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SECURITIES AND EXCHANGE COMMISSION


Washington, D.C. 20549





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FORM 10-KSB





(Mark One)


xANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE


SECURITIES EXCHANGE ACT OF 1934 [FEE
REQUIRED]





For the fiscal year ended December 31,
2001


OR


 ̈ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE


SECURITIES EXCHANGE ACT OF 1934 [NO FEE REQUIRED]





For the transition period
from to





Commission File Number 0-27264





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GENSTAR THERAPEUTICS CORPORATION


(Exact name of registrant as specified in its
charter)





DELAWARE (State or other jurisdiction of incorporation or organization)

30-687976 (I.R.S. Employer Identification No.)





10865 ALTMAN ROW, SAN DIEGO, CA,
92121


(Address of principal executive offices) (Zip code)





Registrants Telephone Number, Including Area Code:


(858) 450-5949





Securities registered pursuant to Section 12(b) of the act:





None





Securities registered pursuant to Section 12(g) of the act:





Common Stock, $.001 Par Value





(Title of Class)





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








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





The Companys revenues for the fiscal year ended December 31, 2001 were $300,900.





The number of shares of the Common Stock of the registrant outstanding as of March 18, 2002, was 23,761,333. The number of shares of Common Stock held by nonaffiliates on such date was approximately 19,945,800 with an
estimated value of $25,531,000 based on the closing price of the Companys Common Stock on the American Stock Exchange on March 18, 2002.





Traditional Small Business Disclosure Format (Check one): Yes  x;  No  ̈





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GENSTAR THERAPEUTICS CORPORATION


(A DEVELOPMENT-STAGE ENTERPRISE)





FORM 10-KSB





TABLE OF CONTENTS





ITEM NUMBER AND CAPTION

PAGE NO.PART I



3Item 1.

Business

18Item 2.

Properties

18Item 3.

Legal Proceedings

18Item 4.

Submission of Matters to a Vote of Security HoldersPART IIItem 5.

Market For Registrants Common Equity and Related Stockholder Matters

19Item 6.

Selected Financial Data

20Item 7.

Managements Discussion and Analysis of Financial Condition and Results of Operations

21Item 7A.

Quantitative and Qualitative Disclosures about Market Risk

27Item 8.

Financial Statements and Supplementary Data

27Item 9.

Changes in and Disagreements with Accountants on Accounting and Financial Disclosure

27PART IIIItem 10.

Directors and Executive Officers of the Registrant

28Item 11.

Executive Compensation

33Item 12.

Security Ownership of Certain Beneficial Owners and Management

35Item 13.

Certain Relationships and Related Transactions

37PART IVItem 14.

Exhibits and Financial Statement Schedules, and Reports on Form 8-K

40







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CAUTIONARY FACTORS THAT MAY AFFECT FUTURE RESULTS





Our disclosure and analysis in this report and in our other public statements may contain forward-looking statements. Forward-looking statements give
our current expectations or forecasts of future events. You can identify these statements by the fact that they do not relate strictly to historical or current facts. They may use words such as anticipate, estimate,
expect, project, intend, plan, believe, and other words and terms of similar meaning in connection with any discussion of future operations or financial performance. In particular, these
include statements relating to future actions, prospective products or product approvals, future performance or results of current and anticipated products, sales efforts, expenses and financial results. From time to time, we also may provide oral
or written forward-looking statements in other materials we release to the public. Any or all of our forward-looking statements in this report and in any other public statements may turn out to be wrong. They can be affected by inaccurate
assumptions we might make or by known or unknown risks and uncertainties. Many factors mentioned in the discussion below, for example regulatory approval and proprietary protection of our gene therapy products, and their market success relative to
alternative products, will be important in determining future results. Consequently, no forward-looking statement can be guaranteed. Actual future results may vary materially. We undertake no obligation to publicly update any forward-looking
statements, whether as a result of new information, future events or otherwise. You are advised, however, to consult any further disclosures we make on related subjects in our future 10-Q, 8-K and 10-K reports filed with the SEC. Also see the
section in this report titled Risks and Uncertainties following on page 12, where we discuss certain risks and uncertainties which could materially affect the outcome of events described in our forward-looking statements. Other risks and
uncertainties besides those listed in this report could also adversely affect us. This discussion is provided as permitted by the Private Securities Litigation Reform Act of 1995.





PART I





ITEM 1.    
BUSINESS





GenStar Therapeutics Corporation ( referred to as we, us,
our, GenStar or the Company) is a biotechnology company dedicated to the development of innovative gene therapy products utilizing advanced gene delivery technologies for the treatment of serious medical
disorders. The primary focus of our research and development efforts are in the generation of products for the treatment of hemophilia, cancer and therapeutic vaccines.





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. An essential requirement of gene therapy is a suitable delivery system for introducing therapeutic genes into cells.





RESEARCH AND DEVELOPMENT





GenStar has created a broad technology platform that we believe
is capable of treating a wide range of serious diseases, from liver-based diseases such as hemophilia to various types of cancer and infectious diseases that include HIV and AIDS. The Company is currently focusing on developing proprietary
adenoviral and lentiviral vector technologies that we anticipate will be used for products for the treatment of hemophilia, prostate cancer and HIV/AIDS.




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MAXIMUM-AD: The Core Technology





GenStars novel core technology is the MAXIMUM-AD (also MAX-AD system, which is based on a common-cold adenoviral vector system that facilitates maximum therapeutic DNA
delivery. MAXIMUM-AD has been bioengineered from a common cold adenovirus, with all viral genes removed to provide improved safety and maximum capacity for gene delivery. MAXIMUM-AD is capable of delivering genes to virtually all cell types, with
the capacity to carry several times the genetic material of earlier-generation vectors. This large vector can accommodate long strands of DNA that are capable of promoting high levels of transgene expression. The large-capacity MAXIMUM-AD system
also can accommodate multiple pieces of DNA which, working together, we believe can increase vector retention in the patient, enhancing long-term expression.





Treatment of Genetic Diseases





MAXIMUM-AD technology is being applied to the delivery of
the Factor VIII gene, which is used to treat hemophilia. Patients with Hemophilia A currently must receive frequent injections of Factor VIII. We believe delivery of Factor VIII through gene therapy using the MAXIMUM-AD system will significantly
improve blood coagulation on a sustained basis, with long-term expression maintaining the effectiveness of treatment for a much greater duration than existing treatments. Over time, GenStar plans to extend MAXIMUM-AD technology to the treatment of
other diseases.





Hemophilia A





There are 50,000 patients with hemophilia in the United States and Europe and approximately half of these patients have Hemophilia A, a severe form of the disease requiring repeated injections of Factor VIII. The
total estimated annual market for hemophilia treatment in these two regions alone is approximately $2 billion.





Hemophilia A is a genetic disorder defined by an individuals inability to produce the blood clotting Factor VIII coagulant protein. Patients suffer from bleeding into soft tissues,
muscles and joints and the disease is often debilitating and sometimes fatal. The primary treatment for this disorder is repeated injections of Factor VIII protein.





Believing that gene therapy provides a viable alternative to protein injections, GenStar, working with our research partner,
Baxter Healthcare Corporation, has developed a gene-delivery system called MAX-AD FVIII, which is based on the companys large-capacity MAXIMUM-AD technology. Developed from a common cold adenovirus, GenStars product has been genetically
modified to replace all viral genes with therapeutic genes that produce Factor VIII. GenStars hemophilia product carries the entire human Factor VIII gene coding sequence and is designed to optimize the production of Factor VIII in the liver,
one of its primary biological production sites. MAX-AD FVIII uses a molecular switch with a genetic sequence that is designed for increasing Factor VIII expression and sustaining high-level expression and secretion of the
protein.





MAX-AD FVIII has been designed to overcome a
serious deficiency in current gene therapy approaches, which is the inability to obtain long-term therapeutic levels of gene expression. Gene therapy could provide an improved, more convenient, and more prolonged therapeutic alternative to frequent
injections and dramatically improve patients quality of life.





Earlier studies in mice demonstrated that MAXIMUM-AD
expressed Factor VIII therapeutic threshold levels for nearly one year. Results of this research were published in the scientific periodical BLOOD, the prestigious journal of the American Society of Hematology. Studies in non-human primates




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during 2000 confirmed earlier investigations showing that a single injection of the MAX-AD FVIII vector can produce
therapeutic levels of Factor VIII without adverse effects.





In June 2001, the Phase I safety study commenced with the treatment
of the first patient with the MAX-AD FVIII product. The patient demonstrated an increase in Factor VIII clotting factor levels that has been sustained for eight months at approximately the 1% level and continued evaluation of the patient is ongoing.
Following the treatment, transient liver chemistries and hematologic abnormalities were observed from an analysis of the patients blood. While some of these laboratory abnormalities were severe, these laboratory values returned to normal
shortly thereafter, and were not considered clinically serious. After discussions with the Food and Drug Administration (FDA), the study protocol was amended to reduce the dosage for subsequent patients and patient accrual under the revised protocol
is ongoing. Patient recruitment is currently underway.





DUAL-AD Technology for Prostate Cancer





GenStars DUAL-AD technology combines the MAXIMUM-AD vector platform with a second helper vector to produce three essential
therapies for prostate cancer patients: 1) the destruction of tumor cells by viral replication; 2) making tumor cells more responsive to radiation therapy; and 3) the creation of an anti-tumor immune response that is capable of destroying metastatic
lesions. We anticipate that these multiple methods of treatment will have significant benefits in the treatment of prostrate cancer and other tumors.





With over 185,000 men diagnosed with prostate cancer in the United States each year, and an estimated 375,000 new cases worldwide, there is a pressing
need for an effective treatment for this potentially fatal cancer. Assuming that only one half of patients are being treated using current therapies, the total annual market for prostate cancer is estimated at $5 billion.





Current treatments for prostate cancer include surgical removal of the prostate gland and various combinations of chemotherapy, radiation and
cryotherapy, none of which are very effective in attacking distant metastatic lesions. GenStars DUAL-AD therapy has been designed to kill prostate cancer cells directly and improve the efficacy of radiation therapy while generating an immune
response that can destroy metastatic lesions and suppress the spread of the disease to other organs.





The companys DUAL-AD
technology uses the large MAXIMUM-AD vector platform to deliver therapeutic genes by direct injection into the tumor. The two complementary viruses replicate in infected cells, destroying the cancer. Prior to destroying the tumor cells, the vectors
have been engineered to replicate and express a therapeutic gene, the cytokine gene interleukin-3 (IL-3), which can enhance the effects of radiation therapy and induce anti-tumor immunity throughout the patients body. GenStar has an exclusive
license to a patent for the use of IL-3 gene transfer to develop treatments for prostate and other cancers.





GenStars pre-clinical studies, with DUAL-AD vectors incorporating a prostate specific antigen (PSA) promoter, have eradicated prostate tumors in animals. Studies also have
demonstrated the effectiveness of IL-3 gene expression in enhancing the effects of localized radiation and improving the results of radiation treatments. The Companys research on prostate cancer has been supported in part by a Small Business
Innovation Research grant from the National Cancer Institute.





MAXIMUM-AD as a Vaccine Platform





MAXMIMUM-AD is an excellent platform for vaccinations because it can be delivered intranasally, intradermally or orally and has a large insert capacity.
Initially, the MAXIMUM-AD vector system will be used to carry genes for the immunization and treatment of HIV. Eventually, GenStar expects




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to create vaccines for other sexually transmitted diseases and diseases of the upper respiratory and gastrointestinal
tracts that can be administered using MAXIMUM-AD technology.





There are an estimated 33 million individuals infected with HIV
worldwide, with approximately 1.5 million individuals affected in the United States and Europe. The total U.S. and European market for HIV/AIDS vaccine therapy is estimated to be $3
billion.





The HIV virus responsible for AIDS is a
lentivirus. Current treatments for HIV do not eliminate the virus and there is a profound need to develop improved therapies for infected patients. Of equal importance, medical science is moving as rapidly as possible to develop vaccines to prevent
the spread of HIV and AIDS. As with each of GenStars MAXIMUM-AD products, the large DNA delivery capacity of the vector system enhances potential clinical efficacy by incorporating a large number of HIV genes in the vaccination.





LENTI-HIV technology for HIV/AIDS





GenStar is also investigating the use of its lentiviral technology for HIV vaccine applications. LENTI-HIV is a genetically engineered HIV lentivirus in which the genes responsible for the HIV viruss replication
have been eliminated. The compelling advantage of LENTI-HIV is its ability to generate an immune response to the intact HIV virus without the danger of replicating the active virus. Lentiviral vector systems have the potential to become a
gene-delivery system with therapeutic applications beyond the prevention and treatment of HIV. This gene-delivery system offers the broad infectivity and long-term gene expression characteristics of natural lentiviruses and holds potential for
clinical development.





The GenStar LENTI-HIV product is
a vaccination containing a genetically modified HIV virus. The virus is capable of infecting cells and expressing a wide variety of HIV antigens, suitable for the generation of immune responses that eradicate HIV-infected cells. The breadth of
expression of the modified GenStar virus should provide superior efficacy compared to other vaccines that are comprised of a smaller subset of viral antigens.





Laboratory studies of GenStars HIV vaccine candidate support the vaccines activity and the Companys approach. Tests have shown that the genetically modified HIV vaccine can infect cells and induce
immune responses, but does not replicate to cause the disease. Studies also demonstrated that the HIV vaccine candidate induced a specific immune response that destroyed HIV infected cells.





Manufacturing





GenStars 8,600 square foot manufacturing facility was
utilized to produce materials for the Phase I clinical trials of our hemophilia product. The manufacturing operations are in the process of being moved to a 23,000 square foot facility we leased in 2001, which will provide for additional
manufacturing capacity.





Manufacturing for Phase II, Phase III and commercial scale quantities will require significant
improvements in our current manufacturing techniques, as well as rigorous process controls. Companies often encounter manufacturing difficulties during the course of implementing processes for commercial manufacturing, including:





| |  |  | problems involving production yields;
| | - |  | -------------------------------------




| |  |  | quality control and assurance; and
| | - |  | ----------------------------------




| |  |  | shortages of qualified personnel.
| | - |  | ---------------------------------



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We may encounter manufacturing difficulties and any such difficulties which are not easily
overcome may have a material adverse affect upon our business, financial condition and results of operations.





Facilities which
manufacture product for human clinical trials are required to be registered with the FDA and will be subject to inspections confirming compliance with the FDAs Good Manufacturing Practices regulations.





Patents and Licenses





We believe that patent and
trade secret protection is important to our business and that our future will depend, in part, on our ability to maintain our technology licenses, protect our own trade secrets, secure additional patents and operate without infringing the
proprietary rights of others. GenStar currently holds exclusive rights to two issued United States patents for tumor radiosensitization gene therapy technology and several other pending patent applications that relate to genetic therapies and
molecular diagnostics.





We have filed a series of United States and foreign patent applications for the MAXIMUM-AD and DUAL-AD
vector systems. These applications cover all fields of use for the MAXIMUM-AD system. We have obtained exclusive world-wide rights to a patent covering the use of IL-3 gene transfer used in combination with radiation for enhancing the effects of
radiation and stimulating anti-tumor immunity in the treatment of cancer. We have obtained from the University of California exclusive world-wide rights to several patent applications covering all fields of use for the LENTI-HIV
systems.





The pharmaceutical and biotechnology fields
are characterized by a large number of patent filings. A substantial number of patents have already been issued to other pharmaceutical and biotechnology companies. Research has been conducted for many years in the gene therapy field by
pharmaceutical and biotechnology companies and other organizations. Competitors may have filed applications for or have been issued patents and may obtain additional patents and proprietary rights related to products or processes competitive with or
similar to ours. Patent applications are maintained in secrecy for a period after filing. Publication of discoveries in the scientific or patent literature tends to lag behind actual discoveries and the filing of related patent applications. We may
not be aware of all of the patents potentially adverse to GenStars interest that may have been issued to other companies, research or academic institutions, or others. No assurances can be given that adverse patents or patent applications do
not contain claims relating to GenStars technology.





To date, no consistent policy has emerged regarding the breadth of
claims allowed in pharmaceutical and biotechnology patents. If patents have been or are issued to others containing preclusive or conflicting claims, and these claims are ultimately determined to be valid, we may be required to obtain licenses to
one or more of these patents or to develop or obtain alternative technology. We believe that our current and proposed activities do not infringe on any patents that would be determined to be valid. We can not guarantee that patents do not exist in
the United States or in other countries or that patents will not be issued to third parties that contain preclusive or conflicting claims with respect to any of GenStars technologies. Commercialization of GenStars proposed products may
require licensing and/or cross-licensing of one or more patents with other organizations in the field. We can not assure you that the licenses that might be required for GenStars processes or products would be available on commercially
acceptable terms, if at all.





GenStars breach of an existing license or failure to obtain a license to technology required
to commercialize its product candidates may have a material adverse effect on our business, financial condition and results of operations. Litigation, which could result in substantial cost, may also be necessary to enforce any patents issued to
GenStar or to determine the scope and validity of third-party proprietary rights. If our competitors prepare and file patent applications in the United States that claim technology also claimed by us, we may have to participate in interference
proceedings declared by the United Stated Patent and




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Trademark Office to determine the priority of invention, which could result in substantial cost, even if the eventual
outcome is favorable to us. An adverse outcome could subject GenStar to significant liabilities to third parties and require us to license disputed rights from third parties or to cease using our technology.





