---




U. S. SECURITIES AND EXCHANGE COMMISSION


Washington, D.C. 20549





Form 10-Q





(Mark One)





x

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934For the quarterly period ended March 31, 2002OR ̈

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





Commission File Number 0-27264





GenStar Therapeutics Corporation


(Exact name of registrant as specified in its charter)





DELAWARE (State or other jurisdiction of incorporation or organization)

33-0687976 (I.R.S. Employer Identification no.)





10865 Altman Row, 2nd Floor, San Diego, CA, 92121


(Address of principal executive offices)                         (Zip
code)





Registrants Telephone Number, including area code: (858) 450-5949





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  ̈





The number of shares of the Common Stock of the registrant outstanding as of May 7, 2002, was 23,763,740.





---



---




GENSTAR THERAPEUTICS CORPORATION


(A development stage enterprise)





INDEX TO FORM 10-Q





Page No.PART I.

FINANCIAL INFORMATIONItem 1.

Financial StatementsCondensed Consolidated Balance Sheets March 31, 2002 (Unaudited) and December 31, 2001

2Condensed Consolidated Statements of Operations (Unaudited) Three Months Ended March 31, 2002 and 2001 and the period from July 1, 1991 (inception) to March 31, 2002

3Condensed Consolidated Statements of Cash Flows (Unaudited) Three Months Ended March 31, 2002 and 2001 and the period from July 1, 1991 (inception) to March 31, 2002

4Notes to Unaudited Condensed Consolidated Financial Statements

5Item 2.

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

7PART II.

OTHER INFORMATIONItem 1.

Legal Proceedings

11Item 2.

Changes in Securities

11Item 3.

Defaults Upon Senior Securities

11Item 4.

Submission of Matters to a Vote of Security Holders

11Item 5.

Other Information

11Item 6.

Exhibits and Reports on Form 8-K

11Signatures

12







1




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GENSTAR THERAPEUTICS CORPORATION


(A development stage enterprise)





CONDENSED CONSOLIDATED BALANCE SHEETS





March 31, 2002


December 31, 2001(unaudited)ASSETSCurrent assets:Cash and cash equivalents

$
1,775,589


$
2,437,291Short-term investments


11,298,128



13,923,884Accounts receivable


1,211,899



535,259Other current assets


332,281



274,714Total current assets


14,617,897



17,171,148Property and equipment, net


2,623,715



2,346,098Restricted cash


440,509



438,271Deferred loan fee


247,770



315,344Other assets


839,129



830,710$
18,769,020


$
21,101,571LIABILITIES AND STOCKHOLDERS EQUITYCurrent liabilities:Accounts payable

$
845,537


$
607,452Accrued employee benefits


222,242



201,436Other accrued liabilities


387,806



302,243Current portion of notes payable


300,604



299,335Current portion of capital lease obligation


503,608



381,191Total current liabilities


2,259,797



1,791,657Notes payable, net of current portion


151,719



225,157Capital lease obligation, net of current portion


677,275



469,767Other long-term liabilities


392,894



328,289Deferred compensation


272,559



502,006CommitmentsStockholders 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 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



13Series C Preferred Stock, 2,000 shares issued and outstanding, liquidation preference of $2,000,000 prior to any distribution to
holders of Series A Preferred Stock and holders of Common Stock


2



2Common Stock$0.001 par value, 40,000,000 shares authorized; 23,763,740 and 23,738,990 issued and outstanding


23,764



23,739Unrealized gain on short-term investments


148,373



285,900Additional paid-in capital


50,799,634



50,703,975Deficit accumulated during development stage


(35,957,016
)


(33,228,940
)Total stockholders equity


15,014,776



17,784,695$
18,769,020


$
21,101,571





See accompanying notes.







