drug application or biologic license applications for filing and, even if filed, that any approval will be granted on a timely basis, if at all. In the past, new drug applications and biologic license applications
submitted to the FDA have taken, on average, one to two years to receive approval after submission of all test data. If questions arise during the FDA review process, approval can take more than two years.



Notwithstanding the submission of relevant data, the FDA may ultimately decide that the new
drug application or biologic license application does not satisfy its regulatory criteria for approval and require additional studies. In addition, the FDA may condition marketing approval on the conduct or specific post-marketing studies to further
evaluate safety and effectiveness. Rigorous and extensive FDA regulation of pharmaceutical products continues after approval, particularly with respect to compliance with current good manufacturing practices, or GMPs, reporting of
adverse effects, advertising, promotion and marketing. 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.



14



---

##### Table of Contents

Ethical, social and legal concerns about gene therapy, genetic testing and genetic research could result in additional
regulations restricting or prohibiting the processes we or our suppliers may use. Federal and state agencies, congressional committees and foreign governments have expressed interest in further regulating biotechnology. More restrictive regulations
or claims that our products are unsafe or pose a hazard could prevent us from commercializing any products.



In addition to the foregoing, state and federal laws regarding environmental protection and hazardous substances, including the Occupational Safety and Health Act, the Resource Conservancy and Recovery Act and the
Toxic Substances Control Act, affect our business. 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. If our operations result in
contamination of the environment or expose individuals to hazardous substances, we could be liable for damages and governmental fines. We believe that we are in material compliance with applicable environmental laws and that continued compliance
therewith will not have a material adverse effect on our business. We cannot predict, however, how changes in these laws may affect our future operations.



Competition



The pharmaceutical and biotechnology industries are intensely competitive. Any product candidate developed by us would compete with existing drugs and therapies and with others under development. There are many
pharmaceutical companies, biotechnology companies, public and private universities and research organizations actively engaged in research and development of products for the treatment of cardiovascular and vascular disease. Many of these
organizations have financial, technical, research, clinical, manufacturing and marketing resources that are greater than ours. If a competing company develops or acquires rights to a more efficient, more effective, or safer competitive therapy for
treatment of the same diseases we have targeted, or one that offers significantly lower costs of treatment, our business, financial condition and results of operations could be materially adversely affected. We believe that the most significant
competitive factor in the gene therapy field is the effectiveness and safety of a product due to the relatively early stage of the industry.



We believe that our product development programs will be subject to significant competition from companies using alternative technologies, as well as to increasing
competition from companies that develop and apply technologies similar to ours. Other companies may succeed in developing products earlier than we do, obtaining approvals for these products from the FDA more rapidly than we do or developing products
that are safer and more effective than those under development or proposed to be developed by us. We cannot assure you that research and development by others will not render our technology or potential products obsolete or non-competitive or result
in treatments superior to any therapy developed by us, or that any therapy developed by us will be preferred to any existing or newly developed technologies.



We are aware of products currently under development by competitors for the treatment of the cardiovascular and vascular diseases targeted by us for our VEGF-2 product
development. These include gene therapy treatments using forms of genes and therapeutic proteins. For example, Collateral Therapeutics, Inc., a subsidiary of Schering AG, has previously reported that it has completed a Phase I/II clinical trial for
a gene therapy product utilizing the FGF-4 fibroblast growth factor gene for the treatment of coronary artery disease. Collateral Therapeutics has also reported that it has begun a Phase IIb/III clinical trial for this product candidate in the
United States. However, on January 30, 2004, Collateral Therapeutics announced that it has ceased enrollment in its clinical trials, citing that such trials will not provide sufficient evidence of the efficacy to warrant continued enrollment. In
addition, GenVec, Inc. has previously indicated that it is conducting Phase II clinical trials for gene therapy products using the VEGF (121) gene for the treatment of coronary artery disease and peripheral artery disease. On January 8, 2004, GenVec
announced it had entered into a research collaboration with Cordis Corporation, a Johnson & Johnson company, regarding its gene therapy products. We will also face competition from entities using other traditional methods, including new drugs
and mechanical therapies, to treat cardiovascular and vascular disease.



Marketing And Sales



Our product candidates must undergo
testing and development in clinical trials. We do not currently have any capacity to market and sell any of our products.



15



---

##### Table of Contents

Pursuant to our distribution agreement with Boston Scientific, we have granted Boston Scientific the exclusive right to
market, distribute and sell our VEGF-2 products worldwide, if and when such products receive regulatory approval in each jurisdiction.



Boston Scientific will purchase our VEGF-2 products, if and when such products receive regulatory approval, at a wholesale price based on a percentage of the net revenues
received by Boston Scientific for its sales of such products, which wholesale price may not in any event be less than a minimum price designed to recover our costs of production. However, in the event of any sale of our VEGF-2 business, including a
merger or other transaction, to certain competitors designated by Boston Scientific from time to time, the percentage upon which the wholesale price is based will be reduced.



During the time that Boston Scientific has exclusive distribution rights to our VEGF-2 products, Boston Scientific has granted to us a
non-exclusive and non-transferable license under all patents owned or licensed and sublicensable by Boston Scientific that are necessary for the commercialization of our VEGF-2 products. For such license, we are required to pay Boston Scientific a
royalty equal to a percentage of the wholesale price that Boston Scientific pays us for our VEGF-2 products, when and if such sales are made. However, in the event certain patent licenses to Boston Scientific are terminated, we may elect to
terminate this license from Boston Scientific and the corresponding obligation to pay royalties.



Research and Development Expenses



Research and development expenses totaled approximately $3,217,000, $9,067,000 and $8,624,000 for the years ended December 31, 2003, 2002 and 2001, respectively.



Employees



At December 31, 2002, we had 30 employees, including four in research and development, 14 in process development and manufacturing, four in regulatory, clinical and
quality assurance and eight in finance and administration. Immediately after the merger with Vascular Genetics on February 5, 2003, we had 32 employees. On March 25, 2003, we terminated 15 employees to reduce costs and restructure our organization.
As of December 31, 2003, we had 15 employees.



Our continued success will
depend in large measure on our ability to attract and retain highly skilled employees who are in great demand. None of our employees are represented by a labor union, and we believe that our relations with the employees are generally good.



Available Information



A copy of this Annual Report on Form 10-K, as well as our Quarterly Reports on Form 10-Q,
Current Reports on Form 8-K and any amendments to these reports, are available free of charge on the Internet at our website, www.corautus.com, as soon as reasonably practicable after we electronically file these reports with, or furnish these
reports to, the Securities and Exchange Commission. The reference to our website address does not constitute incorporation by reference of the information contained on the website and should not be considered part of this document.



Risks and Uncertainties



You should carefully consider the risks described below before making an investment decision. You should also refer to the other information
in this annual report, including the information incorporated by reference into this annual report. The risks and uncertainties we describe below are those that we currently believe may materially affect us. Additional risks and uncertainties that
we are unaware of or that we currently deem immaterial also may become important factors that affect us.



16



---

##### Table of Contents

Risks Significant to Corautus



We are a development stage company with a history of insignificant revenues and significant net losses. We expect continued net losses
for the foreseeable future and may never become profitable.



We are a
development stage company, and we have not yet generated significant revenues. From our inception in July 1991 to December 31, 2003, we incurred cumulative losses of approximately $79.4 million, including a net loss of approximately $30.4 million
for the year ended December 31, 2003, almost all of which consisted of research and development, including write-offs of acquired in-process technology, and general and administrative expenses.



We expect to spend significant additional amounts to fund the research and development
activities and clinical trials for our VEGF-2 product candidates. In addition, we do not expect to generate revenues from sales for a number of years, if at all. As a result, we expect our net losses from operations to continue for at least the next
four years.



Our ability to generate revenues and become profitable will depend
on our ability, alone or with collaborators, to timely, efficiently and successfully complete the development of our proposed products, conduct pre-clinical and clinical tests, obtain necessary regulatory approvals, and manufacture and market our
proposed products. Even if we do achieve profitability, we cannot predict the level of such profitability.



We will need substantial additional funding to develop our products and for our future operations.



The development of our proposed products will require a commitment of substantial funds to conduct the costly and time-consuming research, pre-clinical and clinical
testing necessary to obtain regulatory approvals and bring our products to market. Our future capital requirements will depend on many factors, including:



| |  | the progress of our research and development programs;
| | - | ------------------------------------------------------



| |  | the progress, scope and results of our pre-clinical and clinical testing;
| | - | -------------------------------------------------------------------------



| |  | the time and cost involved in obtaining regulatory approvals;
| | - | -------------------------------------------------------------



| |  | the cost of manufacturing for our proposed product candidates;
| | - | --------------------------------------------------------------



| |  | the cost of prosecuting, defending and enforcing patent claims and other intellectual property rights;
| | - | ------------------------------------------------------------------------------------------------------



| |  | competing technological and market developments; and
| | - | ----------------------------------------------------



| |  | our ability to establish and maintain collaborative and other arrangements with third parties to assist in bringing our products to market and the cost of such arrangements.
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------



We will need to raise substantial additional capital to fund our
future operations. We cannot be certain that additional financing will be available on acceptable terms, or at all. To the extent we raise additional cash by issuing equity securities, our existing stockholders may be diluted. If additional funds
are raised through the issuance of debt securities, these securities are likely to have rights, preferences and privileges senior to our common stock and preferred stock.



Failure to successfully address ongoing liquidity requirements will have a material adverse effect upon our business. In the event that we
are unable to obtain additional capital on acceptable terms, we will be required to take actions that will harm our business and our ability to achieve cash flow in the future, including possibly the surrender of our rights to some technologies or
product opportunities, delaying our clinical trials or curtailing or ceasing operations.



17



---

##### Table of Contents

If our right to use the VEGF-2 technology and other intellectual property we license from third parties is
terminated or affected, our financial condition, operations or ability to develop and commercialize our proposed products may be harmed.



We substantially rely on licenses to use certain technologies that are material to our operations. For example, we license patents, patent applications and other
intellectual property from Human Genome Sciences for the use of the VEGF-2 technology in our proposed products for vascular and cardiovascular disease. We have also obtained licenses from Caritas St. Elizabeths Medical Center of Boston, Boston
Scientific and Vical to use certain patents and patent applications relating to gene therapy delivery methods in connection with the use of VEGF-2 for gene therapy. We do not own the patents, patent applications and other intellectual property
rights that underlie these licenses. We rely upon our licensors to properly prosecute and enforce the patents, file patent applications and prevent infringement of those patents and patent applications.



While the licenses from Human Genome Sciences and Vical provide us with exclusive rights in
specified fields, the scope of our rights under these and other licenses may be subject to dispute by our licensors or third parties. The licenses from Caritas St. Elizabeths Medical Center of Boston and Boston Scientific provide us with
nonexclusive rights in specified fields and may likewise be subject to dispute by our licensors or third parties.



In addition, the license agreements with Human Genome Sciences and Vical contain certain milestones that we must meet in order to maintain these licenses. The milestones
relevant to the Human Genome Sciences license are listed above under the heading Licenses and Intellectual Property. The next milestone under such license requires us to initiate a Phase IIb or Phase III clinical trial within 3 months of
validating that we have VEGF-2 material acceptable for such clinical trial, but in no event later than June 30, 2004. There is no assurance that we can meet such upcoming milestone or any other milestones in either license or that we can obtain an
extension of the milestones from either Human Genome Sciences or Vical. Our licensors may terminate these licenses if we fail to meet the applicable milestones. If Human Genome Sciences or Vical elects to terminate its license to us, our business
and financial condition may be adversely affected, and we may have to curtail or cease operations. Further, if Human Genome Sciences terminates the license to use the VEGF-2 technology for failure to meet the applicable milestones, we must grant
Human Genome Sciences a license to all data and information generated by us under the license agreement.



We may experience delays in our clinical trials that could adversely affect our financial results and our commercial prospects.



We do not know when planned clinical trials will commence or whether we will complete any of our clinical trials on schedule or at all. We
submitted a protocol to the FDA in the third quarter of 2003 and are currently continuing verbal and written communications with the FDA for a later Phase II, or Phase IIb, clinical trial of our VEGF-2 product candidate for the treatment of coronary
artery disease. We expect further direction from the FDA in the near term and plan on initiating our clinical trials in early 2004 but the timing of the commencement of the trial is dependent on the FDA. We cannot go forward with such clinical
trials until the FDA permits the trials to proceed and the FDA has not given such permission. The FDAs determination of when to permit the trials to proceed is more complex than a typical product candidate because our clinical trials will also
involve the investigation of injection catheters supplied by a third party for gene transfer.



Additionally, we may not be able to find acceptable patients or may experience delays in enrolling patients for our clinical trials. The FDA or we may suspend our clinical trials at any time if either believes that we
are exposing the subjects participating in these trials to unacceptable health risks. The FDA or institutional review boards and/or institutional biosafety committees at the medical institutions and healthcare facilities where we sponsor clinical
trials may suspend any trial indefinitely if they find deficiencies in the conduct of these trials. Our clinical trials were previously suspended on February 23, 2000 by the FDA, and this clinical hold on our Phase II trial was lifted by the FDA on
October 19, 2001. The FDA and institutional review boards may also require large numbers of patients, and the FDA may require that we repeat a clinical trial.



Product development costs to us and our collaborators will increase if we have delays in testing or approvals or if we need to perform more or larger clinical trials
than planned. We typically rely on third party clinical investigators at



18



---

##### Table of Contents

medical institutions and healthcare facilities to conduct our clinical trials, and, as a result, we may face additional
delaying factors outside our control. Significant delays may adversely affect our financial results and the commercial prospects for our proposed products and delay our ability to become profitable.



Additionally, we are required pursuant to our license agreement with Human Genome Sciences to
achieve certain milestones relating to our clinical trials. The next milestone under such license requires us to initiate a Phase IIb or Phase III clinical trial within three months of validating that we have VEGF-2 material acceptable for such
clinical trial, but in no event later than June 30, 2004. Any delay in our clinical trials may prevent us from achieving such milestone, and there is no assurance that we can meet such milestone or that the milestone can be extended. In the event we
fail to meet any of the milestones, Human Genome Sciences may immediately terminate our license if we have not met the particular milestone within 60 days of receiving a notice from Human Genome Sciences regarding the failure to satisfy such
milestone.



Our proposed product requires additional research,
development, testing and regulatory approvals prior to marketing. If our proposed product is delayed or fails, our financial condition will be negatively affected, and we may have to curtail or cease our operations.



We are in the early stage of product development. We currently do not sell any products and
do not expect to have any products commercially available for several years, if at all. Our proposed product requires additional research and development, clinical testing and regulatory clearances prior to marketing. There are many reasons that our
proposed product may fail or not advance beyond clinical testing, including the possibility that:



| |  | our proposed product may be ineffective, unsafe or associated with unacceptable side effects;
| | - | ---------------------------------------------------------------------------------------------



| |  | our proposed product may fail to receive necessary regulatory approvals or otherwise fail to meet applicable regulatory standards;
| | - | ----------------------------------------------------------------------------------------------------------------------------------



| |  | our proposed product may be too expensive to develop, manufacture or market;
| | - | ----------------------------------------------------------------------------



| |  | physicians, patients, third-party payers or the medical community in general may not accept or use our proposed product;
| | - | ------------------------------------------------------------------------------------------------------------------------



| |  | our collaborators may withdraw support for or otherwise impair the development and commercialization of our proposed product;
| | - | -----------------------------------------------------------------------------------------------------------------------------



| |  | the commencement of our clinical trial may be affected or delayed because of our incorporation of an injection catheter device, as well as a therapeutic, in the trial;
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | other parties may hold or acquire proprietary rights that could prevent us or our collaborators from developing or marketing our proposed product; or
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------



| |  | others may develop equivalent or superior products.
| | - | ---------------------------------------------------



In addition, our proposed product is subject to the risks of failure inherent in the development of gene therapy products based on innovative technologies. As a result,
we are not able to predict whether our research, development and testing activities will result in any commercially viable products or applications. To our knowledge, the FDA has not approved any gene therapy products. If our proposed product is
delayed or we fail to successfully develop and commercialize our proposed product, our financial condition may be negatively affected, and we may have to curtail or cease our operations.



19



---

##### Table of Contents

Because we cannot predict whether or when we will obtain regulatory approval to commercialize our product
candidates, we cannot predict the timing of any future revenue from these product candidates.



We cannot commercialize any of our product candidates to generate revenue until the appropriate regulatory authorities have reviewed and approved the applications for the product candidates. We cannot assure you that
the regulatory agencies will complete their review processes in a timely manner or that we will obtain regulatory approval for any product candidate we or our collaborators develop. Satisfaction of regulatory requirements typically takes many years,
is dependent upon the type, complexity and novelty of the product and requires the expenditure of substantial resources. Regulatory approval processes outside the United States include all of the risks associated with the FDA approval process. In
addition, we may experience delays or rejections based upon additional government regulation from future legislation or administrative action or changes in FDA policy during the period of product development, clinical trials and FDA regulatory
review.



We may not successfully establish and maintain collaborative and
licensing arrangements, which could adversely affect our ability to develop and commercialize our proposed products.



Our strategy for the development, testing, manufacturing and commercialization of our proposed product relies on establishing and maintaining collaborations with
corporate partners, licensors and other third parties. At present, we have licenses from Human Genome Sciences, Caritas St. Elizabeths Medical Center of Boston, Boston Scientific and Vical relating to the use and delivery of our VEGF-2 product
candidates for the treatment of vascular disease. We have also entered into a collaboration agreement with Boston Scientific for the development of catheter-based delivery of our VEGF-2 product candidates. We may not be able to maintain or expand
these licenses and collaborations or establish additional licensing and collaboration arrangements necessary to develop and commercialize our proposed products. Even if we are able to maintain or establish licensing or collaboration arrangements,
these arrangements may not be on favorable terms. Any failure to maintain or establish licensing or collaboration arrangements on favorable terms could adversely affect our business prospects, financial condition or ability to develop and
commercialize our proposed products.



We expect to continue to rely on third
party collaborators to perform a number of activities relating to the development and commercialization of our proposed products, including the manufacturing of product materials, the funding and conduct of clinical trials, obtaining regulatory
approvals, and marketing and distribution of any successfully developed products. If we are unable to maintain or expand such collaborative arrangements, it could negatively affect our operations. To the extent that we instead undertake any of these
activities internally, our expenses may increase.



In addition, our success
depends on the performance of our collaborators of their responsibilities under these arrangements. Some collaborators may not perform their obligations in a timely fashion or in a manner satisfactory to us.



We rely on third parties to manufacture our proposed products and the catheters used to
deliver the products. There can be no guarantee that we can obtain sufficient and acceptable quantities of our proposed products and the catheters on acceptable terms, which may delay or impair our ability to develop, test and market such products.



Our business strategy relies on third parties to manufacture and
produce our proposed products and the catheters used to deliver the products in accordance with good manufacturing practices established by the FDA. These third party manufacturers are subject to extensive government regulation and must receive FDA
approval before they can produce clinical material or commercial product. Our proposed products may be in competition with other products for access to these facilities and may be subject to delays in manufacture if third parties give other products
greater priority than our proposed products. These third parties may also not deliver sufficient quantities of our proposed products or the catheters, manufacture our proposed products or the catheters in accordance with specifications, or comply
with applicable government regulations. Additionally, if the manufactured proposed products or the catheters fail to perform as specified, our business and reputation could be severely impacted.



In our prior clinical trials, our product materials were produced by a third party
collaborator, and we have recently entered into a manufacturing agreement for the production of additional product materials in a German facility for



20



---

##### Table of Contents

anticipated Phase III clinical trials and initial commercial use. In the event the manufacturing agreement is terminated,
there are very few contract manufacturers who currently have the capability to produce our proposed products on acceptable terms, or on a timely and cost-effective basis. Although we previously engaged in internal production of the product materials
for the next planned phase, Phase IIb, of our clinical trials, we no longer have any capability to produce our proposed products. There can be no assurance that other manufacturers will be able to successfully produce our proposed products on
acceptable terms, or on a timely or cost-effective basis. There can also be no assurance that manufacturers will be able to manufacture our products in accordance with our product specifications.



We must have sufficient and acceptable quantities of our product materials to conduct our
clinical trials and to market our future products, if and when such products have been approved by the FDA for marketing. If we are unable to obtain sufficient and acceptable quantities of our product material, we may be required to delay the
clinical testing and marketing of our products.



If we do not comply with
applicable regulatory requirements in the manufacture and distribution of our products, we may incur penalties that may inhibit our ability to commercialize our products and adversely affect our revenue.



Our failure or the failure of our collaborators or third party manufacturers to comply with
applicable FDA or other regulatory requirements including manufacturing, quality control, labeling, safety surveillance, promoting and reporting may result in criminal prosecution, civil penalties, recall or seizure of our products, total or partial
suspension of production or an injunction, as well as other regulatory action against our potential products or us. Discovery of previously unknown problems with a product, supplier, manufacturer or facility may result in restrictions on the sale of
our products, including a withdrawal of such products from the market.



In
addition, we have recently entered into a manufacturing agreement for the production of product materials for anticipated Phase III clinical trials and initial commercial use. However, the manufacturing facility is outside of the United States and
is still under consideration for commercial certification by German authorities. There is no assurance that necessary approvals from the FDA or other regulatory authorities can be obtained timely for the manufacturing of our products at such
facility for further clinical trials or for sale in the United States or other countries.



Our licenses and collaboration agreements may restrict our ability to develop, test and market our proposed products.



Our strategy for the development, testing, manufacturing and marketing of our proposed products relies on establishing and maintaining
collaborations with corporate partners, licensors and other third parties. These arrangements may contain provisions that will restrict our ability to develop, test and market our proposed products.



For example, we currently have a collaboration agreement with Boston Scientific that
prohibits us from entering into any development, distribution or similar agreement with respect to VEGF-2 product candidates delivered via an injection catheter or hypodermic needle (excluding clinical site agreements, manufacturing agreements,
contract research agreements and other agreements necessary or useful for the clinical testing of such products) with persons other than Boston Scientific. In addition, we currently have a distribution agreement with Boston Scientific that provides
Boston Scientific with exclusive distribution rights for our proposed VEGF-2 product candidates if and when such products have been approved and are ready for marketing.



Our collaborators may control aspects of our clinical trials, which could result in delays and other obstacles in the
commercialization of our proposed products.



We are dependent on third
party collaborators to design and conduct our clinical trials. Our collaborative partners may also have or acquire rights to control aspects of our product development and clinical programs. As a result, we may not be able to conduct these programs
in the manner or on the time schedule we currently contemplate. In addition, if any of these collaborative partners withdraw support for our programs or proposed products or otherwise impair their development, our business could be negatively
affected.



21



---

##### Table of Contents

If we are unable to create and maintain sales, marketing and distribution capabilities or enter into agreements
with third parties to perform those functions, we will not be able to commercialize our proposed products.



We currently have no sales, marketing or distribution capabilities. Therefore, in order to commercialize our future products, if and when such products have been approved
and are ready for marketing, we must collaborate with third parties to perform these functions.



We have granted exclusive distribution rights for our VEGF-2 products to Boston Scientific. However, Boston Scientific, might, at its discretion, limit the amount of resources and time it devotes to marketing our
products or terminate its agreement with us at any time and for any reason regardless of the terms of the agreement, and our revenues may be significantly affected by Boston Scientifics efforts and the prices it charges for our products.



In the event we no longer have Boston Scientific as a distributor, we have no
experience in developing, training or managing a sales force and will incur substantial additional expenses if we are forced to market our future products directly. Developing a marketing and sales force is also time consuming and could delay launch
of our future products. In addition, we will compete with many companies that currently have extensive and well-funded marketing and sales operations. Our marketing and sales efforts may be unable to compete successfully against these companies.



If we are unable to attract and retain key personnel and advisors, it
may adversely affect our ability to obtain financing, pursue collaborations or develop our proposed products.



Our future success depends on our ability to attract, retain and motivate highly qualified management and scientific and regulatory personnel and advisors. To pursue our
business strategy, we will need to hire or otherwise engage qualified scientific personnel and managers, including personnel with expertise in clinical trials, government regulation and manufacturing. Competition for qualified personnel is intense
among companies, academic institutions and other organizations. If we are unable to attract and retain key personnel and advisors, it may negatively affect our ability to successfully develop, test and commercialize our proposed products.



We use hazardous and biological materials in our business. Any claims
relating to improper handling, storage or disposal of these materials could be time consuming and costly.



Our processes and our collaborators processes involve the controlled storage, use and disposal of hazardous and biological materials and waste products. We and our
suppliers and other collaborators are subject to federal, state and local regulations governing the use, manufacture, storage, handling and disposal of materials and waste products. Even if we and these suppliers and collaborators comply with the
standards prescribed by law and regulation, the risk of accidental contamination or injury from hazardous materials cannot be completely eliminated. In the event of an accident, we could be held liable for any damages that result, and any liability
could exceed the limits or fall outside the coverage of our insurance and exceed our financial resources. We may not be able to maintain insurance on acceptable terms, or at all. We may incur significant costs to comply with current or future
environmental laws and regulations.



If we are unable to maintain our
listing on the American Stock Exchange, our business could be adversely affected, and the liquidity of our common stock would be seriously limited.



Our common stock is currently traded on the American Stock Exchange, or AMEX. To sustain a listing on AMEX, we must maintain certain minimum listing requirements,
including certain levels of stockholders equity. The closing price of our common stock on March 24, 2004 was $6.80 per share. Additionally, AMEX may consider, among other things, the amount of public float, nature of business, financial
integrity and future outlook of a company in considering whether to de-list a company. If our common stock is de-listed from AMEX, it could reduce the liquidity of our common stock, decrease the market price of our common stock and negatively impact
our ability to obtain additional capital.



22



---

##### Table of Contents

Vascular Genetics, which is a wholly-owned subsidiary of Corautus, is a defendant in a pending wrongful death
action. An unfavorable settlement or judgment in this action could harm our business and financial condition.



Vascular Genetics has been named as a defendant in a complaint filed in the Superior Court of Suffolk County in the State of Massachusetts alleging wrongful death and
product liability claims in connection with the death of a patient enrolled in Vascular Genetics clinical trials at St. Elizabeths Medical Center of Boston. The complaint alleges, in part, that the deceased patient should have been
excluded from Vascular Genetics clinical trials because his condition was treatable by conventional revascularization procedures and that the deceased patient did not receive sufficient disclosure of risks and an alleged financial conflict of
interest to provide an informed consent to treatment. Vascular Genetics has filed an answer in response to the complaint denying liability and the principal allegations of the complaint. The litigation is currently in its initial stages.



Although Vascular Genetics denies liability and believes that its current insurance
coverage is adequate to cover any potential liabilities in connection with such litigation, no assurances can be given as to the outcome of this action. An unfavorable settlement or decision in this action could negatively affect our operations and
financial condition. Any liability resulting from this action may exceed our financial resources.



Risks Related to Our Industry



Negative public opinion and increased regulatory scrutiny of gene therapy and genetic research may adversely affect our ability to conduct our business or obtain regulatory approvals for our proposed products.



Ethical, social and legal concerns about gene therapy and genetic research could result in
additional regulations restricting or prohibiting the products and processes we may use. More restrictive government regulations or negative public opinion may have a negative effect on our business or financial condition and may delay or impair the
development and commercialization of our proposed products.



We are
subject to significant government regulation with respect to our proposed products. Compliance with government regulation can be a costly and time-consuming process, with no assurance of ultimate regulatory approval. If these approvals are not
obtained, we will not be able to sell our proposed products.