GenStar also relies on trade secrets to protect our technology, especially where patent protection is not believed to be appropriate or obtainable. We
protect our proprietary technology and processes, in part, by confidentiality agreements with our employees, consultants and collaborators. We cannot assure you that these agreements will not be breached, that we would have adequate remedies for any
breach, or that GenStars trade secrets or those of its collaborators or contractors will not otherwise become known or be discovered independently by competitors.





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 GenStar.





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-or other issues may prevent GenStar 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.





Government Regulation





The production and marketing of our proposed products and our research and development activities are subject to regulation for safety, effectiveness and quality by numerous governmental authorities in the United
States and other countries. In the United States, drugs are subject to rigorous FDA regulations. The Federal Food, Drug, and Cosmetic Act, as amended, the regulations promulgated thereunder, and other federal and state statutes and regulations
govern, among other things, the testing, manufacture, safety, effectiveness, labeling, storage, record keeping, advertising and promotion of our products. Product development and approval within this regulatory framework take a number of years and
involve the expenditure of substantial resources.





The steps required before our proposed products may be marketed in the United
States include:





| |  |  | preclinical laboratory tests, in vivo preclinical studies and formulation studies,
| | - |  | ----------------------------------------------------------------------------------




| |  |  | the submission to the FDA of an Initial New Drug application for human clinical testing, which must become effective before human clinical trials commence,
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------




| |  |  | adequate and wellcontrolled human clinical trials to establish the safety and effectiveness of the drug,
| | - |  | ---------------------------------------------------------------------------------------------------------




| |  |  | the submission to the FDA of a Product License Application (for a biologic) or a New Drug Application (for a drug), and
| | - |  | -----------------------------------------------------------------------------------------------------------------------




| |  |  | the FDA approval of the Product License Application or New Drug Application prior to any commercial sale or shipment of the drug.
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------



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The Recombinant DNA Advisory Committee (RAC) is an advisory committee to the National Institute
of Health (NIH) Director for certain gene transfer technologies. The NIH requires that sponsors of novel gene transfer experiments in humans present the clinical protocol to the RAC for review and comment in order to remain eligible to receive
funding from the Federal government.





In addition to obtaining FDA approval for each product and indication, each domestic
manufacturing establishment must be registered with, and approved by, the FDA. Domestic manufacturing establishments are subject to biennial inspections by the FDA and must comply with the FDAs Good Manufacturing Practices for both drugs and
devices. To supply products for use in the United States, foreign manufacturing establishments, including third party facilities, must comply with the FDAs Good Manufacturing Practices and are subject to periodic inspection by the FDA or by
corresponding regulatory agencies in countries under reciprocal agreements with the FDA. In addition to FDA regulation, we are also subject to a variety of additional governmental regulations under the Occupational Safety and Health Act, the
Environmental Protection Act, the Toxic Substances Control Act, the Energy Reorganization Act of 1974, the Resource Conservation and Recovery Act and other current and future federal, state and local regulations.





Preclinical tests include laboratory evaluation of product chemistry and formulation, as well as animal studies to assess the potential safety and
effectiveness of the product. Compounds must be adequately manufactured and preclinical safety tests must be conducted by laboratories that comply with FDA Good Laboratory Practices regulations. The results of the preclinical tests are submitted to
the FDA as part of an Initial New Drug application and are reviewed by the FDA prior to the commencement of human clinical trials. There can be no assurance that submission of an Initial New Drug application will result in FDA authorization to
commence clinical trials.





Clinical trials involve the administration of the investigational new drug to healthy volunteers or
to patients, under the supervision of qualified principal investigators. Clinical trials must be conducted in accordance with the FDAs Good Clinical Practices under protocols that detail the objectives of the study, the parameters to be used
to monitor safety and the effectiveness criteria to be evaluated. Each protocol must be submitted to the FDA for clearance as part of the Initial New Drug application. Further, each clinical trial must be conducted under the auspices of an
independent Institutional Review Board (IRB) at the institution at which the trial will be conducted. The IRB will consider, among other things, ethical factors, the safety of human subjects, informed consent and the possible liability of the
institution. Additionally, all gene transfer studies must be approved by the Institutional Biosafety Committee (IBC) at each institution at which the trial will be conducted.





Clinical trials are typically conducted in three sequential phases, but the phases often overlap. In Phase I, the initial introduction of the drug into healthy subjects or patients, the
drug is tested for safety (adverse effects), dosage tolerance, absorption, distribution, metabolism, excretion and pharmacodynamics (clinical pharmacology). Phase II involves studies in a limited patient population to:





| |  |  | determine the effectiveness of the drug for specific, targeted indications,
| | - |  | ---------------------------------------------------------------------------




| |  |  | determine dosage tolerance and optional dosage and
| | - |  | --------------------------------------------------




| |  |  | identify possible adverse effects and safety risks.
| | - |  | ---------------------------------------------------




When a compound is found to be effective and to have an acceptable safety profile in Phase II evaluations, Phase III trials are undertaken to further evaluate clinical effectiveness and to further test for safety
within an expanded patient population at geographically dispersed clinical study sites. Phase I, Phase II or Phase III testing may not be completed within any specific time period, if at all, with respect to any of our products. Furthermore, we or
the FDA may suspend clinical trials at any time if it is believed that the patients are being exposed to an unacceptable health risk.





Among other things, the results of the preclinical and clinical studies, along with manufacturing information, are submitted to the FDA in the form of a Product License Application or a New Drug Application for approval of the marketing and
commercial shipment of the drug. Upon accepting a companys marketing approval applications, the FDA generally convenes an Advisory Committee to review clinical trial results and make a nonbinding recommendation concerning the drugs
approval. After considering the Advisory Committee recommendation and other information, the FDA may or may not issue




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an approval letter. This letter sets out the specific terms and conditions that the company must satisfy in order to
receive final approval to market. The testing and approval process is likely to require substantial time and effort and there can be no assurance that any approval will be granted on a timely basis, if at all. The FDA may deny a Product License
Application or a New Drug Application if applicable regulatory criteria are not satisfied, require additional testing or information, or require post-marketing testing and surveillance to monitor the safety of the companys products if they do
not view the Product License Application or the New Drug Application as containing adequate evidence of the safety and effectiveness of the drug. Notwithstanding the submission of data, the FDA may ultimately decide that the application does not
satisfy regulatory criteria for approval. Moreover, if regulatory approval is granted, such approval will entail limitations on the indicated uses for which it may be marketed. Finally, approvals may be withdrawn if compliance with regulatory
standards is not maintained or if problems occur following initial marketing.





Under the Orphan Drug Act, the FDA may designate
drug products as orphan drugs if there is no reasonable expectation of recovery of the costs of research and development from sales in the United States or if these drugs are intended to treat a rare disease or condition, which is defined as a
disease or condition that affects less than 200,000 persons in the United States. If certain conditions are met, designation as an orphan drug confers upon the sponsor marketing exclusivity for seven years following FDA approval of the product,
meaning that the FDA cannot approve another version of the same product for the same use during the sevenyear period. The market exclusivity provision does not, however, prevent the FDA from approving a different orphan drug for the same use
or the same orphan drug for a different use. We believe that some of our potential products may qualify for orphan drug designation. Our potential products may not ultimately receive orphan drug designation, or the benefits currently provided by an
orphan drug designation may be amended or eliminated. The Orphan Drug Act has been controversial, and many legislative proposals have from time to time been introduced in Congress to modify various aspects of the Orphan Drug Act, particularly the
market exclusivity provisions. New legislation may be introduced in the future that may adversely impact the availability or attractiveness of orphan drug status for any of our potential products.





Among the conditions for FDA approval is the requirement that the prospective manufacturers quality control and manufacturing procedures conform
to Good Manufacturing Practices. In complying with standards set forth in these regulations, manufacturers must continue to expend time, money and effort in the area of production and quality control to ensure full technical compliance. The FDA
stringently applies regulatory standards for manufacturing.





We are currently conducting the Phase I clinical trial for our
MAX-AD FVIII product. Our other potential products are in preclinical testing. We anticipate that it will take between five to ten years for our MAX-AD FVIII product and our DUAL-AD product for prostate cancer to complete clinical trials and, if the
trials are successful, to be approved by the FDA.





Competition





The pharmaceutical and biotechnology industries are intensely competitive. Any product candidate developed by GenStar 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 hemophilia and prostate
cancer. Many of these organizations have financial, technical, manufacturing and marketing resources which 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 which 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.




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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 GenStar will be preferred to any existing or newly developed technologies.





Marketing And Sales





We
entered into a Distribution Agreement with Baxter Healthcare Corporation in July 1998. Under the Distribution Agreement, Baxter has the exclusive, worldwide right to market, sell and distribute all products which are developed under the Development
Collaboration Agreement with Baxter. Baxter has funded the development of the MAX-AD FVIII product and will have distribution rights for any related products using the MAXIMUM-AD technology. Under the terms of the agreement, GenStar receives a
percentage of the revenues generated by Baxter from sales of the MAX-AD FVIII product and any other products developed under the agreement with Baxter.





We have no internal sales force and currently plan to enter into additional corporate partnership arrangements under which a corporate partner would fund development of our DUAL-AD cancer product and/or other
potential products and would have distribution rights for the product funded. See Risks and Uncertainties for a further discussion of the risks associated with distribution agreements.





Employees





At December 31, 2001, GenStar had 43
employees, including 18 in research and development, 9 in process development and manufacturing, 5 in regulatory, clinical and quality assurance and 11 in finance and administration. 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.




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RISKS AND UNCERTAINTIES





GenStar Risks





We will need substantial additional funding which, if not available to
us could limit our growth or jeopardize our operations.





Although we raised $25.3 million dollars in the first quarter of
fiscal 2000, from which we expect to fund operations until the middle of 2003, 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 five 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. GenStars future capital requirements will depend on many factors:





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




| |  |  | the progress of preclinical and clinical testing;
| | - |  | -------------------------------------------------




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




| |  |  | 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 collaborative and other arrangements with third parties, such as licensing and manufacturing agreements.
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------




We expect that our existing capital resources will enable us to maintain our current and planned operations until the middle of 2003. However, no
guarantee can be made that we will not need additional funding prior to the middle of 2003. We will need to raise substantial additional capital to fund our operations. We intend to seek 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. If adequate funds are not available, we may be required to delay or reduce the
scope of our operations or to obtain funds through arrangements with collaborative partners or others that may require us to relinquish rights we may have acquired in the interim.





We are in the early stage of product development. Our technology requires additional research and development, clinical testing and regulatory clearances prior to marketing our
products. If any of our potential products are delayed or fail, our business may not succeed.





Our products are in the early
stages of development. They will require additional research and development, clinical testing and regulatory clearances. We currently do not sell any products and do not expect to have any products commercially available for at least five years, if
at all. Our proposed products are 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 and development activities will result in any commercially viable products or applications. In our industry, the majority of the potential products fail to
enter clinical studies, and the majority of products entering clinical studies after achieving promising preclinical results are not commercialized successfully.




12




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We have treated one patient in our Phase I safety study for our hemophilia program. We may
not be able to recruit additional patients in a timely manner. Any potential adverse events experienced may cause the FDA to suspend or revoke our current protocol.





In June 2001, the Phase I safety study commenced with the treatment of the first patient with the MAX-AD FVIII product. The patient demonstrated an increase in Factor VIII clotting
factor levels that has been sustained for eight months at approximately the 1% level and continued evaluation of the patient is ongoing. Following the treatment, transient liver chemistries and hematologic abnormalities were observed from an
analysis of the patients blood. While some of these laboratory abnormalities were severe, these laboratory values returned to normal shortly thereafter, and were not considered clinically serious. After discussions with the Food and Drug
Administration (FDA), the study protocol was amended to reduce the dosage for subsequent patients and patient accrual under the revised protocol is ongoing. Patient recruitment is currently underway.





We cannot guarantee that we will be able to recruit additional patients for this study in a timely manner, if at all. Additionally, if significant
adverse events occur in additional patients, the FDA may suspend or revoke the current protocol.





We have limited
manufacturing experience and marketing experience, which may impair the sale of our products.





We cannot guarantee that we
will be able to develop manufacturing or marketing capabilities successfully, either on our own or through third parties. To date, we have engaged only in the development of pharmaceutical technology and products and small-scale manufacturing, and
have more limited experience in larger-scale manufacturing or procuring products in commercial quantities or in marketing pharmaceutical products. We have only limited experience in conducting clinical trials and other later-stage phases of the
regulatory approval process. We cannot be certain that we will be able to engage successfully in any of these activities for any of the products we attempt to commercialize.





Our business is expanding and our business prospects may suffer if we are not able to effectively manage the growth of our operations, retain employees and successfully integrate new
personnel.





We currently plan to expand our operations to include development of our prostate cancer, AIDS and lentiviral
gene therapy programs and other programs yet to be identified. Additionally, while we currently have a manufacturing facility to produce material for Phase I clinical trials, the establishment a large-scale manufacturing facility will require
substantial additional funds and personnel. We will be required to comply with extensive regulations applicable to such a facility. This growth may strain our management and operations. Our ability to manage such growth depends on the ability of our
officers and key employees to:





| |  |  | broaden and strengthen our management team and to attract, hire and retain skilled employees;
| | - |  | ---------------------------------------------------------------------------------------------




| |  |  | implement and improve our operational, management information and financial control systems;
| | - |  | --------------------------------------------------------------------------------------------




| |  |  | expand, train and manage our employee base; and
| | - |  | -----------------------------------------------




| |  |  | develop additional expertise among existing management personnel.
| | - |  | -----------------------------------------------------------------




We depend on future collaborations with others, which may be difficult to obtain, and our revenues may depend on the efforts of third parties.





Our strategy for the development, clinical testing, manufacturing and commercialization of our products includes entering into various collaborations with corporate partners, licensors,
licensees and others. We have entered into a distribution agreement with Baxter Healthcare Corporation under which Baxter has the exclusive right to market, sell and distribute the MAX-AD FVIII product. Therefore, any revenues we may receive from
the MAX-AD FVIII product are dependent on the efforts of Baxter. To the extent that we enter into additional co-promotion, distribution or other licensing arrangements, any revenues we receive will depend on the efforts of the other parties in these
arrangements.





We may not be able to negotiate these collaborative arrangements on acceptable terms, if at all. Even if we enter
into these collaborative arrangements, they may not be successful. If we are unable to establish these arrangements, we would need to raise additional capital to undertake these activities at our own expense. In addition, we may encounter
significant delays in introducing our products into some markets or find that the development, manufacture or sale of our products in these markets is adversely affected by the absence of these collaborative agreements.







13




---




We are a development stage company with a limited operating history; we expect continued
losses and may never become profitable.





We are considered a development stage company because we have not yet generated
significant revenues from sales. From our inception through December 31, 2001, we have incurred cumulative losses of approximately $37.0 million, almost all of which consisted of research and development and general and administrative expenses. We
expect our losses to increase in the future as we begin our clinical trials and increase our research and development activities. We may never achieve significant revenues or become profitable.





Even if we eventually generate significant revenues from sales, we expect to incur significant operating losses over the next several years. Our ability to become profitable and to
achieve long-term success will depend on:





| |  |  | the time and expense necessary to develop our proposed products;
| | - |  | ----------------------------------------------------------------




| |  |  | whether and how quickly we can obtain regulatory approvals for proposed products; and
| | - |  | -------------------------------------------------------------------------------------




| |  |  | our success in bringing these products to market.
| | - |  | -------------------------------------------------




Industry Risks





Clinical trials are designed to test the safety and efficacy of our potential products in
human subjects. Successful clinical trials depend on the complexity of the potential product and the rate of patient enrollment. If the clinical trials are not successful, we will incur additional expense and/or our potential products may not be
approved for sale.





Extensive and costly clinical testing will be necessary to assess the safety and efficacy of our
potential products. The rate of completion of clinical trials depends on, among other factors, the type, novelty and complexity of the product and the rate of patient enrollment. Patient enrollment is a function of many factors, including:





| |  |  | the nature of the clinical trial protocols;
| | - |  | -------------------------------------------




| |  |  | the existence of competing protocols;
| | - |  | -------------------------------------




| |  |  | size of the patient population;
| | - |  | -------------------------------




| |  |  | proximity of patients to clinical sites; and
| | - |  | --------------------------------------------




| |  |  | eligibility criteria for the study.
| | - |  | -----------------------------------




Our initial clinical trial is for our MAX-AD FVIII product, and our next clinical trial is expected to be for our DUAL-AD prostate cancer product. There are other companies conducting clinical trials in patients with hemophilia and prostate
cancer. As a result, we must compete with them for clinical sites, physicians and the limited number of patients with hemophilia who fulfill the stringent requirements for participation in clinical trials. Delays in patient enrollment will increase
costs and delay the introduction of our potential products, thereby harming our business and financial condition.





Even if we
successfully enroll subjects in our clinical trials, we cannot guarantee they will respond to our potential products. If we do not comply with the U.S. Food and Drug Administration regulations applicable to clinical trials, our trials could be
delayed, suspended or canceled, or the FDA might not accept the results of our trials. The potential for adverse results exists with any clinical trial. The FDA may suspend clinical trials at any time if it concludes that the subjects participating
in our trials are being










14




---




exposed to unacceptable health risks. Further, we cannot assure you that human clinical testing will show any current or
future product candidate to be safe and effective or assure you that if approved, such products would be accepted or successful in the marketplace.