2




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GENSTAR THERAPEUTICS CORPORATION


(A development stage enterprise)





CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS


(Unaudited)





Three Months Ended


July 1, 1991 (inception) to March 31, 2002March 31, 2002


March 31, 2001Revenue

$
268,130


$
32,171


$
1,690,040Costs and expenses:Cost of sales










821,878Research and development


2,327,936



1,943,106



25,339,788Write-off of acquired in-process technology










7,110,429General and administrative


808,714



831,657



9,057,388Total costs and expenses


3,136,650



2,774,763



42,329,483Loss from operations


(2,868,520
)


(2,742,592
)


(40,639,443
)Other income (expense)


60,033



(33
)


38,909Interest expense


(117,486
)


(123,512
)


(1,472,483
)Interest income


197,897



297,454



2,390,208Net loss

$
(2,728,076
)

$
(2,568,683
)

$
(39,682,809
)Basic and diluted loss per share

$
(0.11
)

$
(0.11
)Number of weighted-average shares used in the computation of basic and diluted loss per share


23,744,101



22,747,278








See accompanying notes.




3




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GENSTAR THERAPEUTICS CORPORATION


(A development stage enterprise)





CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS


(Unaudited)





For the three months ended March 31,


July 1, 1991, (inception) to March 31, 20022002


2001Net loss

$
(2,728,076
)

$
(2,568,683
)

$
(39,682,809
)Adjustments to reconcile net loss to net cash used in operating activities:Write-off of in-process technology acquired with stock










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










695,557Depreciation and amortization


191,657



158,079



1,900,635Stock and options issued for services and other


92,863







971,161Accrued interest satisfied through issuance of common stock










40,245Loss on disposal of fixed assets










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


67,574



67,574



1,013,526Deferred rent


64,605



11,507



392,894Change in assets and liabilities:Accounts receivable


(676,640
)


11,450



(1,211,899
)Other current assets


(57,567
)


12,209



(332,281
)Other assets


(10,656
)


(302,480
)


(1,279,638
)Accounts payable


238,085



8,550



845,537Other current liabilities


106,368



(5,083
)


591,963Deferred compensation


(229,447
)


(12,954
)


272,559Net cash used in operating activities


(2,941,234
)


(2,619,831
)


(28,877,123
)Cash flows from investing activities:Purchase of short-term investments


(4,722,990
)


(3,304,273
)


(42,545,544
)Sale of short-term investments


7,211,220



4,398,295



31,395,790Purchase of property and equipment


(257,144
)


(228,278
)


(3,410,052
)Net cash provided by (used in) investing activities


2,231,086



865,744



(14,559,806
)Cash flows from financing activities:Advances from related party










12,193,883Repayment of note receivable from stockholder










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






123,820



123,820Proceeds from capital leases and other


226,594



445,504



3,213,368Repayment of capital lease and notes payable


(180,968
)


(109,377
)


(951,537
)Stock issuance costs










(1,965,976
)Proceeds from issuance of common stock upon exercise of options and warrants


2,820



13,972



889,572Proceeds from sale of common stock










25,308,736Proceeds from issuance of Series C preferred stock










2,000,000Repurchase of restricted shares










(2,813
)Net advances from Medstone










3,883,465Capital contribution by Medstone










500,000Net cash provided by financing activities


48,446



473,919



45,212,518Net (decrease) increase in cash and equivalents


(661,702
)


(1,280,168
)


1,775,589Cash and equivalents, beginning of period


2,437,291



5,294,655



Cash and equivalents, end of period

$
1,775,589


$
4,014,487


$
1,775,589





See accompanying notes




4




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GENSTAR THERAPEUTICS CORPORATION


(A development stage enterprise)





NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS





March 31,
2002





1.  The unaudited financial information furnished herein, in the opinion of management, reflects all
adjustments, consisting only of normal recurring adjustments, which are necessary to state fairly the consolidated financial position, results of operations, and cash flows of GenStar Therapeutics Corporation as of and for the periods indicated.
GenStar presumes that users of the interim financial information have read or have access to the Companys audited consolidated financial statements and Managements Discussion and Analysis of Financial Condition and Results of Operations
for the year ended December 31, 2001 and that the adequacy of additional disclosure needed for a fair presentation, except in regard to material contingencies or recent significant events, may be determined in that context. Accordingly, footnote and
other disclosures which would substantially duplicate the disclosures contained in Form 10-KSB for the year ended December 31, 2001 filed on March 29, 2002 by the Company have been omitted. The financial information herein is not necessarily
representative of a full years operations.