We and
our collaborators are subject to extensive and rigorous government regulation in the United States and abroad. The FDA, the National Institute of Health and comparable agencies in foreign countries impose many requirements on the introduction of new
pharmaceutical products through lengthy and detailed clinical testing procedures and other costly and time consuming compliance procedures. These requirements vary widely from country to country and make it difficult to estimate when our potential
products will be commercially available, if at all. In addition, gene therapies such as those being developed by us are relatively new and are only beginning to be tested in humans. Regulatory authorities may require us or our collaborators to
demonstrate that our products are improved treatments relative to other therapies or may significantly modify the requirements governing gene therapies, which could result in regulatory delays or rejections. If we are delayed or fail to obtain
required approvals for our proposed products, our operations and financial condition would be damaged. We may not sell our products without applicable regulatory approvals.



Numerous regulations in the United States and abroad also govern the manufacturing, safety, labeling, storage, record keeping, reporting and
marketing of our proposed products. Compliance with these regulatory requirements is time consuming and expensive. If we fail to comply with regulatory requirements, either prior to approval or in marketing our products after approval, we could be
subject to regulatory or judicial enforcement actions. These actions could result in withdrawal of existing approvals, product recalls, injunctions, civil penalties, criminal prosecution, and enhanced exposure to product liabilities.



We cannot assure you that our proposed products will prove safe and effective in clinical
trials and will meet all of the applicable regulatory requirements needed to receive regulatory approval. We will need to conduct significant research, pre-clinical testing and clinical trials before we can file product approval applications with
the FDA and similar regulatory authorities in other countries. Pre-clinical testing and clinical trials are long, expensive and uncertain processes. We may spend several years completing our testing for any particular product candidate, and failure
can occur at any stage.



23



---

##### Table of Contents

Even if we achieve positive results in early clinical trials, these results do not necessarily predict final results. A
number of companies in the pharmaceutical industry have suffered significant setbacks in advanced clinical trials, even after achieving positive results in earlier trials. Negative or inconclusive results or adverse medical events during a clinical
trial could cause the FDA or us to terminate a clinical trial or require that we repeat a clinical trial.



We face intense competition and must cope with rapid technological change, which may adversely affect our financial condition and/or our ability to successfully commercialize our proposed products.



Our competitors and potential competitors include large
pharmaceutical and medical device companies and more established biotechnology companies. These companies have significantly greater financial and other resources and greater expertise than us in research and development, manufacturing, pre-clinical
and clinical testing, obtaining regulatory approvals and marketing. Small companies may also prove to be significant competitors, particularly through collaborative arrangements with large pharmaceutical companies. Many of these competitors have
significant products approved or in development and operate large, well-funded research and development programs. Our potential competitors also include academic institutions, governmental agencies and other public and private research organizations
that conduct research, seek patent protection and establish collaborative arrangements for product and clinical development and marketing.



We are engaged in gene therapy, which is a rapidly changing field. Existing products and therapies to treat vascular and cardiovascular disease, including drugs and
surgical procedures, will compete directly with the products that we are seeking to develop and market. In addition, our competitors may develop more effective or more affordable products, or achieve earlier patent protection or product
commercialization and market penetration than us. As these competitors develop their technologies, they may develop proprietary positions that prevent us from successfully commercializing our future products. Additionally, technologies developed by
our competitors may render our potential products uneconomical or obsolete, and we may not be successful in marketing our potential products against competitors.



Changes and reforms in the health care system or reimbursement policies may adversely affect the sale of our future products or our
ability to obtain an adequate level of reimbursement or acceptable prices for our future products.



We currently have no products approved for marketing. Our ability to earn sufficient returns on our future products, if and when such products are approved and ready for marketing, will depend in part on the extent to
which reimbursement for our products and related treatments will be available from government health administration authorities, private health coverage insurers, managed care organizations and other third-party payers. If we fail to obtain
appropriate reimbursement, it could prevent us from successfully commercializing our future products.



There have been and continue to be efforts by governmental and third-party payers to contain or reduce the costs of health care through various means, including limiting coverage and the level of reimbursement. We
expect that there will continue to be a number of legislative proposals to implement government controls and other reforms to limit coverage and reimbursement. The announcement of these proposals or reforms could impair our ability to raise capital.
The adoption of these proposals or reforms could impair our operations and financial condition.



Additionally, third-party payers, including Medicare, are increasingly challenging the price of medical products and services and are limiting the reimbursement levels offered to consumers for these medical products
and services. If purchasers or users of our future products are not able to obtain adequate reimbursement from third-party payers for the cost of using these products, they may forego or reduce their use. Significant uncertainty exists as to the
reimbursement status of newly approved health care products, including gene therapy treatments, and whether adequate third-party coverage will be available.



24



---

##### Table of Contents

If our proposed products are not effectively protected by valid issued patents or if we are not otherwise able to
protect our proprietary information, it could harm our business.



The
success of our operations will depend in part on our ability and that of our licensors to:



| |  | obtain patent protection for our methods of gene therapy, therapeutic genes and/or gene-delivery methods both in the United States and in other countries with substantial markets;
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | defend patents once obtained;
| | - | -----------------------------



| |  | maintain trade secrets and operate without infringing upon the patents and proprietary rights of others; and
| | - | ------------------------------------------------------------------------------------------------------------



| |  | obtain appropriate licenses upon reasonable terms to patents or proprietary rights held by others that are necessary or useful to us in commercializing our technology, both in the
United States and in other countries with substantial markets.
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



If we are not able to maintain adequate patent protection for our proposed products, we may be unable to prevent our competitors from using our technology or technology that we license.



The patent positions of gene therapy technologies such as those being developed by us and our
collaborators involve complex legal and factual uncertainties. As a result, we cannot be certain that we or our collaborators will be able to obtain adequate patent protection for our potential products.



We do not know whether our licensors pending patent applications will result in the
issuance of patents. In addition, issued patents may be subjected to proceedings limiting their scope, may be held invalid or unenforceable, or may otherwise provide insufficient proprietary protection or commercial advantage. Changes in, or
different interpretations of, patent laws in the United States and other countries may also adversely affect the scope of our patent protection and our competitive situation.



Due to the significant time lag between the filing of patent applications and the publication of such patents, we cannot be certain that our
licensors were the first to file the patent applications we license. In addition, a number of pharmaceutical and biotechnology companies and research and academic institutions have developed technologies, filed patent applications or received
patents on various technologies that may be related to our operations. Some of these technologies, applications or patents may conflict with our or our licensors technologies or patent applications. A conflict could limit the scope of the
patents, if any, that we or our licensors may be able to obtain or result in denial of our or our licensors patent applications. If patents that cover our activities are issued to other companies, we may not be able to develop or obtain
alternative technology.



Patents issued and patent applications filed
internationally relating to gene therapy are numerous, and we cannot assure you that current and potential competitors or other third parties have not filed or received, or will not file or receive applications in the future for patents or obtain
additional proprietary rights relating to products or processes used or proposed to be used by us.



Additionally, there is certain subject matter which is patentable in the United States but not generally patentable outside of the United States. Differences in what constitutes patentable subject matter in various
countries may limit the protection we can obtain on some of our inventions outside of the United States. For example, methods of treating humans are not patentable in many countries outside of the United States. These and other issues may prevent us
from obtaining patent protection outside of the United States, which would have a material adverse effect on our business, financial condition and results of operations.



25



---

##### Table of Contents

We may be subject to costly claims, and, if we are unsuccessful in resolving conflicts regarding patent rights, we
may be prevented from developing or commercializing our proposed products.



There has been, and will likely continue to be, substantial litigation regarding patent and other intellectual property rights in the biotechnology industry. As the biotechnology industry expands and more patents are issued, the risk
increases that our processes and potential products may give rise to claims that they infringe on the patents of others. Others could bring legal actions against us claiming damages and seeking to stop clinical testing, manufacturing and marketing
of the affected product or use of the affected process. Litigation may be necessary to enforce our or our licensors proprietary rights or to determine the enforceability, scope and validity of proprietary rights of others. If we become
involved in litigation, it could be costly and divert our efforts and resources. In addition, if any of our competitors file patent applications in the U.S. claiming technology also invented by us or our licensors, we may need to participate in
interference proceedings held by the U.S. Patent and Trademark Office to determine priority of invention and the right to a patent for the technology. Like litigation, interference proceedings can be lengthy and often result in substantial costs and
diversion of resources.



As more potentially competing patent applications are
filed, and as more patents are actually issued, in the field of gene therapy and with respect to component methods or compositions that we may employ, the risk increases that we or our licensors may be subjected to litigation or other proceedings
that claim damages or seek to stop our product development or commercialization efforts. Even if such patent applications or patents are ultimately proven to be invalid, unenforceable or non-infringed, such proceedings are generally expensive and
time consuming and could consume a significant portion of our resources and substantially impair our product development efforts.



If there were an adverse outcome of any litigation or interference proceeding, we could have a potential liability for significant damages. In addition, we could be
required to obtain a license to continue to make or market the affected product or use the affected process. Costs of a license may be substantial and could include ongoing royalties. We may not be able to obtain such a license on acceptable terms,
or at all.



We may not have adequate protection for our unpatented
proprietary information, which could adversely affect our competitive position.



We substantially rely on trade secrets, know-how, continuing technological innovations and licensing opportunities to develop and maintain our competitive position. However, others may independently develop
substantially equivalent proprietary information and techniques or otherwise gain access to our trade secrets or disclose our technology. To protect our trade secrets, we may enter into confidentiality agreements with employees, consultants and
collaborators. However, these agreements may not provide meaningful protection of our trade secrets or adequate remedies in the event of unauthorized use or disclosure of such information. Likewise, our trade secrets or know-how may become known
through other means or be independently discovered by our competitors. Any of these events could prevent us from developing or commercializing our proposed products.



We face the risk of product liability claims, which could adversely affect our business and financial condition.



Our operations will expose us to potential product liability risks that are inherent in
the testing, manufacturing and marketing of gene therapy products. Failure to obtain sufficient product liability insurance or otherwise protect against product liability claims could prevent or delay the commercialization of our proposed products
or negatively affect our financial condition. Regardless of the merit or eventual outcome, product liability claims may result in withdrawal of proposed products from clinical trials, costs of litigation, substantial monetary awards to plaintiffs
and decreased demand for products.



Product liability may result from harm to
patients using our products that was either not communicated as a potential side-effect or was more extreme than communicated. We will require all patients enrolled in our clinical trials to sign consents, which explain the risks involved with
participating in the trial. The consents, however, provide only a limited level of protection, and product liability insurance will be required. Additionally, we indemnify the clinical centers and related parties in connection with losses they may
incur through their involvement in the clinical trials. We may not be able to obtain or maintain product liability insurance on acceptable terms or with adequate coverage against potential liabilities.



26



---

##### Table of Contents

Risks Related to Our Common Stock



Our stock price has been volatile and an investment in our common stock could decline in value.



The market price of our common stock, and the market prices for securities of pharmaceutical
and biotechnology companies in general, have been highly volatile and may continue to be highly volatile in the future. The following factors, in addition to other risk factors described herein and in light of the low volume of trades in our common
stock, may have a significant impact on the market price of our common stock:



| |  | developments concerning any research and development, clinical trials, manufacturing, and marketing collaborations;
| | - | -------------------------------------------------------------------------------------------------------------------



| |  | announcements of technological innovations or new commercial products by our competitors or us;
| | - | -----------------------------------------------------------------------------------------------



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



| |  | publicity regarding actual or potential results relating to medicinal products under development by our competitors or us;
| | - | --------------------------------------------------------------------------------------------------------------------------



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



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



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



| |  | period-to-period fluctuations in financial results.
| | - | ---------------------------------------------------



Our common stock is thinly traded, which means large transactions in our common stock may be difficult to conduct in a short time frame.



We have a low volume of daily trades in our common stock on the American Stock Exchange. For
example, the daily trading volume in our common stock on the American Stock Exchange over the ten day trading period prior to the filing of this annual report was less than 20,000 shares per day. Any large transactions in our common stock may be
difficult to conduct and may cause significant fluctuations in the price of our common stock.



Our quarterly operating results may fluctuate, causing volatility in our stock price.



We do not receive any revenues from sales of our product candidates. Our results of operations historically have fluctuated on a quarterly basis, which we expect to
continue. Our results of operations at any given time will be based primarily on the following factors:



| |  | the status of development of our product candidates;
| | - | ----------------------------------------------------



| |  | whether we enter into additional collaboration agreements and the timing and accounting treatment of payments, if any, to us under those agreements;
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------



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



| |  | the addition or termination of research programs or funding support.
| | - | --------------------------------------------------------------------



27



---

##### Table of Contents

We believe that quarterly comparisons of our financial results are not necessarily meaningful and should not be relied
upon as an indication of future performance. These fluctuating results may cause the price of our stock to fluctuate, perhaps substantially.



ITEM 2. PROPERTIES



We currently lease
approximately 4,000 square feet of administrative offices in the Advanced Technology Development Center in Atlanta, Georgia. The lease for this office expires in April 2004 and has consecutive 90 day renewals at our option.



We also currently lease approximately 8,600 square feet of laboratory and office space in San
Diego, California. The lease for this space expires in August 2004, and carries 2 three-year renewal terms at our option.



We believe that our current leased facilities are adequate for our current needs.



ITEM 3. LEGAL PROCEEDINGS



PMSI Barnes Canyon,
LLC v. Corautus Genetics Inc., Superior Court, State of California, County of San Diego. In May 2003, the landlord of the manufacturing facility Corautus leased, located at 10030 Barnes Canyon Road, San Diego, California, filed an unlawful
detainer and breach of lease action, claiming Corautus had failed to pay the rents owed under the lease for such facility. On May 27, 2003 we entered into the Agreement for Surrender of Leasehold Interest, Termination of Tenancy and Reservation of
Rights Under Lease, terminating the lease and relinquishing the building to the landlord on June 17, 2003. The security deposit on that facility in the amount of $699,787 (approximately equivalent to six (6) months rent payments) was forfeited to
the landlord. On November 12, 2003, the lawsuit was dismissed by the landlord without prejudice. This dismissal was pursuant to a settlement and release agreement with the landlord dated November 7, 2003 for the settlement of the remaining payments
that would have been due for the original term of such lease, which is described herein under the heading Certain Lease Obligations on page 3.



William C. Raschke v. GenStar Therapeutics, Inc., Corautus Genetics Inc., and Paul D. Quadros, Superior Court, State of California, County of San Diego. On June
27, 2003, Dr. William Raschke, a former officer and employee of Corautus, filed a lawsuit against Corautus and one of its directors, Paul D. Quadros, asserting, among other matters, that we refused to allow him to sell shares of Corautus common
stock he held while he was employed by us. He asserts that he suffered substantial damages because our stock price was much lower after he was no longer employed by us than during the time he was our employee. Dr. Raschke sought compensation for
such alleged losses. On January 15, 2004, the parties settled this action pursuant to a written settlement agreement. The action was dismissed with prejudice on March 5, 2004.



Susan Darke, individually and as Executrix of the Estate of Roger J. Darke v. Estate of Dr. Jeffrey Isner, et al., Suffolk Superior
Court, Suffolk County Massachusetts (Case No. SUCV2002-02194). Corautus wholly-owned subsidiary, Vascular Genetics Inc., has been named as a defendant in the above titled action, alleging that Vascular Genetics is liable for intentional
battery, wrongful death, gross negligence, intentional infliction of emotional distress, product liability, deceit/intentional misrepresentation/fraud in the inducement, and loss of consortium. The complaint does not state a specific dollar amount
for the damages sought by the plaintiff. However, pursuant to a letter required by Massachusetts law to be delivered to the defendants, the plaintiff demanded $5,000,000. Subsequent to such letter, the plaintiff has offered to settle this matter for
$947,000. Vascular Genetics believes it has insurance coverage for any amounts that may be awarded in this action. This action is currently in the discovery phase.



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



No matters were submitted to a vote of security holders during the fourth quarter of the fiscal year ended December 31, 2003.



28



---

##### Table of Contents

ITEM 4A. EXECUTIVE OFFICERS OF THE REGISTRANT



Set
forth below, in accordance with General Instruction G(3) of Form 10-K and Instruction 3 of Item 401(b) of Regulation S-K, are the names, ages and positions of our executive officers along with their business experience during the past five years.
Unless otherwise indicated, the information set forth is as of December 31, 2003. The age of each officer listed is as of the date of the filing of this report. Unless otherwise indicated, all of our executive officers have served continuously since
the dates indicated. There are no family relationships among the officers.



|                                                                                                                         |  |                                      
|------------------------------------------------------------------------------------------------------------------------ |  | -------------------------------------
|Name, Age and Position with the Company                                                                                  |  | Dates Elected or Appointed           
|Richard E. Otto, Age 54 Chief Executive Officer President                                                                |  | February 7, 2003 April 11, 2003 (1)  
|                                                                                                                         | 
|Robert T. Atwood, Age 64 Executive Vice President Chief Financial Officer and Secretary                                  |  | October 13, 2003 February 7, 2003 (2)
|                                                                                                                         | 
|Yawen Chiang, Age 53 Senior Vice President - Research and Development Chief Scientific Officer                           |  | August 1, 2001 February 7, 2003 (3)  
|                                                                                                                         | 
|Nina Vincent Sewell, Age 44 Senior Vice President - Clinical/Regulatory                                                  |  | September 1, 2003 (4)                
|                                                                                                                         | 
|Jack W. Callicutt, Age 37 Vice President - Finance and Administration, Chief Accounting Officer, and Assistant Secretary |  | September 1, 2003 (5)                

---

|(1) | Richard E. Otto is our Chief Executive Officer, President and director and has served as Chief Executive Officer and director since the merger between GenStar and Vascular Genetics
in February 2003. Mr. Otto became President of Corautus in April 2003. Prior to the merger, he served as Chief Executive Officer, President and a director of Vascular Genetics since January 2002. From March 1998 through January 2002, Mr. Otto served
as a consultant to various charitable and commercial organizations. Mr. Otto has spent the past 35 years in the cardiac therapy industry. From September 1995 to March 1998 he served as Chief Executive Officer and a director of CardioDynamics
International Corporation, a publicly traded company listed on NASDAQ that develops, manufactures and markets noninvasive heart-monitoring devices. Mr. Otto has served as a consultant to the founder of WebMD and as a consultant to the Cardiac Rhythm
Management division of St. Jude Medical. His career includes key management positions with Cardiac Pacemakers Inc. (now a Guidant company). Mr. Otto also held positions at Intermedics, Inc., Medtronic Inc., and Eli Lilly and Company. Mr. Otto has
served on the Georgia board of directors of the Juvenile Diabetes Foundation, and Leukemia Society. Mr. Otto was a semifinalist in the 1997 Entrepreneur of the Year Award for the Southern California Region. He received a Bachelor of Science degree
in chemistry from the University of Georgia.
|--- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(2) | Robert T. Atwood is our Chief Financial Office, Executive Vice President, Secretary and Director and has served as Chief Financial Officer and Secretary since the merger between
GenStar and Vascular Genetics in February 2003. Mr. Atwood became Executive Vice President in October 2003 and director in November 2003. Prior to the merger, he served as Chief Financial Officer of Vascular Genetics since January 2002. Prior to
joining Vascular Genetics, Mr. Atwood served for 10 years as Executive Vice President and Chief Financial Officer of First Union Corporation, Charlotte, N.C. Prior to working with First Union, Mr. Atwood was a partner in the international accounting
firm of Deloitte & Touche, having spent 28 years serving clients and in administrative positions in Atlanta, the District of Columbia, and New York. Throughout his career, Mr. Atwood has served on numerous professional association and industry
committees. He was appointed to the Presidents Price Advisory Committee to the Council on Wage and Price Stability from 1978 to 1980 and to the Investment Policy Advisory Committee to the United States Trade Representative from 1984 to 1987.
In addition, Mr. Atwood has served on the board of trustees of many educational, cultural, and charitable activities. In 2001, Mr. Atwood received the Spirit of
|--- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



29



---

##### Table of Contents

Giving Award from the Mint Museum of Art and the Royal and Sun Alliance Company in Charlotte, N.C. Mr.
Atwood graduated from the University of San Diego in 1962 and in May 2001 was awarded the Author E. Hughes Career Achievement Award by the University of San Diego School of Business Administration.

|(3) | Yawen L. Chiang, Ph.D., joined Corautus as Senior Vice President, Research & Development in August 2001. In February 2003, Dr. Chiang became Chief Scientific Officer of
Corautus. Dr. Chiang has twenty-one years of research and development experience in the biotechnology and pharmaceutical industries. Dr. Chiang has had experience with numerous gene therapy clinical trials and has published many articles in the
field of gene therapy. She is named as inventor on several issued or pending patent applications including the 1999 issued patent on Vectors for Tissue Specific Replication. From February 1998 to August 2001, Dr. Chiang was Site Director
for the Aventis/Gencell Research Center in Hayward, California where she was responsible for research and project management, alliance and collaboration management, and technology transfer. Prior to Aventis/Gencell, she was Vice President, Clinical
Studies at Novartis/Genetic Therapy Inc. for ten years. She was the principal investigator on numerous collaborative research and development agreement programs and received SBIR Phase I and II grants. She also had considerable experience with gene
therapy clinical production. Dr. Chiang received a B.S. in Medical Technology, Allied Health, from the University of Maryland, an M.A. in Health Care Administration from Central Michigan University and both an M.S. in Biochemistry and a PhD in
Genetics from George Washington University.
|--- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(4) | Nina Vincent Sewell has served as senior Vice President, Clinical/Regulatory since September 2003. From 1999 to 2003, she managed her own clinical trial consulting firm,
CardioConsult, and provided consulting services to Vascular Genetics, among other pharmaceutical and device companies as well as managing Medical Writer, Inc., a medical education company. Prior to 1999, she was employed in scientific and medical
research positions at Emory University School of Medicine in Atlanta, Georgia. Ms. Sewell received a Bachelor of Science degree in biology and health science from Emory University.
|--- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(5) | Jack W. Callicutt has served as Vice President, Finance and Administration, Chief Accounting Officer and Assistant Secretary since September 2003. Prior to joining Corautus, Mr.
Callicutt spent 14 years with Deloitte & Touche, the last six years as an audit senior manager. Mr. Callicutt is a Certified Public Accountant and graduated, with honors, from Delta State University in 1989 with degrees in Accounting and
Computer Information Systems.
|--- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



PART II



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



Our common stock is currently traded on the American Stock Exchange under the symbol CAQ. Prior to February 7, 2003, our common stock was traded on the
American Stock Exchange under the symbol GNT. On March 10, 2003, we effected a reverse stock split pursuant to which each seven shares of common stock were converted into one share of common stock. The share-related information presented
in this annual report has been adjusted to reflect the reverse stock split. As of March 23, 2004, there were approximately 556 registered holders of record of common stock.



On February 5, 2003, we completed a merger with Vascular Genetics, pursuant to which 5,320,166 shares of our common stock were issued to
stockholders of Vascular Genetics. In connection with the merger, 556,904 shares of Corautus common stock were reserved for potential indemnity obligations payable to former Vascular Genetics stockholders and the outstanding shares of our Series B
preferred stock were converted into 287,274 shares of our common stock. On March 7, 2003, the outstanding shares of our Series A preferred stock were converted into 832,857 shares of our common stock. As of December 31, 2003 there were outstanding
options to purchase 2,062,177 shares of our common stock and warrants to purchase 710,611 shares of our common stock. There are 2,000 shares of our Series C preferred stock outstanding.



30



---

##### Table of Contents

On July 30, 2003, Corautus entered into a strategic alliance with Boston Scientific Corporation. In connection with such
alliance, Boston Scientific made a $9,000,000 investment in exchange for 1,385,377 shares of Series D Preferred Stock, which were convertible into 1,396,116 shares of common stock as of March 24, 2004, subject to adjustment. The Series D Preferred
Stock was sold pursuant to a private offering, with no general solicitation, and was therefore eligible for an exemption from registration pursuant to Section 4(2) of the Securities Act of 1933. The proceeds of this offering were used for working
capital and other general corporate purposes.



On November 7, 2003, we entered
into a settlement and release agreement with PMSI Barnes Canyon, LLC, the landlord of one of the facilities we leased, for the settlement of the remaining payments that would have been due for the original term of the lease for such property (as
further discussed herein under the heading Certain Lease Obligations on page 3). Pursuant to the settlement and release agreement, we delivered to the landlord a warrant to acquire 100,000 shares of our common stock at an exercise price
of $4.50 per share. The warrant is exercisable for seven years immediately following issuance. Additionally, we are obligated, for twenty-four months beginning November 2003, to deliver to the landlord that number of shares of our common stock which
on the first day of each such month shall have a trading value of $50,000. The common stock and warrants were issued pursuant to a private offering, with no general solicitation, and were therefore eligible for an exemption from registration
pursuant to Section 4(2) of the Securities Act of 1933. The consideration we received for this issuance of stock and warrants was release from our obligations under the lease and did not include any cash consideration.



On December 19, 2003, Corautus and three investors (The Walters Group, Rancho Vista Del Mar,
Inc. and The Arthur Engel Trust) entered into a Common Stock and Warrant Purchase Agreement, whereunder the investors agreed to purchase in two tranches an aggregate of 793,640 shares of Corautus common stock and warrants exercisable for 158,728
shares of Corautus common stock. The common stock was issued at a price equal to 90% of the closing market price of Corautus common stock on the day immediately preceding the agreement execution date (i.e., $3.967 per share). The warrants are
exercisable at a price equal to 125% of the closing market price of Corautus common stock on the day immediately preceding the date each transaction closed (i.e., $5.4375 per share for tranche one (108,338 shares) and $6.7625 per share for tranche
two (50,390 shares)). Additionally, the warrants are exercisable by the holder for up to five years immediately following issuance. The transaction closed on December 31, 2003 with respect to 541,690 shares and January 27, 2004 with respect to the
remaining shares. In connection with this offering, we issued two warrants to purchase an aggregate of 32,331 shares of our common stock at an exercise price of $1.00 per share as a finders fee for the offering. The common stock and warrants
were issued pursuant to a private offering, with no general solicitation, and were therefore eligible for an exemption from registration pursuant to Section 4(2) of the Securities Act of 1933. The proceeds of the offering (totaling $3,149,957 with
no underwriting discounts or commissions) will be used for working capital and other general corporate purposes.



On January 8, 2004, Corautus and a group of investors (Ardsley Partners and its affiliates and Vertical Ventures LLC) entered into a Common Stock and Warrant Purchase
Agreement, whereunder the investors agreed to purchase an aggregate of 1,200,000 shares of Corautus common stock and warrants exercisable for 240,000 shares of Corautus common stock. The common stock was issued at a price equal to 90% of the closing
market price of Corautus common stock on the day immediately preceding the agreement execution date (i.e., $4.3819 per share). The warrants are exercisable at a price equal to 120% of the closing market price of Corautus common stock on the day
immediately preceding the date the transaction closed (i.e., $6.72 per share). Additionally, the warrants are exercisable by the holder for up to five years immediately following issuance. The transaction closed on January 16, 2004. The common stock
and warrants were issued pursuant to a private offering, with no general solicitation, and were therefore eligible for an exemption from registration pursuant to Section 4(2) of the Securities Act of 1933. The proceeds of the offering (totaling
$5,260,680 less $289,337 in finders fees) will be used for working capital and other general corporate purposes.



Pursuant to the common stock and warrant purchase agreements, we were obligated to file a registration statement with the Securities and Exchange Commission to register
the shares sold thereunder within 30 days of the issuance. On January 27, 2004, we filed a registration statement on Form S-3 to register an aggregate of 4,185,318 shares of common stock, which included: (i) 2,424,699 shares issued or issuable
pursuant to the common stock and warrant purchase agreements, (ii) 366,664 shares issued or issuable to PMSI Barnes Canyon LLC pursuant to the settlement and release agreement (see Certain Lease Obligations above for a discussion on the
settlement), and (iii) 1,393,955 shares issuable upon conversion of the Series D Preferred Stock. The registration statement of Form S-3, as amended on February 2, 2004, was declared effective on February 6, 2004.