We face intense competition and must cope with rapid technological change, which may adversely affect earnings and financial condition and/or render our potential products obsolete.





We are engaged in gene transfer research, which is a rapidly changing field. Existing products and therapies to treat hemophilia, prostate cancer and
HIV/AIDS will compete directly with the products that we are seeking to develop and market. Competition from fully integrated pharmaceutical companies and more established biotechnology companies is expected to increase. Most of these companies have
significantly greater financial resources and expertise than we do in the following areas:





| |  |  | research and development;
| | - |  | -------------------------




| |  |  | manufacturing;
| | - |  | --------------




| |  |  | preclinical and clinical testing;
| | - |  | ---------------------------------




| |  |  | obtaining regulatory approvals; and
| | - |  | -----------------------------------




| |  |  | marketing.
| | - |  | ----------







Smaller 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.





Academic institutions, governmental agencies and
other public and private research organizations also conduct research, seek patent protection and establish collaborative arrangements for product and clinical development and marketing. These companies and institutions also compete with us in
recruiting and retaining highly qualified scientific and management personnel.





In addition, our competitors may develop more
effective or more affordable products, or achieve earlier patent protection or product commercialization and market penetration than we will. 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.





We need to comply with
significant government regulation to obtain product approvals and to market products after approvals. Compliance with government regulation can be a costly and time consuming process, with no assurance of ultimate approval. If these approvals are
not obtained, we will not be able to sell our potential products.





Various agencies in the United States and abroad regulate
the testing, manufacturing, labeling, distribution, marketing and advertising of proposed products and ongoing research and development activities. The U.S. Food and Drug Administration, the U.S. National Institutes 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 make it
difficult to estimate when our potential products will be commercially available, if at all.





Our potential products will
require substantial clinical trials and FDA review as new drugs. We cannot predict with certainty when we might submit any of our proposed products currently under development for regulatory review. Once we submit a product for review, we cannot
guarantee that FDA or other regulatory approvals will be granted on a timely basis, if at all.







15




---




If we are delayed or fail to obtain required approvals, our business and results of operations
would be damaged. 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:





| |  |  | product recalls or seizures;
| | - |  | ----------------------------




| |  |  | injunctions;
| | - |  | ------------




| |  |  | civil penalties;
| | - |  | ----------------




| |  |  | criminal prosecution;
| | - |  | ---------------------




| |  |  | refusal to approve new products and withdrawal of existing approvals; and
| | - |  | -------------------------------------------------------------------------




| |  |  | enhanced exposure to product liabilities.
| | - |  | -----------------------------------------




If we sell our products outside the U.S., we will be subject to regulatory requirements governing these sales. These requirements vary widely from country to country and could delay introduction of our products in those countries.





Inability to protect our technologies through patent protection could allow our competitors to exploit our proprietary
products and technologies.





We actively pursue patent protection for our proprietary products and technologies. However, our
patents may not protect us against our competitors. We may be required to file suit to protect our patents, and we cannot be certain that we will have the resources necessary to pursue such litigation or otherwise protect our patent rights.





We also rely on trade secret protection for our unpatented proprietary technology. However, trade secrets are difficult to
protect. Others could develop substantially equivalent information or gain access to our trade secrets.





We have a policy
requiring that our employees and consultants execute proprietary information agreements upon commencement of employment or consulting relationships. These agreements provide that all confidential information developed or made known to the individual
during the course of the relationship must be kept confidential except in specified circumstances. However, these agreements may not successfully protect our trade secrets or other proprietary information.





Intellectual property disputes are common in our industry and they are costly regardless of the outcome.





Others could assert claims against us based on their patents. Claims could seek damages as well as an injunction prohibiting clinical testing,
manufacturing and marketing of the product at issue. If any of these actions are successful, in addition to any potential liability for damages, we could be required to obtain a license in order to continue to manufacture or market the product at
issue. It is possible that any license required under any patent would not be made available on acceptable terms, if at all. There has been, and we believe that there will continue to be, significant litigation in the pharmaceutical industry
regarding patent and other intellectual property rights. If we become involved in any litigation, a substantial portion of our financial and personnel resources could be consumed, regardless of the outcome of litigation.




16




---




Competition for highly-skilled personnel is intense and the success of our business depends
on our ability to attract and retain key personnel.





Our future success, if any, depends to a significant degree upon the
continued service of key technical and senior management personnel, the loss of whose services might significantly delay our product development and commercialization efforts. We do not have agreements with senior management personnel which would
assure retention of their services for more than sixty days.





We will also need substantial additional expertise in the areas of
manufacturing and marketing, among others, in order to achieve our business objectives. Competition for qualified personnel is intense, and the loss of key personnel or the inability to attract and retain the additional skilled personnel required
for the expansion of our business could damage our business.





The pricing of our product may depend on third-party payors,
whose reimbursement and/or cost control policies may limit the revenues from our products.





In both domestic and foreign
markets, sales of our products, if any, will depend, in part, on the extent to which third-party payors, including government agencies such as Medicare, managed care providers and private health insurers will reimburse users for the costs of our
products and any related treatments. If those who buy our products are not adequately reimbursed, they may forego or reduce use.





Third-party payors are engaged in ongoing efforts to reduce the costs of pharmaceutical products. In the United States, an increasing emphasis on managed care and consolidation of hospital purchasing has and is expected to continue to place
pressure on pharmaceutical prices, and may reduce the prices we can charge for our potential products. In many major foreign markets, pricing approval is required before sales can commence and prices are often set by governmental authorities. These
price controls are subject to change at unpredictable times. Market acceptance of our potential products will be severely curtailed if adequate coverage and reimbursement levels are not provided by governmental authorities and private third-party
payors.





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





Our business will expose us to potential product liability risks that are inherent in the testing, manufacturing and
marketing of human therapeutic products. Product liability results from harm to patients using our potential product that was either not communicated as a potential side-effect, or was more extreme than communicated. We will require all patients
enrolled in the 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. We may not be
able to obtain and maintain product liability insurance for all of our clinical trials. We may not be able to obtain or maintain product liability insurance in the future on acceptable terms or with adequate coverage against potential liabilities
which would expose us to potential product liability.




17




---




Accidents related to hazardous materials used in our research and development efforts could
subject us to significant liability.





Our research and development efforts involve the controlled use of radioactive and
hazardous materials and biological hazardous materials, such as isopropyl alcohol, ethanol, bromides and viruses. Although we believe that our safety procedures for handling and disposing of these materials comply with the standards prescribed by
state and federal regulations, the risk of accidental contamination or injury from these 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 our
resources.





ITEM 2.PROPERTIES





GenStar leases approximately 22,000 square feet of office and
laboratory space in San Diego, California. The term of the lease expires in September 2005 with an option to extend until September 2010. We also lease approximately 8,600 square feet of office and laboratory space for our manufacturing operations
in San Diego, California. The term of the lease expires in August 2004, with two options to extend the lease for an additional three years. Additionally, we lease approximately 43,000 square feet of manufacturing, office and laboratory space in San
Diego, California. The lease expires in 2011, with one option to extend the lease for an additional five years. We are in the process of moving our manufacturing operations from the 8,600 square foot facility into 23,000 square feet of the 43,000
square foot facility. We intend to enter into subleases on the excess capacity. We believe our existing and proposed facilities will be sufficient to meet our anticipated operating needs for at least the next three years.





ITEM 3.LEGAL PROCEEDINGS





GenStar is not a party to any material litigation or legal
proceedings.





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





None.




18




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PART II





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




GenStar Common Stock is traded on the American Stock Exchange under the symbol GNT. As of December 31, 2001, there are also options outstanding to purchase 4,692,321 shares of
Common Stock, warrants to purchase 2,486,447 shares of Common Stock, Series A Preferred Stock convertible into 5,830,000 shares of Common Stock and Series B Preferred Stock convertible into 2,010,920 shares of Common Stock. Additionally, there are
2,000 shares of Series C Preferred Stock which are convertible into Common Stock at the fair value at the date of conversion. We had approximately 700 holders of record of GenStar Common Stock as of March 18,
2002.





Dividend
Policy





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 the Common Stock:





HIGH

LOWFISCAL YEAR ENDED December 31, 2002:First Quarter (through March 18, 2002)

$
2.43

$
1.00FISCAL YEAR ENDED December 31, 2001:First Quarter

$
9.75

$
2.75Second Quarter

$
8.35

$
3.55Third Quarter

$
7.89

$
1.90Fourth Quarter

$
3.49

$
2.11FISCAL YEAR ENDED December 31, 2000:First Quarter

$
19.00

$
0.66Second Quarter

$
8.13

$
3.63Third Quarter

$
11.00

$
6.18Fourth Quarter

$
13.31

$
7.00







19




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ITEM 6.SELECTED FINANCIAL DATA





The following is selected historical financial data of
GenStar Therapeutics Corporation. The financial data as of December 31, 2001 and 2000 and for each of the years in the three-year period ended December 31, 2001 have been derived from the audited financial statements of the GenStar, included
elsewhere in this annual report. The financial data for all other periods and dates have been derived from audited financial statements of GenStar which 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.





Year Ended December 31,


Period from July 1, 1991 (inception) to December 31, 20012001


2000


1999


1998


1997(in thousands except per share data)Statement of Operations Data:Net revenues

$
301


$
162


$
118


$
192


$
194


$
1,422Costs and expenses:Cost of sales






















822Research and development


8,452



6,414



2,711



1,916



346



23,012General and administrative


3,711



2,374



817



487



151



8,249Write-off of acquired in-process technology






1,655







5,455







7,110Total costs and expenses


12,163



10,443



3,528



7,858



497



39,193Loss from operations


(11,862
)


(10,281
)


(3,410
)


(7,666
)


(303
)


(37,771
)Other income (expense)


(1
)


(12
)


(72
)










(21
)Interest expense


(459
)


(230
)


(360
)


(306
)






(1,355
)Interest income


1,227



913



24



10



4



2,192Net loss

$
(11,095
)

$
(9,610
)

$
(3,818
)

$
(7,962
)

$
(299
)

$
(36,955
)Basic and diluted net loss per share

$
(0.48
)

$
(0.46
)

$
(0.35
)

$
(1.00
)

$
(0.04
)Weighted average shares outstanding


23,108



21,006



10,763



7,997



7,311





December 31,2001

2000

1999


1998


1997(in thousands)Balance Sheet Data:Working capital (deficit)

$
15,379

$
20,343

$
448


$
(1,274
)

$
6Total assets


21,102


24,444


1,897



1,098



78Long-term debt, net of current portion


695


2,585


1,927



1,274



Shareholders equity (deficit)


17,785


20,183


(905
)


(1,934
)


9




20




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|ITEM  7. |  | MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION ANDRESULTS 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. 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 the Companys expectations, beliefs, intentions or strategies regarding the future. All forward-looking statements included in this document are based on
information available to the Company on the date hereof, and the Company assumes no obligation to update any such forward-looking statements. The Companys actual results could differ materially from those anticipated in these forward-looking
statements. See the section in this report titled Cautionary Factors That May Affect Future Results.





OVERVIEW





GenStar Therapeutics Corporation is a biotechnology company dedicated to the development of innovative gene therapy products utilizing
advanced gene delivery technologies for the treatment of serious medical disorders. The primary focus of our research and development efforts is in the generation of products for the treatment of hemophilia, cancer and vaccines.





GenStar commenced operations as a stand-alone entity in January 1996 and has been in the development stage since inception. Our original
mission was to develop products to treat diseases in urology, with a particular interest in prostate cancer. We had licensed technology that uses the IL-3 gene to treat several types of cancer, but did not have technology to deliver the gene. On
July 8, 1998, we entered into an agreement with Baxter Healthcare Corporation in which we acquired the exclusive rights to certain gene delivery technologies and laboratory equipment. The gene delivery technology has been used to enhance our
existing technology and to develop products to deliver other genes. We believe that the gene delivery technology provides a higher level of expression of the gene being delivered compared to other gene therapy approaches. Prior to our license of the
technology, Baxter had been developing this technology for the treatment of hemophilia and cancer and continued to fund the development of our MAX-AD FVIII product for hemophilia through the date of treatment of the first patient in a clinical trial
for that product. See Certain Relationships and Related Transactions-Baxter Agreements.





In May 2000, we acquired all of the outstanding shares of Allegro Cell Systems, Inc. (Allegro) in exchange for 288,000 shares of GenStar Common Stock and an obligation to issue an
additional 12,000 shares of Common Stock once approved by the University of California Regents. Allegros sole asset was a license to certain technologies for the treatment and prevention of AIDS and for lentiviral gene therapy. Allegro has no
products, revenues, employees, facilities or other assets. Based upon the very early stage of development of the technology and the lack of alternative future uses for it, the value of the technology was charged to acquired in-process technology.





GenStars current activities consist of the development of the MAXUMIMUM-AD gene transfer system for our MAX-AD FVIII
product, our DUAL-AD vector product for prostate cancer, and the MAX-AD and LENTI-HIV vector systems for the treatment of HIV/AIDS. We anticipate defining additional uses for our vector technologies and potentially acquiring other technologies. We
expect to incur increasing research and development expenditures as we focus our efforts on further development of these products. We expect no product revenues in the near future and to incur significant losses for at least the next five years. We
may never become profitable.




21




---




CRITICAL ACCOUNTING POLICIES AND ESTIMATES





Our discussion and analysis of our financial condition and results of operations are based upon the Companys 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 financial statements on page F-50).





Revenue recognition





Grant revenue is recognized as the
research expenses related to the grants are incurred. All amounts received under the collaborative research agreements or research grants are not refundable, regardless of the success of the underlying research.





Patent costs





We expense
the costs related to filing and pursuing patent applications as the costs are incurred because the recoverability of such expenditures is uncertain.





Income taxes





We record a valuation allowance to reduce our deferred tax assets to the
amount that is more likely than not to be realized. While we have considered future taxable income and ongoing prudent and feasible tax planning strategies in assessing the need for the valuation allowance, in the event we were to determine that we
would be able to realize our deferred tax assets in the future in excess of its net recorded amount, an adjustment to the deferred tax asset would increase income in the period such determination was made. Likewise, should we determine that we would
not be able to realize all or part of our net deferred tax asset in the future, an adjustment to the deferred tax asset would be charged to income in the period such determination was made. The Companys policy is to record a valuation
allowance equal to the net deferred tax asset.





Stock based compensation





The Company grants 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, 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, 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 No. 96-18,
Accounting for Equity Instruments that are Issued to Other than Employees for Acquiring, or in Conjunction with Selling Goods and Services. Options, warrants or stock awards are valued at the date of grant, are periodically remeasured as the
awards vest and the related expense is recorded to the expense category related to the services provided.







22




---




RESULTS OF OPERATIONS





Revenues





GenStar has generated revenues to date of $1,422,000 from contract research
agreements and grants. Total revenues for the years ended December 31, 2001, 2000 and 1999 were $301,000, $162,000 and $118,000, respectively. Revenue for all three years was from a research grant. We anticipate seeking additional research
agreements and grants to help fund research and development efforts. We do not anticipate revenues from products for at least five years. Product revenues are contingent on the success of our clinical trials.





Research and development and acquired in-process technology





Research and development expenses and acquired in-process technology charges increased $382,000 to $8,452,000 for the year ended December 31, 2001 compared to $8,069,000 for the year
ended December 31, 2000. Excluding the year 2000 charge to write-off acquired in-process technology of $1,655,000 related to the Allegro acquisition, research and development expenses increased $2,037,000. There were no charges to write-off acquired
in-process technology during 2001. 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.





In the first quarter of 2000, we raised $25.3 million in private equity financing, which enabled GenStar to expand its research and development efforts, which prior to that time had been primarily focused on the
MAX-AD FVIII program. After the first quarter 2000, we significantly expanded our activities on the DUAL-AD prostate cancer program and commenced research on the vaccine program. During 2000, we hired twelve employees in the research and development
group, and hired an additional eleven employees in 2001.





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 which 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.





Research and development expenses and acquired in-process technology charges increased $5,358,000 to $8,069,000
for the year ended December 31, 2000 compared to $2,711,000 for the year ended December 31, 1999. The increase in research and development expenses and acquired in-process technology charges for the year 2000 compared to 1999 is due to an overall
increase in research and development activity and the commencement of operations of our manufacturing facility in the first quarter of 2000. The increase is also attributable to the acquisition of Allegro in 2000, which resulted in a charge to
write-off acquired in-process technology of $1,655,000. There were no similar charges during 1999.





We estimate that it will
take at least five 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 preclinical
and clinical testing necessary to bring our products to market and to establish manufacturing and marketing capabilities.





General and administrative expenses





General and administrative expenses increased $1,337,000 for the year ended
December 31, 2001 to $3,711,000 compared to $2,374,000 for the year ended December 31, 2000. General and administrative expenses increased $1,557,000 for the year ended December 31, 2000 to $2,374,000 compared to $817,000




23




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for the year ended December 31, 1999. 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. General and administrative expenses increased both during 2001 and 2000 related to the increased level of operations. We expect the
number of financial and administrative employees to remain constant and overall general and administrative expenses to be consistent with 2001 expenses during 2002.