2.  Cash and cash equivalents consist primarily of highly liquid
investments with original maturities of 90 days or less when purchased. Short-term investments consist of debt and equity securities with maturities in excess of 90 days when purchased. In accordance with the Financial Accounting Standards
Boards 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.





3.  In accordance with the Financial Accounting Standards Boards SFAS No. 128,
Earnings per Share, net loss per share is based on the weighted-average number of shares of common stock outstanding during the three-month periods ended March 31, 2002 and 2001. Equivalent shares arising from convertible preferred stock,
convertible debt, warrants for Common Stock and outstanding stock options have not been included in the computation of net loss per share as their effect would be antidilutive.





4.  In February 2001, the Company entered into a capital lease agreement under which up to $2,325,000 in equipment may be leased. The Company financed $438,500 and $445,504 of
equipment under this lease agreement during the three months ended March 31, 2002 and 2001, respectively, and has financed a total of $1,300,000 of equipment under this lease since inception. 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 30, 2002.





5.  In April
2002, the Company entered into a research agreement with a corporate partner whereby the two companies will collaborate on certain research projects. Under this agreement GenStar will be reimbursed for expenses incurred, which are estimated to be
$250,000. An initial payment of $150,000 was due upon signing of the agreement and is recorded as deferred revenue as of March 31, 2002. The revenue will be recognized as the work is completed.





6.  Cash paid for interest during the three months ended 2002 and 2001 was $46,000 and $52,000.




5




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GENSTAR THERAPEUTICS CORPORATION


(A development stage
enterprise)





NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS(Continued)





March 31, 2002







7.  SFAS No. 130, Reporting Comprehensive Income, reporting and
displaying comprehensive income (loss) and its components which, for the Company, includes net loss and unrealized gains and losses on investments. In accordance with SFAS No. 130, the accumulated balance of other comprehensive income is disclosed
as a separate component of stockholders equity. For the three months ended March 31, 2002 and 2001, respectively, the comprehensive loss consisted of:





Three months ended March 31,2002


2001Net loss

$
(2,728,076
)

$
(2,568,683
)Other comprehensive loss:Unrealized (loss) gain on investments


(137,527
)


74,460Comprehensive loss

$
(2,865,603
)

$
(2,494,223
)





8.  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 was required to adopt SFAS No. 142 effective January 1, 2002. The Companys adoption of these pronouncements did not 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, 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. SFAS No. 144 is effective for fiscal years beginning after December 15, 2001. The Companys adoption of SFAS No. 144 in January 2002 did not have a material
impact on its financial statements.




6




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ITEM 2.

MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATION





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 in our Annual Report on Form 10-KSB for the year ended December 31, 2001 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. The following information should be read in
conjunction with the condensed financial statements and the notes thereto included in Item 1 of this quarterly report. We also urge readers to review and consider our disclosures describing various factors that affect our business in our Annual
Report on Form 10-KSB for the year ended December 31, 2001, including the disclosures under the captions Managements Discussion and Analysis of Financial Condition and Results of Operations and Cautionary Factors That May
Affect Future Results and Risks and Uncertainties, as well as the audited financial statements and notes thereto contained in such report.





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 gene delivery technologies and laboratory equipment. The gene delivery
technology will be 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 had 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.





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 MAXIMUM-AD gene transfer system for our MAX-AD FVIII product, our DUAL-AD vector product for prostate cancer, and the MAX-AD and 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 be profitable.