31



---

##### Table of Contents

On March 3, 2004, Corautus and Millennium Partners, L.P. entered into a Common Stock and Warrant Purchase Agreement,
whereunder Millennium agreed to purchase 334,220 shares of Corautus common stock and warrants exercisable for 16,711 shares of Corautus common stock for net cash proceeds of approximately $2.0 million. The common stock was issued at a price equal to
88% of the closing market price of Corautus common stock on the day immediately preceding the agreement execution date (i.e., $5.9835 per share). The warrants are exercisable at a price equal to 125% of the closing market price of Corautus common
stock on the day immediately preceding the date the transaction closed (i.e., $8.375 per share). Additionally, the warrants are exercisable by the holder for up to five years immediately following issuance. The transaction closed on March 18, 2004.
The common stock and warrants were issued pursuant to a private offering, with no general solicitation, and were therefore eligible for an exemption from registration pursuant to Section 4(2) of the Securities Act of 1933. The proceeds of the
offering will be used as part of the funding for Corautus planned Phase IIb clinical trial.



On March 5, 2004, Corautus and Fusion Capital Fund II, LLC entered into a Common Stock and Warrant Purchase Agreement, whereunder Fusion agreed to purchase 41,780 shares of Corautus common stock and warrants
exercisable for 2,089 shares of Corautus common stock for net cash proceeds of approximately $250,000. The common stock was issued at a price equal to 88% of the closing market price of Corautus common stock on the day immediately preceding the
agreement execution date (i.e., $5.9835 per share). The warrants are exercisable at a price equal to 125% of the closing market price of Corautus common stock on the day immediately preceding the date the transaction closed (i.e., $8.375 per share).
Additionally, the warrants are exercisable by the holder for up to five years immediately following issuance. The transaction closed on March 18, 2004. The common stock and warrants were issued pursuant to a private offering, with no general
solicitation, and were therefore eligible for an exemption from registration pursuant to Section 4(2) of the Securities Act of 1933. The proceeds of the offering will be used as part of the funding for Corautus planned Phase IIb clinical
trial.



We have never paid any cash dividends on our common stock to date. We
currently anticipate that we will retain all future earnings, if any, to fund the development and growth of our business and do not anticipate paying any cash dividends for at least the next five years, if ever.



The following table shows for the periods indicated the high and low closing prices for our
common stock on the American Stock Exchange (adjusted for the one-for-seven reverse stock split which occurred on March 10, 2003):



|                                       |  |      |       |     |   |     
|-------------------------------------- |  | ---- | ----- | --- | - | ----
|                                       |  | HIGH |       | LOW
|FISCAL YEAR ENDED December 31, 2002:   |  |      |       |     |   |     
|First Quarter                          |  | $    | 17.08 |     | $ | 7.00
|Second Quarter                         |  | $    | 7.70  |     | $ | 2.52
|Third Quarter                          |  | $    | 5.25  |     | $ | 1.75
|Fourth Quarter                         |  | $    | 4.13  |     | $ | 1.89
|                                       |  |     
|FISCAL YEAR ENDED December 31, 2003:   |  |      |       |     |   |     
|First Quarter                          |  | $    | 3.57  |     | $ | 1.33
|Second Quarter                         |  | $    | 3.55  |     | $ | 1.27
|Third Quarter                          |  | $    | 6.36  |     | $ | 2.82
|Fourth Quarter                         |  | $    | 6.20  |     | $ | 4.34
|                                       |  |     
|FISCAL YEAR ENDED December 31, 2004:   |  |      |       |     |   |     
|First Quarter (through March 24, 2004) |  | $    | 7.51  |     | $ | 4.50



ITEM 6. SELECTED FINANCIAL DATA



The following
selected financial data are derived from our consolidated financial statements, which have been audited by Ernst & Young LLP, independent auditors. Ernst & Young LLPs report on our consolidated financial



32



---

##### Table of Contents

statements for the three years ended December 31, 2003, and for the period from July 1, 1991 (inception) to December 31,
2003, appears elsewhere herein. The financial data for all other periods and dates have been derived from consolidated audited financial statements of Corautus that are not included in this annual report. The data should be read in conjunction with
Managements Discussion and Analysis of Financial Condition and Results of Operations and the consolidated financial statements, related notes and other financial information included in this annual report. The historical results
are not necessarily indicative of results to be expected for any future period.



|                                            |  |                                      |         |   |                                                       |   |         |      |  |   |         |   |  |      |         |   |  |   |        |   |  |   |         |  
|------------------------------------------- |  | ------------------------------------ | ------- | - | ----------------------------------------------------- | - | ------- | ---- |  | - | ------- | - |  | ---- | ------- | - |  | - | ------ | - |  | - | ------- | -
|                                            |  | Year Ended December 31,              |         |   | Period fromJuly 1, 1991(inception) toDecember 31,2003 |  
|                                            |  | 2003                                 |         |   | 2002                                                  |   |         | 2001 |  |   | 2000    |   |  | 1999 |         |  
|                                            |  | (in thousands except per share data) |        
|Statement of Operation Data:                |  |                                      |         |   |                                                       |   |         |      |  |   |         |   |  |      |         |   |  |   |        |   |  |   |         |  
|Net revenues                                |  | $                                    | 35      |   |                                                       | $ | 1,120   |      |  | $ | 301     |   |  | $    | 162     |   |  | $ | 118    |   |  | $ | 2,577   |  
|                                            |  |                                      |         |   |                                                       |  
|Costs and expenses:                         |  |                                      |         |   |                                                       |   |         |      |  |   |         |   |  |      |         |   |  |   |        |   |  |   |         |  
|Cost of sales                               |  |                                      |        |   |                                                       |   |        |      |  |   |        |   |  |      |        |   |  |   |       |   |  |   | 822     |  
|Research and development                    |  |                                      | 3,217   |   |                                                       |   | 9,067   |      |  |   | 8,624   |   |  |      | 6,414   |   |  |   | 2,711  |   |  |   | 35,468  |  
|General and administrative                  |  |                                      | 7,939   |   |                                                       |   | 3,670   |      |  |   | 3,539   |   |  |      | 2,374   |   |  |   | 817    |   |  |   | 19,686  |  
|Write-off of acquired in-process technology |  |                                      | 17,295  |   |                                                       |   |        |      |  |   |        |   |  |      | 1,655   |   |  |   |       |   |  |   | 24,405  |  
|Write-off of property and equipment         |  |                                      | 1,946   |   |                                                       |   | 636     |      |  |   | 12      |   |  |      |        |   |  |   |       |   |  |   | 2,594   |  
|                                            |  |                                      |         |   |                                                       |  
|Total costs and expenses                    |  |                                      | 30,397  |   |                                                       |   | 13,373  |      |  |   | 12,175  |   |  |      | 10,443  |   |  |   | 3,528  |   |  |   | 82,975  |  
|                                            |  |                                      |         |   |                                                       |  
|Loss from operations                        |  |                                      | (30,362 | ) |                                                       |   | (12,253 | )    |  |   | (11,874 | ) |  |      | (10,281 | ) |  |   | (3,410 | ) |  |   | (80,398 | )
|                                            |  |                                      |         |   |                                                       |  
|Other income (expense)                      |  |                                      | 19      |   |                                                       |   | 75      |      |  |   | 10      |   |  |      | (12     | ) |  |   | (72    | ) |  |   | 86      |  
|Interest expense                            |  |                                      | (123    | ) |                                                       |   | (462    | )    |  |   | (459    | ) |  |      | (230    | ) |  |   | (360   | ) |  |   | (1,940  | )
|Interest income                             |  |                                      | 58      |   |                                                       |   | 586     |      |  |   | 1,228   |   |  |      | 913     |   |  |   | 24     |   |  |   | 2,836   |  
|                                            |  |                                      |         |   |                                                       |  
|Net loss                                    |  | $                                    | (30,408 | ) |                                                       | $ | (12,054 | )    |  | $ | (11,095 | ) |  | $    | (9,610  | ) |  | $ | (3,818 | ) |  | $ | (79,416 | )
|                                            |  |                                      |         |   |                                                       |  
|Basic and diluted net loss per share        |  | $                                    | (3.31   | ) |                                                       | $ | (3.54   | )    |  | $ | (3.36   | ) |  | $    | (3.20   | ) |  | $ | (2.48  | ) |  |   |         |  
|                                            |  |                                      |         |   |                                                       |  
|Weighted average shares outstanding         |  |                                      | 9,196   |   |                                                       |   | 3,408   |      |  |   | 3,301   |   |  |      | 3,001   |   |  |   | 1,538  |   |  |   |         |  



|                                                                      |  |                |        |      |   |        |  |      |        |      |   |        |  |   |       |  
|--------------------------------------------------------------------- |  | -------------- | ------ | ---- | - | ------ |  | ---- | ------ | ---- | - | ------ |  | - | ----- | -
|                                                                      |  | December 31,   |       
|                                                                      |  | 2003           |        | 2002 |   | 2001   |  | 2000 |        | 1999 |  
|                                                                      |  | (in thousands) |       
|Balance Sheet Data:                                                   |  |                |        |      |   |        |  |      |        |      |   |        |  |   |       |  
|Working capital                                                       |  | $              | 6,750  |      | $ | 2,061  |  | $    | 15,379 |      | $ | 20,343 |  | $ | 448   |  
|Total assets                                                          |  |                | 10,534 |      |   | 10,621 |  |      | 21,102 |      |   | 24,444 |  |   | 1,897 |  
|Long-term debt and capital lease obligations, net of current portions |  |                | 2,500  |      |   | 506    |  |      | 695    |      |   | 2,585  |  |   | 1,927 |  
|Lease settlement obligation, net of current portion                   |  |                | 1,815  |      |   |       |  |      |       |      |   |       |  |   |      |  
|Shareholders equity (deficit)                                        |  |                | 2,491  |      |   | 6,097  |  |      | 17,785 |      |   | 20,183 |  |   | (905  | )



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



This Managements Discussion and Analysis of Financial Condition and Results of Operations contains forward-looking statements that are subject to a variety of
risks and uncertainties including those set forth under Risks and Uncertainties in Item 1 of this report. The statements that are not purely historical are forward-looking statements within the meaning of Section 27A of the Securities
Act of 1933 and Section 21E of the Securities Exchange Act of 1934, including without limitation statements regarding our expectations, beliefs, intentions or strategies regarding



33



---

##### Table of Contents

the future. All forward-looking statements included in this document are based on information available to us on the
date hereof, and we assume no obligation to update any such forward-looking statements. Our actual results could differ materially from those anticipated in these forward-looking statements. See the section at the beginning of this report titled
Cautionary Factors That May Affect Future Results.



Introduction



Corautus Genetics Inc. is a
biopharmaceutical company dedicated to the development of innovative gene therapy products for the treatment of cardiovascular and vascular disease.



On February 5, 2003, we completed a merger with Vascular Genetics, pursuant to which Vascular Genetics became a wholly-owned subsidiary of Corautus. Concurrently, the
name of our company was changed from GenStar Therapeutics Corporation to Corautus Genetics Inc. The focus of our resources and efforts for the foreseeable future will be the clinical development of gene therapy products using a vascular growth
factor gene known as Vascular Endothelial Growth Factor 2, or VEGF-2, for the treatment of severe cardiovascular and vascular disease.



A total of 5,320,166 shares of our common stock were issued to Vascular Genetics stockholders in connection with the merger. Additionally, we issued options to purchase
229,648 shares of our common stock and warrants to purchase 19,164 shares of our common stock in exchange for outstanding Vascular Genetics options and warrants.



The acquisition has been accounted for as a purchase of assets by us for financial reporting purposes, in accordance with accounting
principles generally accepted in the United States. After February 5, 2003, the results of Vascular Genetics have been included in our consolidated financial statements. The purchase price was allocated based on the fair value of the assets acquired
and the liabilities assumed. Pursuant to the Emerging Issues Task Forces Issue No. 98-3, Determining Whether a Nonmonetary Transaction Involves the Receipt of Productive Assets or of a Business, Vascular Genetics did not meet the
criteria necessary to qualify as a business. Therefore, our acquisition of Vascular Genetics did not qualify as a business combination under Statement of Financial Accounting Standards No. 141, Business Combinations, and no goodwill resulted
from the recording of the transaction. Identified intangible assets with finite lives are being amortized over those lives. We are required to review long-lived assets on at least an annual basis. To the extent the value of the long-lived assets are
impaired, we will be required to record an impairment charge. One of the intangible assets that was identified is in-process research and development. The value of this intangible asset has been charged to operations upon the close of the
transaction as it did not otherwise qualify for capitalization as there were significant required regulatory approvals remaining. The other intangible asset identified was acquired workforce of $80,000, which is being amortized over two years. The
final determination of the intangible asset values and required purchase accounting adjustments, including the allocation of the purchase price to the assets acquired and liabilities assumed based on their respective values, has been made and
recorded during 2003.



On July 30, 2003, we entered into a strategic alliance
with Boston Scientific Corporation to develop and commercialize VEGF-2. Boston Scientific made a $9,000,000 investment in exchange for 1,385,377 shares of Series D Preferred Stock and a $1,000,000 license fee for certain intellectual property, which
is being recognized as revenue over the anticipated term of the license of 12 years. Boston Scientific also agreed to purchase up to $15 million of convertible debt from Corautus based on achievement of certain milestones. Boston Scientific has
obtained exclusive rights to market, distribute and sell Corautus VEGF-2 gene products, if and when regulatory approval is obtained.



After the establishment of our alliance with Boston Scientific and the receipt of the $10,000,000 in funding relating to that transaction, one of the critical issues
remaining for us in 2003 was securing additional financing needed to fund our operations and our planned Phase IIb clinical trial. Since we have no significant revenues at this time, we must raise funds either from equity or loans. We expect that
the cost of the Phase IIb clinical trial will be approximately $30,000,000; however, additional costs may be associated with any changes in the protocol. Subsequent trials needed prior to the receipt of commercial revenues, if ever achieved, will
cost additional substantial sums of money.



34



---

##### Table of Contents

Over the past several months, we have been raising money in two primary ways. First, we have a $15 million loan facility
with Boston Scientific (discussed above). In December 2003, Boston Scientific made the first advance of $2.5 million on that loan facility in advance of the first milestone having been met.



Second, we have also been raising funds by the private placement of our securities to
institutional and private investors. In these transactions, we have sold unregistered securities and granted the investors certain registration rights. From December 2003 to the date of this Annual Report on Form 10-K, we have raised a total of
$10.7 million through private placements of our common stock to certain accredited investors.



We believe that our existing capital resources will be sufficient to support our current operating plan through the first quarter of 2005. We will require additional financing to fund our operations beyond that date,
and we are continuing our efforts to raise additional funds at the present time.



Looking ahead, the most critical component to our current business plan is initiating and successfully completing the Phase IIb clinical trial for our product candidate for the treatment of coronary artery disease. Prior to the completion
of our merger with Vascular Genetics, Vascular Genetics had already completed Phase I/II clinical trials for this product utilizing a surgical procedure and a randomized, placebo-controlled Phase I/II clinical trial employing a percutaneous
catheter-based method to deliver the VEGF-2 plasmid DNA directly to the heart muscle. The Phase I/II clinical trials provided preliminary data that we believe supports the safety of the product candidate and its delivery method. In the clinical
trial process, the next step is a later Phase II, or Phase IIb, clinical trial to further evaluate the safety and effectiveness of this product candidate. We submitted a protocol to the FDA in the third quarter of 2003 for that trial, and we are
continuing written and verbal communications with the FDA. The FDA must approve our submissions before we may proceed with the Phase IIb clinical trial and that approval has not been obtained. The FDAs determination of when to permit the
trials to proceed is more complex than a typical product candidate because our clinical trials will also involve the investigation of injection catheters supplied by a third party for gene transfer. We expect further direction from the FDA in the
near term and the commencement of our Phase IIb clinical trial in early 2004.



Critical Accounting Policies and Estimates



Our
discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The
preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. On an ongoing basis,
we evaluate our estimates, including those related to revenue recognition, patent costs and income taxes. We base our estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the
results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.



We believe the following critical accounting policies affect the significant
judgments and estimates used in the preparation of our consolidated financial statements (see Note 1 to our consolidated financial statements).



Revenue Recognition



Grant revenue is recognized as the research expenses related to the grants are incurred. Contract revenue arising from collaborative research agreements is recognized either (i) ratably over the term of the agreement,
which approximates the performance of services, for contracts specifying payment for services over a given period, or (ii) as services are performed under the agreement, for contracts specifying payment on a per full-time employee basis. All amounts
received under collaborative research agreements or research grants are not refundable, regardless of the success of the underlying research.



35



---

##### Table of Contents

Stock Based Compensation



We grant stock options for a fixed number of shares to employees in accordance with Accounting Principles Board Opinion No. 25 (APB 25), Accounting for Stock Issued
to Employees, and accordingly, recognize no compensation expense for the stock option grants to employees provided that the option exercise price is not less than the fair market value of the underlying stock on the date of the grant. The value
of options, warrants, or stock awards issued to non-employees have been determined in accordance with SFAS No. 123, Accounting for Stock Based Compensation,and Emerging Issues Task Force Issue No. 96-18, Accounting for Equity Instruments
that are Issued to Other than Employees for Acquiring, or in Conjunction with Selling Goods and Services, and are periodically remeasured as the options vest, if required. Warrants for common stock are valued at the date of issuance and are
recorded to the expense category related to the services provided.



Results of Operations



Revenues



We have generated revenues to date of $2,577,070 from contract research agreements and
grants. Total revenues for the years ended December 31, 2003, 2002 and 2001 were approximately $35,000, $1,120,000, and $301,000, respectively. Revenues for the year ended December 31, 2003, were from the sublicense of certain patents to Boston
Scientific Corporation as part of Boston Scientifics investment in Corautus. For the year ended December 31, 2002, $870,000 of revenue was from a research grant and $250,000 was contract revenue from a research agreement with a corporate
partner. Revenue for the year ended December 31, 2001 was from a research grant. We do not anticipate revenues from products for at least four to six years. Product revenues are contingent on the success of our clinical trials.



Research and Development and Acquired In-Process Technology



Research and development expenses decreased $5,850,000 to $3,217,000 for the year ended
December 31, 2003 compared to approximately $9,067,000 for the year ended December 31, 2002. The decrease in research and development expenses for the year ended December 31, 2003 is due to an overall decrease in research and development activity.
Research and development expenses primarily consist of costs associated with pre-clinical testing and clinical trials of our product candidates, including the costs of manufacturing the product candidates, compensation and other expenses related to
research and development personnel, research supplies, contract research services and facilities expenses. As Corautus focused its efforts in the cardiovascular area, we curtailed virtually all spending on other research and development activities
that had been previously occurring. The charge of approximately $17,295,000 for the write-off of acquired in-process technology related to the merger with Vascular Genetics as it did not otherwise qualify for capitalization as there were significant
required regulatory approvals remaining.



In 2003, we completed the
manufacturing of the VEGF-2 materials and believe that we have all of the VEGF-2 material expected to be needed through the Phase IIb clinical trial. Research on the MAX-AD, DUAL-AD and lentiviral systems was suspended early in 2003. Thus, research
costs for those programs were not significant.



Research and development
expenses increased $443,000 to $9,067,000 for the year ended December 31, 2002 compared to approximately $8,624,000 for the year ended December 31, 2001. The increase in research and development expenses for the year ended December 31, 2002 is due
to an overall increase in research and development activity. Research and development expenses primarily consist of costs associated with pre-clinical testing and clinical trials of our product candidates, including the costs of manufacturing the
product candidates, compensation and other expenses related to research and development personnel, research supplies, contract research services and facilities expenses.



Research and development activities in 2001 in the MAX-AD FVIII program consisted primarily of generating and testing materials for the
Phase I clinical trial that commenced in June 2001. Additionally, a laboratory for analysis of clinical samples was established. In the DUAL-AD prostate cancer program, activities consisted of additional efficacy studies in animal models and the
development of manufacturing processes for this product. Activities in the vaccines program consisted of the generation of vaccine vectors and proof of concept studies in animal models.



36



---

##### Table of Contents

During the two years ended December 31, 2002, research and development activities consisted primarily of research for the
MAX-AD, DUAL-AD and lentiviral systems. The majority of the research and development costs related to pre-clinical research in these programs areas. Additionally, research and development expense included costs related to the Phase I clinical trial
for the FVIII MAX-AD program, in which one patient was treated.



We estimate
that it will take between four to six years to complete clinical testing of any of our products and obtain regulatory approvals, if we are able to obtain approvals. We anticipate increasing research and development expenditures in the future as we
conduct clinical testing necessary to bring our products to market.



General
and Administrative Expenses



General and administrative expenses increased
$4,269,000 for the year ended December 31, 2003 to approximately $7,939,000 compared to approximately $3,670,000 for the year ended December 31, 2002. General and administrative expenses increased $131,000 for the year ended December 31, 2002 to
approximately $3,670,000 compared to approximately $3,539,000 for the year ended December 31, 2001.



General and administrative expenses include the costs of our administrative personnel and consultants, office lease expenses and other overhead costs, including legal and accounting costs. In 2003, we settled a lease
obligation for approximately $3,400,000 in cash and stock, which was incurred when we terminated a lease on a manufacturing facility, which would have run eight more years and had minimum payments of approximately $16,500,000. The majority of the
remaining increase in general and administrative expenses related to legal fees, severance and other costs associated with relocating Corautus principal offices to Atlanta, Georgia from San Diego, California. General and administrative
expenses increased during 2002 and 2001 related to the increased level of operations. We expect the number of financial and administrative employees to remain relatively constant in 2004 and for costs to decline from 2003 primarily due to the lease
settlement obligation charge recorded in 2003.



Write-off of Property and
Equipment



The write-off of property and equipment of approximately
$1,946,000 in 2003 related to the decision to abandon our manufacturing facility and outsource future manufacturing operations. The charge relates to tenant improvement costs and certain equipment related to the manufacturing operations. The
write-off of property and equipment of approximately $636,000 in 2002 related to the disposal of equipment with no future use as a result of Corautus change in focus relating to the merger with Vascular Genetics and certain leasehold
improvements resulting from vacating the Altman Row facility.



Interest
Income and Expense



Interest income decreased $528,000 for the year ended
December 31, 2003 to approximately $58,000 compared to approximately $586,000 for the year ended December 31, 2002. Interest income decreased $641,000 for the year ended December 31, 2002 to approximately $586,000 compared to approximately
$1,227,000 for the year ended December 31, 2001. The decrease in interest income for the years 2003 compared to 2002 and 2002 compared to 2001 is due to the decline in our cash, cash equivalents and short term investments balances during 2003 and
2002, respectively.



Interest expense decreased $339,000 for the year ended
December 31, 2003 to approximately $123,000 compared to approximately $462,000 for the year ended December 31, 2002. Interest expense increased $3,000 for the year ended December 31, 2002 to approximately $462,000 compared to approximately $459,000
for the year ended December 31, 2001. Interest expense decreased in 2003 compared to 2002 due to a decrease in amortization of deferred financing costs and lower average debt and capital lease obligations balances.



37



---

##### Table of Contents

Liquidity and Capital Resources



From inception through December 31, 2003, we have primarily financed our operations through private placements of equity and convertible
debt securities, our strategic alliance with Boston Scientific Corporation and through our partnership with Baxter Healthcare. We have raised approximately $3.9 million in convertible debt offerings, $27.5 million in private equity financings, $8.1
million in net proceeds from the Boston Scientific Corporation investment and received equity funding of $14.9 million related to our relationship with Baxter Healthcare. Additionally, we have financed equipment purchases under capital leases and
secured notes payable totaling $1.9 million.



Net cash used by operating
activities was approximately $7,568,000, $9,225,000, and $10,882,000 during 2003, 2002 and 2001, respectively. Net cash used by operating activities primarily consists of expenditures for research and development and general and administrative
expenses. Net cash provided by investing activities of $4,285,000 during 2003 consists of the net sale of short-term investments and sale of property and equipment net of purchases of such. Net cash generated from investing activities of
approximately $7,817,000 and $1,343,000 during 2002 and 2001 respectively, consists of purchases of short-term investments net of sales of short-term investments and purchases of property and equipment. Net cash provided by financing activities of
$11,501,000 during 2003 consists primarily of net proceeds from the Boston Scientific Corporation investment of $8,084,000, private placement of common stock and warrants of $2,150,000 and proceeds from convertible notes payable to Boston Scientific
Corporation of $2,500,000 reduced by payments on capital leases of $1,320,000. Net cash used by financing activities of $336,000 during 2002 consists primarily of proceeds from our notes payable of $429,000, offset by repayments of our capital lease
and notes payable of $832,000, and proceeds from the issuance of common stock upon exercise of options and warrants for common stock of $68,000. Net cash provided by financing activities of $6,682,000 during 2001 consists primarily of $3,873,000
paid by Baxter Healthcare under the credit agreement, proceeds from the sale of Series C preferred stock to Baxter Healthcare of $2,000,000 and proceeds from our capital lease agreement of $807,000, offset by repayments of our capital lease and
notes payable of $540,000, proceeds from the issuance of common stock upon exercise of options and warrants for common stock of $421,000 and investor short swing profit of $124,000.



As of December 31, 2003, we had cash, cash equivalents and short-term investments totaling approximately $8.9 million. We received net
proceeds of approximately $6.0 million in January 2004 from the private placement of common stock and warrants. We received net proceeds of approximately $2.25 million from the private placement of common stock and warrants in March 2004. We expect
to draw an additional $2.5 million of convertible notes payable from Boston Scientific Corporation upon treatment of our first patient in our Phase IIb clinical trial. Our operations to date have consumed substantial amounts of cash and have
generated insignificant revenues. The negative cash flow from operations is expected to continue and to accelerate for at least the next four years. The development of our products will require a commitment of substantial funds to conduct the costly
and time-consuming research, preclinical and clinical testing necessary to bring our products to market and to establish manufacturing and marketing capabilities. Our future capital requirements will depend on many factors including the progress of
our research and development programs; the progress, scope and results of our pre-clinical and clinical testing; the time and cost involved in obtaining regulatory approvals; the cost of manufacturing for our proposed products; the cost of filing,
prosecuting, defending and enforcing patent claims and other intellectual property rights; competing technological and market developments; and our ability to establish and maintain collaborative and other arrangements with third parties, such as
licensing and manufacturing agreements, and the cost of such arrangements.



We
expect that our existing capital resources will enable us to maintain our current and planned operations through the first quarter of 2005. We will need to raise substantial additional capital to fund our planned operations. We will be seeking this
additional funding either through collaborative arrangements or through public or private equity or debt financings. We cannot be certain that additional financing will be available on acceptable terms, or at all. We do not have any commitments or
arrangements assuring us of any additional funds in the future, and there is no assurance that we will be able to obtain additional capital on acceptable terms, or at all. Failure to successfully address ongoing liquidity requirements will have a
material adverse effect upon our business. In the event that we are unable to obtain additional capital, we will be required to take actions that will harm our business and our ability to achieve cash flow in the future. To the extent we raise
additional cash by issuing equity securities, our existing stockholders will be diluted. If additional funds are raised through the issuance of debt securities, these securities are likely to have rights, preferences and privileges senior to our
common stock and preferred stock.