Interest income and expense





Interest income
increased $314,000 for the year ended December 31, 2001 to $1,227,000 compared to $913,000 for the year ended December 31, 2000. Interest income increased $889,000 for the year ended December 31, 2000 to $913,000 compared to $24,000 for the year
ended December 31, 1999. The increase in interest income in both years is the result of investment of excess cash in money market accounts, corporate and international notes and certificates of deposit.





Interest expense increased $230,000 for the year ended December 31, 2001 to $459,000 compared to $229,000 for the year ended December 31, 2000. Interest
expense decreased $131,000 for the year ended December 31, 2000 to $229,000 compared to $360,000 for the year ended December 31, 1999. Interest expense in both 2001 and 2000 relates to equipment financing and the deferred compensation liability.
Interest expense in 1999 was comprised of $309,000 of amortization of the discount on convertible notes payable, $25,000 related to the 8% interest rate on the notes and $26,000 related to interest on the capital lease line. Interest expense in 2000
was comprised of $101,000 related to amortization of the deferred loan fees, $82,000 related to the capital lease line, $34,000 related to notes payable and $12,000 related to deferred compensation liability. Interest expense in 2001 was comprised
of $270,000 related to amortization of the deferred loan fees, $106,000 related to the capital lease line, $66,000 related to notes payable and $17,000 related to deferred compensation liability.





Liquidity and Capital Resources





From inception through December 31, 2001, we
have primarily financed our operations through private placements of equity and convertible debt securities and through our partnership with Baxter Healthcare. We have raised $1.4 million in convertible debt offerings, $25.3 million in private
equity financings and received equity funding of $14.9 million related to our relationship with Baxter. Additionally we have financed equipment purchases under capital leases and secured notes payable totaling $1.9 million.





Net cash used by operating activities was $10,882,000, $6,735,000 and $3,813,000 during 2001, 2000 and 1999, respectively. Net cash used by operating
activities consists of expenditures for research and development and general and administrative expenses. Net cash generated from investing activities was $1,343,000 during 2001 and consists of purchases of short-term investments net of sales of
short-term investments and purchases of property and equipment. Net cash used by investing activities of $17,385,000 and $170,000 during 2000 and 1999, respectively, consists of the purchase of short-term investments and property and equipment. Net
cash provided by financing activities of $6,682,000 during 2001 consists primarily of $3,873,000 paid by Baxter under the credit agreement, proceeds from the sale of Series C Preferred Stock to Baxter 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, and proceeds from the issuance of Common Stock upon exercise of options and warrants for Common Stock of $421,000. Net cash provided by financing
activities of $28,492,000 during 2000 consists primarily of net proceeds from the sale of Common Stock and warrants for Common Stock of $23,426,000, proceeds from notes payable of $750,000 and $4,143,000 received from Baxter under the credit
agreement for development of the hemophilia product. Net cash provided by financing activities of $4,590,000 in 1999 consists primarily of $4,178,000 paid by Baxter under the aforementioned credit agreement and $400,000 in proceeds from notes
payable.





GenStars future capital requirements will depend on many factors, including scientific progress in our research
and development programs, our ability to establish collaborative arrangements with others for drug




24




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development, progress with preclinical and clinical trials, the time and costs involved in obtaining regulatory approvals and effective commercialization
activities. As of December 31, 2001, the Company had cash, cash equivalents and short-term investments totaling $16,361,000 and working capital of $15,379,000. GenStar has incurred net losses of $37.0 million since its inception through December 31,
2001, and has never been profitable during its existence. We expect to incur significant additional operating losses over the next several years as our research and development efforts expand. Our ability to achieve profitability depends upon our
ability, alone or with others, to successfully complete development of products, obtain required regulatory approvals and manufacture and market products. We may not be successful and we may never attain significant revenues or profitability. Our
operations to date have consumed substantial amounts of cash. The negative cash flow from operations is expected to continue and to accelerate for at least the next four or five 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.





Under the terms of our Developmental Collaboration Agreement and Credit Agreements with Baxter (See Certain Relationships and Related
TransactionsBaxter Agreements), Baxter was required to provide funding for development of the hemophilia product. Total funding received from Baxter under these agreements was $12,890,000, which was converted into 12,890 shares of Series
B Preferred Stock. When the Company treated the first patient in a Phase I clinical trial for the hemophilia product, a milestone payment of $2,000,000 was due from Baxter. In June 2001, the first patient was treated using the hemophilia product and
Baxter paid the $2,000,000 milestone payment in exchange for 2,000 shares of Series C Preferred Stock. The Series B Preferred Stock is convertible into 2,010,920 shares of Common Stock. The Series C Preferred Stock is convertible at Baxters
option 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 between Baxter and the Company and (ii) the date seven years after the achievement of the most recently achieved Series C Milestone.





We anticipate our existing capital resources will enable us to maintain our current and planned operations until the middle of 2003. However,
no assurance can be given that we will not need additional funds prior to the middle of 2003. We will need to raise substantial additional capital to fund future operations. We intend to seek additional funding either through collaborative
arrangements or through public or private equity financings. Additional financing may not be available on acceptable terms or at all. If adequate funds are not available, we may be required to delay or reduce the scope of our operations or to obtain
funds through arrangements with collaborative partners or others that may require us to relinquish rights we may otherwise have.





New Accounting
Pronouncements





In June 2001, the FASB issued SFAS No. 141, Business Combinations,and No. 142, Goodwill and Other
Intangible Assets. SFAS No. 141 requires all business combinations initiated after June 30, 2001, to be accounted for by the purchase method. Under SFAS No. 142, goodwill and intangible assets with indefinite lives are no longer amortized but
are reviewed annually (or more frequently if impairment indicators arise) for impairment. Separate intangible assets that are not deemed to have an indefinite life will continue to be amortized over their useful lives (but with no maximum life). The
amortization provisions of SFAS No. 142 apply to goodwill and intangible assets acquired after June 30, 2001. With respect to goodwill and intangible assets acquired prior to July 1, 2001, the Company is required to adopt SFAS No. 142 effective
January 1, 2002. The Company does not expect the adoption of these pronouncements to have an effect on the consolidated financial statements as the Company has not recorded any goodwill or other intangible assets as a result of a business
combination.




25




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In October 2001, the FASB issued SFAS No. 144, Accounting for the Impairment or Disposal of
Long-Lived Assets, which addresses financial reporting for the impairment or disposal of long-lived assets and supercedes SFAS No. 121, Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of, and
the accounting and reporting provisions of APB Opinion No. 30. While earlier application is encouraged, SFAS No. 144 is effective for fiscal years beginning after December 15, 2001. The Company does not believe the adoption of SFAS No. 144 will have
a material impact on its financial statements.





Technology Licenses





In May 2000, GenStar acquired the rights to a license agreement between Allegro and the University of California Regents (UC Regents) to license certain technologies for the
treatment and prevention of AIDS and for lentiviral gene therapy. Under the license agreement, the Company is obligated to issue 12,000 shares of Common Stock to the UC Regents in the name of Shellwater & Co. Additionally, beginning in May 2003
the Company is required to pay an annual license fee of $10,000 until May 2006, or until sales of licensed product commence, whichever occurs first. The Company is also 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.





GenStar entered into a license agreement with The Immune Response Corporation
(IRC) in March 1997, which was subsequently amended in January 1999 whereby we licensed from IRC tumor radiation enhancing gene therapy technology. Under the IRC License, GenStar is obligated to make a milestone payment to IRC of
$200,000 upon the approval by the Food and Drug Administration or the governing health authority of any other country of GenStars first product related to the technology licensed from IRC. This fee can be offset against future royalty
payments. GenStar is obligated to pay royalties on its net sales revenue and a percentage of all revenues received from sublicenses relating to the licensed technology. Additionally, GenStar agreed in the 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, GenStar and IRC entered into an Assignment and Assumption Agreement under which the license agreement between
GenStar and IRC was terminated and IRCs rights under its license agreement with the UC Regents for the related intellectual property were transferred to GenStar. GenStar paid IRC $100,000 as compensation for the transfer of such rights. Under
the agreement with the UC Regents, GenStar has rights to treat all forms of cancer using the tumor radiation enhancing technology, and is obligated to pay an annual license maintenance fee of $10,000 until we start to sell licensed product. GenStar
must also pay royalties to the UC Regents on its net sales revenues of licensed products or royalties from sublicenses.





In
September 1996, GenStar entered into a license agreement with the UC Regents to license rights to patents in the field of diagnosis of cancer using very sensitive molecular biology techniques that detect the presence of cancer cells. We are required
to pay an annual license maintenance fee of $10,000 until we start selling licensed product. We are also required to pay milestone fees of $25,000 upon filing an Investigative Device Exemption Application on a licensed product or method with the
Food and Drug Administration and $50,000 upon marketing approval of a licensed product or method by the FDA. GenStar must also pay royalties to the UC Regents on its net sales revenues of licensed products or royalties from sublicenses. A minimum
annual royalty of $50,000 is payable beginning with the year of first commercial sale of licensed product, but no later than the fifth year of the agreement. The minimum annual royalty may be credited against revenue-based royalties due for the year
in which the annual minimum payment was made.




26




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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 2001 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 do not conduct business with foreign entities, and do not have any foreign exchange risk.





ITEM
8.FINANCIAL STATEMENTS





SEE ITEM 14.  Exhibits, Financial Statement Schedules,
and Reports On 8-K.





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




NONE.







27




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PART III





ITEM 10.DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT





The names of the directors and
executive officers of GenStar, their ages as of December 31, 2001 and certain information about them are set forth below:





Name of Directors and Executive Officers

Age

Principal OccupationPaul D. Quadros

55

Chairman of the Board of Directors & Chief Financial OfficerRobert E. Sobol, M.D.

49

Chief Executive Officer & DirectorLee R. McCracken

43

President & Chief Business OfficerYawen L. Chiang PhD

51

Senior Vice President, Research and DevelopmentConnie J. Kohne

49

Vice President, Regulatory Affairs & Corporate QualityWilliam C. Raschke, PhD

55

Vice President, Scientific PartneringCarin D. Sandvik

38

Sr. Director, Finance & Administration, and Corporate SecretaryPeter F. Bernardoni

42

DirectorIvor Royston, M.D.

56

DirectorVictor W. Schmitt

53

Director





Paul D. Quadroshas been Chairman of the Board and our Chief Financial
Officer since August 1998. Prior to that Mr. Quadros had been the President and Chief Executive Officer since April 1997 and prior to that was the Chairman of the Board, Chief Financial Officer and Secretary since our formation in June 1995.
Mr.Quadros was, from January 1985 an officer and from April 1986 a general partner of Technology Funding, a venture capital management organization. From 1986 through 1994, Mr. Quadros was a member of Technology Fundings Commitments Committee,
serving as its chairman from 1987 to 1990. From 1990 to 1994 Mr. Quadros was chairman of Technology Fundings Medical Investment Committee and was involved in managing Technology Fundings healthcare portfolio. Mr. Quadros is a co-founder,
director and former Chairman of the Board of Cardiac Science, Inc. (NASDAQ: DFIB). In addition to GenStar and Cardiac Science, Mr. Quadros serves as a director of several private companies. Mr. Quadros has a B.A. in Finance from California State
University at Fullerton and an M.B.A. from The Anderson School at UCLA.





Robert E. Sobol, M.D.has been Chief
Executive Officer since July 1998. Prior to that Dr. Sobol was the President from Chief Executive Officer from July 1998 until May 2000 and the Executive Vice President and Chief Operating Officer from July 1996 to July 1998. Dr. Sobol was
previously the Director of Clinical Science at Sidney Kimmel Cancer Center, which is affiliated with Sharp HealthCare, one of the largest healthcare providers in San Diego. Dr. Sobol has developed clinical applications of immuno therapy and gene
therapy for the treatment of cancer and is a founder of several successful biotechnology ventures.




28




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He was a founder and Vice President of IDEC Pharmaceuticals Corporation, a publicly traded company developing monoclonal
antibody based treatments for cancer and autoimmune disorders. He was also a founder of GeneSys Therapeutics, a gene therapy company which merged with publicly traded Somatix Therapy Corporation and subsequently with Cell GeneSys Incorporated.





Dr. Sobol led the research team which was the first to treat a brain tumor patient with cytokine gene therapy. He is also the
principal investigator for one of the first gene therapy protocols approved for the treatment of colon carcinoma.





Dr. Sobol
received a B.A. in Philosophy from Boston University and an M.D. from The Chicago Medical School. He subsequently trained at the University of Southern California Medical Center and at the University of California, San Diego. He is Board Certified
in Internal Medicine and Medical Oncology.





Lee R. McCrackenjoined GenStar as President and Chief Business Officer in
May 2000. Prior to joining GenStar, Mr. McCracken was Senior Vice President, Corporate Development/New Business Ventures with CombiChem, Inc. (acquired by DuPont Pharmaceuticals), a computational discovery company. At CombiChem he was
responsible for establishing seven corporate collaborations and one joint venture spanning pharmaceutical, agrochemical and materials science discovery.





Previously, he was Vice President of Business Development at Watson Pharmaceuticals and Managing Director of Pacific Pharma, a subsidiary of Allergan. Mr. McCracken was a venture capitalist with 3i Capital and Union
Venture. Mr. McCracken holds a B.S. in Commerce at Santa Clara University, an M.S. in Computer Science from the University of Dayton, and an M.B.A. from The Anderson School at UCLA.





Yawen L. Chiang, Ph.D.joined GenStar as Senior Vice President, Research & Development in August, 2001. Dr. Chiang has 17 years of research and development experience in the
biotechnology and pharmaceutical industries. She 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.





Prior to joining GenStar, she
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/Gene 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.





Connie J. Kohnejoined GenStar as Vice President, Regulatory Affairs and Corporate quality in June 2000. Prior to joining GenStar, Ms. Kohne served as Regulatory Affairs Head of
Virology, Advertising and Promotion at Agouron Pharmaceuticals Inc. (Warner Lambert/Pfizer Pharmaceuticals). During her tenure at Agouron, she was responsible for U.S. regulatory affairs for antiviral products from Phase I through Phase IV clinical
trials, working on several drug candidates under evaluation for the treatment of patients with HIV, including an HIV protease inhibitor that gained marketing approval. Ms. Kohnes responsibilities also included advertising and promotion
regulatory affairs and clinical compliance worldwide. Previously, she served as Director of Regulatory Affairs at Canji Inc. (Schering-Plough) where she worked on gene therapy using adenoviral gene constructs designed to treat cancer.





In 1997, Ms. Kohne won the prestigious National Performance Review, Hammer Award, from Vice President Al Gore, for her
work with the Food and Drug Administration (FDA) in the area of regulatory




29




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reform. In 1998, she was awarded the Food and Drug Administrations Commissioners Special Citation. The citation was awarded in recognition of
outstanding leadership and commitment in furthering the FDAs efforts to provide the consumer and the regulated industry with a more responsive Agency.





Ms. Kohne received a B.S. degree from the University of Oregon, at Eugene, in chemistry and biology.





William C. Raschke, PH.D.has been Vice President since August 1998 and devotes his efforts to both scientific and corporate development projects. He was previously Director of Research since September 1996. Dr. Raschke also holds
the positions of Member and Director of Molecular Immunology of the Sidney Kimmel Cancer Center (formerly the San Diego Regional Cancer Center), positions he has held since coming to the Center in 1994. Since March 1997, he has also served as the
Acting Scientific Director of the Center. Dr. Raschke has previously held positions at SIBIA, Inc. from 1988 to 1994 where he was Senior Research Fellow, The Salk Institute from 1988 to 1994, and 1975 to 1981 with various staff appointments and the
La Jolla Cancer Research Foundation (now the Burnham Institute) from 1981 to 1988 as Associate Scientific Director and Staff Scientist.





Dr. Raschke has served as a reviewer for the National Institute of Health with two four- year terms on the Experimental Immunology Study Section, the American Cancer Society and The National Science Foundation, as
well as international funding agencies. He also reviews manuscripts for various immunology and cancer journals.





Dr. Raschke received a B.S. in Chemistry from the University of Texas, Austin and a Ph.D. in Biochemistry from the University of California, Berkeley. He conducted post graduate training
at the Salk Institute in Developmental Biology and Immunology.





Carin D. Sandvikhas served as Senior Director, Finance
and Administration, Chief Accounting Officer and Corporate Secretary since January 2001. Prior to that, she served as Controller, Chief Accounting Officer and Corporate Secretary since joining GenStar in October 1998. Ms. Sandvik currently manages
the accounting, treasury and human resources functions. Prior to joining GenStar, Ms. Sandvik was a Senior Manager in the Technology Industry Group at PricewaterhouseCoopers LLP (formerly Price Waterhouse LLP), where she had served in various
positions for twelve years. While at PricewaterhouseCoopers, Ms. Sandvik specialized in assisting clients with acquisitions and SEC reporting. Ms. Sandvik received a B.A. in Business Administration with an emphasis in Accounting from the University
of San Diego.





Peter F. Bernardonihas served as a Director since 1996. He is also a Partner of Technology
Funding. Mr. Bernardoni joined Technology Funding as an Investment Officer in 1988, was elected as a Vice President in 1992 and a Partner in 1994. Mr. Bernardoni has served as a member of Technology Fundings Commitments Committee since 1994
and as Chairman of Technology Fundings Medical Investment Committee since 1994. Prior to joining Technology Funding, Mr. Bernardoni held several executive positions at IBM. He began his career as a design engineer in disk drive products and
moved into sales and marketing where he managed a sales team that targeted pharmaceutical and healthcare providers.