7




---




Results of Operations





Revenues





GenStar has generated revenues to date of $1,690,000 from contract research
agreements and grants.Total revenues for the three months ended March 31, 2001 and 2002 were $32,000 and $268,000, respectively. 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.





Research and development





Research and development expenses during the three months ended March 31, 2001 and 2002 were $1,943,000 and $2,328,000, respectively. Research and development expense increased
$385,000, or 20%, in the first quarter of 2002 compared to the first quarter of 2001 due to an upgrade in the capacity of our manufacturing capabilities. 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 expense





General and administrative expense was largely unchanged during the three months ended March 31,
2001 and 2002 and was $832,000 and $809,000, respectively. General and administrative expenses include the costs of our administrative personnel and consultants, office lease expenses and other overhead costs, including legal and accounting costs.
In future periods, we expect general and administrative expenses to remain constant to support our research and development activities.




8




---




Interest income and expense





Interest income during the three months ended March 31, 2001 and 2002 of $297,000 and $198,000, respectively, is a result of investment of excess cash in money market accounts, corporate
and international notes and certificates of deposit. Interest expense for the three months ended March 31, 2001 and 2002 was $124,000 and $117,000, respectively. Interest expense in both periods relates to equipment financing, amortization of
deferred loan fees and the interest accrued on the deferred compensation liability.





Liquidity and Capital Resources





Net cash used by operating activities during the three months ended March 31, 2001 and 2002 was $2,620,000 and $2,941,000, respectively. Net
cash used by operating activities consists of expenditures for research and development and general and administrative expenses. Net cash provided by investing activities during the three months ended March 31, 2001 and 2002 of $866,000 and
$2,231,000, respectively, consists of purchases of short-term investments net of sales of short-term investments and the purchase of property and equipment. Net cash provided by financing activities for the three months ended March 31, 2001 and 2002
of $474,000 and $48,000, respectively, consists primarily of proceeds from our capital lease agreement, offset by repayments of capital leases and 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 development, progress with preclinical and clinical trials, the time and costs involved in obtaining regulatory approvals and effective commercialization activities. As of March 31, 2002, the Company had cash, cash
equivalents and short-term investments totaling $13,074,000 and working capital of $12,358,000. GenStar has incurred net losses of $40.0 million since its inception through March 31, 2002 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, Baxter was required to provide funding for development of the hemophilia product. Total funding received from Baxter under the agreement 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.




9




---




We anticipate our existing capital resources will enable us to maintain our current and planned
operations through 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 or debt 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.





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 fair value of 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 fair value of the principal amount of our investment will probably decline. To minimize this risk, we 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. The average duration of all of our investments has generally been less than one year. Due to the short-term nature of these investments, we believe we
have no material exposure to interest rate risk arising from our investments. Therefore, no quantitative tabular disclosure is required.





The Company does not conduct business with foreign entities, and does not have any foreign exchange risk.




10




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GENSTAR THERAPEUTICS CORPORATION


(A development stage enterprise)





PART II.    OTHER INFORMATION





Item 1.

LEGAL PROCEEDINGS





None.





Item 2.

CHANGES IN SECURITIES





None.





Item 3.

DEFAULTS UPON SENIOR SECURITIES





None.





Item 4.

SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS





None.





Item 5.

OTHER INFORMATION





None.





Item 6.

EXHIBITS AND REPORTS ON FORM 8-K





None.







11




---




SIGNATURES





In accordance with the requirements of the Exchange Act, the Registrant has caused this
Report to be signed on its behalf by the undersigned, hereunto duly authorized.





GENSTAR THERAPEUTICS CORPORATION A Delaware
CorporationBy:

/s/    Carin D. SandvikCarin D. Sandvik Sr. Director of Finance and Administration Chief Accounting Officer (Principal  accounting  officer)





Date: May 14, 2002




12