38



---

##### Table of Contents

Contractual Obligations



The following is a summary of our contractual obligations as of December 31, 2003:



|                             |  |                        |           |                  |   |             |  |             |           |                   |   |  |   |          
|---------------------------- |  | ---------------------- | --------- | ---------------- | - | ----------- |  | ----------- | --------- | ----------------- | - |  | - | ---------
|                             |  | Payments due by Period
|Contractual obligations      |  | Total                  |           | Less than 1 year |   | 1  3 years |  | 3  5 years |           | More than 5 years
|Long-term debt               |  | $                      | 2,500,000 |                  |   |            |  |             |          |                   |  |  | $ | 2,500,000
|                             |  |                        |           |                  |  
|Capital lease obligation (1) |  | $                      | 402,000   |                  | $ | 353,000     |  | $           | 49,000    |                   |  |  |   |         
|                             |  |                        |           |                  |  
|Operating lease              |  | $                      | 188,000   |                  | $ | 188,000     |  |             |          |                   |  |  |   |         
|                             |  |                        |           |                  |  
|Purchase obligations         |  | $                      | 3,375,000 |                  | $ | 2,031,000   |  | $           | 1,344,000 |                   |  |  |   |         
|                             |  |                        |           |                  |  
|Lease settlement obligation  |  | $                      | 2,943,000 |                  | $ | 1,128,000   |  | $           | 1,815,000 |                   |  |  |   |         
|                             |  |                        |           |                  |  
|Total                        |  | $                      | 9,408,000 |                  | $ | 3,700,000   |  | $           | 3,208,000 |                   |  |  | $ | 2,500,000

---

|(1) | As a result of the write-off and sale of certain of the assets and the lack of payment for a period of time during 2003, we were in default under the terms of its capital leases and
have classified the entire balance as current. We are negotiating a new arrangement with the lender with regard to the default and believe the remaining payments will be made in accordance with the schedule above.
|--- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



New Accounting Pronouncements



In January 2003, the FASB issued FASB Interpretation No. 46, or FIN 46, Consolidation of
Variable Interest Entities. FIN 46 requires a variable interest entity to be consolidated by a company if that company is subject to a majority of the risk of loss from the variable interest entitys activities or entitled to receive a
majority of the entitys residual returns or both. A variable interest entity either (a) does not have equity investors with voting rights, or (b) has equity investors that do not provide sufficient financial resources to the entity to support
its activities. FIN 46 is effective immediately for all new variable interest entities created or acquired after January 31, 2003. For variable interest entities created or acquired prior to February 1, 2003, the provisions of FIN 46 must be applied
for the first interim or annual period beginning after September 15, 2003. The adoption of FIN 46 did not have a material impact on our results of operations or financial condition.



In May 2003, the FASB issued SFAS No 150, Accounting for Certain Instruments with Characteristics of Both Liabilities and Equity.
SFAS No. 150 requires that certain financial instruments issued in the form of shares that are mandatorily redeemable as well as certain other financial instruments be classified as liabilities in the financial



39



---

##### Table of Contents

statements. SFAS No 150 is effective for financial instruments entered into or modified after May 31, 2003 and otherwise
is effective at the beginning of the first interim period beginning after June 15, 2003. Adoption of this standard did not have a material impact on Corautus financial position, results of operations or cash flows.



ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK



The primary objective of our investment activities is to preserve principal while at the same time maximizing the income we receive from our investments without significantly increasing risk. Some of the securities
that we invest in may have market risk. This means that a change in prevailing interest rates may cause the principal amount of the investment to fluctuate. For example, if we hold a security that was issued with a fixed interest rate at the
then-prevailing rate and the prevailing interest rate later rises, the market value of our investment will probably decline. To minimize this risk in the future, we intend to maintain our portfolio of cash equivalents and short-term investments in a
variety of securities, including commercial paper, money market funds, government and non-government debt securities and certificates of deposit. The average duration of the majority of our investments in 2003 was less than one year. Due to the
short-term nature of these investments, we believe that we have no material exposure to interest rates arising from our investments. Therefore, no quantitative tabular disclosure is included in this report.



We are subject to a certain amount of short-term foreign exchange risk related to a
manufacturing contract we entered into in December 2003 with a German corporation. The contract is for the manufacture of our VEGF-2 plasmid material for our planned Phase III clinical trial and commercial use. The payments made under the contract
are denominated in Euros and are expected to be made over the next two to three years. Such payments will not commence until successful completion of our Phase IIb clinical trial and we are unable to predict currency exchange risk at this time.



ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA



SEE ITEM 15. Exhibits, Financial Statement Schedules, and Reports on Form 8-K.



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



NONE



ITEM 9A. CONTROLS AND PROCEDURES



| | (a) | Evaluation of disclosure controls and procedures. Our chief executive officer and chief financial officer are responsible for establishing and maintaining disclosure
controls and procedures (as defined in the Securities and Exchange Act of 1934 Rules 13a-15(e) and 15d-15(e)) for the company. Our chief executive officer and chief financial officer, after evaluating the effectiveness of our disclosure
controls and procedures as of the end of the period covered by this annual report, have concluded that our disclosure controls and procedures were effective in timely alerting them to material information relating to us (including our consolidated
subsidiaries) required to be included in our periodic SEC filings.
| | --- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | (b) | Changes in internal controls over financial reporting. There were no changes in our internal controls over financial reporting that occurred during our most recent fiscal
quarter that have materially affected, or are reasonably likely to materially affect, our internal controls over financial reporting.
| | --- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



40



---

##### Table of Contents

PART III



ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT



The information required by this item with respect to directors is set forth under the captions Security Ownership of Certain Beneficial Owners and Management, Proposal 1 - Election of
Directors and Section 16(a) Beneficial Ownership Reporting Compliance in the Proxy Statement and is incorporated herein by reference. The information required by this item with respect to the executive officers is, pursuant to
Instruction 3 of Item 401(b) of Regulation S-K and General Instruction G (3) of Form 10-K, set forth at Part I, Item 4(A) of this report under the caption Executive Officers of the Registrant.



We have adopted a code of business conduct and ethics, which applies to our chief executive
officer and our senior financial officers. Our code of business conduct and ethics is posted on our website at www.corautus.com under the headings Investor Relations- Corporate Governance- Code of Business Conduct and Ethics. We will
also provide a copy of the code of business conduct and ethics to stockholders upon request. Any amendments to or waivers from any provision of our code of business conduct and ethics will be disclosed by posting such information on our website.



ITEM 11. EXECUTIVE COMPENSATION



The information
required by this item is set forth under the caption Compensation of Directors and Executive Officers, Compensation Committee Report on Executive Compensation and Stock Performance Graph in the Proxy Statement and
is incorporated herein by reference.



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



Equity Compensation Plan Information:



The information required by this item is set forth under the caption Compensation of Directors and Executive Officers in the Proxy Statement and is
incorporated herein by reference.



ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS



The information required by this item is set forth under the caption Certain Relationships and Related Transactions in the Proxy Statement and is incorporated by reference.



ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES



The information required by this item is set forth under the caption Proposal 4 - Ratification of Re-Appointment of Independent Accountants in the Proxy Statement and is incorporated by reference.



PART IV



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



|(a) | Index to Financial Statements
|--- | -----------------------------



|   |  |                                                                                                                                                               |  |     
|-- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ----
|   |  |                                                                                                                                                               |  | Page
|1. |  | Consolidated Financial Statements                                                                                                                             |  |     
|   |  |                                                                                                                                                              
|   |  | Report of Ernst & Young LLP, Independent Auditors                                                                                                             |  | F-1 
|   |  |                                                                                                                                                              
|   |  | Consolidated Balance Sheets as of December 31, 2003 and 2002                                                                                                  |  | F-2 
|   |  |                                                                                                                                                              
|   |  | Consolidated Statements of Operations for the years ended December 31, 2003, 2002, and 2001 and the period from July 1, 1991 (inception) to December 31, 2003 |  | F-3 
|   |  |                                                                                                                                                              
|   |  | Consolidated Statements of Stockholders Equity (Deficit) for the period from July 1, 1991 (inception) to December 31, 2003                                   |  | F-4 
|   |  |                                                                                                                                                              
|   |  | Consolidated Statements of Cash Flows for the years ended December 31, 2003, 2002, and 2001 and the period from July 1, 1991 (inception) to December 31, 2003 |  | F-10
|   |  |                                                                                                                                                              
|   |  | Notes to Consolidated Financial Statements                                                                                                                    |  | F-11



41



---

##### Table of Contents

|2. | Schedules to Financial Statements
|-- | ---------------------------------



All schedules are omitted because they are not applicable or the required information is included in the financial statements or notes thereto.



|(b) | Reports on Form 8-K
|--- | -------------------



None



|(c) | Exhibits
|--- | --------



|              |  |                                                                                                                                                                                                                           |  |                           |  |          |  |              
|------------- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ------------------------- |  | -------- |  | -------------
|              |  |                                                                                                                                                                                                                           |  | Incorporated by Reference
|ExhibitNumber |  | Exhibit Description                                                                                                                                                                                                       |  | Form                      |  | Date     |  | FiledHerewith
|              |  |                                                                                                                                                                                                                           | 
|2.1           |  | Agreement and Plan of Reorganization, dated as of September 12, 2002, by and among GenStar Therapeutics Corporation, Genesis Acquisition Corporation and Vascular Genetics Inc.                                           |  | 8-K                       |  | 09/16/02 |  |              
|              |  |                                                                                                                                                                                                                           |  |                          
|2.2           |  | Amendment to Agreement and Plan of Reorganization, dated as of November 26, 2002, between GenStar Therapeutics Corporation, Genesis Acquisition Corporation and Vascular Genetics
Inc.                                    |  | S-4/A*                    |  | 12/19/02 |  |              
|              |  |                                                                                                                                                                                                                           |  |                          
|2.3           |  | Second Amendment to Agreement and Plan of Reorganization, dated as of February 5, 2003, between GenStar Therapeutics Corporation, Genesis Acquisition Corporation and Vascular Genetics
Inc.                              |  | 8-K                       |  | 2/14/03  |  |              
|              |  |                                                                                                                                                                                                                           |  |                          
|2.4           |  | Escrow Agreement, dated as of December 18, 2002, among GenStar Therapeutics Corporation, Genesis Acquisition Corporation, Vascular Genetics Inc., Century Capital Associates LLC and U.S. Bank
Trust National Association |  | 10-K                      |  | 03/28/03 |  |              
|              |  |                                                                                                                                                                                                                           |  |                          
|3.1           |  | Restated Certificate of Incorporation                                                                                                                                                                                     |  | 10-Q                      |  | 08/14/03 |  |              
|              |  |                                                                                                                                                                                                                           |  |                          
|3.2           |  | Certificate of Amendment to the Restated Certificate of Incorporation                                                                                                                                                     |  | 10-KSB                    |  | 03/30/00 |  |              



42



---

##### Table of Contents

|              |  |                                                                                                                                                          |  |                           |  |          |  |              
|------------- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ------------------------- |  | -------- |  | -------------
|              |  |                                                                                                                                                          |  | Incorporated by Reference
|ExhibitNumber |  | Exhibit Description                                                                                                                                      |  | Form                      |  | Date     |  | FiledHerewith
|3.3           |  | Certificate of Amendment to the Restated Certificate of Incorporation                                                                                    |  | 10-K                      |  | 03/28/03 |  |              
|              |  |                                                                                                                                                          |  |                          
|3.4           |  | Certificate of Amendment to the Restated Certificate of Incorporation                                                                                    |  | 10-K                      |  | 03/28/03 |  |              
|              |  |                                                                                                                                                          |  |                          
|3.5           |  | Certificate of Amendment to the Restated Certificate of Incorporation                                                                                    |  | 10-K                      |  | 03/28/03 |  |              
|              |  |                                                                                                                                                          |  |                          
|3.6           |  | Amended and Restated Certificate of Designation of Preferences and Rights of Series A Preferred Stock                                                    |  | S-4/A*                    |  | 12/19/02 |  |              
|              |  |                                                                                                                                                          |  |                          
|3.7           |  | Amended and Restated Certificate of Designation of Preferences and Rights of Series B Preferred Stock                                                    |  | S-4/A*                    |  | 12/19/02 |  |              
|              |  |                                                                                                                                                          |  |                          
|3.8           |  | Amended and Restated Certificate of Designation of Preferences and Rights of Series C Preferred Stock                                                    |  | S-4/A*                    |  | 12/19/02 |  |              
|              |  |                                                                                                                                                          |  |                          
|3.9           |  | Certificate of Designation of Preferences and Rights of Series D Preferred Stock                                                                         |  | 10-Q                      |  | 08/14/03 |  |              
|              |  |                                                                                                                                                          |  |                          
|3.10          |  | Second Amended and Restated Bylaws                                                                                                                       |  |                           |  |          |  | X            
|              |  |                                                                                                                                                          |  |                          
|4.1           |  | Investor Rights Agreement, dated July 8, 1998, between UroGen Corp. and Baxter Healthcare Corporation                                                    |  | 8-K                       |  | 07/23/98 |  |              
|              |  |                                                                                                                                                          |  |                          
|4.2           |  | First Amendment to the Investor Rights Agreement, effective February 5, 2003, between GenStar Therapeutics Corporation and Baxter Healthcare Corporation |  | S-4/A*                    |  | 12/19/02 |  |              
|              |  |                                                                                                                                                          |  |                          
|4.3           |  | Investor Rights Agreement, dated July 30, 2003, between Corautus and Boston Scientific Corporation                                                       |  | 10-Q                      |  | 08/14/03 |  |              
|              |  |                                                                                                                                                          |  |                          
|10.1          |  | Form of Indemnification Agreement                                                                                                                        |  | 10-SB                     |  | 02/09/96 |  |              
|              |  |                                                                                                                                                          |  |                          
|10.2          |  | Consulting and Employment Agreement, dated April 23, 1997, by and between UroGen Corp. and Paul D. Quadros                                               |  | S-4/A*                    |  | 12/19/02 |  |              
|              |  |                                                                                                                                                          |  |                          
|10.3          |  | Amendment to the Consulting and Employment Agreement, dated December 18, 2002, by and between GenStar Therapeutics Corporation and Paul D. Quadros       |  | S-4/A*                    |  | 12/19/02 |  |              
|              |  |                                                                                                                                                          |  |                          
|10.4          |  | Separation Agreement and General Release of Claims, dated April 4, 2003, by and between Corautus Genetics Inc. and Robert E. Sobol, M.D.                 |  | 10-Q                      |  | 05/14/03 |  |              
|              |  |                                                                                                                                                          |  |                          
|10.5          |  | Employment Agreement, dated May 14, 2003, by and between Corautus Genetics Inc. and Richard E. Otto                                                      |  | 10-Q                      |  | 08/14/03 |  |              
|              |  |                                                                                                                                                          |  |                          
|10.6          |  | Employment Agreement, dated May 14, 2003, by and between Corautus Genetics Inc. and Robert T. Atwood                                                     |  | 10-Q                      |  | 08/14/03 |  |              
|              |  |                                                                                                                                                          |  |                          
|10.7          |  | Retention Agreement, dated April 15, 2003, by and between Corautus Genetics Inc. and Carin D. Sandvik                                                    |  | 10-Q                      |  | 08/14/03 |  |              
|              |  |                                                                                                                                                          |  |                          
|10.8          |  | Employment Letter, dated August 27, 2003, by and between Corautus Genetics Inc. and Jack W. Callicutt                                                    |  | 10-Q                      |  | 11/13/03 |  |              



43



---

##### Table of Contents

|              |  |                                                                                                                                                           |  |                           |  |          |  |              
|------------- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ------------------------- |  | -------- |  | -------------
|              |  |                                                                                                                                                           |  | Incorporated by Reference
|ExhibitNumber |  | Exhibit Description                                                                                                                                       |  | Form                      |  | Date     |  | FiledHerewith
|10.9          |  | Employment Letter, dated August 26, 2003, by and between Corautus Genetics Inc. and Nina Vincent Sewell                                                   |  | 10-Q                      |  | 11/13/03 |  |              
|              |  |                                                                                                                                                           |  |                          
|10.10         |  | Employment Letter, dated September 22, 2003, by and between Corautus Genetics Inc. and Yawen Chiang                                                       |  | 10-Q                      |  | 11/13/03 |  |              
|              |  |                                                                                                                                                           |  |                          
|10.11         |  | Investment Agreement, dated July 30, 2003, by and between Corautus Genetics Inc. and Boston Scientific Corporation.                                       |  | 10-Q                      |  | 08/14/03 |  |              
|              |  |                                                                                                                                                           |  |                          
|10.12         |  | Loan Agreement, dated July 30, 2003, by and among Corautus Genetics Inc., Vascular Genetics Inc. and Boston Scientific Corporation.                       |  | 10-Q                      |  | 08/14/03 |  |              
|              |  |                                                                                                                                                           |  |                          
|10.13         |  | First Amendment to Loan Agreement, dated December 29, 2003, by and among Corautus Genetics Inc., Vascular Genetics Inc. and Boston Scientific Corporation |  |                           |  |          |  | X            
|              |  |                                                                                                                                                           |  |                          
|10.14         |  | Promissory Note issued on December 29, 2003, by Corautus Genetics Inc. and Vascular Genetics Inc. to Boston Scientific Corporation                        |  |                           |  |          |  | X            
|              |  |                                                                                                                                                           |  |                          
|10.15         |  | Development Agreement, dated July 30, 2003, by and between Corautus Genetics Inc. and Boston Scientific Corporation.                                      |  | 10-Q                      |  | 08/14/03 |  |              
|              |  |                                                                                                                                                           |  |                          
|10.16         |  | Distribution Agreement, dated July 30, 2003, by and between Corautus Genetics Inc. and Boston Scientific Corporation                                      |  | 10-Q                      |  | 08/14/03 |  |              
|              |  |                                                                                                                                                           |  |                          
|10.17         |  | Sub-Lease Agreement with Sidney Kimmel Cancer Center, dated April 12, 2000, for property located at 10835 Altman Row, San Diego, California               |  | S-4/A*                    |  | 12/19/02 |  |              
|              |  |                                                                                                                                                           |  |                          
|10.18         |  | Amended and Restated License Agreement, dated February 28, 2001, by and between Vascular Genetics Inc. and Human Genome Sciences, Inc.                    |  | 10-Q                      |  | 05/14/03 |  |              
|              |  |                                                                                                                                                           |  |                          
|10.19         |  | First Amendment to Amended and Restated License Agreement, dated October 10, 2002, by and between Vascular Genetics Inc. and Human Genome Sciences, Inc.  |  | 10-Q                      |  | 05/14/03 |  |              
|              |  |                                                                                                                                                           |  |                          
|10.20         |  | License Agreement, dated February 24, 2000, by and between Vascular Genetics Inc. and Vical Incorporated.                                                 |  | 10-Q                      |  | 05/14/03 |  |              
|              |  |                                                                                                                                                           |  |                          
|10.21         |  | Employee Stock Purchase Plan                                                                                                                              |  | 10-KSB                    |  | 03/29/02 |  |              
|              |  |                                                                                                                                                           |  |                          
|10.22         |  | Lease Agreement with PMSI Barnes Canyon, LLC, dated January 22, 2001, for property located at 10030 Barnes Canyon Road, San Diego, California             |  | S-4/A*                    |  | 12/19/02 |  |              
|              |  |                                                                                                                                                           |  |                          
|10.23         |  | Settlement Agreement and Release, dated November 7, 2003, by and between Corautus Genetics Inc. and PMSI Barnes Canyon, LLC                               |  | 10-Q                      |  | 11/13/03 |  |              



44



---

##### Table of Contents

|              |  |                                                                                                                                     |  |                           |  |          |  |              
|------------- |  | ----------------------------------------------------------------------------------------------------------------------------------- |  | ------------------------- |  | -------- |  | -------------
|              |  |                                                                                                                                     |  | Incorporated by Reference
|ExhibitNumber |  | Exhibit Description                                                                                                                 |  | Form                      |  | Date     |  | FiledHerewith
|10.24         |  | Common Stock and Warrant Purchase Agreement dated December 19, 2003 between Corautus Genetics Inc. and the investors therein named. |  | S-3**                     |  | 1/27/04  |  |              
|              |  |                                                                                                                                     |  |                          
|10.25         |  | Common Stock and Warrant Purchase Agreement dated January 8, 2003 between Corautus Genetics Inc. and the investors therein named.   |  | S-3**                     |  | 1/27/04  |  |              
|              |  |                                                                                                                                     |  |                          
|10.26         |  | Common Stock and Warrant Purchase Agreement dated March 3, 2004 between Corautus Genetics Inc. and the investors therein named      |  |                           |  |          |  | X            
|              |  |                                                                                                                                     |  |                          
|10.27         |  | Common Stock and Warrant Purchase Agreement dated March 5, 2004 between Corautus Genetics Inc. and the investors therein named      |  |                           |  |          |  | X            
|              |  |                                                                                                                                     |  |                          
|10.28         |  | 2002 Stock Plan                                                                                                                     |  | S-4/A*                    |  | 12/19/02 |  |              
|              |  |                                                                                                                                     |  |                          
|10.29         |  | Warrant Certificate dated June 20, 2002 between GenStar Therapeutics Corporation and CEOcast, Inc.                                  |  | 10-K                      |  | 03/28/03 |  |              
|              |  |                                                                                                                                     |  |                          
|10.30         |  | Warrant Certificate dated June 20, 2002 between GenStar Therapeutics Corporation and CEOcast, Inc.                                  |  | 10-K                      |  | 03/28/03 |  |              
|              |  |                                                                                                                                     |  |                          
|10.31         |  | Warrant Certificate dated May 9, 2002 between GenStar Therapeutics Corporation and Lyon & Lyon LLP                                  |  | 10-K                      |  | 03/28/03 |  |              
|              |  |                                                                                                                                     |  |                          
|21.1          |  | Subsidiaries of Corautus Genetics Inc.                                                                                              |  |                           |  |          |  | X            
|              |  |                                                                                                                                     |  |                          
|23.1          |  | Consent of Ernst & Young LLP, Independent Auditors                                                                                  |  |                           |  |          |  | X            
|              |  |                                                                                                                                     |  |                          
|24.1          |  | Power of Attorney (included with signature page hereto)                                                                             |  |                           |  |          |  | X            
|              |  |                                                                                                                                     |  |                          
|31.1          |  | Section 302 Certification of Chief Executive Officer and Chief Financial Officer                                                    |  |                           |  |          |  | X            
|              |  |                                                                                                                                     |  |                          
|32.1          |  | Section 906 Certification of Chief Executive Officer and Chief Financial Officer                                                    |  |                           |  |          |  | X            

---

|* | Form S-4/A file no. 333-101606
|- | ------------------------------

|** | Form S-3 file no. 333-112239
|-- | ----------------------------



45



---

##### Table of Contents

SIGNATURES



Pursuant to the requirements of Section 13 or 15 (d) of Securities Exchange Act of 1934, the Registrant has duly caused this Report to be signed on its behalf by the
undersigned, thereunto duly authorized on March 30, 2004.



CORAUTUS GENETICS INC.A Delaware CorporationBy:

/s/ Robert T. AtwoodRobert T. AtwoodExecutive Vice President, Chief Financial Officer,Secretary and Director




Power of
Attorney



KNOW ALL MEN BY THESE PRESENTS, that each person whose signature
appears below constitutes and appoints Richard E. Otto, Robert T. Atwood and Jack W. Callicutt, and each of them his or her true and lawful attorneys-in-fact and agents, with full power of substitution and resubstitution, for him or her and in his
or her name, place and stead, in any and all capacities, to sign any and all amendments to this Annual Report on Form 10-K for the calendar year ended December 31, 2003, and to file the same, with all exhibits thereto and other documents in
connection therewith, with the Securities and Exchange Commission, granting unto said attorneys-in-fact and agents, and each of them, full power and authority to do and perform each and every act and thing requisite or necessary to be done, as fully
to all intents and purposes as he or she might or could do in person, hereby ratifying and confirming all that said attorneys-in-fact and agents or ay of them, or their or his substitute or substitutes, may lawfully do or cause to be done by virtue
hereof.



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 and in the capacities indicated as of March 30, 2004.



|                                       |  |                                                                                                                            
|-------------------------------------- |  | ---------------------------------------------------------------------------------------------------------------------------
|Signatures                             |  | Title                                                                                                                      
|                                       | 
|/s/ Richard E. OttoRichard E. Otto     |  | Chief Executive Officer (Principal Executive Officer), President and Director                                              
|                                       | 
|/s/ Robert T. AtwoodRobert T. Atwood   |  | Executive Vice President, Chief Financial Officer (Principal Financial Officer), Secretary, and Director                   
|                                       | 
|/s/ Jack W. CallicuttJack W. Callicutt |  | Vice President of Finance and Administration (Principal Accounting Officer), Chief Accounting Officer & Assistant Secretary
|                                       | 
|/s/ Paul D. QuadrosPaul D. Quadros     |  | Chairman of the Board of Directors                                                                                         



46



---

##### Table of Contents

|                                         |  |         
|---------------------------------------- |  | --------
|                                         | 
|Eric N. Falkenberg                       |  | Director
|                                         | 
|/s/ James C. GilstrapJames C. Gilstrap   |  | Director
|                                         | 
|/s/ John R. LarsonJohn R. Larson         |  | Director
|                                         | 
|/s/ Daniel PharandDaniel Pharand         |  | Director
|                                         | 
|/s/ Ivor Royston, M.D.Ivor Royston, M.D. |  | Director
|                                         | 
|/s/ Victor W. SchmittVictor W. Schmitt   |  | Director



47



---

##### Table of Contents

REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS



The Board of Directors and Stockholders

Corautus Genetics Inc.



We have audited the
accompanying consolidated balance sheets of Corautus Genetics Inc. (formerly GenStar Therapeutics Corporation) (a development stage enterprise) (the Company) as of December 31, 2003 and 2002, and the related consolidated statements of
operations, stockholders equity (deficit), and cash flows for each of the three years in the period ended December 31, 2003 and for the period from July 1, 1991 (inception) to December 31, 2003. These consolidated financial statements are the
responsibility of the Companys management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.



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



In our opinion, the consolidated financial statements referred to above present fairly, in
all material respects, the consolidated financial position of Corautus Genetics Inc. (a development stage enterprise) at December 31, 2003 and 2002, and the consolidated results of its operations and its cash flows for each of the three years in the
period ended December 31, 2003 and the for period from July 1, 1991 (inception) to December 31, 2003, in conformity with accounting principles generally accepted in the United States.



/s/ ERNST & YOUNG LLP



Atlanta, Georgia

March 18, 2004



F-1



---

##### Table of Contents

CORAUTUS GENETICS INC.