Mr.
Bernardoni currently serves on the Board of Directors of Endocare, Inc., Prolinx Inc., Resoultion Sciences Corporation and Sanarus Medical Inc., and is Chairman of Portable Energy Products. Mr. Bernardoni has a B.S.M.E. from Santa Clara University
and an M.S.M.E. from Stanford University.





Ivor Royston, M.D.was the Chairman of the Board from April 1997 until August
1998. Prior to that, he served as President and Chief Executive Officer. He has served as a Director since our formation in June 1995.





Dr. Royston is a General Partner of Forward Ventures, a life science venture capital firm. From 1990 until 2000, he was the President and Chief Executive Officer of Sidney Kimmel Cancer Center (formerly the San Diego
Regional Cancer Center). From 1977 to 1993, Dr. Royston held various positions in academic




30




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medicine at the University of California, San Diego (UCSD) School of Medicine. Dr. Royston also served as Director, Clinical Immunology Program at the UCSD
Cancer Center and Chief of Oncology at the San Diego VA Medical Center.





Dr. Royston was a founder and Director of Hybritech,
Inc., GeneSys Therapeutics Corporation and IDEC Pharmaceuticals, Inc. He has served on the Board of Directors of various companies, including Unisyn Technologies, Inc., Medstone International Inc., Sequana Therapeutics, Inc., Corixa, Inc.,
CombiChem, Inc. IDEC Pharmaceuticals and GenQuest, Inc. He currently is a member of the Board of Directors of Avalon Pharmaceuticals, Favrille, Inc. and Conforma Therapeutics and is Chairman of the Board of CancerVax and Sagres Discovery. Dr.
Royston was appointed by the President of United States to the National Cancer Advisory Board during 1996.





Dr. Royston received
a B.A. in Human Biology from Johns Hopkins University and an M.D. from the Johns Hopkins School of Medicine. He later trained in internal medicine and oncology at Stanford University and is board certified in both Internal Medicine and Medical
Oncology.





Victor W. Schmitthas served as a director since 1998. He is President, Venture Management, Baxter Healthcare
Corporation. He has held this position since 1994 and is responsible for the creation and management of Baxters interests in development-stage biotech companies. Prior to his current assignment, he held the operating position of President,
Baxter Biotech Europe. He has also served as Vice President, Business Development and Finance for Baxters Blood Therapy Group.





Mr. Schmitt joined Baxter from a sixteen-year career with the American Red Cross Blood Services. At the Red Cross Blood Services, Mr. Schmitt held positions in marketing and operations. At the time of his departure,
he was Vice President, Blood Services with responsibility for the organizations national blood services program.





Mr.
Schmitt holds a B.S. from the University of Virginia and an M.B.A. from the University of Maryland. He serves on the Board of Directors of a number of development-stage biotech companies.





SCIENTIFIC ADVISORY BOARD





GenStars Scientific Advisory Board is
comprised of the following individuals who have expertise in immunology, cancer, vaccines and gene therapy:





James P. Allison, Ph.D., Professor of Immunology, Howard Hughes Medical Institute, University of California at Berkeley, Berkeley, CA





Malcolm K. Brenner, Ph.D., Professor of Pediatrics and Medicine, Director, Cell and Gene Therapy Program, Baylor College of Medicine, Houston, TX





Albert B. Deisseroth, M.D., Ph.D., President and CEO, Sidney Kimmel Cancer Center, San Diego, CA





Daniel P. Gold, Ph.D., Executive VP, Research and Development, Favrille, Inc., San Diego, CA





Stephen M. Hedrick, Ph.D., Professor of Biology, University of California at San Diego, San Diego, CA





Norman R. Klinman, M.D., Ph.D.,Professor of Immunology, The Scripps Research Institute, San Diego, CA





William H. Mcbride, Ph.D., D,Sc, Professor, Department of Radiology, University of California at Los Angeles, Los
Angeles, CA





Thomas C. Merigan, M.D.,Professor of Medicine, Stanford University School of Medicine,
Stanford, CA





Linda A. Sherman, Ph.D., Professor of Immunology, The Scripps Research Institute, San
Diego, CA





Wei-wei Zhang, M.D., Ph.D., Chief Executive Officer, GenWay Biotech, Inc.




31




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COMPENSATION OF DIRECTORS





Cash Compensation





GenStar does not compensate its Directors for their services as such.
However, Directors are reimbursed for their out-of-pocket expenses in attending Board meetings.





1995 Directors Option Plan





Non-employee directors also receive stock options under GenStars 1995 Directors Option Plan (the Directors
Plan). The Directors Plan was adopted and approved by the shareholders of the Company in 1995 and amended in 2000 to provide automatic, nondiscretionary grants of options to non-employee directors of the Company. A total of 550,000
shares of Common Stock have been reserved for issuance under the Directors Plan. The Directors Plan provides that each non- employee director is automatically granted an option to purchase 45,000 shares of Common Stock upon his or her
initial election or appointment as an non-employee director (Initial Options). Subsequently, each non-employee director who has served for at least six months will be granted an additional option to purchase 15,000 shares of Common Stock on December
31 or each year so long as he or she remains an non-employee director (Subsequent Options). The exercise price of the 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 ten-year terms, subject to an non-employee directors continued service as a director. Initial Options vest over three years at a rate of 33.3% per year, subsequent options vest one year from the grant date. As of
December 31, 2001, options to purchase 140,000 shares of Common Stock to non-employee directors has been granted under the Directors Plan.





SECTION 16(a) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE





Section 16(a) of the Exchange Act (Section
16) requires GenStars executive officers, directors and beneficial owners of more than 10% of GenStar Common Stock to file reports of ownership and changes in ownership of Common Stock of the Company with the Securities and Exchange
Commission, and to furnish us with copies of all Section 16(a) forms they file. Based solely on GenStars review of the copies of such forms received by it, or written representations from certain reporting persons that no Form 5s were
required for those persons, no reporting persons filed late Section 16 filings during 2001.




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ITEM 11.EXECUTIVE COMPENSATION





The table below sets forth certain summary information concerning compensation
earned by our Chief Executive Officer and each of our four other most highly compensated officers (the Named Executive Officers) who received cash compensation greater than $100,000 during the three years ended December 31, 2001 for
services to GenStar in all capacities during the three years ended December 31, 2001:





Summary Compensation Table





Fiscal Period

Annual Compensation

Long-Term CompensationRestricted Stock Award ($)

Securities Underlying Options (#)


All Other Compensation ($)Name and Principal Position


Salary ($)

Bonus ($)Paul D. Quadros(1)

2001

$
138,125









$
13,270
(6)Chairman of the Board & Chief Financial

2000

$
134,441

$
20,540



50,000


$
13,764
(6)Officer

1999

$
120,000






81,903


$
13,951
(6)Robert E. Sobol, MD(2)

2001

$
255,000

$
47,400






$
29,657
(7)Chief Executive Officer

2000

$
258,942






105,000


$
32,905
(7)1999

$
200,000






627,141


$
30,927
(7)Lee R. McCracken(3)

2001

$
215,000

$
13,825






$
29,114
(8)President and Chief Business Officer

2000

$
126,734






500,000


$
17,788
(8)Wei-Wei Zhang, MD, PhD(4)

2001

$
120,375









$
7,324
(9)Sr. Vice President and

2000

$
190,110

$
28,440



105,000
(5)

$
26,538
(9)Chief Scientific Officer

1999

$
160,000

$
30,000



941,713
(5)

$
81,712
(9)Connie J. Kohne

2001

$
138,125

$
5,333






$
11,621
(10)Vice President, Regulatory Affairs and

2000

$
78,238






125,000


$
5,996
(10)Corporate QualityWilliam C. Raschke, PhD

2001

$
125,469

$
13,998






$
16,454
(11)Vice President, Scientific Partnering

2000

$
108,990






24,574


$
13,486
(11)1999

$
75,000






95,426


$
11,092
(11)


---

|(1) |  | Mr. Quadros served as the President and CEO from April,1997 to August,1998.
|--- |  | ---------------------------------------------------------------------------

|(2) |  | Dr. Sobol served as the Executive Vice President and Chief Operating Officer from July, 1996 to August, 1998 and as President from August, 1998 to May, 2000.
|--- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------

|(3) |  | Mr. McCracken joined GenStar in May 2000.
|--- |  | -----------------------------------------

|(4) |  | Dr. Zhang terminated his employment with GenStar in July, 2001 and became a consultant to the Company. During 2001 the Company accrued consulting expense in the amount of
$23,000. Additionally, when he became a consultant, the Company allowed his stock options to continue to vest based on their original term. The extension of the vesting period resulted in a charge to expense of $49,000 in 2001.
|--- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(5) |  | Dr. Zhangs spouse was employed by GenStar. Amount includes stock options beneficially owned by both Dr. Zhang and his spouse.
|--- |  | ------------------------------------------------------------------------------------------------------------------------------

|(6) |  | Mr. Quadros other compensation includes contributions to the 401K Plan of $7,849, $9,275 and $8,400 for 2001, 2000 and 1999, respectively, and the Deferred Compensation
Plan of $5,421, $4,489 and $5,551 for 2001, 2000 and 1999, respectively.
|--- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(7) |  | Dr. Sobols other compensation includes contributions to the 401K Plan of $11,970, $14,000 and $11,200 for 2001, 2000 and 1999, respectively, and the Deferred Compensation
Plan of $17,687, $18,905 and $19,727 for 2001, 2000 and 1999, respectively.
|--- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(8) |  | Mr. McCrackens other compensation includes contributions to the 401K Plan of $11,807 and $8,575 for 2001 and 2000, respectively, and the Deferred Compensation Plan of
$17,307 and $9,213 for 2001 and 2000, respectively.
|--- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(9) |  | Dr. Zhangs other compensation includes contributions to the 401K Plan of $7,324, $11,900 and $11,200 for 2001, 2000 and 1999, respectively, and the Deferred Compensation
Plan of $0, $14,638 and $14,178 for 2001, 2000 and 1999, respectively. The Company also reimbursed Dr. Zhang for $56,334 of relocation costs in 1999.
|--- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(10) |  | Ms. Kohnes other compensation includes contributions to the 401K Plan of $7,835 and $4,725 for 2001 and 2000, respectively, and the Deferred Compensation Plan of $3,786
and $1,271 for 2001 and 2000, respectively.
|---- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(11) |  | Dr. Raschkes other compensation includes contributions to the 401K Plan of $6,510, $7,416 and $5,250 for 2001, 2000 and 1999, respectively, and the Deferred Compensation
Plan of $9,944, $6,070 and $5,842 for 2001, 2000 and 1999, respectively.
|---- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



33




---




Employment Agreement





In April 1997, Paul D. Quadros entered into an employment agreement with GenStar. If Mr Quadros is terminated by GenStar without cause, Mr. Quadros is entitled to receive his base salary and benefits for six months
from the date of termination, and one-half of his base salary and benefits for months six through twelve after termination. Mr. Quadros is required to give GenStar sixty days written advance notice of his intent to resign.





In May 2000, Lee R. McCracken entered into an employment agreement with GenStar. If Mr. McCracken is terminated by GenStar without cause, Mr. McCracken
is entitled to receive his base salary and benefits for six months from the date of termination, and one-half of his base salary and benefits for months six through twelve after termination. Mr. McCracken is required to give GenStar sixty days
written advance notice of his intent to resign.




34




---




ITEM 12.    
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT





The following table sets forth
information with respect to the beneficial ownership of GenStar Common Stock owned by (i) the holders of more than 5% of the GenStar Common Stock, (ii) each Director of the Company, (iii) each Executive Officer listed under the heading
Executive Compensation and (iv) all Directors and Executive Officers of the Company as a group. The information provided below is based on the record ownership and total outstanding shares of GenStar Therapeutics Corporation Common Stock
at February 28, 2002, and includes GenStar Common Stock shares issuable upon exercise of stock options and warrants granted to Officers, Directors and key employees of the Company. See Executive Compensation.





Name of person or Identity of Group

Shares Beneficially Owned(1)


Approximate Percent OwnedVictor W. Schmitt One Baxter
Parkway Deerfield, Illinois 60015

9,856,808
(2)

31.2
%Baxter Healthcare Corporation One Baxter Parkway Deerfield, Illinois 60015

9,782,139
(2)

30.9
%Aries Select, LTD 787
7thAvenue, 48thFloor New York, NY 10019

3,371,089
(3)

14.0
%Aries Select I, LLC 787
7thAvenue, 48thFloor New York, NY 10019

1,555,167
(3)

6.5
%Ivor Royston 9255 Towne Centre
Dr. San Diego, California 92121

935,713
(4)

3.9
%Peter F. Bernardoni 1035 Suncast
Lane, Suite 122 El Dorado Hills, CA 95762

760,032
(5)(6)

3.2
%Technology Funding 1035 Suncast
Lane, Suite 122 El Dorado Hills, CA 95762

730,032
(5)

3.0
%Robert E. Sobol 10865 Altman
Row San Diego, California 92121

841,197
(7)

3.5
%Wei-Wei Zhang 10130 Sorrento
Valley Road, Suite C San Diego, CA 92121

896,535
(8)

3.7
%William C. Raschke 10865 Altman
Row San Diego, CA 92121

636,274
(9)

2.6
%Paul D. Quadros 10865 Altman
Row San Diego, CA 92121

469,814
(10)

2.0
%Lee R. McCracken 10865 Altman
Row San Diego, CA 92121

240,583
(11)

1.0
%Connie J. Kohne 10865 Altman
Row San Diego, CA 92121

57,292
(12)

*All Executive Officers and Directors as a group (12 persons)

14,973,810


36.4
%





See footnotes on following page.




35




---

|(1) |  | The number and percentage of shares beneficially owned is determined under the rules of the SEC, and the information is not necessarily indicative of beneficial ownership for
any other purpose. Under such rules, beneficial ownership includes any shares as to which the individual has sole or shared voting power or investment power and also any shares which the individual has the right to acquire within sixty days of
March 31, 2002, through the exercise of any stock option or other right. Unless otherwise indicated in the footnotes, each person has sole voting and investment power (or shares such power with his or her spouse) with respect to the shares
shown as beneficially owned.
|--- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(2) |  | Includes 5,830 shares of non-voting Series A Preferred Stock convertible subsequent to July 8, 2001 into 5,830,000 shares of Common Stock and 12,890 shares of Series B
Preferred Stock convertible subsequent to June 13, 2001 into 2,010,920 shares of Common Stock held by Baxter Healthcare Corporation. Baxter Healthcare Corporation and Mr. Victor W. Schmitt are entitled to exercise voting and investment power with
respect to all shares owned by Baxter Healthcare Corporation, and therefore, are deemed to be beneficial owner of such shares.
|--- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(3) |  | Paramount Capital Asset Management, Inc. (PCAM) is the general partner of the parent entity of each of the Aries Select I LLC and Aries Select II LLC funds and
serves as investment manager of Aries Select, Ltd. Dr. Lindsay A. Rosenwald is the chairman and sole stockholder of PCAM. As a result, Dr. Rosenwald and PCAM may be deemed to have voting and investment control over the securities of GenStar
owned by Aries Select I LLC, Aries Select II LLC and Aries Select, LTD under Rule 16a0(a)(1) of the Securities Act of 1934. Dr. Rosenwald and PCAM disclaim beneficial ownership of the securities held by the Aries Funds, except to the extent of its
pecuniary interest therein. Includes currently exercisable warrants to purchase 374,703 and 170,045 shares of Common Stock by Aries Select, Ltd and Aries Select I LLC, respectively.
|--- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(4) |  | Includes 108,333 shares issuable upon exercise of presently outstanding warrants and 15,000 shares issuable upon the exercise of vested options.
|--- |  | ------------------------------------------------------------------------------------------------------------------------------------------------

|(5) |  | Includes 291,667 shares issuable upon exercise of presently outstanding warrants held by Technology Funding Venture Partners IV, an Aggressive Growth Fund, L.P. Technology
Funding, Inc. and Technology Funding Ltd. (together Technology Funding), of which Peter Bernardoni is an officer and a partner, are the managing general partners of Technology Funding Venture Partners IV, an Aggressive Growth Fund, L.P.
Technology Funding and Mr. Bernardoni are entitled to exercise voting and investment power with respect to all shares owned by Technology Funding Venture Partners IV, an Aggressive Growth Fund, L.P. and therefore are deemed to be beneficial owner of
such shares.
|--- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(6) |  | Includes 45,000 shares issuable upon exercise of presently outstanding and currently exercisable stock options.
|--- |  | ---------------------------------------------------------------------------------------------------------------

|(7) |  | Includes 614,314 shares issuable upon the exercise of options vesting within 60 days.
|--- |  | -------------------------------------------------------------------------------------

|(8) |  | Includes 796,535 shares issuable upon exercise of options vesting within 60 days.
|--- |  | ---------------------------------------------------------------------------------

|(9) |  | Includes 189,167 shares issuable upon exercise of presently outstanding warrants and 85,486 shares issuable upon the exercise of options vesting within 60 days.
|--- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------

|(10) |  | Includes 98,374 shares issuable upon the exercise of options vesting within 60 days.
|---- |  | ------------------------------------------------------------------------------------

|(11) |  | Includes 239,583 shares issuable upon the exercise of options vesting within 60 days.
|---- |  | -------------------------------------------------------------------------------------

|(12) |  | Includes 57,292 shares issuable upon the exercise of options vesting within 60 days.
|---- |  | ------------------------------------------------------------------------------------

|* |  | Less than 1%.
|- |  | -------------



36




---




ITEM 13.    
CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS





Baxter Agreements





In July 1998, GenStar executed various agreements with Baxter Healthcare Corporation pursuant to which we acquired certain rights and assets from
Baxter. Under the terms of the agreements, GenStar obtained the rights to Baxters adenoviral-based gene transfer technologies and certain equipment in exchange for 5,830 shares of non-voting convertible Series A Preferred Stock and 1,841,219
shares of Common Stock. The shares issued to acquire the gene transfer technologies were valued at $5,455,505 based on the fair value of the stock on the date of issuance and the purchase price was charged to acquired in-process technology due to
the early stage of development of the technology. The value of the stock issued for fixed assets was $343,937 based upon the fair value of those assets.