(A DEVELOPMENT STAGE ENTERPRISE)



CONSOLIDATED BALANCE SHEETS



|                                                                                                                                                                                                                       |  |              |             |   |      |   |             |  
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ------------ | ----------- | - | ---- | - | ----------- | -
|                                                                                                                                                                                                                       |  | December 31, |            
|                                                                                                                                                                                                                       |  | 2003         |             |   | 2002 |  
|ASSETS                                                                                                                                                                                                                 |  |              |             |   |      |   |             |  
|Current assets:                                                                                                                                                                                                        |  |              |             |   |      |   |             |  
|Cash and cash equivalents                                                                                                                                                                                              |  | $            | 8,911,994   |   |      | $ | 694,013     |  
|Short-term investments                                                                                                                                                                                                 |  |              |            |   |      |   | 4,218,020   |  
|Accounts receivable                                                                                                                                                                                                    |  |              | 39,249      |   |      |   | 70,611      |  
|Other current assets                                                                                                                                                                                                   |  |              | 644,901     |   |      |   | 349,047     |  
|                                                                                                                                                                                                                       |  |              |             |   |      |   |             |  
|Total current assets                                                                                                                                                                                                   |  |              | 9,596,144   |   |      |   | 5,331,691   |  
|Property and equipment, net                                                                                                                                                                                            |  |              | 184,338     |   |      |   | 2,616,451   |  
|Deferred merger expenses                                                                                                                                                                                               |  |              |            |   |      |   | 1,323,854   |  
|Restricted cash                                                                                                                                                                                                        |  |              | 680,901     |   |      |   | 450,933     |  
|Deferred loan fee                                                                                                                                                                                                      |  |              |            |   |      |   | 45,049      |  
|Other assets                                                                                                                                                                                                           |  |              | 72,652      |   |      |   | 853,078     |  
|                                                                                                                                                                                                                       |  |              |             |   |      |   |             |  
|                                                                                                                                                                                                                       |  | $            | 10,534,035  |   |      | $ | 10,621,056  |  
|                                                                                                                                                                                                                       |  |              |             |   |      |   |             |  
|LIABILITIES AND STOCKHOLDERS EQUITY                                                                                                                                                                                   |  |              |             |   |      |   |             |  
|Current liabilities:                                                                                                                                                                                                   |  |              |             |   |      |   |             |  
|Accounts payable                                                                                                                                                                                                       |  | $            | 380,998     |   |      | $ | 1,408,884   |  
|Accrued employee benefits                                                                                                                                                                                              |  |              | 83,917      |   |      |   | 152,573     |  
|Other accrued liabilities                                                                                                                                                                                              |  |              | 792,900     |   |      |   | 1,000,030   |  
|Capital lease obligation, current portion                                                                                                                                                                              |  |              | 376,265     |   |      |   | 558,825     |  
|Deferred revenue, current portion                                                                                                                                                                                      |  |              | 83,333      |   |      |   |            |  
|Lease settlement obligation, current portion                                                                                                                                                                           |  |              | 1,128,189   |   |      |   |            |  
|Notes payable, current portion                                                                                                                                                                                         |  |              |            |   |      |   | 150,772     |  
|                                                                                                                                                                                                                       |  |              |             |   |      |   |             |  
|Total current liabilities                                                                                                                                                                                              |  |              | 2,845,602   |   |      |   | 3,271,084   |  
|Notes payable, net of current portion                                                                                                                                                                                  |  |              | 2,500,000   |   |      |   | 74,386      |  
|Lease settlement obligation, net of current portion                                                                                                                                                                    |  |              | 1,815,289   |   |      |   |            |  
|Deferred revenue, net of current portion                                                                                                                                                                               |  |              | 881,944     |   |      |   |            |  
|Capital lease obligation, net of current portion                                                                                                                                                                       |  |              |            |   |      |   | 431,893     |  
|Other long-term liabilities                                                                                                                                                                                            |  |              |            |   |      |   | 592,848     |  
|Deferred compensation                                                                                                                                                                                                  |  |              |            |   |      |   | 154,016     |  
|                                                                                                                                                                                                                       |  |             
|Stockholders equity:                                                                                                                                                                                                  |  |              |             |   |      |   |             |  
|Convertible Preferred Stock$0.001 par value, 5,000,000 shares authorized:                                                                                                                                             |  |              |             |   |      |   |             |  
|Series A Preferred Stock, 0 and 5,830 shares issued and outstanding, respectively, liquidation preference of $58,300                                                                                                   |  |              |            |   |      |   | 6           |  
|Series B Preferred Stock, 0 and 12,890 shares issued and outstanding, respectively, liquidation preference of $12,890,000 prior to any
distribution to holders of Series A Preferred Stock and holders of Common Stock |  |              |            |   |      |   | 13          |  
|Series C Preferred Stock, 2,000 shares issued and outstanding, liquidation preference of $2,000,000 prior to any distribution to holders of
Series A Preferred Stock and holders of Common Stock                       |  |              | 2           |   |      |   | 2           |  
|Series D Preferred Stock, 1,385,377 and 0 shares issued and outstanding, respectively, liquidation preference of $9,004,951 prior to any
distribution to holders of Series A Stock and holders of Common Stock         |  |              | 1,385       |   |      |   |            |  
|Common Stock$0.001 par value, 100,000,000 shares authorized; 10,564,877 and 3,431,393 shares issued and outstanding,
respectively                                                                                     |  |              | 10,565      |   |      |   | 3,431       |  
|Additional paid-in capital                                                                                                                                                                                             |  |              | 78,169,917  |   |      |   | 51,376,821  |  
|Deficit accumulated during development stage                                                                                                                                                                           |  |              | (75,690,669 | ) |      |   | (45,282,523 | )
|Accumulated other comprehensive income (loss)                                                                                                                                                                          |  |              |            |   |      |   | (921        | )
|                                                                                                                                                                                                                       |  |              |             |   |      |   |             |  
|Total stockholders equity                                                                                                                                                                                             |  |              | 2,491,200   |   |      |   | 6,096,829   |  
|                                                                                                                                                                                                                       |  |              |             |   |      |   |             |  
|                                                                                                                                                                                                                       |  | $            | 10,534,035  |   |      | $ | 10,621,056  |  
|                                                                                                                                                                                                                       |  |              |             |   |      |   |             |  



See accompanying notes.



F-2



---

##### Table of Contents

CORAUTUS GENETICS INC.

(A DEVELOPMENT STAGE ENTERPRISE)



CONSOLIDATED STATEMENTS OF OPERATIONS



|                                                                             |      |                                 |             |      |                                               |   |             |   |  |   |             |   |  |   |             |  
|---------------------------------------------------------------------------- | ---- | ------------------------------- | ----------- | ---- | --------------------------------------------- | - | ----------- | - |  | - | ----------- | - |  | - | ----------- | -
|                                                                             |      | For the Year Ended December 31, |             |      | July 1, 1991 (inception) to December 31, 2003 |  
|                                                                             | 2003 |                                 |             | 2002 |                                               |   | 2001        |   | 
|Revenues                                                                     |      | $                               | 34,722      |      |                                               | $ | 1,120,438   |   |  | $ | 300,900     |   |  | $ | 2,577,070   |  
|Costs and expenses:                                                          |      |                                 |             |      |                                               |   |             |   |  |   |             |   |  |   |             |  
|Cost of sales                                                                |      |                                 |            |      |                                               |   |            |   |  |   |            |   |  |   | 821,878     |  
|Research and development                                                     |      |                                 | 3,217,327   |      |                                               |   | 9,066,519   |   |  |   | 8,624,082   |   |  |   | 35,468,070  |  
|General and administrative                                                   |      |                                 | 7,939,065   |      |                                               |   | 3,670,159   |   |  |   | 3,538,641   |   |  |   | 19,685,526  |  
|Write-off of acquired in-process technology                                  |      |                                 | 17,294,576  |      |                                               |   |            |   |  |   |            |   |  |   | 24,405,005  |  
|Write-off of property and equipment                                          |      |                                 | 1,945,743   |      |                                               |   | 636,433     |   |  |   | 11,866      |   |  |   | 2,594,042   |  
|                                                                             |      |                                 |             |      |                                               |   |             |   |  |   |             |   |  |   |             |  
|Total costs and expenses                                                     |      |                                 | 30,396,711  |      |                                               |   | 13,373,111  |   |  |   | 12,174,589  |   |  |   | 82,974,521  |  
|                                                                             |      |                                 |             |      |                                               |   |             |   |  |   |             |   |  |   |             |  
|Loss from operations                                                         |      |                                 | (30,361,989 | )    |                                               |   | (12,252,673 | ) |  |   | (11,873,689 | ) |  |   | (80,397,451 | )
|Other income (expense), net                                                  |      |                                 | 19,458      |      |                                               |   | 74,586      |   |  |   | 10,390      |   |  |   | 84,786      |  
|Interest expense                                                             |      |                                 | (123,415    | )    |                                               |   | (461,410    | ) |  |   | (458,998    | ) |  |   | (1,939,822  | )
|Interest income                                                              |      |                                 | 57,800      |      |                                               |   | 585,914     |   |  |   | 1,227,287   |   |  |   | 2,836,025   |  
|                                                                             |      |                                 |             |      |                                               |   |             |   |  |   |             |   |  |   |             |  
|Net loss                                                                     |      | $                               | (30,408,146 | )    |                                               | $ | (12,053,583 | ) |  | $ | (11,095,010 | ) |  | $ | (79,416,462 | )
|                                                                             |      |                                 |             |      |                                               |   |             |   |  |   |             |   |  |   |             |  
|Basic and diluted loss per share                                             |      | $                               | (3.31       | )    |                                               | $ | (3.54       | ) |  | $ | (3.36       | ) |  |   |             |  
|                                                                             |      |                                 |             |      |                                               |   |             |   |  |   |             |   |  |   |             |  
|Number of shares used in the computation of basic and diluted loss per share |      |                                 | 9,195,964   |      |                                               |   | 3,407,754   |   |  |   | 3,301,085   |   |  |   |             |  
|                                                                             |      |                                 |             |      |                                               |   |             |   |  |   |             |   |  |   |             |  



See accompanying notes.



F-3



---

##### Table of Contents

CORAUTUS GENETICS INC.

(A DEVELOPMENT STAGE ENTERPRISE)



CONSOLIDATED STATEMENTS OF STOCKHOLDERS EQUITY (DEFICIT)

For the Period July 1, 1991 (Inception) To December 31, 2003



|                                                                                                                                                                    |                  |                 |        |              |                  |                            |           |                                  |   |       |                                              |   |           |                        |   |         |                                |  |   |                                               |   |       |   |            |   |  |   |            |   |  |   |   |  |   |            |  
|------------------------------------------------------------------------------------------------------------------------------------------------------------------- | ---------------- | --------------- | ------ | ------------ | ---------------- | -------------------------- | --------- | -------------------------------- | - | ----- | -------------------------------------------- | - | --------- | ---------------------- | - | ------- | ------------------------------ |  | - | --------------------------------------------- | - | ----- | - | ---------- | - |  | - | ---------- | - |  | - | - |  | - | ---------- | -
|                                                                                                                                                                    |                  | Preferred Stock |        | Common Stock |                  | Additional Paid-in Capital |           | Note Receivable From Stockholder |   |       | Deficit Accumulated During Development Stage |   |           | Advances From Medstone |   |         | Divisional Accumulated Deficit |  |   | Accumulated Other Comprehensive Income (loss) |   | Total |  
|                                                                                                                                                                    | Number of Shares |                 | Amount |              | Number of Shares |                            | Amount    |                                  |   |       |                                              |   |           |                       
|Advances and contributions from Medstone July 1, 1991 to December 31, 1997                                                                                          |                  |                |        | $            |                 |                            |          |                                  | $ |      |                                              | $ |          |                        | $ |        |                                |  | $ |                                              |   |       | $ | 4,388,875  |   |  | $ |           |   |  | $ |  |  | $ | 4,388,875  |  
|Distribution of stock dividend and net assets February 9, 1996                                                                                                      |                  |                |        |              |                 |                            | 802,361   |                                  |   | 802   |                                              |   | 662,280   |                        |   |        |                                |  |   |                                              |   |       |   | (4,388,875 | ) |  |   | 3,725,793  |   |  |   |  |  |   |           |  
|Distribution of Common Stock for Services at $0.35 per share                                                                                                        |                  |                |        |              |                 |                            | 51,857    |                                  |   | 52    |                                              |   | 18,098    |                        |   |        |                                |  |   |                                              |   |       |   |           |   |  |   |           |   |  |   |  |  |   | 18,150     |  
|Issuance of Common Stock for cash upon exercise of options at $0.35 per share                                                                                       |                  |                |        |              |                 |                            | 201,429   |                                  |   | 201   |                                              |   | 70,299    |                        |   |        |                                |  |   |                                              |   |       |   |           |   |  |   |           |   |  |   |  |  |   | 70,500     |  
|Issuance of Common Stock for cash and note receivable at $0.35 per share                                                                                            |                  |                |        |              |                 |                            | 21,113    |                                  |   | 21    |                                              |   | 7,369     |                        |   | (7,242  | )                              |  |   |                                              |   |       |   |           |   |  |   |           |   |  |   |  |  |   | 148        |  
|Net loss and comprehensive loss July 1, 1991 to December 31, 1997                                                                                                   |                  |                |        |              |                 |                            |          |                                  |   |      |                                              |   |          |                        |   |        |                                |  |   | (743,175                                      | ) |       |   |           |   |  |   | (3,725,793 | ) |  |   |  |  |   | (4,468,968 | )
|                                                                                                                                                                    |                  |                 |        |              |                  |                            |           |                                  |   |       |                                              |   |           |                        |   |         |                                |  |   |                                               |   |       |   |            |   |  |   |            |   |  |   |   |  |   |            |  
|Balance at December 31, 1997                                                                                                                                        |                  |                |        |              |                 |                            | 1,076,760 |                                  |   | 1,076 |                                              |   | 758,046   |                        |   | (7,242  | )                              |  |   | (743,175                                      | ) |       |   |           |   |  |   |           |   |  |   |  |  |   | 8,705      |  
|                                                                                                                                                                    |                  |                 |        |              |                  |                            |           |                                  |   |       |                                              |   |           |                        |   |         |                                |  |   |                                               |   |       |   |            |   |  |   |            |   |  |   |   |  |   |            |  
|Issuance of Preferred and Common Stock for equipment and acquired in-process technology at $630 and $4.41 per share, respectively, net of
issuance costs of $83,366 |                  | 5,830           |        |              | 6                |                            | 263,031   |                                  |   | 263   |                                              |   | 5,715,806 |                        |   |        |                                |  |   |                                              |   |       |   |           |   |  |   |           |   |  |   |  |  |   | 5,716,075  |  
|Issuance of warrants for Common Stock valued at $4.13 per share                                                                                                     |                  |                |        |              |                 |                            |          |                                  |   |      |                                              |   | 305,910   |                        |   |        |                                |  |   |                                              |   |       |   |           |   |  |   |           |   |  |   |  |  |   | 305,910    |  
|Interest and other related to note receivable from stockholder                                                                                                      |                  |                |        |              |                 |                            |          |                                  |   |      |                                              |   | 11,250    |                        |   | (13,280 | )                              |  |   |                                              |   |       |   |           |   |  |   |           |   |  |   |  |  |   | (2,030     | )
|Net loss and comprehensive loss                                                                                                                                     |                  |                |        |              |                 |                            |          |                                  |   |      |                                              |   |          |                        |   |        |                                |  |   | (7,962,388                                    | ) |       |   |           |   |  |   |           |   |  |   |  |  |   | (7,962,388 | )
|                                                                                                                                                                    |                  |                 |        |              |                  |                            |           |                                  |   |       |                                              |   |           |                        |   |         |                                |  |   |                                               |   |       |   |            |   |  |   |            |   |  |   |   |  |   |            |  
|Balance at December 31, 1998                                                                                                                                        |                  | 5,830           |        | $            | 6                |                            | 1,339,791 |                                  | $ | 1,339 |                                              | $ | 6,791,012 |                        | $ | (20,522 | )                              |  | $ | (8,705,563                                    | ) |       | $ |           |   |  | $ |           |   |  | $ |  |  | $ | (1,933,728 | )
|                                                                                                                                                                    |                  |                 |        |              |                  |                            |           |                                  |   |       |                                              |   |           |                        |   |         |                                |  |   |                                               |   |       |   |            |   |  |   |            |   |  |   |   |  |   |            |  



Continued on next page



F-4



---

##### Table of Contents

CORAUTUS GENETICS INC.

(A DEVELOPMENT STAGE ENTERPRISE)



CONSOLIDATED STATEMENTS OF STOCKHOLDERS EQUITY (DEFICIT)

For the Period July 1, 1991 (Inception) To December 31,
2003 (Continued)



|                                                                                                             |                  |                 |        |              |                  |                            |           |                                  |   |       |                                              |   |            |                        |   |                                |   |                                               |   |             |   |  |   |   |  |   |   |  |   |   |  |   |            |  
|------------------------------------------------------------------------------------------------------------ | ---------------- | --------------- | ------ | ------------ | ---------------- | -------------------------- | --------- | -------------------------------- | - | ----- | -------------------------------------------- | - | ---------- | ---------------------- | - | ------------------------------ | - | --------------------------------------------- | - | ----------- | - |  | - | - |  | - | - |  | - | - |  | - | ---------- | -
|                                                                                                             |                  | Preferred Stock |        | Common Stock |                  | Additional Paid-in Capital |           | Note Receivable From Stockholder |   |       | Deficit Accumulated During Development Stage |   |            | Advances From Medstone |   | Divisional Accumulated Deficit |   | Accumulated Other Comprehensive Income (loss) |   | Total       |  
|                                                                                                             | Number of Shares |                 | Amount |              | Number of Shares |                            | Amount    |                                  |   |       |                                              |   |            |                       
|Balance at December 31, 1998                                                                                 |                  | 5,830           |        | $            | 6                |                            | 1,339,791 |                                  | $ | 1,339 |                                              | $ | 6,791,012  |                        | $ | (20,522                        | ) |                                               | $ | (8,705,563  | ) |  | $ |  |  | $ |  |  | $ |  |  | $ | (1,933,728 | )
|Issuance of Preferred Stock from conversion of advance from related party at $1,000 per share                |                  | 2,998           |        |              | 3                |                            |          |                                  |   |      |                                              |   | 2,997,997  |                        |   |                               |   |                                               |   |            |   |  |   |  |  |   |  |  |   |  |  |   | 2,998,000  |  
|Issuance of Common Stock upon conversion of notes payable plus accrued interest at $7.00 and $2.10 per share |                  |                |        |              |                 |                            | 351,544   |                                  |   | 352   |                                              |   | 1,512,067  |                        |   |                               |   |                                               |   |            |   |  |   |  |  |   |  |  |   |  |  |   | 1,512,419  |  
|Collection of note receivable                                                                                |                  |                |        |              |                 |                            |          |                                  |   |      |                                              |   |           |                        |   | 20,522                         |   |                                               |   |            |   |  |   |  |  |   |  |  |   |  |  |   | 20,522     |  
|Issuance of Common Stock for cash upon exercise of options at $0.35 per share                                |                  |                |        |              |                 |                            | 5,188     |                                  |   | 5     |                                              |   | 1,506      |                        |   |                               |   |                                               |   |            |   |  |   |  |  |   |  |  |   |  |  |   | 1,511      |  
|Issuance of warrants valued at $1.26 and $1.40 per share                                                     |                  |                |        |              |                 |                            |          |                                  |   |      |                                              |   | 311,667    |                        |   |                               |   |                                               |   |            |   |  |   |  |  |   |  |  |   |  |  |   | 311,667    |  
|Issuance of Common Stock for cash upon exercise of warrants at $0.007 per share                              |                  |                |        |              |                 |                            | 31,205    |                                  |   | 31    |                                              |   | 187        |                        |   |                               |   |                                               |   |            |   |  |   |  |  |   |  |  |   |  |  |   | 218        |  
|Issuance of Common Stock for services at $2.03 per share                                                     |                  |                |        |              |                 |                            | 1,429     |                                  |   | 2     |                                              |   | 2,898      |                        |   |                               |   |                                               |   |            |   |  |   |  |  |   |  |  |   |  |  |   | 2,900      |  
|Net loss and comprehensive loss                                                                              |                  |                |        |              |                 |                            |          |                                  |   |      |                                              |   |           |                        |   |                               |   |                                               |   | (3,818,827  | ) |  |   |  |  |   |  |  |   |  |  |   | (3,818,827 | )
|                                                                                                             |                  |                 |        |              |                  |                            |           |                                  |   |       |                                              |   |            |                        |   |                                |   |                                               |   |             |   |  |   |   |  |   |   |  |   |   |  |   |            |  
|Balance at December 31, 1999                                                                                 |                  | 8,828           |        | $            | 9                |                            | 1,729,157 |                                  | $ | 1,729 |                                              | $ | 11,617,334 |                        | $ |                               |   |                                               | $ | (12,524,390 | ) |  | $ |  |  | $ |  |  | $ |  |  | $ | (905,318   | )
|                                                                                                             |                  |                 |        |              |                  |                            |           |                                  |   |       |                                              |   |            |                        |   |                                |   |                                               |   |             |   |  |   |   |  |   |   |  |   |   |  |   |            |  



Continued on next page



F-5



---

##### Table of Contents

CORAUTUS GENETICS INC.

(A DEVELOPMENT STAGE ENTERPRISE)



CONSOLIDATED STATEMENTS OF STOCKHOLDERS EQUITY (DEFICIT)

For the Period July 1, 1991 (Inception) To December 31,
2003 (Continued)



|                                                                                              |                 |                 |        |              |                  |                            |           |  |                                  |       |                                              |   |            |                        |  |                                |   |                                               |   |             |   |  |   |   |  |   |   |  |   |         |  |   |            |  
|--------------------------------------------------------------------------------------------- | --------------- | --------------- | ------ | ------------ | ---------------- | -------------------------- | --------- |  | -------------------------------- | ----- | -------------------------------------------- | - | ---------- | ---------------------- |  | ------------------------------ | - | --------------------------------------------- | - | ----------- | - |  | - | - |  | - | - |  | - | ------- |  | - | ---------- | -
|                                                                                              |                 | Preferred Stock |        | Common Stock |                  | Additional Paid-in Capital |           |  | Note Receivable From Stockholder |       | Deficit Accumulated During Development Stage |   |            | Advances From Medstone |  | Divisional Accumulated Deficit |   | Accumulated Other Comprehensive Income (loss) |   | Total       |  
|                                                                                              | Number ofShares |                 | Amount |              | Number of Shares |                            | Amount    |  |                                  |       |                                              |   |            |                       
|Balance at December 31, 1999                                                                  |                 | 8,828           |        | $            | 9                |                            | 1,729,157 |  | $                                | 1,729 |                                              | $ | 11,617,334 |                        |  | $                              |  |                                               | $ | (12,524,390 | ) |  | $ |  |  | $ |  |  | $ |        |  | $ | (905,318   | )
|Issuance of Preferred Stock from conversion of advance from related party at $1,000 per share |                 | 4,043           |        |              | 4                |                            |          |  |                                  |      |                                              |   | 4,043,075  |                        |  |                                |  |                                               |   |            |   |  |   |  |  |   |  |  |   |        |  |   | 4,043,079  |  
|Issuance of Common Stock, net of offering costs                                               |                 |                |        |              |                 |                            | 1,194,686 |  |                                  | 1,195 |                                              |   | 23,423,194 |                        |  |                                |  |                                               |   |            |   |  |   |  |  |   |  |  |   |        |  |   | 23,424,389 |  
|Issuance of Common Stock for cash upon exercise of options                                    |                 |                |        |              |                 |                            | 80,131    |  |                                  | 80    |                                              |   | 126,020    |                        |  |                                |  |                                               |   |            |   |  |   |  |  |   |  |  |   |        |  |   | 126,100    |  
|Issuance of Common Stock for cash upon exercise of warrants                                   |                 |                |        |              |                 |                            | 58,326    |  |                                  | 58    |                                              |   | 268,528    |                        |  |                                |  |                                               |   |            |   |  |   |  |  |   |  |  |   |        |  |   | 268,586    |  
|Net exercises of warrants for Common Stock                                                    |                 |                |        |              |                 |                            | 141,707   |  |                                  | 142   |                                              |   | (142       | )                      |  |                                |  |                                               |   |            |   |  |   |  |  |   |  |  |   |        |  |   |           |  
|Issuance of options at less than Fair Market Value                                            |                 |                |        |              |                 |                            |          |  |                                  |      |                                              |   | 217,200    |                        |  |                                |  |                                               |   |            |   |  |   |  |  |   |  |  |   |        |  |   | 217,200    |  
|Issuance of Common Stock for purchase of technology                                           |                 |                |        |              |                 |                            | 41,143    |  |                                  | 41    |                                              |   | 1,458,679  |                        |  |                                |  |                                               |   |            |   |  |   |  |  |   |  |  |   |        |  |   | 1,458,720  |  
|Issuance of Common Stock for services                                                         |                 |                |        |              |                 |                            | 1,429     |  |                                  | 1     |                                              |   | 64,999     |                        |  |                                |  |                                               |   |            |   |  |   |  |  |   |  |  |   |        |  |   | 65,000     |  
|Issuance of stock options to consultant                                                       |                 |                |        |              |                 |                            |          |  |                                  |      |                                              |   | 47,436     |                        |  |                                |  |                                               |   |            |   |  |   |  |  |   |  |  |   |        |  |   | 47,436     |  
|Issuance of warrants valued at $14.00 per share in connection with a loan agreement           |                 |                |        |              |                 |                            |          |  |                                  |      |                                              |   | 687,000    |                        |  |                                |  |                                               |   |            |   |  |   |  |  |   |  |  |   |        |  |   | 687,000    |  
|Comprehensive loss:                                                                           |                 |                 |        |              |                  |                            |           |  |                                  |       |                                              |   |            |                        |  |                                |   |                                               |   |             |   |  |   |   |  |   |   |  |   |         |  |   |            |  
|Net loss                                                                                      |                 |                |        |              |                 |                            |          |  |                                  |      |                                              |   |           |                        |  |                                |  |                                               |   | (9,609,540  | ) |  |   |  |  |   |  |  |   |        |  |   | (9,609,540 | )
|Unrealized gain on short-term investments                                                     |                 |                |        |              |                 |                            |          |  |                                  |      |                                              |   |           |                        |  |                                |  |                                               |   |            |   |  |   |  |  |   |  |  |   | 360,586 |  |   | 360,586    |  
|                                                                                              |                 |                 |        |              |                  |                            |           |  |                                  |       |                                              |   |            |                        |  |                                |   |                                               |   |             |   |  |   |   |  |   |   |  |   |         |  |   |            |  
|Comprehensive loss                                                                            |                 |                 |        |              |                  |                            |           |  |                                  |       |                                              |   |            |                        |  |                                |   |                                               |   |             |   |  |   |   |  |   |   |  |   |         |  |   | (9,248,954 | )
|                                                                                              |                 |                 |        |              |                  |                            |           |  |                                  |       |                                              |   |            |                        |  |                                |   |                                               |   |             |   |  |   |   |  |   |   |  |   |         |  |   |            |  
|Balance at December 31, 2000                                                                  |                 | 12,871          |        | $            | 13               |                            | 3,246,579 |  | $                                | 3,246 |                                              | $ | 41,953,323 |                        |  | $                              |  |                                               | $ | (22,133,930 | ) |  | $ |  |  | $ |  |  | $ | 360,586 |  | $ | 20,183,238 |  
|                                                                                              |                 |                 |        |              |                  |                            |           |  |                                  |       |                                              |   |            |                        |  |                                |   |                                               |   |             |   |  |   |   |  |   |   |  |   |         |  |   |            |  



Continued on next page



F-6



---

##### Table of Contents

CORAUTUS GENETICS INC.

(A DEVELOPMENT STAGE ENTERPRISE)



CONSOLIDATED STATEMENTS OF STOCKHOLDERS EQUITY (DEFICIT)

For the Period July 1, 1991 (Inception) To December 31,
2003 (Continued)



|                                                                                                       |                  |                 |        |              |                  |  |                            |        |  |                                  |       |                                              |  |   |                        |   |                                |   |                                               |  |   |             |   |  |   |   |  |   |   |  |   |         |   |  |   |             |  
|------------------------------------------------------------------------------------------------------ | ---------------- | --------------- | ------ | ------------ | ---------------- |  | -------------------------- | ------ |  | -------------------------------- | ----- | -------------------------------------------- |  | - | ---------------------- | - | ------------------------------ | - | --------------------------------------------- |  | - | ----------- | - |  | - | - |  | - | - |  | - | ------- | - |  | - | ----------- | -
|                                                                                                       |                  | Preferred Stock |        | Common Stock |                  |  | Additional Paid-in Capital |        |  | Note Receivable From Stockholder |       | Deficit Accumulated During Development Stage |  |   | Advances From Medstone |   | Divisional Accumulated Deficit |   | Accumulated Other Comprehensive Income (loss) |  |   | Total       |  
|                                                                                                       | Number of Shares |                 | Amount |              | Number of Shares |  |                            | Amount |  |                                  |       |                                              |  |   |                        |  
|Balance at December 31, 2000                                                                           |                  | 12,871          |        | $            | 13               |  | 3,246,579                  |        |  | $                                | 3,246 |                                              |  | $ | 41,953,323             |   |                                | $ |                                              |  | $ | (22,133,930 | ) |  | $ |  |  | $ |  |  | $ | 360,586 |   |  | $ | 20,183,238  |  
|Issuance of Common Stock for cash upon exercise of options                                             |                  |                |        |              |                 |  | 43,509                     |        |  |                                  | 43    |                                              |  |   | 74,544                 |   |                                |   |                                              |  |   |            |   |  |   |  |  |   |  |  |   |        |   |  |   | 74,587      |  
|Issuance of Common Stock for cash upon exercise of warrants                                            |                  |                |        |              |                 |  | 70,622                     |        |  |                                  | 71    |                                              |  |   | 346,767                |   |                                |   |                                              |  |   |            |   |  |   |  |  |   |  |  |   |        |   |  |   | 346,838     |  
|Issuance of Series B Preferred Stock from conversion of advance from related party at $1,000 per share |                  | 5,849           |        |              | 6                |  |                           |        |  |                                  |      |                                              |  |   | 5,848,355              |   |                                |   |                                              |  |   |            |   |  |   |  |  |   |  |  |   |        |   |  |   | 5,848,361   |  
|Issuance of Series C Preferred Stock for cash at $1,000 per share                                      |                  | 2,000           |        |              | 2                |  |                           |        |  |                                  |      |                                              |  |   | 1,999,998              |   |                                |   |                                              |  |   |            |   |  |   |  |  |   |  |  |   |        |   |  |   | 2,000,000   |  
|Net exercises of warrants for Common Stock                                                             |                  |                |        |              |                 |  | 27,634                     |        |  |                                  | 28    |                                              |  |   | (28                    | ) |                                |   |                                              |  |   |            |   |  |   |  |  |   |  |  |   |        |   |  |   |            |  
|Proceeds from investors short-swing profit                                                            |                  |                |        |              |                 |  |                           |        |  |                                  |      |                                              |  |   | 123,820                |   |                                |   |                                              |  |   |            |   |  |   |  |  |   |  |  |   |        |   |  |   | 123,820     |  
|Extension of stock option exercise period for terminated employees                                     |                  |                |        |              |                 |  |                           |        |  |                                  |      |                                              |  |   | 35,504                 |   |                                |   |                                              |  |   |            |   |  |   |  |  |   |  |  |   |        |   |  |   | 35,504      |  
|Repurchase of restricted stock                                                                         |                  |                |        |              |                 |  | (1,488                     | )      |  |                                  | (1    | )                                            |  |   | (2,811                 | ) |                                |   |                                              |  |   |            |   |  |   |  |  |   |  |  |   |        |   |  |   | (2,812      | )
|Stock grants to employees                                                                              |                  |                |        |              |                 |  | 4,428                      |        |  |                                  | 4     |                                              |  |   | 94,146                 |   |                                |   |                                              |  |   |            |   |  |   |  |  |   |  |  |   |        |   |  |   | 94,150      |  
|Issuance of options and warrants for services                                                          |                  |                |        |              |                 |  |                           |        |  |                                  |      |                                              |  |   | 250,705                |   |                                |   |                                              |  |   |            |   |  |   |  |  |   |  |  |   |        |   |  |   | 250,705     |  
|Comprehensive loss:                                                                                    |                  |                 |        |              |                  |  |                            |        |  |                                  |       |                                              |  |   |                        |   |                                |   |                                               |  |   |             |   |  |   |   |  |   |   |  |   |         |   |  |   |             |  
|Net loss                                                                                               |                  |                |        |              |                 |  |                           |        |  |                                  |      |                                              |  |   |                       |   |                                |   |                                              |  |   | (11,095,010 | ) |  |   |  |  |   |  |  |   |        |   |  |   | (11,095,010 | )
|Unrealized loss on short-term investments                                                              |                  |                |        |              |                 |  |                           |        |  |                                  |      |                                              |  |   |                       |   |                                |   |                                              |  |   |            |   |  |   |  |  |   |  |  |   | (74,686 | ) |  |   | (74,686     | )
|                                                                                                       |                  |                 |        |              |                  |  |                            |        |  |                                  |       |                                              |  |   |                        |   |                                |   |                                               |  |   |             |   |  |   |   |  |   |   |  |   |         |   |  |   |             |  
|Comprehensive loss                                                                                     |                  |                 |        |              |                  |  |                            |        |  |                                  |       |                                              |  |   |                        |   |                                |   |                                               |  |   |             |   |  |   |   |  |   |   |  |   |         |   |  |   | (11,169,696 | )
|                                                                                                       |                  |                 |        |              |                  |  |                            |        |  |                                  |       |                                              |  |   |                        |   |                                |   |                                               |  |   |             |   |  |   |   |  |   |   |  |   |         |   |  |   |             |  
|Balance at December 31, 2001                                                                           |                  | 20,720          |        | $            | 21               |  | 3,391,284                  |        |  | $                                | 3,391 |                                              |  | $ | 50,724,323             |   |                                | $ |                                              |  | $ | (33,228,940 | ) |  | $ |  |  | $ |  |  | $ | 285,900 |   |  | $ | 17,784,695  |  
|                                                                                                       |                  |                 |        |              |                  |  |                            |        |  |                                  |       |                                              |  |   |                        |   |                                |   |                                               |  |   |             |   |  |   |   |  |   |   |  |   |         |   |  |   |             |  



Continued on next page



F-7



---

##### Table of Contents

CORAUTUS GENETICS INC.

(A DEVELOPMENT STAGE ENTERPRISE)



CONSOLIDATED STATEMENTS OF STOCKHOLDERS EQUITY (DEFICIT)

For the Period July 1, 1991 (Inception) To December 31,
2003 (Continued)



|                                                                   |  |                 |  |              |    |                  |           |   |        |   |                            |  |   |                                  |   |                                              |   |   |                        |   |                                |   |                                               |   |   |       |   |   |  |   |          |   |  |   |             |  
|------------------------------------------------------------------ |  | --------------- |  | ------------ | -- | ---------------- | --------- | - | ------ | - | -------------------------- |  | - | -------------------------------- | - | -------------------------------------------- | - | - | ---------------------- | - | ------------------------------ | - | --------------------------------------------- | - | - | ----- | - | - |  | - | -------- | - |  | - | ----------- | -
|                                                                   |  | Preferred Stock |  | Common Stock |    |                  |           |   |        |   |                            |  |   |                                  |   |                                              |   |   |                        |   |                                |  
|                                                                   |  | Number ofShares |  | Amount       |    | Number of Shares |           |   | Amount |   | Additional Paid-in Capital |  |   | Note Receivable From Stockholder |   | Deficit Accumulated During Development Stage |   |   | Advances From Medstone |   | Divisional Accumulated Deficit |   | Accumulated Other Comprehensive Income (loss) |   |   | Total |  
|Balance at December 31, 2001                                       |  | 20,720          |  | $            | 21 |                  | 3,391,284 |   |        | $ | 3,391                      |  | $ | 50,724,323                       |   |                                              | $ |  |                        | $ | (33,228,940                    | ) |                                               | $ |  |       | $ |  |  | $ | 285,900  |   |  | $ | 17,784,695  |  
|Issuance of Common Stock for cash upon exercise of options         |  |                |  |              |   |                  | 31,549    |   |        |   | 31                         |  |   | 67,939                           |   |                                              |   |  |                        |   |                               |   |                                               |   |  |       |   |  |  |   |         |   |  |   | 67,970      |  
|Net exercises of warrants for Common Stock                         |  |                |  |              |   |                  | 1,607     |   |        |   | 2                          |  |   | (2                               | ) |                                              |   |  |                        |   |                               |   |                                               |   |  |       |   |  |  |   |         |   |  |   |            |  
|Extension of stock option exercise period for terminated employees |  |                |  |              |   |                  |          |   |        |   |                           |  |   | 47,564                           |   |                                              |   |  |                        |   |                               |   |                                               |   |  |       |   |  |  |   |         |   |  |   | 47,564      |  
|Repurchase of restricted stock                                     |  |                |  |              |   |                  | (119      | ) |        |   |                           |  |   | (268                             | ) |                                              |   |  |                        |   |                               |   |                                               |   |  |       |   |  |  |   |         |   |  |   | (268        | )
|Issuance of options and warrants for services and other            |  |                |  |              |   |                  | 7,072     |   |        |   | 7                          |  |   | 537,265                          |   |                                              |   |  |                        |   |                               |   |                                               |   |  |       |   |  |  |   |         |   |  |   | 537,272     |  
|Comprehensive loss:                                                |  |                 |  |              |    |                  |           |   |        |   |                            |  |   |                                  |   |                                              |   |   |                        |   |                                |   |                                               |   |   |       |   |   |  |   |          |   |  |   |             |  
|Net loss                                                           |  |                |  |              |   |                  |          |   |        |   |                           |  |   |                                 |   |                                              |   |  |                        |   | (12,053,583                    | ) |                                               |   |  |       |   |  |  |   |         |   |  |   | (12,053,583 | )
|Unrealized loss on short-term investments                          |  |                |  |              |   |                  |          |   |        |   |                           |  |   |                                 |   |                                              |   |  |                        |   |                               |   |                                               |   |  |       |   |  |  |   | (286,821 | ) |  |   | (286,821    | )
|                                                                   |  |                 |  |              |    |                  |           |   |        |   |                            |  |   |                                  |   |                                              |   |   |                        |   |                                |   |                                               |   |   |       |   |   |  |   |          |   |  |   |             |  
|Comprehensive loss                                                 |  |                 |  |              |    |                  |           |   |        |   |                            |  |   |                                  |   |                                              |   |   |                        |   |                                |   |                                               |   |   |       |   |   |  |   |          |   |  |   | (12,340,404 | )
|                                                                   |  |                 |  |              |    |                  |           |   |        |   |                            |  |   |                                  |   |                                              |   |   |                        |   |                                |   |                                               |   |   |       |   |   |  |   |          |   |  |   |             |  
|Balance at December 31, 2002                                       |  | 20,720          |  | $            | 21 |                  | 3,431,393 |   |        | $ | 3,431                      |  | $ | 51,376,821                       |   |                                              | $ |  |                        | $ | (45,282,523                    | ) |                                               | $ |  |       | $ |  |  | $ | (921     | ) |  | $ | 6,096,829   |  
|                                                                   |  |                 |  |              |    |                  |           |   |        |   |                            |  |   |                                  |   |                                              |   |   |                        |   |                                |   |                                               |   |   |       |   |   |  |   |          |   |  |   |             |  



See accompanying notes.



F-8



---

##### Table of Contents

CORAUTUS GENETICS INC.

(A DEVELOPMENT STAGE ENTERPRISE)



CONSOLIDATED STATEMENTS OF STOCKHOLDERS EQUITY (DEFICIT)

For the Period July 1, 1991 (Inception) To December 31,
2003 (Continued)



|                                                                        |                 |                 |   |        |              |       |                            |  |            |                                  |   |                                              |  |   |                        |   |                                |   |                                               |  |   |             |   |  |   |   |  |   |   |  |   |      |   |  |   |             |  
|----------------------------------------------------------------------- | --------------- | --------------- | - | ------ | ------------ | ----- | -------------------------- |  | ---------- | -------------------------------- | - | -------------------------------------------- |  | - | ---------------------- | - | ------------------------------ | - | --------------------------------------------- |  | - | ----------- | - |  | - | - |  | - | - |  | - | ---- | - |  | - | ----------- | -
|                                                                        |                 | Preferred Stock |   |        | Common Stock |       | Additional Paid-in Capital |  |            | Note Receivable From Stockholder |   | Deficit Accumulated During Development Stage |  |   | Advances From Medstone |   | Divisional Accumulated Deficit |   | Accumulated Other Comprehensive Income (loss) |  |   | Total       |  
|                                                                        | Numberof Shares |                 |   | Amount |              |       | Number of Shares           |  | Amount     |                                  |   |                                              |  |   |                        |  
|Balance at December 31, 2002                                            |                 | 20,720          |   |        | $            | 21    |                            |  | 3,431,393  |                                  | $ | 3,431                                        |  | $ | 51,376,821             |   |                                | $ |                                              |  | $ | (45,282,523 | ) |  | $ |  |  | $ |  |  | $ | (921 | ) |  | $ | 6,096,829   |  
|Issuance of Common Stock for cash upon exercise of options              |                 |                |   |        |              |      |                            |  | 132,365    |                                  |   | 133                                          |  |   | 86,133                 |   |                                |   |                                              |  |   |            |   |  |   |  |  |   |  |  |   |     |   |  |   | 86,266      |  
|Net exercises of warrants for Common Stock                              |                 |                |   |        |              |      |                            |  | 10,436     |                                  |   | 10                                           |  |   | (10                    | ) |                                |   |                                              |  |   |            |   |  |   |  |  |   |  |  |   |     |   |  |   |            |  
|Conversion of Preferred stock into Common stock                         |                 | (18,720         | ) |        |              | (19   | )                          |  | 1,120,131  |                                  |   | 1,120                                        |  |   | (1,101                 | ) |                                |   |                                              |  |   |            |   |  |   |  |  |   |  |  |   |     |   |  |   |            |  
|Issuance of options and warrants for services and other                 |                 |                |   |        |              |      |                            |  |           |                                  |   |                                             |  |   | 724,407                |   |                                |   |                                              |  |   |            |   |  |   |  |  |   |  |  |   |     |   |  |   | 724,407     |  
|Issuance of options at less than fair market value                      |                 |                |   |        |              |      |                            |  |           |                                  |   |                                             |  |   | 164,490                |   |                                |   |                                              |  |   |            |   |  |   |  |  |   |  |  |   |     |   |  |   | 164,490     |  
|Issuance of Common Stock for Services at $5.75 per share                |                 |                |   |        |              |      |                            |  | 8,696      |                                  |   | 9                                            |  |   | 49,991                 |   |                                |   |                                              |  |   |            |   |  |   |  |  |   |  |  |   |     |   |  |   | 50,000      |  
|Extension of stock option exercise period for terminated employees      |                 |                |   |        |              |      |                            |  |           |                                  |   |                                             |  |   | 68,340                 |   |                                |   |                                              |  |   |            |   |  |   |  |  |   |  |  |   |     |   |  |   | 68,340      |  
|Issuance of Common Stock and Stock Purchase Warrants for Cash           |                 |                |   |        |              |      |                            |  | 541,690    |                                  |   | 542                                          |  |   | 2,149,426              |   |                                |   |                                              |  |   |            |   |  |   |  |  |   |  |  |   |     |   |  |   | 2,149,968   |  
|Issuance of Common Stock in connection with Merger                      |                 |                |   |        |              |      |                            |  | 5,320,166  |                                  |   | 5,320                                        |  |   | 15,468,429             |   |                                |   |                                              |  |   |            |   |  |   |  |  |   |  |  |   |     |   |  |   | 15,473,749  |  
|Issuance of Preferred Stock for Cash, net of issuance costs of $915,624 |                 | 1,385,377       |   |        |              | 1,385 |                            |  |           |                                  |   |                                             |  |   | 8,082,991              |   |                                |   |                                              |  |   |            |   |  |   |  |  |   |  |  |   |     |   |  |   | 8,084,376   |  
|Comprehensive loss:                                                     |                 |                 |   |        |              |       |                            |  |            |                                  |   |                                              |  |   |                        |   |                                |   |                                               |  |   |             |   |  |   |   |  |   |   |  |   |      |   |  |   |             |  
|Net loss                                                                |                 |                |   |        |              |      |                            |  |           |                                  |   |                                             |  |   |                       |   |                                |   |                                              |  |   | (30,408,146 | ) |  |   |  |  |   |  |  |   |     |   |  |   | (30,408,146 | )
|Unrealized loss on short-term investments reclassified into earnings    |                 |                |   |        |              |      |                            |  |           |                                  |   |                                             |  |   |                       |   |                                |   |                                              |  |   |            |   |  |   |  |  |   |  |  |   | 921  |   |  |   | 921         |  
|                                                                        |                 |                 |   |        |              |       |                            |  |            |                                  |   |                                              |  |   |                        |   |                                |   |                                               |  |   |             |   |  |   |   |  |   |   |  |   |      |   |  |   |             |  
|Comprehensive loss                                                      |                 |                 |   |        |              |       |                            |  |            |                                  |   |                                              |  |   |                        |   |                                |   |                                               |  |   |             |   |  |   |   |  |   |   |  |   |      |   |  |   | (30,407,225 | )
|                                                                        |                 |                 |   |        |              |       |                            |  |            |                                  |   |                                              |  |   |                        |   |                                |   |                                               |  |   |             |   |  |   |   |  |   |   |  |   |      |   |  |   |             |  
|Balance at December 31, 2003                                            |                 | 1,387,377       |   |        | $            | 1,387 |                            |  | 10,564,877 |                                  | $ | 10,565                                       |  | $ | 78,169,917             |   |                                | $ |                                              |  | $ | (75,690,669 | ) |  | $ |  |  | $ |  |  | $ |     |   |  | $ | 2,491,200   |  
|                                                                        |                 |                 |   |        |              |       |                            |  |            |                                  |   |                                              |  |   |                        |   |                                |   |                                               |  |   |             |   |  |   |   |  |   |   |  |   |      |   |  |   |             |  



See accompanying notes.



F-9



---

##### Table of Contents

CORAUTUS GENETICS INC.

(A DEVELOPMENT STAGE ENTERPRISE)



CONSOLIDATED STATEMENTS OF CASH FLOWS



|                                                                                                                                                 |      |                                 |             |      |                                               |   |             |   |  |   |             |   |  |   |             |  
|------------------------------------------------------------------------------------------------------------------------------------------------ | ---- | ------------------------------- | ----------- | ---- | --------------------------------------------- | - | ----------- | - |  | - | ----------- | - |  | - | ----------- | -
|                                                                                                                                                 |      | For the Year Ended December 31, |             |      | July 1, 1991 (inception) to December 31, 2003 |  
|                                                                                                                                                 | 2003 |                                 |             | 2002 |                                               |   | 2001        |   | 
|Cash flows from operating activities:                                                                                                            |      |                                 |             |      |                                               |   |             |   |  |   |             |   |  |   |             |  
|Net loss                                                                                                                                         |      | $                               | (30,408,146 | )    |                                               | $ | (12,053,583 | ) |  | $ | (11,095,010 | ) |  | $ | (79,416,462 | )
|Adjustments to reconcile net loss to net cash used in operating activities:                                                                      |      |                                 |             |      |                                               |   |             |   |  |   |             |   |  |   |             |  
|Write-off of in-process technology acquired with stock                                                                                           |      |                                 | 16,507,514  |      |                                               |   |            |   |  |   |            |   |  |   | 23,482,519  |  
|Expenses satisfied via advances from related party                                                                                               |      |                                 |            |      |                                               |   |            |   |  |   |            |   |  |   | 695,557     |  
|Depreciation and amortization                                                                                                                    |      |                                 | 467,173     |      |                                               |   | 938,812     |   |  |   | 694,965     |   |  |   | 3,114,963   |  
|Accrued interest satisfied through issuance of Common Stock                                                                                      |      |                                 |            |      |                                               |   |            |   |  |   |            |   |  |   | 40,245      |  
|Stock, stock options and warrants issued for services, extension of stock option exercise period and issuance of options below fair market
value |      |                                 | 517,240     |      |                                               |   | 584,835     |   |  |   | 380,359     |   |  |   | 1,980,373   |  
|Charge related to lease termination settlement                                                                                                   |      |                                 | 3,423,791   |      |                                               |   |            |   |  |   |            |   |  |   | 3,423,791   |  
|Loss on disposal of property and equipment                                                                                                       |      |                                 | 1,945,743   |      |                                               |   | 636,433     |   |  |   | 11,866      |   |  |   | 2,512,598   |  
|Amortization of debt discount and loan fee                                                                                                       |      |                                 | 45,049      |      |                                               |   | 270,296     |   |  |   | 270,295     |   |  |   | 1,261,297   |  
|Deferred rent                                                                                                                                    |      |                                 | (539,354    | )    |                                               |   | 224,225     |   |  |   | 294,426     |   |  |   | 13,160      |  
|Deferred revenue                                                                                                                                 |      |                                 | 965,277     |      |                                               |   |            |   |  |   |            |   |  |   | 965,277     |  
|Change in operating assets and liabilities, net of acquisition:                                                                                  |      |                                 |             |      |                                               |   |             |   |  |   |             |   |  |   |             |  
|Accounts receivable                                                                                                                              |      |                                 | 132,503     |      |                                               |   | 464,648     |   |  |   | (522,082    | ) |  |   | 61,892      |  
|Other current assets                                                                                                                             |      |                                 | (295,854    | )    |                                               |   | (74,333     | ) |  |   | (144,742    | ) |  |   | (644,901    | )
|Other assets                                                                                                                                     |      |                                 | 1,837,646   |      |                                               |   | (1,358,884  | ) |  |   | (1,094,511  | ) |  |   | (790,220    | )
|Accounts payable                                                                                                                                 |      |                                 | (1,586,862  | )    |                                               |   | 801,432     |   |  |   | 158,188     |   |  |   | (177,978    | )
|Other current liabilities                                                                                                                        |      |                                 | (371,716    | )    |                                               |   | 648,925     |   |  |   | 79,828      |   |  |   | 762,804     |  
|Other long-term liabilities                                                                                                                      |      |                                 | (53,494     | )    |                                               |   | 40,334      |   |  |   |            |   |  |   | (13,160     | )
|Deferred compensation                                                                                                                            |      |                                 | (154,016    | )    |                                               |   | (347,990    | ) |  |   | 84,682      |   |  |   |            |  
|                                                                                                                                                 |      |                                 |             |      |                                               |   |             |   |  |   |             |   |  |   |             |  
|Net cash used in operating activities                                                                                                            |      |                                 | (7,567,506  | )    |                                               |   | (9,224,850  | ) |  |   | (10,881,736 | ) |  |   | (42,728,245 | )
|                                                                                                                                                 |      |                                 |             |      |                                               |   |             |   |  |   |             |   |  |   |             |  
|Cash flows from investing activities:                                                                                                            |      |                                 |             |      |                                               |   |             |   |  |   |             |   |  |   |             |  
|Purchase of short-term investments                                                                                                               |      |                                 | (168,899    | )    |                                               |   | (7,006,847  | ) |  |   | (22,122,369 | ) |  |   | (44,998,300 | )
|Sale of short-term investments                                                                                                                   |      |                                 | 4,387,840   |      |                                               |   | 16,425,890  |   |  |   | 24,184,570  |   |  |   | 44,998,300  |  
|Purchase of property and equipment                                                                                                               |      |                                 | (96,603     | )    |                                               |   | (1,601,811  | ) |  |   | (719,536    | ) |  |   | (4,851,322  | )
|Proceeds from sale of property and equipment                                                                                                     |      |                                 | 162,153     |      |                                               |   |            |   |  |   |            |   |  |   | 162,153     |  
|                                                                                                                                                 |      |                                 |             |      |                                               |   |             |   |  |   |             |   |  |   |             |  
|Net cash provided by (used in) investing activities                                                                                              |      |                                 | 4,284,491   |      |                                               |   | 7,817,232   |   |  |   | 1,342,665   |   |  |   | (4,689,169  | )
|                                                                                                                                                 |      |                                 |             |      |                                               |   |             |   |  |   |             |   |  |   |             |  
|Cash flows from financing activities:                                                                                                            |      |                                 |             |      |                                               |   |             |   |  |   |             |   |  |   |             |  
|Advances from related party                                                                                                                      |      |                                 |            |      |                                               |   |            |   |  |   | 3,872,768   |   |  |   | 12,193,883  |  
|Repayment of note receivable from stockholder                                                                                                    |      |                                 |            |      |                                               |   |            |   |  |   |            |   |  |   | 20,000      |  
|Proceeds from investors short-swing profit                                                                                                      |      |                                 |            |      |                                               |   |            |   |  |   | 123,820     |   |  |   | 123,820     |  
|Proceeds from notes payable                                                                                                                      |      |                                 | 2,500,000   |      |                                               |   | 428,518     |   |  |   | 806,774     |   |  |   | 5,915,292   |  
|Repayment of capital lease and notes payable                                                                                                     |      |                                 | (1,319,614  | )    |                                               |   | (831,880    | ) |  |   | (540,267    | ) |  |   | (2,922,062  | )
|Proceeds from issuance of Common Stock upon exercise of options and warrants                                                                     |      |                                 | 86,266      |      |                                               |   | 67,970      |   |  |   | 421,425     |   |  |   | 1,040,986   |  
|Proceeds from sale of Common Stock, net of issuance costs                                                                                        |      |                                 | 2,149,968   |      |                                               |   |            |   |  |   |            |   |  |   | 25,492,728  |  
|Proceeds from issuance of Series C Preferred Stock                                                                                               |      |                                 |            |      |                                               |   |            |   |  |   | 2,000,000   |   |  |   | 2,000,000   |  
|Proceeds from issuance of Series D Preferred Stock, net of issuance costs                                                                        |      |                                 | 8,084,376   |      |                                               |   |            |   |  |   |            |   |  |   | 8,084,376   |  
|Repurchase of restricted shares of common stock                                                                                                  |      |                                 |            |      |                                               |   | (268        | ) |  |   | (2,813      | ) |  |   | (3,080      | )
|Net advances from Medstone                                                                                                                       |      |                                 |            |      |                                               |   |            |   |  |   |            |   |  |   | 3,883,465   |  
|Capital contribution by Medstone                                                                                                                 |      |                                 |            |      |                                               |   |            |   |  |   |            |   |  |   | 500,000     |  
|                                                                                                                                                 |      |                                 |             |      |                                               |   |             |   |  |   |             |   |  |   |             |  
|Net cash provided by (used by) financing activities                                                                                              |      |                                 | 11,500,996  |      |                                               |   | (335,660    | ) |  |   | 6,681,707   |   |  |   | 56,329,408  |  
|                                                                                                                                                 |      |                                 |             |      |                                               |   |             |   |  |   |             |   |  |   |             |  
|Net increase (decrease) in cash and cash equivalents                                                                                             |      |                                 | 8,217,981   |      |                                               |   | (1,743,278  | ) |  |   | (2,857,364  | ) |  |   | 8,911,994   |  
|Cash and cash equivalents, beginning of period                                                                                                   |      |                                 | 694,013     |      |                                               |   | 2,437,291   |   |  |   | 5,294,655   |   |  |   |            |  
|                                                                                                                                                 |      |                                 |             |      |                                               |   |             |   |  |   |             |   |  |   |             |  
|Cash and cash equivalents, end of period                                                                                                         |      | $                               | 8,911,994   |      |                                               | $ | 694,013     |   |  | $ | 2,437,291   |   |  | $ | 8,911,994   |  
|                                                                                                                                                 |      |                                 |             |      |                                               |   |             |   |  |   |             |   |  |   |             |  



See Notes 6 and 12 for
supplemental cash flow information.

See accompanying notes.



F-10



---

##### Table of Contents

CORAUTUS GENETICS INC.

(A DEVELOPMENT STAGE ENTERPRISE)



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS



1. Organization
and Summary of Significant Accounting Policies



Organization



Corautus Genetics Inc. (the Company) is a biopharmaceutical
company dedicated to the development of innovative gene therapy products for the treatment of cardiac and vascular disease.



The Company was incorporated as UroGen Corp. in the State of Delaware on June 30, 1995, as a wholly-owned subsidiary of Medstone International, Inc. Between July 1, 1991
(Inception) and June 30, 1995, the Company operated as a division of Medstone. On December 29, 1995, Medstone declared a dividend of all of the stock of UroGen Corp. to be distributed to all Medstone stockholders. In March 2000, the Companys
name was changed to GenStar Therapeutics Corporation.



On February 5, 2003, the
Company completed a merger with Vascular Genetics Inc. and concurrently changed the Companys name from GenStar Therapeutics Corporation to Corautus Genetics Inc. (See Note 5). The Companys focus for the foreseeable future will be the
clinical development of gene therapy products using a vascular growth factor gene known as Vascular Endothelial Growth Factor 2, or VEGF-2, for the treatment of severe cardiovascular disease.