Baxter has provided funding to GenStar for research and development of this technology as it relates to the treatment of hemophilia under the Developmental Collaboration Agreement. Baxter provided funding through the
date on which the treatment of the first patient in a Phase I clinical trial began. This development funding was provided under a Credit Agreement. Under the terms of the Credit Agreement, the amounts outstanding under the Credit Agreement are due
and payable on December 31 of each year during the term of the agreement. At GenStars option, the amounts may be paid by issuing to Baxter the number of shares of Series B Preferred Stock determined by dividing the outstanding amount under the
Credit Agreement by one thousand. Series B Preferred Stock is convertible into Common Stock. The remaining balance under the Credit Agreement was converted to Series B Preferred Stock in 2001 subsequent to the treatment of the first patient in the
Phase I clinical trial for the MAX-AD FVIII product. The balance was presented as a non-current liability on the accompanying balance sheet due to the conversion feature and because we converted the debt rather than repay it with cash. Amounts
outstanding under the Credit Agreement do not accrue interest unless GenStar is in default, in which case the amount due bears interest at prime plus 4%.





GenStar entered into a Distribution Agreement with Baxter under which Baxter will have an exclusive, worldwide right to market, sell and distribute all products which 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.





GenStar, Baxter and certain founding shareholders entered into the Investor Rights Agreement
under which the shares held by these entities are subject to certain restrictions on transferability of the shares until July 8, 2003 and have certain registration rights. Additionally, under this agreement, Baxter has the right to purchase up to
twenty percent of any new securities issued at the offering price of such securities and has the obligation to purchase Series C Preferred Stock at a price of $1,000 per share upon our achievement of the following milestones:





| |  |  | $2,000,000 upon treatment of the first patient in a Phase I clinical trial for a product developed under the Developmental Collaboration Agreement, which occurred on June 13,
2001,
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------




| |  |  | $5,000,000 upon commencement of Phase III clinical trials of a product developed under the Developmental Collaboration Agreement, and
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------




| |  |  | $10,000,000 upon approval by the Food and Drug Administration of a product developed under the Developmental Collaboration Agreement.
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------



37




---




Sidney Kimmel Cancer Center





Sidney Kimmel Cancer Center (SKCC) originally owned 339,000 shares of GenStar Common Stock and Dr. Royston was Chief Executive Officer of SKCC
until June 2000. GenStar has entered into the following transactions with SKCC:





In 2000, GenStar entered into another facility
lease with SKCC and a note payable to SKCC in the amount of $200,000 to finance leasehold improvements on the facility. During 2001, 2000 and 1999, the Company paid SKCC $1,121,106, $555,399 and $308,972, respectively, for rent, license fees and
services.





In August 1998, GenStar and SKCC entered into a sublease agreement for approximately 4,800 square feet of
office and laboratory space. The monthly lease payment is approximately $14,800 plus our share of facility expenses. The lease expired in May 2000.





Other Transactions





In August 1997, GenStar issued warrants to purchase
200,000 shares of Common Stock to Dr. Sobol. These warrants were exercisable at $0.05 per share (the fair market value of the Common Stock on the date of grant) and expired on July 31, 2001. The warrant was exercised in February 2000.





In July 1998, we received $1,030,000 representing proceeds from the sale of unsecured convertible notes payable which bore interest at 8% per
annum and were due on June 30, 1999, unless previously converted. The notes were convertible, at the option of the holder, into Common Stock at $1.00 per share, and automatically converted into 1,030,000 shares of Common Stock on June 22, 1999 upon
filing of a registration statement to register the resale of the underlying shares. In addition, each note holder received a warrant to purchase a number of shares of Common Stock of GenStar equal to one share for each $2.00 of principal under the
purchased note. The warrants are exercisable for seven years from issuance and have an exercise price of $0.74 per share. The warrants were valued at an aggregate value of $305,910 and recorded to interest expense. The following GenStar officers and
directors participated in these transactions: Mr. Quadros, Dr. Sobol, Dr. Raschke and Dr. Royston each purchased notes for $50,000 and received a warrant for 25,000 shares of Common Stock.





In April 1999, we received $400,000 representing proceeds from the sale of unsecured convertible notes payable which bear interest at 8% per annum and are due on March 31, 2000, unless
previously converted. The notes were convertible, at the option of the holder, into Common Stock at $0.30 per share, and automatically converted into 1,333,333 shares of Common Stock on June 22, 1999 upon filing of a registration statement to
register the resale of the underlying shares. In addition, each note holder received a warrant to purchase a number of shares of Common Stock of GenStar equal to one share for each $0.30 of principal under the purchased note. The warrants are
exercisable for seven years from issuance and have an exercise price of $0.30 per share. The warrants were valued at an aggregate value of $266,667 and recorded to interest expense. The following GenStar officers and directors participated in this
transactions:





| |  |  | Mr. Quadros purchased notes for $10,000 and received a warrant for 33,333 shares of Common Stock.
| | - |  | -------------------------------------------------------------------------------------------------




| |  |  | Dr. Raschke purchased notes for $40,000 and received warrants for 133,333 shares of Common Stock.
| | - |  | -------------------------------------------------------------------------------------------------




| |  |  | Ms. Sandvik purchased notes for $5,000 and received warrants for 16,667 shares of Common Stock.
| | - |  | -----------------------------------------------------------------------------------------------




| |  |  | Dr. Royston purchased notes for $25,000 and received a warrant for 83,333 shares of Common Stock.
| | - |  | -------------------------------------------------------------------------------------------------




| |  |  | Dr. Raschke and his spouse also received a Finders Fee for amounts raised in this offering of $9,250 in cash and warrants for 30,833 shares of common stock exerciseable
at $0.30 per share for seven years.
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



38




---




In January 2000, we completed an offering of 6,362,801 shares of common stock and warrants to
purchase 1,773,899 shares of common stock for $8.3 million. Victor W. Schmitt, a director of the company, purchased 33,113 shares of common stock and a warrant exercisable for 16,556 shares of Common Stock at an aggregate purchase price of $25,000.





In July 2001, the Company entered into a Separation Agreement with Dr. Wei-Wei Zhang, who had served as Sr. Vice President,
Chief Scientific Officer and Director of the Company since October 1998. Concurrently, GenStar and Dr. Zhang entered into a consulting agreement. Under the terms of the Separation Agreement, Dr. Zhangs unvested stock options were allowed to
continue to vest pursuant to the original vesting schedule as long as Dr. Zhang remained a consultant to the Company. Under the terms of the Consulting agreement, Dr. Zhang agreed to become the Chairman of GenStars Scientific Advisory Board,
and to complete certain mutually agreed upon projects for a three year period. Compensation under the consulting agreement is $4,167 per month for the period July 15, 2001 through July 15, 2002; $3,333 per month for the period July 15, 2002 through
July 14, 2003; and $2,500 per month for the period July 15, 2003 through July 15, 2004. Either party may terminate the consulting agreement with ninety (90) days written notice.




39




---




PART IV





ITEM. 14.    
EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K





(a)Index to Financial
Statements





1.  Historical Financial Statements





PageReport of Ernst & Young LLP, Independent Auditors

F-42Consolidated Balance Sheets at December 31, 2001 and 2000

F-43Consolidated Statements of Operations for the years ended December 31, 2001, 2000, and 1999 and the period from July 1, 1991
(inception) to December 31, 2001

F-44Consolidated Statements of Stockholders Equity (Deficit) for the period from July 1, 1991 (inception) to December 31,
2001

F-45Consolidated Statements of Cash Flows for the years ended December 31, 2001, 2000, and 1999 and the period from July 1, 1991
(inception) to December 31, 2001

F-49Notes to Consolidated Financial Statements

F-50





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





No reports on Form 8-K were filed during the past quarter of the year ended December 31, 2001.





(c)Exhibits





Exhibit No.

Description2.1

Distribution Agreement between the Company and Medstone International Inc.(1)2.2

Asset Purchase Agreement, dated as of February 28, 1998, between UroGen and Baxter Healthcare Corporation(2)2.3

Amendment to Asset Purchase Agreement, dated as of May 27, 1998, between UroGen and Baxter.(2)2.4

Distribution Agreement, dated July 8, 1998, between UroGen and Baxter.(2)2.5

Investor Rights Agreement, dated July 8, 1998, between UroGen and Baxter.(2)2.6

Developmental Collaboration Agreement, dated July 8, 1998 between UroGen and Baxter.(2)2.7

Credit Agreement, dated July 8, 1998, between UroGen and Baxter.(2)2.8

Technology License Agreement, dated July 8, 1998, between UroGen and Baxter.(2)2.9

Second Amendment to Asset Purchase Agreement, dated July 20, 2001, between GenStar and Baxter.2.10

Third Amendment to Asset Purchase Agreement, dated December 31, 2001, between GenStar and Baxter.3.1

Certificate of Incorporation of the Company(1)3.2

Bylaws of the Company(1)




40




---




3.3

Certificate of Amendment of the Restated Certificate of Incorporation(5)4.1

Certificate of Designation of Preferences and Rights of Series A Preferred Stock of UroGen.(2)4.2

Certificate of Designation of Preferences and Rights of Series B Preferred Stock of UroGen.(2)4.3

Certificate of Designation of Preferences and Rights of Series C Preferred Stock of UroGen.(2)4.4

Certificate of Designation of Preferences and Rights of Series A Preferred Stock of GenStar Therapeutics Corporation (As Amended).4.5

Certificate of Designation of Preferences and Rights of Series B Preferred Stock of GenStar Therapeutics Corporation (As Amended).4.6

Certificate of Designation of Preferences and Rights of Series C Preferred Stock of GenStar Therapeutics Corporation (As Amended).4.7

Third Amendment to Certificate of Designation of Preferences and Rights of Series B Preferred Stock of GenStar Therapeutics Corporation.10.1

Contribution Agreement between the Company and Medstone International, Inc. dated October 31, 1995(1)10.2

Form of Indemnification Agreement(1)10.3

UroGen Corp. 1995 Stock Plan(1)10.4

UroGen Corp. 1995 Director Option Plan(1)10.5

License Agreement, dated March 5, 1997, between UroGen and The Immune Response Corporation(3)10.6

Amendment to License Agreement, dated January 29, 1999, between UroGen and The Immune Response Corporation.(3)10.7

License Agreement, dated November 5, 1997, by and among UroGen, Sidney Kimmel Cancer Center and Daniel A. Mercola, M.D., Ph.D.(3)10.8

License Agreement, dated September 20, 1996 between UroGen and The Regents of the University of California.(3)10.9

Form of Note and Warrant Purchase Agreement, dated July 8, 1998 between UroGen and various investors.(3)10.10

Warrant Certificate, dated July 31, 1997, between UroGen and Robert E. Sobol.(3)10.11

Distribution Agreement, dated July 8, 1998, by and among UroGen and Baxter.(2)10.12

Investor Rights Agreement, dated July 8, 1998, between UroGen and Baxter.(2)10.13

Developmental Collaboration Agreement, dated July 8, 1998 between UroGen and Baxter.(2)10.14

Credit Agreement, dated July 8, 1998, between UroGen and Baxter.(2)10.15

Technology License Agreement, dated July 8, 1998, between UroGen and Baxter.(2)10.16

Form of Note and Warrant Purchase Agreement, dated April 28, 1999 between UroGen and various investors.(4)10.17

UroGen Corp. 1999 Stock Plan(4)10.18

Form of Common Stock and Warrant Purchase Agreement dated January 21, 2000 between UroGen and various investors.(4)10.19

Form of Common Stock Purchase Agreement dated January 21, 2000 between UroGen and various investors.(4)10.20

Form of Common Stock Purchase Agreement dated February 17, 2000 between UroGen and various investors.(4)10.21

Assignment Agreement dated June 8, 2000 between GenStar and Baxter.10.22

Warrant certificate dated February 25, 2000 between UroGen and Baxter.10.23

GenStar Therapeutics Corporation Employee Stock Purchase Plan.10.24

Warrant certificate dated October 18, 2001 between GenStar and SCO Financial Group LLC.10.25

Assignment and Assumption Agreement dated February 25, 2002 between GenStar and the Immune Response Corp.23.1

Consent of Ernst & Young LLP, Independent Auditors


---

|(1) |  | Previously filed with the Companys Application for Registration on Form 10-SB dated February 9, 1996.
|--- |  | ------------------------------------------------------------------------------------------------------

|(2) |  | Previously filed with the Companys current Report on Form 8-K dated February 9, 1996.
|--- |  | --------------------------------------------------------------------------------------

|(3) |  | Previously filed with the Companys Annual Report on Form 10-KSB dated May 24, 1999.
|--- |  | ------------------------------------------------------------------------------------

|(4) |  | Previously filed with the Company Registration Statement on Form SB-2 dated February 10, 2000.
|--- |  | ----------------------------------------------------------------------------------------------

|(5) |  | Previously filed with the Companys Annual Report on Form 10-KSB dated April 1, 2001.
|--- |  | -------------------------------------------------------------------------------------

|
|



41




---

REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS





The Board of Directors and Stockholders


GenStar Therapeutics
Corporation





We have audited the accompanying consolidated balance sheets of GenStar Therapeutics Corporation (a development
stage enterprise) as of December 31, 2001 and 2000 and the related consolidated statements of operations, stockholders equity, and cash flows for each of the three years in the period ended December 31, 2001 and the period from July 1, 1991
(inception) to December 31, 2001. 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 financial position of GenStar Therapeutics Corporation (a development stage enterprise) at December 31, 2001 and 2000, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2001 and
the period from July 1, 1991 (inception) to December 31, 2001, in conformity with accounting principles generally accepted in the United States.





| | /s/ | ERNST & YOUNG LLP
| | --- | -----------------




San Diego, California


March 1, 2002




F-42




---




GENSTAR THERAPEUTICS CORPORATION


(A development stage enterprise)





CONSOLIDATED BALANCE SHEETS





December 31,2001


2000ASSETSCurrent assets:Cash and cash equivalents

$
2,437,291


$
5,294,655Short-term investments


13,923,884



16,060,771Accounts receivable


535,259



13,177Investments underlying deferred compensation, current portion






69,481Other current assets


274,714



129,972Total current assets


17,171,148



21,568,056Property and equipment, net


2,346,098



2,185,786Restricted cash


438,271



Deferred loan fee


315,344



585,639Other assets


830,710



104,990$
21,101,571


$
24,444,471LIABILITIES AND STOCKHOLDERS EQUITYCurrent liabilities:Accounts payable

$
607,452


$
449,264Accrued employee benefits


201,436



172,879Other accrued liabilities


302,243



250,972Capital lease obligation, current portion


381,191



79,886Notes payable, current portion


299,335



272,002Total current liabilities


1,791,657



1,225,003Capital lease obligation, net of current portion


469,767



84,955Notes payable, net of current portion


225,157



524,492Other long-term liabilities


328,289



33,862Deferred compensation


502,006



417,324Advance from related party






1,975,597CommitmentsStockholders equity:Convertible Preferred Stock$0.001 par value, 5,000,000 shares authorized:Series A Preferred Stock, 5,830 shares issued and outstanding, liquidation preference of $58,300


6



6Series B Preferred Stock, 12,890 and 7,041 shares issued and outstanding, liquidation preference of $12,890,000 prior to any
distribution to holders of Series A Preferred Stock and holders of Common Stock


13



7Series C Preferred Stock, 2,000 and 0 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



Common Stock$0.001 par value, 40,000,000 shares authorized; 23,738,990 and 22,726,052 shares issued and outstanding


23,739



22,726Additional paid-in capital


50,703,975



41,933,843Deficit accumulated during development stage


(33,228,940
)


(22,133,930
)Accumulated other comprehensive income


285,900



360,586Total stockholders equity


17,784,695



20,183,238$
21,101,571


$
24,444,471





See accompanying notes.




F-43




---




GENSTAR THERAPEUTICS CORPORATION


(A development stage enterprise)





CONSOLIDATED STATEMENTS OF
OPERATIONS





For the Year Ended December 31,


July 1, 1991 (inception) to December 31, 20012001


2000


1999Revenues

$
300,900


$
161,763


$
117,867


$
1,421,910Costs and expenses:Cost of sales














821,878Research and development


8,451,710



6,414,553



2,710,921



23,011,852General and administrative


3,711,013



2,373,597



817,111



8,248,674Write-off of acquired in-process technology






1,654,924







7,110,429Total costs and expenses


12,162,723



10,443,074



3,528,032



39,192,833Loss from operations


(11,861,823
)


(10,281,311
)


(3,410,165
)


(37,770,923
)Other income (expense), net


(1,476
)


(11,975
)


(71,749
)


(21,124
)Interest expense


(458,998
)


(229,476
)


(360,417
)


(1,354,997
)Interest income


1,227,287



913,222



23,504



2,192,311Net loss

$
(11,095,010
)

$
(9,609,540
)

$
(3,818,827
)

$
(36,954,733
)Basic and diluted loss per share

$
(0.48
)

$
(0.46
)

$
(0.35
)Number of shares used in the computation of basic and diluted loss per share


23,107,593



21,006,279



10,762,787





See accompanying notes.




F-44




---




GENSTAR THERAPEUTICS CORPORATION


(A development stage enterprise)





CONSOLIDATED STATEMENTS OF STOCKHOLDERS EQUITY (DEFICIT)


For the period July 1, 1991 (inception) to December 31, 2001





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

TotalNumber of Shares

Amount

Number of Shares

AmountAdvances and contributions from Medstone July 1, 1991 to December 31, 1997






















$
4,388,875








$
4,388,875Distribution of stock dividend and net assets February 9, 1996






5,616,528

$
5,617

$
657,465










(4,388,875
)

$
3,725,793





Distribution of Common Stock for Services at $0.05 per share






363,000


363


17,787




















18,150Issuance of Common Stock for cash upon exercise of options at $0.05 per share






1,410,000


1,410


69,090




















70,500Issuance of Common Stock for cash and note receivable at $0.05 per share






147,791


148


7,242

$
(7,242
)
















148Net loss and comprehensive loss July 1, 1991 to December 31, 1997


















$
(743,175
)






(3,725,793
)




(4,468,968
)Balance at December 31, 1997






7,537,319


7,538


751,584


(7,242
)


(743,175
)












8,705Issuance of Preferred and Common Stock for equipment and acquired in-process technology at $0.63 and $630 per share, respectively,
net of issuance costs of $83,366

5,830

$
6

1,841,219


1,841


5,714,228




















5,716,075Issuance of warrants for Common Stock valued at $0.59 per share












305,910




















305,910Interest 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

9,378,538

$
9,379

$
6,782,972

$
(20,522
)

$
(8,705,563
)











$
(1,933,728
)





Continued on next page




F-45




---




GENSTAR THERAPEUTICS CORPORATION


(A development stage enterprise)





CONSOLIDATED STATEMENTS OF STOCKHOLDERS EQUITY (DEFICIT)


For the period July 1, 1991 (inception) to December 31, 2001 (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

TotalNumber of Shares

Amount

Number of Shares

AmountBalance at December 31, 1998

5,830

$
6

9,378,538

$
9,379

$
6,782,972

$
(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



















2,998,000Issuance of Common Stock upon conversion of notes payable plus accrued interest at $1.00 and $0.30 per share






2,460,811


2,461


1,509,958



















1,512,419Collection of note receivable















20,522
















20,522Issuance of Common Stock for cash upon exercise of options at $0.05 per share






36,319


36


1,475



















1,511Issuance of warrants valued at $0.18 and $0.20 per share












311,667



















311,667Issuance of Common Stock for cash upon exercise of warrants at $.001 per share






218,433


218






















218Issuance of Common Stock for services at $0.29 per share






10,000


10


2,890



















2,900Net loss and comprehensive loss



















(3,818,827
)











(3,818,827
)Balance at December 31, 1999

8,828

$
9

12,104,101

$
12,104

$
11,606,959

$



$
(12,524,390
)

$


$


$


$
(905,318
)





Continued on next page




F-46




---




GENSTAR THERAPEUTICS CORPORATION


(A development stage enterprise)





CONSOLIDATED STATEMENTS OF STOCKHOLDERS EQUITY (DEFICIT)


For the period July 1, 1991 (inception) to December 31, 2001 (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

TotalNumber of Shares

Amount

Number of Shares

AmountBalance at December 31, 1999

8,828

$
9

12,104,101

$
12,104

$
11,606,959


$


$
(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



















4,043,079Issuance of Common Stock, net of offering costs






8,362,801


8,363


23,416,026



















23,424,389Issuance of Common Stock for cash upon exercise of options






560,917


561


125,539



















126,100Issuance of Common Stock for cash upon exercise of warrants






408,281


408


268,178



















268,586Net exercises of warrants for Common Stock






991,952


992


(992
)


















Issuance of options at less than Fair Market Value












217,200



















217,200Issuance of Common Stock for purchase of technology






288,000


288


1,458,432



















1,458,720Issuance of Common Stock for services






10,000


10


64,990



















65,000Issuance of stock options to consultant












47,436



















47,436Issuance of warrants valued at $2.00 per share in connection with a loan agreement












687,000



















687,000Comprehensive loss:Net loss



















(9,609,540
)











(9,609,540
)Unrealized gain on short-term investments





























360,586


360,586Comprehensive loss
































(9,248,954
)Balance at December 31, 2000

12,871

$
13

22,726,052

$
22,726

$
41,933,843


$


$
(22,133,930
)

$


$


$
360,586

$
20,183,238





See accompanying notes.




F-47




---




GENSTAR THERAPEUTICS CORPORATION


(A development stage enterprise)





CONSOLIDATED STATEMENTS OF STOCKHOLDERS EQUITY (DEFICIT)


For the period July 1, 1991 (inception) to December 31, 2001 (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


TotalNumber of Shares

Amount

Number of Shares


AmountBalance at December 31, 2000

12,871

$
13

22,726,052


$
22,726


$
41,933,843


$


$
(22,133,930
)

$


$


$
360,586


$
20,183,238Issuance of Common Stock for cash upon exercise of options






304,565



305



74,282




















74,587Issuance of Common Stock for cash upon exercise of warrants






494,355



494



346,344




















346,838Issuance of Series B Preferred Stock from conversion of advance from related party at $1,000 per share

5,849


6









5,848,355




















5,848,361Issuance of Series C Preferred Stock for cash at $1,000 per share

2,000


2









1,999,998




















2,000,000Net exercises of warrants for Common Stock






193,435



193



(193
)



















Proceeds from investors short-swing profit














123,820




















123,820Extension of stock option exercise period for terminated employees














35,504




















35,504Repurchase of restricted stock






(10,417
)


(10
)


(2,802
)



















(2,812
)Stock grants to employees






31,000



31



94,119




















94,150Issuance of options and warrants for services














250,705




















250,705Comprehensive 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

23,738,990


$
23,739


$
50,703,975


$


$
(33,228,940
)

$


$


$
285,900


$
17,784,695





See accompanying notes.




F-48




---




GENSTAR THERAPEUTICS CORPORATION


(A development stage enterprise)





CONSOLIDATED STATEMENTS OF CASH FLOWS





For the Year Ended December 31,


July 1, 1991 (inception) to December 31, 20012001


2000


1999Cash flows from operating activities:Net loss

$
(11,095,010
)

$
(9,609,540
)

$
(3,818,827
)

$
(36,954,733
)Adjustments to reconcile net loss to net cash used in operating activities:Write-off of in-process technology acquired with stock






1,519,500







6,975,005Expenses satisfied via advances from related party














695,557Depreciation and amortization


694,965



363,161



130,525



1,708,978Accrued interest satisfied through issuance of Common Stock










40,245



40,245Stock, warrants and options issued for services


380,359



370,889



2,900



878,298Gain (loss) on disposal of property and equipment


11,866



363







(69,578
)Amortization of debt discount and loan fee


270,295



101,361



308,656



945,952Deferred rent


294,426



33,863







328,289Change in operating assets and liabilities:Accounts receivable


(522,082
)


101,031



(114,208
)


(535,259
)Other current assets


(144,742
)


(120,511
)


10,712



(274,714
)Other assets


(1,094,511
)


37,658



(182,077
)


(1,268,982
)Accounts payable


158,188



49,779



7,024



607,452Amounts due to stockholder










(315,000
)


Other current liabilities


79,828



207,300



(60,529
)


485,595Deferred compensation


84,682



210,362



177,975



502,006Net cash used in operating activities


(10,881,736
)


(6,734,784
)


(3,812,604
)


(25,935,889
)Cash flows from investing activities:Purchase of short-term investments


(22,122,369
)


(15,700,185
)






(37,822,554
)Sale of short-term investments


24,184,570











24,184,570Purchase of property and equipment


(719,536
)


(1,684,454
)


(169,919
)


(3,152,908
)Net cash provided by (used in) investing activities


1,342,665



(17,384,639
)


(169,919
)


(16,790,892
)Cash flows from financing activities:Advances from related party


3,872,768



4,142,669



4,178,446



12,193,883Repayment of note receivable from stockholder










20,000



20,000Proceeds from investors short-swing profit


123,820











123,820Proceeds from notes payable and capital lease


806,774



750,000



400,000



2,986,774Repayment of capital lease and notes payable


(540,267
)


(219,661
)


(10,641
)


(770,569
)Proceeds from issuance of Common Stock upon exercise of options and warrants


421,425



393,098



1,729



886,752Proceeds from sale of Common Stock, net of issuance costs






23,425,978







23,342,760Proceeds from issuance of Series C Preferred Stock


2,000,000











2,000,000Repurchase of restricted shares of common stock


(2,813
)










(2,813
)Net advances from Medstone














3,883,465Capital contribution by Medstone














500,000Net cash provided by financing activities


6,681,707



28,492,084



4,589,534



45,164,072Net (decrease) increase in cash and cash equivalents


(2,857,364
)


4,372,661



607,011



2,437,291Cash and cash equivalents, beginning of period


5,294,655



921,994



314,983



Cash and cash equivalents, end of period

$
2,437,291


$
5,294,655


$
921,994


$
2,437,291





See Note 12 for supplemental cash flow information.


See accompanying notes.




F-49




---




GENSTAR THERAPEUTICS CORPORATION


(A development stage enterprise)





NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


December 31, 2001





1.    Organization and Summary of Significant
Accounting Policies





Organization





GenStar Therapeutics Corporation (the Company) is a biotechnology company dedicated to the development of innovative gene therapy products for the treatment of hemophilia,
cancer, HIV/AIDs and other serious medical disorders.





The Company was incorporated as UroGen Corp. in Delaware on June 30,
1995, as a wholly-owned subsidiary of Medstone International, Inc. 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.





Basis of Presentation





The consolidated financial statements include the accounts of GenStar Therapeutic Corporation and its wholly-owned subsidiary, Urogen Acquisition Corp. 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 as yet, the Companys financial
statements are presented as statements of a development stage enterprise.





Revenue Recognition





Grant revenue is recognized as the research expenses related to the grants are incurred. All amounts received under the research grants 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.





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, 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, 2001,
realized gains were $365,977 and realized losses were $47,450. There were no realized gains or losses for the year ended December 31, 2000. Prior to 2000, the Company did not have any short-term investments, only cash and cash equivalents.




F-50




---



GENSTAR THERAPEUTICS CORPORATION


(A development stage
enterprise)





NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)







At December 31, 2001, short-term investments consisted of the following:





Amortized Cost

Market Value

Unrealized GainCorporate debt securities

$
9,598,746

$
9,838,840

$
240,094Obligations of U.S. government agencies


2,503,221


2,521,219


17,998Other short-term investments


1,536,017


1,563,825


27,808Total short-term investments

$
13,637,984

$
13,923,884

$
285,900





At December 31, 2000, short-term investments consisted of the following:





Amortized Cost

Market Value

Unrealized GainCorporate debt securities

$
12,554,480

$
12,811,040

$
256,560Obligations of U.S. government agencies


1,003,904


1,044,378


40,474Obligations of foreign government agencies


699,801


740,870


41,069Other short-term investments


1,442,000


1,464,483


22,483Total short-term investments

$
15,700,185

$
16,060,771

$
360,586





Approximately 63% and 37% of these securities mature within one and two years of
December 31, 2001, respectively. At December 31, 2000, approximately 74% and 26% of these securities had maturities within one and two years of December 31, 2000.





Property and Equipment





Property and
equipment is stated on the basis of cost. Depreciation and amortization 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. Depreciation and amortization expense
for the years ended December 31, 2001, 2000 and 1999 was $694,965, $363,161 and $130,525, 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 Opinion No. 25 (APB 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 No. 96-18, Accounting for Equity Instrumentsthat are
Issued to Other than Employees for Acquiring, or in Conjunction with Selling Goods and Services, and are periodically remeasured as the options vest.





In March 2000, the FASB issued Interpretation No. 44, (FIN 44), Accounting for Certain Transactions Involving Stock CompensationAn Interpretation of APB 25. This interpretation clarifies the
definition of employee for purposes applying APB 25, the criteria for determining whether a plan qualifies as a non-compensatory plan, the accounting consequence of various modifications to the terms of a previously fixed stock option or award, and
the accounting for an exchange of stock compensation awards in a business combination. FIN 44 was effective and the Company adopted the interpretation on July 1, 2000. The adoption did not have a material impact on the Companys consolidated
results of operations.





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.




F-51




---



GENSTAR THERAPEUTICS CORPORATION


(A development stage
enterprise)





NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)







New Accounting Pronouncements





In June 2001, the FASB issued SFAS No. 141, Business Combinations, and No. 142, Goodwill and Other Intangible Assets. SFAS No. 141
requires all business combinations initiated after June 30, 2001, to be accounted for by the purchase method. Under SFAS No. 142, goodwill and intangible assets with indefinite lives are no longer amortized but are reviewed annually (or more
frequently if impairment indicators arise) for impairment. Separate intangible assets that are not deemed to have an indefinite life will continue to be amortized over their useful lives (but with no maximum life). The amortization provisions of
SFAS No. 142 apply to goodwill and intangible assets acquired after June 30, 2001. With respect to goodwill and intangible assets acquired prior to July 1, 2001, the Company is required to adopt SFAS No. 142 effective January 1, 2002. The Company
does not expect the adoption of these pronouncements to have an effect on the consolidated financial statements as the Company has not recorded any goodwill or other intangible assets as a result of a business combination.





In October 2001, the FASB issued SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets, which addresses financial
reporting for the impairment or disposal of long-lived assets and supercedes SFAS No. 121, Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of, and the accounting and reporting provisions of APB
Opinion No. 30. While earlier application is encouraged, SFAS No. 144 is effective for fiscal years beginning after December 15, 2001. The Company does not believe the adoption of SFAS No. 144 will have a material impact on its financial statements.





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, 2001, 2000 and 1999 is equal
to net loss per share due to the fact that the effect of common stock equivalents outstanding during the periods, including stock options, warrants and convertible debt, are antidilutive.





Income Taxes





The Company provides 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.




F-52




---



GENSTAR THERAPEUTICS CORPORATION


(A development stage
enterprise)





NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)







Comprehensive Income





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 income and other comprehensive
income, 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 income. Comprehensive loss for the three years ended December
31, 2001 consisted of the following:





2001


2000


1999Net loss

$
(11,095,010
)

$
(9,609,540
)

$
(3,818,827
)Other comprehensive loss:Unrealized (loss) gain on short-term investments


(74,686
)


360,586



Comprehensive loss

$
(11,169,696
)

$
(9,248,954
)

$
(3,818,827
)





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.





Reclassifications





Certain amounts in the prior year financial statements have been reclassified to conform with current year presentation.





2.    Property and Equipment





Property and equipment are comprised of the following:





December 31,2001


2000Equipment

$
1,685,989


$
1,756,787Equipment under capital lease


1,182,477



232,163Furniture and fixtures


146,649



235,959Leasehold improvements


534,941



481,2973,550,056



2,706,206Accumulated depreciation


(1,203,958
)


(520,420
)$
2,346,098


$
2,185,786





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 250,000 shares of Common Stock to the lessor (Note 6). 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 may be leased. During 2001, the Company financed $860,115 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. During 2001, the Company also entered into a capital lease agreement with one of our vendors, under which equipment valued at $94,266 was financed.





At December 31, 2001 and 2000, the Company had equipment acquired under capital leases of $1,182,477 and $232,163, respectively, with related accumulated depreciation of $219,523 and
$50,712, respectively. Total




F-53




---



GENSTAR THERAPEUTICS CORPORATION


(A development stage
enterprise)





NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)




depreciation expense on assets under capital lease for the three years ended December 31, 2001, 2000 and 1999 was $201,255, $39,982 and $10,730,
respectively.





Future minimum lease payments at December 31, 2001 are as follows:


2002

$
456,6132003


378,0812004


130,4652005


Total minimum obligations


965,159Interest


114,201Present value of minimum lease obligations


850,958Current portion


(381,191
)Long-term lease obligations at December 31, 2001

$
469,767





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 100,000 shares of Common Stock to a Baxter in exchange for Baxters guarantee of this note payable. As of December 31, 2001, warrants for 100,000 shares remain outstanding.





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 scheduled maturities of notes payable at December 31, 2001
are as follows: $337,268 in 2002, $163,260 in 2003, $50,993 in 2004 and $33,995 in 2005, including interest. The notes mature from 2003 through 2005.