Basis of Presentation



The consolidated financial statements include the accounts of Corautus Genetics Inc. and its wholly-owned subsidiaries, Urogen Acquisition
Corp. and Vascular Genetics Inc. All significant intercompany transactions and balances have been eliminated in consolidation. As the Company is devoting its efforts to research and the development of its products and there has been no revenue
generated from product sales, the Companys financial statements are presented as statements of a development stage enterprise.



The Companys consolidated financial statements for the year ended December 31, 2003 have been prepared on a going concern basis, which contemplates the realization
of assets and the settlement of liabilities and commitments in the normal course of business for the foreseeable future.



Certain amounts from previous periods have been reclassified to conform to the 2003 presentation.



Revenue Recognition



Grant revenue is recognized as the research expenses related to the grants are incurred. Contract revenue arising from collaborative research agreements is recognized
either (i) ratably over the term of the agreement, which approximates the performance of services, for contracts specifying payment for services over a given period, or (ii) as services are performed under the agreement, for contracts specifying
payment on a per full-time employee basis. All amounts received under research grants or from collaborative research agreements are not refundable, regardless of the success of the underlying research.



Cash and Cash Equivalents



The Company considers all highly liquid investments with an original maturity of three
months or less when purchased to be cash equivalents. The carrying amount of cash and cash equivalents approximate fair value at December 31, 2003 and 2002.



Short-Term Investments



In accordance with the Statement of Financial Accounting Standards (SFAS) No. 115,Accounting for Certain Investments in Debt and Equity Securities, management determines the appropriate
classification of short-term investment securities at the time of purchase and reevaluates such designation as of each balance sheet date. Securities classified as available-for-sale are carried at fair value based upon quoted market prices, with
gains and losses, if any, reported as a separate component of stockholders equity and included in comprehensive loss. Realized gains and losses are calculated on the specific identification method and are recorded as interest income. For the
year ended December 31, 2003, realized gains were $47,759 and realized losses were $63,694. For the year ended December 31, 2002, realized gains were $120,661 and realized losses were $104,186. For the year ended December 31, 2001, realized gains
were $365,977 and realized losses were $47,450.



F-11



---

##### Table of Contents

The Company had no short-term investments at December 31, 2003. At December 31, 2002, short-term investments consisted of
the following:



|                             |  |               |           |             |   |          
|---------------------------- |  | ------------- | --------- | ----------- | - | ---------
|                             |  | AmortizedCost |           | MarketValue
|Corporate debt securities    |  | $             | 2,198,915 |             | $ | 2,198,813
|Certificates of deposit      |  |               | 2,020,026 |             |   | 2,019,207
|                             |  |               |           |             |   |          
|Total short-term investments |  | $             | 4,218,941 |             | $ | 4,218,020
|                             |  |               |           |             |   |          



Property and Equipment



Property and equipment is stated on the basis of cost. Depreciation is
computed using the straight-line method over the useful lives of the assets, estimated at three to five years, or the term of the lease if shorter. Depreciation expense for the years ended December 31, 2003, 2002 and 2001 was $420,820, $938,812, and
$694,965, respectively.



Patents



Costs related to filing and pursuing patent applications are expensed as incurred as
recoverability of such expenditures is uncertain.



Stock Based Compensation



The Company grants stock options for a fixed number of shares to
employees in accordance with Accounting Principles Board (APB) Opinion No. 25,Accounting for Stock Issued to Employees, and, accordingly, recognizes no compensation expense for the stock option grants to employees provided that
the option exercise price is not less than the fair market value of the underlying stock on the date of the grant. The value of options or stock awards issued to non-employees have been determined in accordance with SFAS No. 123,Accounting for
Stock Based Compensation, and Emerging Issues Task Force (EITF) Issue No. 96-18,Accounting for Equity Instruments that are Issued to Other than Employees for Acquiring, or in Conjunction with Selling Goods and Services, and
are periodically remeasured as the options vest.



As required under SFAS No.
123, as amended by SFAS No. 148,Accounting for Stock-Based Compensation Transition and Disclosure, the pro forma effects of stock-based compensation on net income (loss) and net earnings (loss) per common share are estimated at the date of
grant using the Black-Scholes option-pricing model with the following weighted-average assumptions for 2003, 2002, and 2001: a risk-free interest rate of 2.6%, 4.5%, and 6.5%, respectively, a dividend yield of 0% for all periods, a volatility factor
of the expected market price of the Companys common stock of 95%, 90%, and 95%, respectively, and an expected life of the option ranging from two to five years.



For purposes of pro forma disclosures, the estimated fair value of the options is amortized to expense over the options vesting
period. The Companys pro forma information follows:



|                                                                                                                 |  |                                 |             |   |      |   |             |      |  |   |             |  
|---------------------------------------------------------------------------------------------------------------- |  | ------------------------------- | ----------- | - | ---- | - | ----------- | ---- |  | - | ----------- | -
|                                                                                                                 |  | For the Year Ended December 31, |            
|                                                                                                                 |  | 2003                            |             |   | 2002 |   |             | 2001 | 
|Net loss, as reported                                                                                            |  | $                               | (30,408,146 | ) |      | $ | (12,053,583 | )    |  | $ | (11,095,010 | )
|Add: Stock based employee compensation included in net loss                                                      |  |                                 | 607,830     |   |      |   | 47,564      |      |  |   | 35,504      |  
|Deduct: Total stock based employee compensation expense determined under fair value based methods for all awards |  |                                 | (1,738,624  | ) |      |   | (543,981    | )    |  |   | (640,494    | )
|Net loss, pro forma                                                                                              |  | $                               | (31,538,940 | ) |      | $ | (12,550,000 | )    |  | $ | (11,700,000 | )
|Basic and diluted loss per share, as reported                                                                    |  | $                               | (3.31       | ) |      | $ | (3.54       | )    |  | $ | (3.36       | )
|Basic and diluted loss per share, pro forma                                                                      |  | $                               | (3.43       | ) |      | $ | (3.68       | )    |  | $ | (3.57       | )



F-12



---

##### Table of Contents

Segment Reporting



SFAS No. 131,Disclosures About Segments of an Enterprise and Related Information, requires the use of a management approach in identifying segments of an
enterprise. Management has determined that the Company operates in one business segment, which is scientific research and development activities.



Net Loss Per Share



Net loss per share is computed on the basis of the weighted average number of common shares outstanding during the periods presented. Loss per share assuming dilution is computed on the basis of the weighted-average
number of common shares outstanding and the dilutive effect of all common stock equivalents and convertible securities. Net loss per share assuming dilution for the years ended December 31, 2003, 2002 and 2001 is equal to net loss per share since
the effect of common stock equivalents outstanding during the periods, including stock options, warrants and convertible debt, are antidilutive.



Income Taxes



The Company accounts for income taxes under SFAS No. 109, Accounting for Income Taxes, which requires that provision be made for taxes currently due and for the expected future tax effects of temporary
differences between book and tax bases of assets and liabilities.



Research
and Development



Research and development costs are expensed as incurred.



Comprehensive Income (Loss)



SFAS No. 130,Reporting Comprehensive Income, requires that all components of
comprehensive income or loss, including net income or loss, be reported in the financial statements in the period in which they are recognized. Comprehensive income or loss is defined as the change in equity during a period from transactions and
other events and circumstances from non-owner sources. Net loss and other comprehensive income (loss), including foreign currency translation adjustments and unrealized gains and losses on investments, shall be reported, net of their related tax
effect, to arrive at comprehensive loss. Comprehensive loss for the years ended December 31 consisted of the following:



|                                                 |  |      |             |   |      |   |             |      |  |   |             |  
|------------------------------------------------ |  | ---- | ----------- | - | ---- | - | ----------- | ---- |  | - | ----------- | -
|                                                 |  | 2003 |             |   | 2002 |   |             | 2001 | 
|Net loss                                         |  | $    | (30,408,146 | ) |      | $ | (12,053,583 | )    |  | $ | (11,095,010 | )
|Other comprehensive loss:                        |  |      |             |   |      |   |             |      |  |   |             |  
|Unrealized (loss) gain on short-term investments |  |      | 921         |   |      |   | (286,821    | )    |  |   | (74,686     | )
|                                                 |  |      |             |   |      |   |             |      |  |   |             |  
|Comprehensive loss                               |  | $    | (30,407,225 | ) |      | $ | (12,340,404 | )    |  | $ | (11,169,696 | )
|                                                 |  |      |             |   |      |   |             |      |  |   |             |  



Use of Estimates



The preparation of financial statements in accordance with accounting principles generally
accepted in the United States requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the
reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.



New Accounting Pronouncements



In January 2003, the FASB issued FASB Interpretation No. 46, or FIN 46,Consolidation of Variable Interest Entities. FIN 46 requires a variable interest entity to
be consolidated by a company if that company is subject to a majority of the risk of loss from the variable interest entitys activities or entitled to receive a majority of the entitys residual returns or both. A variable interest entity
either (a) does not have equity investors with voting rights, or (b) has equity investors that do not provide sufficient financial resources to the entity to support its activities. FIN 46 is effective immediately for all new variable interest
entities created or acquired after January 31, 2003. For variable interest entities created or acquired prior to



F-13



---

##### Table of Contents

February 1, 2003, the provisions of FIN 46 must be applied for the first interim or annual period beginning after
September 15, 2003. The adoption of FIN 46 did not have a material impact on the Companys results of operations or financial condition.



In May 2003, the FASB issued SFAS No 150,Accounting for Certain Instruments with Characteristics of Both Liabilities and Equity. SFAS No. 150 requires that
certain financial instruments issued in the form of shares that are mandatorily redeemable as well as certain other financial instruments be classified as liabilities in the financial statements. SFAS No 150 is effective for financial instruments
entered into or modified after May 31, 2003 and otherwise is effective at the beginning of the first interim period beginning after June 15, 2003. Adoption of this standard had no impact on the Companys financial position, results of
operations or cash flows.



2. Property and Equipment



Property and equipment are comprised of the following:



|                              |  |              |          |   |      |   |            |  
|----------------------------- |  | ------------ | -------- | - | ---- | - | ---------- | -
|                              |  | December 31, |         
|                              |  | 2003         |          |   | 2002 |  
|Equipment                     |  | $            | 486,571  |   |      | $ | 1,693,366  |  
|Equipment under capital lease |  |              |         |   |      |   | 1,418,001  |  
|Furniture and fixtures        |  |              | 16,285   |   |      |   | 151,385    |  
|Leasehold improvements        |  |              | 61,802   |   |      |   | 1,176,537  |  
|                              |  |              |          |   |      |   |            |  
|                              |  |              | 564,658  |   |      |   | 4,439,289  |  
|Accumulated depreciation      |  |              | (380,320 | ) |      |   | (1,822,838 | )
|                              |  |              |          |   |      |   |            |  
|                              |  | $            | 184,338  |   |      | $ | 2,616,451  |  
|                              |  |              |          |   |      |   |            |  



During 2003, the Company decided to
abandon its manufacturing facility and move operations into a smaller facility. As a result of this decision, all tenant improvements related to the manufacturing facility and certain manufacturing equipment, including equipment under capital
leases, and excess furniture and fixtures were identified as having no future use to the Company. A charge of approximately $1,946,000 was recorded in 2003 to write-off the property and equipment, net of estimated salvage value of $200,000. The
equipment written off is currently being marketed by a third party.



As a
result of the merger with Vascular Genetics and the related change of the Companys focus, in December 2002 the Company identified equipment with no future use and recorded a charge to expense of $382,000, net of an estimated salvage value of
$65,000. Additionally in 2002, the Company recorded a charge of $254,000 related to the unamortized portion of capitalized leasehold improvements at the Altman Row facility from which the Company will receive no further benefit due to vacating the
facility in December 2002.



3. Capital Lease Obligation



During 1999, the Company entered into capital lease agreement under which up to $250,000 in
equipment could be leased. In connection with this capital lease agreement, the Company issued a warrant for 35,714 shares of common stock to the lessor. The warrant was exercised in July 2000. Additionally, in February 2001, the Company entered
into a capital lease agreement under which up to $2,325,000 in equipment could be leased.



During 2002, the Company financed $672,304 of equipment under this lease. Under the original terms of the lease, the lease expired in February 2002, however the Company was granted an extension of the lease term
through June 2002. No additional extension of lease term was requested, and the lease term expired June 30, 2002. Therefore, no additional assets can be financed under this facility.



As discussed above in Note 2, in April 2003, the Company decided to outsource future manufacturing and wrote-off the value of all
manufacturing equipment, less an estimated salvage value. Therefore, at December 31, 2003, there was no equipment under capital leases recorded. As a result of the write-off and sale of certain of the assets and the lack of payment for a period of
time during 2003, the Company was in default under the terms of its capital leases and has classified the entire balance as current. The Company is negotiating a new arrangement with the lender with regard to the



F-14



---

##### Table of Contents

default and believes the remaining payments will be made in accordance with the schedule below. At December 31, 2002, the
Company had equipment acquired under capital leases of $1,418,001, with related accumulated depreciation of $537,659. Total depreciation expense on assets under capital lease for the three years ended December 31, 2003, 2002 and 2001 was $72,024,
$357,976, and $201,255, respectively.



Capital lease obligations at December
31, 2003 are as follows:



|                                               |  |   |         |  
|---------------------------------------------- |  | - | ------- | -
|2004                                           |  | $ | 352,326 |  
|2005                                           |  |   | 49,364  |  
|                                               |  |   |         |  
|Total minimum obligations                      |  |   | 401,690 |  
|Interest                                       |  |   | (25,425 | )
|                                               |  |   |         |  
|Capital Lease obligations at December 31, 2003 |  | $ | 376,265 |  
|                                               |  |   |         |  



4. Notes Payable



During 2000, the Company entered into a note payable in the amount of $750,000. The note
payable is secured by equipment and carries an average effective interest rate of approximately 9.6%. In addition, the Company issued a warrant for 14,286 shares of common stock to Baxter Healthcare in exchange for Baxter Healthcares guarantee
of this note payable. The note matured in 2003.



Additionally, during 2000, the
Company entered into a note payable in the amount of $200,000 to finance the construction of leasehold improvements. The note payable carries an interest rate of 10%. The note matures in 2005. The leasehold improvements financed under this note were
written off in December 2002 when the Company moved out of the leased facility. (See Note 10). The balance of this note was repaid in 2003.



On December 31, 2003, the Company executed a senior convertible promissory note and received proceeds of $2,500,000 from Boston Scientific Corporation. The note is
convertible into approximately 250,000 shares of common stock, subject to adjustment, and is only convertible in the event of a change of control, as defined. The note bears interest at 6% and if it remains unconverted, shall be repaid in three
equal, annual payments of principal and interest beginning on the fifth anniversary of issuance.



5. Acquisition of Technology and Related Agreements



In May 2000, the Company acquired all of the outstanding shares of Allegro Cell Systems, Inc. in exchange for 41,143 shares of common stock and an obligation to issue an additional 1,714 shares of common stock. The
additional 1,714 shares of common stock were issued during 2002. Allegros sole asset was a license to certain technologies for the treatment and prevention of AIDS and for lentiviral gene therapy. Allegro had no products, revenues, employees,
facilities or other assets. The shares issued to acquire the technologies were valued at $1,458,720 based on the fair value of the common stock on the date of the agreement which was charged to acquired in-process technology due to the early stage
of development of the technology and the lack of alternative future uses for it.



In July 1998, the Company executed various agreements with Baxter Healthcare pursuant to which the Company acquired certain rights and assets from Baxter Healthcare. Under the terms of the agreements, the Company obtained the rights to
Baxter Healthcares adenoviral-based gene transfer technologies and certain equipment in exchange for 5,830 shares of non-voting convertible Series A preferred stock and 263,031 shares of common stock. The shares issued to acquire the gene
transfer technologies were valued at $5,455,505 based upon a discounted cash flow analysis, estimated research and development costs for six years and product revenues commencing in year seven, after the assumed completion of clinical trials and
product approval by the U.S. Food and Drug Administration, or FDA. The value of the technology was charged to acquired in-process technology because technological feasibility had not been achieved nor had alternative future uses of the technology
been identified. The value of the stock issued for property and equipment was $343,937 based upon the fair value of those assets.



Under the terms of the Companys Developmental Collaboration Agreement and Credit Agreement with Baxter Healthcare, Baxter Healthcare was required to provide funding
for pre-clinical development of the hemophilia product. When the Company treated the first patient in a Phase I clinical trial for the hemophilia product, a milestone payment of $2,000,000



F-15



---

##### Table of Contents

was due from Baxter Healthcare. On June 13, 2001, the first patient was treated using the hemophilia product, and Baxter
Healthcare paid the $2,000,000 milestone payment in exchange for 2,000 shares of Series C preferred stock. Additionally, the remaining balance under the Credit Agreement of approximately $5,848,000 was converted to Series B preferred stock in August
2001. The Series B preferred stock was convertible at Baxter Healthcares option into 287,274 shares of common stock and was converted to common stock in February 2003 in connection with the closing of the merger with Vascular Genetics. (See
Note 6).



The Company entered into a Distribution Agreement with Baxter
Healthcare whereby Baxter Healthcare has an exclusive, worldwide right to market, sell and distribute all products that may be developed under the Developmental Collaboration Agreement. The term of the Distribution Agreement is the longer of ten
years from the date of regulatory approval of the first product or the expiration of the last to expire of any related patents issued on or before ten years from the date of regulatory approval.



The Company, Baxter Healthcare and certain founding shareholders of the Company entered into
an Investor Rights Agreement under which the shares held by these entities were subject to certain restrictions on transfer until July 8, 2003 and these entities have certain registration rights. Additionally, under this agreement, Baxter Healthcare
has the obligation to purchase Series C preferred stock at a price of $1,000 per share upon the Companys achievement of the following milestones: (i) $2,000,000 upon treatment of the first patient in a Phase I clinical trial for a product
developed under the Developmental Collaboration Agreement; (ii) $5,000,000 upon commencement of Phase III clinical trials of a product developed under the Developmental Collaboration Agreement; and (iii) $10,000,000 upon approval by the FDA of a
product developed under the Developmental Collaboration Agreement. (See related discussion in Note 6).



On February 5, 2003, in connection with the merger with Vascular Genetics, a total of 5,320,166 shares of the Companys common stock were issued to Vascular Genetics stockholders. Additionally, the Company
assumed options to purchase 229,648 shares of common stock and warrants to purchase 19,164 shares of common stock. The Company also has reserved 556,904 shares of common stock for potential indemnity obligations to former Vascular Genetics
stockholders. The acquisition has been accounted for as a purchase of assets by the Company for financial reporting purposes, in accordance with accounting principles generally accepted in the United States. After February 5, 2003, the results of
Vascular Genetics have been included in the consolidated financial statements of the Company. The purchase price exceeded the net tangible assets acquired by $17.4 million and was allocated as follows:



|                                    |  |   |           
|----------------------------------- |  | - | ----------
|Acquired workforce                  |  | $ | 80,000    
|In-process research and development |  |   | 17,294,576
|                                    |  |   |           
|Total                               |  | $ | 17,374,576
|                                    |  |   |           



Pursuant to the Emerging Issues Task
Forces Issue No. 98-3, Determining Whether a Nonmonetary Transaction Involves the Receipt of Productive Assets or of a Business, Vascular Genetics did not meet the criteria necessary to qualify as a business. Therefore, the
Companys acquisition of Vascular Genetics did not qualify as a business combination under SFAS No. 141, Business Combinations, and no goodwill resulted from the recording of the transaction. The value of the in-process research and
development has been charged to operations upon the close of the merger. The value allocated to acquired workforce is being amortized over two years. Amortization expense in 2003 was $36,667 and is included in general and administrative expenses.



6. Stockholders Equity



Convertible Preferred Stock



The Company is authorized to issue 5,000,000 shares of preferred stock, $0.001 par value. As
of December 31, 2003, 40,000, 13,000, 17,000 and 1,400,000 shares were designated Series A, Series B, Series C and Series D preferred stock, respectively.



As of December 31, 2003, there were no shares of Series A preferred stock issued and outstanding. Former holders of the Series A preferred stock were not entitled to
receive dividends, had a liquidation preference amount of ten dollars ($10.00) per share and had no voting rights. The Series A preferred stock was convertible into common stock on a 143 to 1 basis; provided, however, that no shares were convertible
prior to July 8, 2001. In February 2003, the stockholders approved an



F-16



---

##### Table of Contents

amendment to the certificate of designation for the Series A preferred stock in which the Series A preferred stock would
be convertible at the Companys option following consummation of the merger with Vascular Genetics. The outstanding shares of Series A preferred stock were converted into shares of common stock on March 7, 2003.



As of December 31, 2003, there were no shares of Series B preferred stock issued and
outstanding. The Series B preferred stock was previously issued to Baxter Healthcare in payment for amounts funded by Baxter Healthcare under the Credit Agreement. Total funding under the Development Collaboration Agreement and Credit Agreement was
$12,890,000. Previous holders of the Series B preferred stock were not entitled to receive dividends, had a liquidation preference amount of one thousand dollars ($1,000.00) per share prior to any distribution to holders of Series A preferred stock
and holders of common stock and had no voting rights, except for a vote as to whether the Company may issue additional Series B preferred stock. The Series B preferred stock was convertible into common stock upon certain triggering events. A
triggering event occurred on June 13, 2001, thus the Series B preferred stock was convertible at Baxter Healthcares option. In February 2003, the stockholders approved an amendment to the certificate of designation for the Series B preferred
stock in which the Series B preferred stock would convert to common immediately prior to the consummation of the merger with Vascular Genetics. The outstanding shares of Series B preferred stock were converted into shares of common stock on February
5, 2003.



As of December 31, 2003, there were 2,000 shares of Series C
preferred stock issued and outstanding. The Company anticipates that Series C preferred stock will be sold only to Baxter Healthcare upon the Company meeting certain specified milestones, referred to as the Series C Milestones. Holders
of the Series C preferred stock are not entitled to receive dividends, have a liquidation preference amount of one thousand dollars ($1,000.00) per share prior to any distribution to holders of Series A preferred stock and to holders of common stock
and have no voting rights, except as to the issuance of additional Series C preferred stock. Each share of Series C preferred stock becomes convertible into common stock upon the earlier of (i) the first business day following the approval by the
FDA of the right to market, sell or distribute any product using the MAXIMUM-AD Vector Technology for treatment of blood clotting disorders in humans relating to Hemophilia A, which product has been developed pursuant to the Companys
Developmental Collaboration Agreement with Baxter Healthcare and (ii) the date seven years after the achievement of the most recently achieved Series C Milestone. The Series C preferred stock is convertible into common stock in an amount equal to
(a) the quotient of (i) the Liquidation Value (adjusted for Recapitalizations), divided by (ii) one hundred and ten percent (110%) of the per share Fair Market Value of the Companys common stock (as defined), multiplied by (b) the number of
shares of Series C Preferred converted. In February 2003, the stockholders approved an amendment to the certificate of designation for the Series C preferred stock in which the Series C preferred stock would be convertible upon the earlier of (i)
the first business day following the approval by the FDA of the right to market, sell or distribute any product using the MAXIMUM-AD Vector Technology for treatment of blood clotting disorders in humans relating to Hemophilia A, which product has
been developed pursuant to the Developmental Collaboration Agreement with Baxter Healthcare and (ii) June 13, 2010.



On July 31, 2003, Boston Scientific Corporation made a $9,000,000 investment in exchange for 1,385,377 shares of Series D Preferred Stock, which was initially convertible
into the same number of shares of common stock, subject to adjustment. As of December 31, 2003, the 1,385,377 shares of Series D Preferred Stock were convertible into 1,391,800 shares of common stock. The Series D Preferred Stock is convertible into
common shares at any time at the option of the holder and votes with the common stock on an as adjusted basis. The Series D Preferred Stock has a liquidation preference of $9,004,951 that is payable prior to any distribution to holders
of Series A Preferred Stock and common stock.



Warrants



In March 2003, a warrant to purchase 100,000 shares of common stock at $1.53 was issued as
part of the consideration paid for investor relations and public relations services. One-fourth of the common stock under the warrant vested upon issuance, with the remaining portion vesting over the next nine months. The warrant is exercisable for
ten years from the issuance date. The value of the vested portion of the warrant totaled approximately $230,000 in 2003 was recorded in general and administrative expense.



In October 2003, the Company issued a warrant to purchase 1,000 shares of common stock in partial consideration for past public relations
services. The warrant is fully vested and exercisable for seven years at an exercise price of $5.87. The warrant was valued at $4,660 and recorded in general and administrative expense.



In conjunction with the lease settlement discussed in Note 10, in November 2003 the Company issued a warrant to acquire 100,000 shares of
Corautus common stock at an exercise price of $4.50 per share. The value of the warrant totaled approximately $490,000 in 2003, which was recorded in general and administrative expense.



In May 2002, the Company issued a warrant to purchase 7,857 shares of common stock in consideration for past legal services. The warrant is
fully vested and is exercisable for three years at an exercise price of $0.35. The warrant was recorded as payment of past invoices totaling $68,800.



F-17



---

##### Table of Contents

In June 2002, the Company issued two warrants to purchase 14,286 and 7,143 shares, respectively, to a service provider.
The warrant for 14,286 shares is exercisable for three years at an exercise price of $3.15 per share. The warrant for 7,143 shares was exercisable for six months at an exercise price of $3.15 and expired unexercised in January 2003. The warrants
were valued at $31,500 and were recorded to general and administrative expense.



In October 2001, the Company issued a warrant to purchase 12,786 shares of common stock to a service provider. The warrant is fully vested and is exercisable for five years at an exercise price of $16.45 per share. The warrant was valued at
$134,250 and was recorded to general and administrative expense.



Holders of
the convertible notes payable issued in 1998 and 1999 also hold warrants to purchase 73,571 and 194,881 shares of common stock at an exercise price of $5.18 per share and $2.10 per share, respectively. As of December 31, 2003, warrants to purchase
48,208 and 121,420 shares of common stock, respectively, remain outstanding.



Private Sale of Common Stock and Warrants



On December 19,
2003, Corautus and three investors entered into the Common Stock and Warrant Purchase Agreement, whereunder the investors agreed to purchase in two tranches an aggregate of 793,640 shares of Corautus common stock and warrants exercisable for 158,728
shares of Corautus common stock. The common stock was issued at a price equal to 90% of the closing market price of Corautus common stock on the day immediately preceding the agreement execution date (i.e., $3.967 per share). The warrants are
exercisable at a price equal to 125% of the closing market price of Corautus common stock on the day immediately preceding the date each transaction closed (i.e., $5.4375 per share for tranche one (108,338 shares) and $6.7625 per share for tranche
two (50,390 shares)). Additionally, the warrants are exercisable by the holder for up to five years immediately following issuance. The transaction closed on December 31, 2003 with respect to 541,690 shares and January 27, 2004 with respect to the
remaining shares. In connection with this offering, the Company issued warrants to purchase an aggregate of 32,331 shares of its common stock at an exercise price of $1.00 per share as a finders fee for the offering. The common stock and
warrants were issued pursuant to a private offering, with no general solicitation, and were therefore eligible for an exemption from registration pursuant to Section 4(2) of the Securities Act of 1933. The proceeds of the offering (totaling
$3,149,957 with no underwriting discounts or commissions) will be used for working capital and other general corporate purposes.



Employee Stock Purchase Plan



In May 2001, the Company adopted an Employee Stock Purchase Plan (the Purchase Plan), which was approved by the stockholders in July 2001. A total of 142,857
shares of common stock have been authorized and reserved for issuance under this Purchase Plan. The Purchase Plan permits all eligible employees to purchase common stock through payroll deductions (which cannot exceed 15% of each employees
compensation) at the lower of 85% of fair market value at the beginning or the end of a 24 month offering period. No shares have been issued under this plan and no employees currently participate in the plan.