5.    Acquisition of Technology and Related Agreements





In May 2000, the Company acquired
all of the outstanding shares of Allegro Cell Systems, Inc. (Allegro) in exchange for 288,000 shares of GenStar common stock, and an obligation to issue an additional 12,000 shares of common stock. 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 $1,519,500 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. The Company anticipates that it
will take at least five years to complete the Allegro product and obtain regulatory approvals, if approvals are obtained.





In
July 1998, the Company executed various agreements with Baxter Healthcare Corporation pursuant to which the Company acquired certain rights and assets from Baxter. Under the terms of the agreements, the Company obtained the rights to Baxters
adenoviral-based gene transfer technologies and certain equipment in exchange for 5,830 shares of non-voting convertible Series A Preferred Stock and 1,841,219 shares of Common Stock of the Company. The shares issued to acquire the gene transfer
technologies were valued at $5,455,505 based upon a discounted cash flow analysis with a discount rate of 50%, 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 Food and Drug Administration (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 (the Credit Agreement) with Baxter, Baxter
was required to provide funding for pre-clinical development of the hemophilia product and when the Company treated the first patient in a Phase I Clinical Trial for the hemophilia product, a




F-54




---



GENSTAR THERAPEUTICS CORPORATION


(A development stage
enterprise)





NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)







milestone payment of $2,000,000 was due from Baxter. On June 13, 2001, the first patient was treated using
the hemophilia product and Baxter 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 is convertible at Baxters option into 2,010,920 shares of Common Stock.





The Company entered into a Distribution Agreement with Baxter whereby Baxter will have an exclusive, worldwide right to market, sell and distribute all products which 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 and certain founding shareholders (the Founders) entered into
the Investor Rights Agreement under which the shares held by these entities are subject to certain restrictions on transferability of the shares until July 8, 2003 and have certain registration rights. Additionally, under this agreement, Baxter has
the right to purchase up to twenty percent of any new securities issued and 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 Food and Drug Administration of a product developed under the Developmental Collaboration Agreement. See related discussion in Note 6.





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, 2001, 40,000, 13,000 and 17,000 shares were designated Series A, Series B, and Series C, respectively.





As of December 31, 2001, there were 5,830 shares of Series A Preferred Stock issued and outstanding. Holders of the Series A Preferred Stock are not entitled to receive dividends, have a liquidation preference amount of ten dollars ($10.00)
per share and have no voting rights. The Series A Preferred Stock is convertible into Common Stock on a 1,000 to 1 basis; provided, however, that no shares were convertible prior to July 8, 2001.





As of December 31, 2001, there were 12,890 shares of Series B Preferred Stock issued and outstanding. The Company anticipates that Series B Preferred Stock will be issued only to
Baxter in payment for amounts funded by Baxter under the Credit Agreement. Total funding under the Development Collaboration Agreement and Credit Agreement was $12,890,000. Holders of the Series B 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 holders of Common Stock and have no voting rights, except for a vote as to whether the
Company may issue additional Series B Preferred Stock. The Series B Preferred Stock is convertible into Common Stock upon the earlier of (i) the first business day following the treatment of the first patient under an Initial New Drug Application
for a Collaboration Product (as defined) commences in a Phase I Clinical Trial (the IND Milestone Date), (ii) the date five years after the last advance of funds by Baxter under the Credit Agreement between Baxter and the Company through
and including the IND Milestone Date and (iii) automatic conversion pursuant to the terms of the Credit Agreement. The IND Milestone Date occurred on June 13, 2001, thus the Series B Preferred Stock is convertible at Baxters option. The Series
B 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 B Preferred converted. The Fair Market Value was set as of  June 13, 2001 at $6.41 or 2,010,920 share of Common Stock.





As of December 31, 2001, 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 upon GenStar meeting certain specified milestones (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




F-55




---



GENSTAR THERAPEUTICS CORPORATION


(A development stage
enterprise)





NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)







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 between Baxter
and the Company 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.





Warrants





In October 2001, the Company issued a warrant to purchase 89,500 shares of Common Stock to a service provider. The warrant is fully vested and is exercisable for five years at an exercise price of $2.35 per share. The
warrant was valued at $134,250 and was recorded to general and administrative expense.





In August 2000, the Company issued a warrant to purchase 100,000 shares of Common Stock to Baxter in exchange for a guarantee of the Companys note payable. The warrant is fully vested and is exercisable for five
years at an exercise price of $2.00 per share. The warrant, valued at $687,000, was classified as a deferred loan fee and is being amortized over the remaining term of the note.





In January 2000, the Company completed an equity offering in which warrants for 1,773,899 shares of Common Stock were issued. Additionally, warrants for 360,000 shares of Common Stock
were issued to the underwriter as part of the underwriters commission. The warrants are exercisable at $0.75 per share and expire in 2005. As of December 31, 2001, warrants for 1,076,112 remain outstanding.





In September 1999, the Company issued a warrant to purchase 250,000 shares to a leasing company related to a lease line for capital equipment (Note 3).
The warrant was exercisable for seven years at an exercise price of $0.30 per share. The warrant was valued at $45,000 and was amortized to interest expense over the term of the lease. The warrant was exercised in July 2000.





Holders of the convertible notes payable issued in 1998 and 1999 also hold warrants to purchase 515,000 and 1,364,166 shares of Common Stock
at an exercise price of $0.74 per share and $0.30 per share, respectively. As of December 31, 2001, warrants to purchase 337,500 and 883,335 shares of Common Stock, respectively, remain outstanding.





In 1997 the Company issued warrants to purchase 200,000 shares of Common Stock to an officer of the Company. These warrants, which were exercisable at
$.05 per share and subject to expiration on July 31, 2001,were exercised in February 2000.





Employee Stock Purchase Plan





In May 2001, GenStar adopted an Employee Stock Purchase Plan, which was approved by the shareholders in July 2001. A total
of 1,000,000 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.





Stock Options





The 1995 Director Option Plan (the Director Plan) was adopted by the Board and
approved by the stockholders in 1995 and amended in February 2000 to provide automatic, nondiscretionary grants of options to non-employee directors of the Company. A total of 550,000 shares of Common Stock have been reserved for issuance under the
Director Plan. The Director Plan provides that each non-employee director is automatically granted an option to purchase 45,000 shares of GenStar Common Stock upon his or her initial election or appointment as a non-employee director. Subsequently,
each non-employee director who has served for at least six months will be granted an additional option to purchase 15,000 shares of GenStar Common Stock on December 31 of each year so long as he or she remains




F-56




---



GENSTAR THERAPEUTICS CORPORATION


(A development stage
enterprise)





NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)







a non-employee director. The exercise price of options granted to non-employee directors must be the fair
market value of GenStar 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, 2001, options to purchase 140,000 shares of Common Stock had been granted under The Director Option Plan and options to purchase 85,000 shares were vested.





The 1995 Stock Plan, which was adopted by the Board of Directors (the Board) and authorized by the Stockholders in 1995, authorizes the Board, or one or more committees which
the Board may appoint from among its members (the Committee), 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 may be
either incentive stock options as defined in Section 422 of the Internal Revenue Code of 1986, as amended (the Code), or nonstatutory stock options, as determined by the Board or the Committee. The 1995 Stock Plan initially
reserved 1,850,000 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 Companys total outstanding common shares. Options granted pursuant to the 1995 Stock Plan
above have exercise periods of ten years and vest over one to four years.





The 1999 Stock Plan, which was adopted by the Board
in 1999 and approved by the Stockholders in February 2000, authorizes the Board or the 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 may be either incentive stock options or nonstatutory stock options, as determined by the Board or the Committee. The 1999 Stock Plan initially reserved 4,000,000 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 Companys total outstanding common shares. Options granted pursuant to the 1999 Stock Plan have exercise periods of ten years and generally vest over four years.




F-57




---



GENSTAR THERAPEUTICS CORPORATION


(A development stage
enterprise)





NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)







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





Employee Stock Options


Director Stock Options


Weighted Average Exercise PriceBalance at December 31, 1998

350,000


35,000


$
0.06Granted

3,021,183


15,000


$
0.30Exercised

(30,217
)




$
0.05Canceled

(114,783
)




$
0.15Expired








Balance at December 31, 1999

3,226,183


50,000


$
2.60Granted

1,883,016


45,000


$
5.96Exercised

(555,917
)

(5,000
)

$
0.22Canceled

(80,000
)




$
0.20Expired








Balance at December 31, 2000

4,473,282


90,000


$
2.66Granted

726,500


45,000


$
3.39Exercised

(289,150
)

(5,000
)

$
0.24Canceled

(348,311
)




$
4.24Expired








Balance at December 31, 2001

4,562,321


130,000


$
2.82





Options outstanding as of December 31, 2001:





Exercise Price

Options Outstanding

Weighted Average Contractual Life in Years

Weighted Average Exercise Price

Options Exercisable

Weighted Average Exercise Price of Options Exercisable$0.05$1.00

2,265,433

6.79

$
0.31

1,850,147

$
0.31$1.01$5.00

1,225,126

9.04

$
3.13

297,772

$
3.61$5.01$10.75

1,201,762

8.53

$
7.20

447,044

$
7.06$0.05$10.75

4,692,321






2,594,963





As disclosed in Note 1, the Company has elected to follow APB 25 and related
interpretations in accounting for its employee and director stock options and warrants, because, as discussed below, the alternative fair value accounting provided for under SFAS 123, requires use of option valuation models that were not developed
for use in valuing employee and director stock options and warrants. Under APB 25, when the exercise price of the Companys employee stock options equals the market price or fair value of the underlying stock on the date of grant, no
compensation expense is recognized.





Pro forma information regarding net loss and net loss per share is required by SFAS 123,
and has been determined as if the Company had accounted for its employee stock options under the fair value method of that statement. The fair value for these options was estimated at the date of grant using a Black-Scholes option pricing model with
the




F-58




---



GENSTAR THERAPEUTICS CORPORATION


(A development stage
enterprise)





NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)







following weighted-average assumptions for 2001, 2000 and 1999: a risk-free interest rate of 4.5%, 6.5% and
6%, respectively, a dividend yield of 0% for all periods, a volatility factor of the expected market price of the Companys common stock of 90%, 95% and 70%, respectively, and an expected life of the option of 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 31,2001


2000


1999Pro forma net loss

$
(11,700,000
)

$
(9,949,000
)

$
(3,846,000
)Pro forma net loss per share

$
(0.51
)

$
(0.47
)

$
(0.36
)





The following Common Stock is reserved for future issuance at December 31, 2001:





Stock option:Granted and outstanding

4,692,321Reserved for future grants

1,263,509Warrants

2,486,447Series A Preferred Stock

5,830,000Series B Preferred Stock

2,010,92016,283,197





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 GenStar 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 were 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 its deferred tax assets as it is more likely than not these amounts will not be realized.




F-59




---



GENSTAR THERAPEUTICS CORPORATION


(A development stage
enterprise)





NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)







Deferred tax assets are comprised of the following:





December 31,2001


2000Loss carryforwards

$
10,823,000


$
6,213,000Research and development and other state credit carryforwards


1,514,000



821,000Capitalized research and development


2,334,000



2,467,000Other, net


215,000



82,000Total deferred tax assets


14,886,000



9,583,000Valuation allowance


(14,886,000
)


(9,583,000
)Net deferred tax assets

$



$






As of December 31, 2001, the Company has Federal and state net operating loss
carryforwards of approximately $26,600,000 and $26,318,000, respectively, which will begin to expire in 2011 and 2004, respectively, unless previously utilized. The company has Federal and state research and development credit carryforwards of
approximately $1,012,000 and $711,000, 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 its 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 three years ended December 31,
2001 all revenue was from research grants from the National Institutes of Health.





9.    Related Party Balances and Transactions





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 2001, 2000 and 1999, the Company paid the research organization $1,121,106, $555,399 and $308,972,
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 of the Company who continues to be a stockholder. The Company accrued expenses of $23,000 associated with this agreement, but no payments were made until January 2002. 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.





During 2001, the Company entered into a note receivable with an Officer and stockholder of the Company in the amount of $37,000. The note will be repaid over a four year period.




F-60




---



GENSTAR THERAPEUTICS CORPORATION


(A development stage
enterprise)





NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)







10.    Commitments





Facilities





During 2000, the Company entered into a lease
agreement with an affiliated research organization for approximately 22,000 square feet of office and laboratory space. The research organization is affiliated due to a common director. The Company also leases approximately 8,600 square feet of
office and laboratory space for our manufacturing facility. This lease expires in August 2004, with two options to extend the lease for an additional three years. Additionally, the Company leases approximately 43,000 square feet of office,
laboratory and clean room space which will be used for manufacturing operations. This lease expires in 2011 with one option to extend for five years.





For the years ended December 31, 2001, 2000 and 1999, rent expense was approximately $1,753,000, $722,000 and $303,000, respectively.





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





2002

$
2,350,7262003


2,431,3822004


2,430,8902005


2,089,9842006


1,650,602Thereafter


8,265,087Total

$
19,218,671





Licenses





In May 2000, GenStar acquired the rights to a license agreement between Allegro and the University of California Regents (UC Regents) to license certain technologies for the
treatment and prevention of AIDS and for lentiviral gene therapy. Under the license agreement, the Company is obligated to issue 12,000 shares of Common Stock to the UC Regents in the name of Shellwater & Co. Additionally, beginning in May 2003
the Company is required to pay an annual license fee of $10,000 until May 2006, or until sales of licensed product commence, whichever occurs first. The Company is also 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.





The Company is obligated to make a milestone payment to Immune Response Corporation
(IRC) of $200,000 upon the approval by the Food and Drug Administration 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 is 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 the 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, GenStar and IRC entered into an Assignment and Assumption Agreeement under which the
license agreement between GenStar and IRC was terminated and IRCs rights under its license agreement with the UC Regents for the related intellectual property were transferred to GenStar. GenStar paid IRC $100,000 as compensation for the
transfer of such rights. Under the agreement with the UC Regents, GenStar has rights related to all forms of cancer for the tumor radiosensitization technology and is obligated to pay an annual license maintenance fee of $10,000 until the
commencement of sales of the licensed product. GenStar must also pay royalties to the UC Regents on its net sales revenue of licenced products or royalties from licences.





In September 1996, the Company entered into a license agreement with the UC Regents to license rights to certain patents and continuing applications thereof in the field of diagnosis of
metastases by nucleic acid amplification. The Company is required to pay an annual license maintenance fee of $10,000 until the Company is selling licensed




F-61




---



GENSTAR THERAPEUTICS CORPORATION


(A development stage
enterprise)





NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)




product. The Company is also required to pay milestone fees of $25,000 upon filing an Initial New Drug Application on a licensed product or method
with the Food and Drug Administration and $50,000 upon marketing approval of a licensed product or method by the FDA. The Company will pay royalties on its net sales revenues of licensed products or methods. A minimum annual royalty of $50,000 is
payable beginning with the year of first commercial sale of licensed product, but no later than the fifth year of the agreement. The minimum annual royalty will be credited against earned royalty due for the year in which the annual minimum payment
was made.





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, 2001, 2000 and 1999 were $238,988, $170,201 and
$105,064, respectively.





In 1998, the Company established a deferred compensation plan. Certain employees are allowed to defer
up to 100% of their salaries and bonuses under this plan. Additionally, the Company allows certain employees approximately 18% of their salaries for employee benefits and employer payroll taxes. A portion of the employer allocation for employee
benefits may be allocated to the deferred compensation plan. During the years ended December 31, 2001, 2000 and 1999, the Companys contributions to the deferred compensation plan were $66,613, $122,650 and $71,488, respectively. Employer
contributions vest over a four-year period.





12.    Supplemental Cash Flow Information





During 2000, a warrant for 100,000 shares of Common Stock was issued to Baxter in conjunction with Baxter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, 2001 and
2000, the Company financed equipment valued at $954,381 and $95,735, respectively, under capital lease agreements. A warrant for 250,000 shares related to the capital lease was valued at $45,000. The warrant was exercised in 2000.





During 2000, the Company issued 288,000 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 3).





During the years ended December 31, 2001 and 2000, amounts due
Baxter 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 was issued to Baxter 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 1,841,219 shares of Common Stock of the Company valued at $5,799,442. The equipment acquired was valued at $343,937 based on an appraisal.





Cash paid for income taxes was $1,600, $1,600 and $2,465 for the three years ended December 31, 2001, 2000 and 1999, respectively. Cash paid for
interest was $234,978, $78,867 and $8,177 for the three years ended December 31, 2001, 2000 and 1999, respectively.




F-62




---







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.





| | GE | NSTAR THERAPEUTICS CORPORATION
| | -- | ------------------------------

| | A | Delware Corporation
| | - | -------------------




Date: March 29, 2002








Signature

Title

Date/s/    PAUL D. QUADROS Paul D. Quadros

Chairman and Chief Financial Officer

March 29, 2002/s/     ROBERT E. SOBOL Robert E. Sobol

Chief Executive Officer

March 29. 2002/s/     LEE R.
MCCRACKEN Lee R. McCracken

President and Chief Business Officer

March 29, 2002/s/     CARIN D. SANDVIK Carin D. Sandvik

Sr. Director of Finance and Admnistration, Chief Accounting Officer (Principal accounting officer)

March 29, 2002/s/     PETER F. BERNARDONI Peter F. Bernardoni

Director

March 29, 2002/s/     IVOR ROYSTON Ivor Royston

Director

March 29, 2002/s/     VICTOR W. SCHMITT Victor W. Schmitt

Director

March 29, 2002







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