Stock Options



The 1995 Directors Option Plan was adopted by the Board of Directors and approved by the stockholders in 1995 and amended in February
2000 to provide automatic, nondiscretionary grants of options to the Companys non-employee directors. A total of 78,571 shares of common stock were reserved for issuance under the 1995 Directors Option Plan. The 1995 Directors
Option Plan provided that each non-employee director would be automatically granted an option to purchase 6,429 shares of common stock upon his or her initial election or appointment as a non-employee director. Subsequently, each non-employee
director who had served for at least six months would be granted an additional option to purchase 2,143 shares of common stock on December 31 of each year so long as he or she remained a non-employee director. The exercise price of options granted
to non-employee directors must be the fair market value of common stock on the date of grant.



Options granted to non-employee directors have a ten-year term, subject to a non-employee directors continued service as a director. The initial options granted to non-employee directors vest over three years at
the rate of one-third per year, and the annual options vest one year from the date of grant. As of December 31, 2002, options to purchase 20,000 shares of common stock had been granted under the 1995 Directors Option Plan, and options to
purchase 12,143 shares of common stock were vested. The 1995 Director Option Stock Plan was terminated by the Board of Directors effective upon approval of the 2002 Stock Plan by the stockholders on February 4, 2003.



F-18



---

##### Table of Contents

The 1995 Stock Plan, which was adopted by the Board of Directors and authorized by the stockholders in 1995, authorized
the Board, or one or more committees which the Board may appoint from among its members, to grant options and rights to purchase common stock to officers, employees, consultants and certain advisors to the Company. Options granted under the 1995
Stock Plan were either incentive stock options as defined in Section 422 of the Internal Revenue Code of 1986, as amended or nonstatutory stock options, as determined by the Board or the committee. The 1995 Stock Plan initially reserved
264,286 shares for issuance under the plan, to be increased the first day of each year by the number of shares equal to two percent of the total outstanding shares of common stock. Options granted pursuant to the 1995 Stock Plan have exercise
periods of ten years and vest over one to four years. The 1995 Stock Plan was terminated by the Board of Directors effective upon approval of the 2002 Stock Plan by the stockholders on February 4, 2003.



The 1999 Stock Plan, which was adopted by the Board of Directors in 1999 and approved by the
stockholders in February 2000, authorizes the Board or a committee to grant options and rights to purchase common stock to officers, key employees, consultants and certain advisors to the Company. Options granted under the 1999 Stock Plan were
either incentive stock options or nonstatutory stock options, as determined by the Board or a committee. The 1999 Stock Plan initially reserved 571,429 shares for issuance under the plan to be increased the first day of each year by the number of
shares equal to two percent of the total outstanding shares of common stock. Options granted pursuant to the 1999 Stock Plan have exercise periods of ten years and generally vest over four years. The 1999 Stock Plan was terminated by the Board of
Directors effective upon approval of the 2002 Stock Plan by the stockholders on February 4, 2003.



In November 2002, the Board of Directors adopted the 2002 Stock Plan, which was approved by the stockholders in February 2003. Under the 2002 Stock Plan, the Board or a committee has the authority to grant options and
rights to purchase common stock to officers, key employees, consultants and certain advisors to the Company. Options granted under the 2002 Stock Plan may be either incentive stock options or nonstatutory stock options, as determined by the Board or
a committee. The 2002 Stock Plan initially reserved 1,428,571 shares for issuance under the Plan plus (a) any shares of common stock which have been reserved but not issued under the 1999 Stock Plan, the 1995 Stock Plan and the 1995 Directors
Option Plan as of the date of stockholder approval of the 2002 Stock Plan, (b) any shares of common stock returned to the 1999 Stock Plan, the 1995 Stock Plan and the 1995 Directors Option Plan as a result of the termination of options or
repurchase of shares of common stock issued under those plans and (c) an annual increase on the first day of each year by the lesser of (i) 71,428 shares, (ii) the number of shares equal to two percent of the total outstanding common shares or (iii)
a lesser amount determined by the Board of Directors.



The following table
summarizes the activity of the Companys stock options:



|                             |  |                        |   |  |                                    |   |  |                                 |      
|---------------------------- |  | ---------------------- | - |  | ---------------------------------- | - |  | ------------------------------- | -----
|                             |  | Employee Stock Options |   |  | Non-employee Director StockOptions |   |  | Weighted Average Exercise Price
|Balance at December 31, 2000 |  | 639,039                |   |  | 12,857                             |   |  | $                               | 18.62
|Granted                      |  | 103,786                |   |  | 6,428                              |   |  | $                               | 23.73
|Exercised                    |  | (41,307                | ) |  | (714                               | ) |  | $                               | 1.68 
|Canceled                     |  | (49,759                | ) |  |                                   |   |  | $                               | 29.68
|                             |  |                        |   |  |                                    |   |  |                                 |      
|Balance at December 31, 2001 |  | 651,759                |   |  | 18,571                             |   |  | $                               | 19.74
|Granted                      |  | 155,716                |   |  |                                   |   |  | $                               | 5.04 
|Exercised                    |  | (31,549                | ) |  |                                   |   |  | $                               | 2.17 
|Canceled                     |  | (228,042               | ) |  |                                   |   |  | $                               | 24.57
|                             |  |                        |   |  |                                    |   |  |                                 |      
|Balance at December 31, 2002 |  | 547,884                |   |  | 18,571                             |   |  | $                               | 15.05
|Granted                      |  | 1,454,067              |   |  | 383,373                            |   |  | $                               | 2.14 
|Exercised                    |  | (132,682               | ) |  |                                   |   |  | $                               | 0.66 
|Canceled                     |  | (198,319               | ) |  | (10,717                            | ) |  | $                               | 16.79
|                             |  |                        |   |  |                                    |   |  |                                 |      
|Balance at December 31, 2003 |  | 1,670,950              |   |  | 391,227                            |   |  | $                               | 4.43 
|                             |  |                        |   |  |                                    |   |  |                                 |      



F-19



---

##### Table of Contents

Options outstanding as of December 31, 2003:



|               |  |                    |  |                                           |  |                                 |       |                     |           |                                                        |   |      
|-------------- |  | ------------------ |  | ----------------------------------------- |  | ------------------------------- | ----- | ------------------- | --------- | ------------------------------------------------------ | - | -----
|Exercise Price |  | OptionsOutstanding |  | Weighted AverageContractual Life in Years |  | Weighted Average Exercise Price |       | Options Exercisable |           | Weighted Average Exercise Price of Options Exercisable
|$0.35$1.30    |  | 1,280,709          |  | 9.28                                      |  | $                               | 1.29  |                     | 809,883   |                                                        | $ | 1.29 
|$1.31$3.00    |  | 264,374            |  | 6.52                                      |  | $                               | 2.16  |                     | 264,374   |                                                        | $ | 2.16 
|$3.01$5.00    |  | 198,225            |  | 9.08                                      |  | $                               | 4.72  |                     | 74,543    |                                                        | $ | 4.63 
|$5.01$20.00   |  | 201,410            |  | 8.35                                      |  | $                               | 7.58  |                     | 187,158   |                                                        | $ | 7.73 
|$20.01$70.00  |  | 117,459            |  | 5.20                                      |  | $                               | 37.81 |                     | 97,757    |                                                        | $ | 40.77
|               |  |                    |  |                                           |  |                                 |       |                     |           |                                                        |   |      
|               |  | 2,062,177          |  |                                           |  |                                 |       |                     | 1,433,715 |                                                        |   |      
|               |  |                    |  |                                           |  |                                 |       |                     |           |                                                        |   |      



The weighted-average grant date fair
value of options granted at fair value on the grant date in 2003, 2002 and 2001 was $1.20, $0.58, and $2.02, respectively. The weighted-average grant date fair value of options granted at less than fair value on the grant date in 2003 was $1.99.
There were no options granted at less than fair value in 2002 and 2001.



During
2003, the Company accelerated the vesting of certain employee stock options upon the employees termination. Also, the Company extended the period during which certain vested employee stock options could be exercised upon employee termination.
Because these changes qualified as stock option modifications under Financial Accounting Standards Board Interpretation No. 44, Accounting for Certain Transactions involving Stock Compensation, an interpretation of APB Opinion No. 25, the
Company recorded compensation expense of approximately $68,000 in general and administrative expense representing the excess of the intrinsic value of the options on the modification date over the options original intrinsic value.



During 2003, the Company granted stock options to certain individuals, which had exercise
prices below the market price of the Companys common stock on the date of grant. In accordance with APB No. 25, the Company recorded compensation expense of approximately $164,500 in general and administrative expense representing the
intrinsic value of the options on the date of grant.



The following common
stock is reserved for future issuance at December 31, 2003:



|                                              |  |          
|--------------------------------------------- |  | ---------
|Stock options                                 |  |          
|Granted and outstanding                       |  | 2,062,177
|Reserved for future grants                    |  | 324,550  
|Common stock warrants                         |  | 710,611  
|Series D Preferred Stock                      |  | 1,391,800
|Employee stock purchase plan                  |  | 142,857  
|Conversion of notes payable                   |  | 250,012  
|Shares reserved for potential indemnification |  | 556,904  
|                                              |  |          
|Total                                         |  | 5,438,911
|                                              |  |          



The number of shares of common stock
into which Series C preferred stock will be converted will not be known until the date of conversion because the conversion factor is based on fair value at the date the Series C preferred stock becomes convertible.



7. Income Taxes



Prior to the distribution of common stock by Medstone, income taxes had been allocated to the Company on a separate return basis
whereby such amounts were determined as if the Company was a separate taxable entity. However, the Companys net operating losses and research and development credits incurred through December 31, 1995 were included in the consolidated tax
returns of Medstone and were fully utilized. As a result, the Companys available net operating losses and research and development credits to offset future taxable income are limited to amounts incurred subsequent to 1995. The Company has
established a valuation allowance to fully offset deferred tax assets as it is more likely than not that these amounts will not be realized.



Deferred tax assets are comprised of the following:



|                                                              |  |              |             |   |      |   |             |  
|------------------------------------------------------------- |  | ------------ | ----------- | - | ---- | - | ----------- | -
|                                                              |  | December 31, |            
|                                                              |  | 2003         |             |   | 2002 |  
|Net operating loss carryforwards                              |  | $            | 20,206,000  |   |      | $ | 15,509,000  |  
|Research and development and other state credit carryforwards |  |              | 2,088,000   |   |      |   | 1,907,000   |  
|Acquired in-process technology                                |  |              | 8,524,000   |   |      |   | 1,542,000   |  
|Lease Settlement Obligation                                   |  |              | 1,199,000   |   |      |   |            |  
|Other, net                                                    |  |              | 521,000     |   |      |   | 290,000     |  
|                                                              |  |              |             |   |      |   |             |  
|Total deferred tax assets                                     |  |              | 32,538,000  |   |      |   | 19,248,000  |  
|Valuation allowance                                           |  |              | (32,538,000 | ) |      |   | (19,248,000 | )
|                                                              |  |              |             |   |      |   |             |  
|Net deferred tax assets                                       |  | $            |            |   |      | $ |            |  
|                                                              |  |              |             |   |      |   |             |  



F-20



---

##### Table of Contents

As of December 31, 2003, the Company has federal and state net operating loss carryforwards of approximately $49,529,000
and $49,923,000, respectively, which will begin to expire in 2011 and 2005, respectively, unless previously utilized. The Company has federal and state research and development credit carryforwards of approximately $1,398,000 and $1,001,000,
respectively. The federal research and development credit carryforwards will begin to expire in 2011 unless previously utilized. The Company has a California manufacturers investment credit of approximately $60,000 that will begin to expire in
2008 unless previously utilized.



Under Internal Revenue Code Sections 382 and
383, the Companys use of net operating loss and tax credit carryforwards could be limited in the event of certain cumulative changes in the Companys stock ownership.



8. Revenues



For the year ended December 31, 2003, all revenue was from the license fee related to certain intellectual property to Boston Scientific Corporation, which is being
recognized as revenue over the licenses expected life of 12 years. For the year ended December 31, 2002, $870,438 of revenue was from research grants from the National Institutes of Health, or NIH, and $250,000 was contract revenue from a
research agreement with a corporate partner whereby the two companies collaborated on certain research projects. For the year ended December 31, 2001, all revenue was from research grants from the NIH.



9. Related Party Balances and Transactions



In connection with the merger with Vascular Genetics, Inc. in February 2003, the Company
assumed $380,000 of promissory notes and $8,266 of related accrued interest, which were payable to stockholders. During 2003, these notes were repaid.



In 2000, the Company entered into a facility lease and a note payable with a research organization in the amount of $200,000 to finance leasehold improvements on the
facility. The research organization is a related party due to a common director. During 2003, 2002, and 2001, the Company paid the research organization $560,621, $1,166,051, and $1,121,106, respectively, for rent, common area charges, license fees
and services (Note 10).



During 2001, the Company entered into a consulting
agreement with a former director and officer who continues to be a stockholder. Payments under this agreement totaled $23,000 and $55,000 for services in 2001 and 2002, respectively. Additionally, the Company extended the stock option exercise
period for options held by this individual, resulting in a charge to consulting expense of $49,000 during 2001. In early 2003, the Company terminated this consulting agreement.



During 2001, the Company entered into a note receivable with an officer and stockholder in the amount of $37,000. The note was originally to
be repaid over a four year period, however in April, 2002, the Company agreed to forgive the loan. Under the terms of the forgiveness arrangement, the loan will be forgiven over a four-year period beginning April, 2002. The amount of the loan that
was forgiven in 2003 and 2002 was $9,206 and $6,904, respectively.



10.
Commitments



Facilities



The Company leases approximately 8,600 square feet of office and laboratory space that can
be used for manufacturing. This lease expires in August 2004, with two options to extend the lease for an additional three years.



In December 2002, the Company vacated the Altman Row facility and consolidated all operations into the Barnes Canyon facility. In accordance with EITF 94-3,Liability
Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including certain costs incurred in a Restructuring), the Company recorded a charge of $510,000, which is the equivalent of six months rent and common
area maintenance charges for the Altman Row facility. The Company entered into a termination agreement with respect to this facility in 2003. Additionally, the Company recorded a charge of $254,000 related to the unamortized portion of capitalized
leasehold improvements at the Altman Row facility from which the Company will receive no further benefit.



F-21



---

##### Table of Contents

In May 2003, the Company entered into an agreement to terminate the lease for its manufacturing facility (Barnes Canyon)
and to surrender possession of such facility without prejudice to any remedies of the landlord for the recovery of rent. As of the date of such termination, future payments due under this operating lease for the remaining eight year term were
approximately $16.5 million. The Company entered into a settlement and release agreement with the landlord, dated as of November 7, 2003, for the settlement of the remaining payments that would have been due for the original term of such lease.
Pursuant to the settlement and release agreement, the Company is obligated to pay or deliver to the landlord the following:



| |  | immediately upon execution of the agreement, a warrant to acquire 100,000 shares of Corautus common stock at an exercise price of $4.50 per share;
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------



| |  | $650,000 in cash on or before April 15, 2004, in one or more installments;
| | - | --------------------------------------------------------------------------



| |  | an aggregate of $550,000 in cash in twenty-two equal consecutive monthly installments beginning February 2004;
| | - | --------------------------------------------------------------------------------------------------------------



| |  | for twenty-four months beginning November 2003, that number of shares of Corautus common stock which on the first day of each such month shall have a trading value of $50,000; and
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | $681,000 in cash on or before January 5, 2006, subject to reduction for certain amounts received by the landlord prior to December 1, 2004 from re-leasing the property.
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------



The Company has delivered to the landlord a standby letter of
credit for $681,000, securing a portion of its obligations under the agreement. The Company agreed to file a registration statement to register the shares delivered to the landlord, including the shares underlying the warrants, pursuant to the
Securities Act of 1933, on or before June 1, 2004. Such registration statement was filed on January 27, 2004 and was amended on February 3, 2004. Effective with the $650,000 cash payment due on or before April 15, 2004, the Company will be released
from its obligations under the lease. The net present value of this settlement amount of $3.4 million was charged to expense in 2003. The estimated fair value of the warrants of $490,000 was recorded to additional paid in capital and as of December
31, 2003, $1,128,189 is included in current liabilities and $1,815,289 is included in long-term liabilities.



For the years ended December 31, 2003, 2002 and 2001, rent expense was approximately $875,000, $3,056,000, and $1,753,000, respectively.



Future minimum lease payments under all of these leases are as follows:



|                    |  |   |        
|------------------- |  | - | -------
|2004                |  | $ | 188,000
|2005 and thereafter |  |   |       
|                    |  |   |        
|Total               |  | $ | 188,000
|                    |  |   |        



Purchase Commitments



In December 2003, the Company entered into agreement with a German
corporation for the manufacture of VEGF-2 plasmid material for the planned Phase III clinical trial and commercial use. The payments made under the contract, estimated at approximately $3,375,000, will be denominated in Euros and are expected to be
made over the next two to three years.



Licenses



In May 2000, the Company acquired the rights to a license agreement between Allegro and the
University of California Regents, or UC Regents, to license certain technologies for the treatment and prevention of AIDS and for lentiviral gene therapy. Under the license agreement, the Company was obligated to issue 1,714 shares of common stock
to the UC Regents in the name of Shellwater & Co. These shares were issued during 2002. Additionally, beginning in May 2003 the Company is required to pay a license fee of $10,000 on an annual basis until May 2006, or until sales of licensed
product commence, whichever occurs first. The Company also is required to make milestone payments of $15,000 upon filing an Investigative Device Exemption Application incorporating any licensed product, $25,000 upon the initiation of the first Phase
II efficacy study for licensed product, $50,000 for each licensed product regulatory approval and $15,000 for each Drug Master File for gene therapy delivery of a third party product. A minimum annual royalty of $25,000 is payable beginning with the
year of first commercial sale of licensed product, but no later than 2006. If clinical trials have not commenced by 2008, the minimum annual royalty will increase to $100,000.



F-22



---

##### Table of Contents

The Company was obligated to make a milestone payment to Immune Response Corporation, or IRC, of $200,000 upon the
approval by the FDA or the governing health authority of any other country of its first product related to the licensed technology. This fee can be offset against future royalty payments. The Company was obligated to pay royalties on its net sales
revenue and a percentage of all revenues received from sublicenses relating to the tumor radiosensitization gene therapy technology. Additionally, the Company agreed in a January 1999 amendment to reimburse IRC for past patent expenses relating to
the licensed technology in the amount of $59,400, which was paid in February 2000. In February 2002, the Company and IRC entered into an Assignment and Assumption Agreement under which the license agreement between the Company and IRC was terminated
and IRCs rights under its license agreement with the UC Regents for the related intellectual property were transferred to the Company. The Company paid IRC $100,000 as compensation for the transfer of such rights. Under the agreement with the
UC Regents, the Company had rights related to all forms of cancer for the tumor radiosensitization technology and was obligated to pay an annual license maintenance fee of $10,000 until the commencement of sales of the licensed product. The Company
would have been required to pay royalties to the UC Regents on its net sales revenues of licensed products or royalties from sublicenses. On January 23, 2004, in accordance with the license agreements, the Company formally terminated the license.



11. Profit Sharing Plan and Deferred Compensation Plan



In 1998, the Company established a savings plan which covers all employees working more than
1,000 hours per year which has been established pursuant to the provisions of Section 401(k) of the Internal Revenue Code. Contributions to the plan are discretionary and vest over a four-year period. Employer contributions during the years ended
December 31, 2003, 2002 and 2001 were $48,904, $62,328, and $238,988, respectively.



In 1998, the Company established a deferred compensation plan. Prior to 2003, certain employees were allowed to defer up to 100% of their salaries and bonuses under this plan. Additionally, the Company allowed certain employees
approximately 18% of their salaries for employee benefits and employer payroll taxes. A portion of the employer allocation for employee benefits was allocated to the deferred compensation plan. During the years ended December 31, 2002 and 2001, the
Companys contributions to the deferred compensation plan were $47,150 and $66,613, respectively. Employer contributions vested over rolling a four-year period based upon the date each employer contribution was made. This plan was terminated as
of January 1, 2003 and vested balances were paid to the respective participants.



12. Supplemental Cash Flow Information



During 2000, a warrant
for 14,286 shares of common stock was issued to Baxter Healthcare in conjunction with Baxter Healthcares guarantee of a note payable. The warrant was valued at $687,000 and classified as deferred loan fees and is being amortized to interest
expense over the term of the note payable. Additionally, the Company acquired $200,000 of leasehold improvements under a note payable to a related party.



During the years ended December 31, 2002, 2001 and 2000, the Company financed equipment valued at $672,305, $954,381 and $95,735, respectively, under capital lease
agreements.



During 2000, the Company issued 41,143 shares of common stock
valued at $1,519,500 to acquire the license for technologies for the treatment and prevention of AIDS and for lentiviral gene therapy (Note 5). During 2002, an additional 1,714 shares of common stock were issued in connection with this transaction.



During the years ended December 31, 2001 and 2000, amounts due Baxter
Healthcare under the Credit Agreement of $5,848,361 and $4,043,079 were converted into 5,849 and 4,043 shares of Series B preferred stock, respectively. Additionally, during 2001, 2,000 shares of Series C preferred stock were issued to Baxter
Healthcare in exchange for a $2,000,000 milestone payment (Note 5).



As more
fully described in Note 5, in 1998 the Company acquired certain technology and equipment in exchange for 5,830 shares of Series A preferred stock and 263,031 shares of common stock valued at $5,799,442. The equipment acquired was valued at $343,937
based on an appraisal.



In October 2003, the Company issued common stock with a
market value of $50,000 (8,696 common shares) to a vendor in settlement for outstanding obligations. The expense was recorded in general and administrative expense.



F-23



---

##### Table of Contents

Cash paid for income taxes was $1,600, $3,200, and $1,600 for the years ended December 31, 2003, 2002 and 2001,
respectively. Cash paid for interest was $78,366, $181,148, and $234,978 for the years ended December 31, 2003, 2002 and 2001, respectively.



13. Selected Quarterly Data (Unaudited)



The following tables set forth certain unaudited quarterly information for each of the eight fiscal quarters in the two-year period ended December 31, 2003. This
quarterly information has been prepared on a consistent basis with the audited financial statements and, in the opinion of management, includes all adjustments, consisting of normal recurring adjustments, necessary for a fair presentation of the
information for the periods presented. The Companys quarterly operating results may fluctuate significantly as a result of a variety of factors and operating results for any quarter are not necessarily indicative of results for a full fiscal
year or future quarters.



|                                               |  |             |            |   |              |   |            |         |  |   |            |   |  |   |             |  
|---------------------------------------------- |  | ----------- | ---------- | - | ------------ | - | ---------- | ------- |  | - | ---------- | - |  | - | ----------- | -
|                                               |  | December 31 |            |   | September 30 |   |            | June 30 |  |   | March 31   |  
|2003 Quarter Ended                             |  |             |            |   |              |   |            |         |  |   |            |   |  |   |             |  
|Total revenue                                  |  | $           | 20,833     |   |              | $ | 13,889     |         |  | $ |           |   |  | $ |            |  
|Operating expenses (1) (2)                     |  |             | 1,627,151  |   |              |   | 4,244,669  |         |  |   | 3,136,207  |   |  |   | 21,388,684  |  
|Net loss applicable to common shareholders (1) |  |             | (1,835,763 | ) |              |   | (4,191,296 | )       |  |   | (2,928,993 | ) |  |   | (21,452,094 | )
|Basic and diluted net loss per common share    |  | $           | (0.18      | ) |              | $ | (0.42      | )       |  | $ | (0.30      | ) |  | $ | (3.07       | )
|                                               |  |             |            |  
|                                               |  | December 31 |            |   | September 30 |   |            | June 30 |  |   | March 31   |  
|2002 Quarter Ended                             |  |             |            |   |              |   |            |         |  |   |            |   |  |   |             |  
|Total revenue                                  |  | $           | 257,636    |   |              | $ | 422,565    |         |  | $ | 172,107    |   |  | $ | 268,130     |  
|Operating expenses(2)                          |  |             | 3,962,487  |   |              |   | 3,059,465  |         |  |   | 3,214,509  |   |  |   | 3,136,650   |  
|Net loss applicable to common shareholders     |  |             | (3,722,431 | ) |              |   | (2,688,559 | )       |  |   | (2,914,517 | ) |  |   | (2,728,076  | )
|Basic and diluted net loss per common share    |  | $           | (1.09      | ) |              | $ | (0.79      | )       |  | $ | (0.86      | ) |  | $ | (0.80       | )

---

|(1) | The charge to write-off acquired in-process technology of $17,699,863 was recorded in the quarter ended March 31, 2003.
|--- | -----------------------------------------------------------------------------------------------------------------------

|(2) | Write-offs of property and equipment of approximately $1,358,000, $574,000 and $600,000 were reclassified into operating expenses from other expense for the quarters ended March 31,
2003, June 30, 2003, and December 31, 2002, respectively.
|--- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



14.
Litigation



The Company is involved in various litigation and
administrative proceedings arising in the normal course of business. In the opinion of management, any liabilities that may result from these claims will not, individually or in the aggregate, have a material adverse effect on the Companys
financial position, results of operations, or cash flows.



In 2002, Vascular
Genetics received notification of a claim alleging wrongful death and product liability claims in connection with the death of a patient enrolled in Vascular Genetics clinical trials. Vascular Genetics has liability insurance with limits of
$5,000,000 in the aggregate. Vascular Genetics denies liability and will vigorously contest the claim. Based on proposals made by the plaintiffs, the Company believes that the claim can be settled within the policy limits. The Company has
determined, without considering any possible insurance recovery, that a loss in connection with this matter is possible, but not probable. Accordingly, the Company has not recorded any liability relating to this matter.



15. Subsequent Events



On January 8, 2004, the Company and a group of investors entered into the Common Stock and Warrant Purchase Agreement, whereunder the
investors agreed to purchase an aggregate of 1,200,000 shares of Corautus common stock and warrants exercisable for 240,000 shares of Corautus common stock. The common stock was issued at a price equal to 90%



F-24



---

##### Table of Contents

of the closing market price of Corautus common stock on the day immediately preceding the agreement execution date (i.e.,
$4.3819 per share). The warrants are exercisable at a price equal to 120% of the closing market price of Corautus common stock on the day immediately preceding the date the transaction closed (i.e., $6.72 per share). Additionally, the warrants are
exercisable by the holder for up to five years immediately following issuance. The transaction closed on January 16, 2004. The common stock and warrants were issued pursuant to a private offering, with no general solicitation, and were therefore
eligible for an exemption from registration pursuant to Section 4(2) of the Securities Act of 1933. The proceeds of the offering (totaling $5,260,680 less $289,337 in finders fees) will be used for working capital and other general corporate
purposes.



In March 2004, the Company and two separate investors entered into
Common Stock and Warrant Purchase Agreements, whereunder the investors agreed to purchase an aggregate of 376,000 shares of Corautus common stock and warrants exercisable for 18,800 shares of Corautus common stock. The common stock was issued at a
price equal to 88% of the closing market price of Corautus common stock on the day immediately preceding the agreement execution date (i.e., $5.9835 per share). The warrants are exercisable at a price equal to 125% of the closing market price of
Corautus common stock on the day immediately preceding the date the transaction closed (i.e., $8.375 per share). Additionally, the warrants are exercisable by the holder for up to five years immediately following issuance. The transaction closed on
March 18, 2004. The common stock and warrants were issued pursuant to a private offering, with no general solicitation, and were therefore eligible for an exemption from registration pursuant to Section 4(2) of the Securities Act of 1933. The
proceeds of the offering (totaling $2,249,984) will be used in funding the Companys Phase IIb clinical trial.



F-25