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U.S. SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549



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Form 10-Q



(Mark
One)



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



| |  | For the quarterly period ended September 30, 2003
| |  | -------------------------------------------------



OR



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



Commission File Number 0-27264



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Corautus Genetics Inc.

(Exact Name of Registrant as Specified in Its Charter)



|Delaware                                                      |  | 33-0687976                         
|------------------------------------------------------------- |  | -----------------------------------
|(State or other jurisdiction ofincorporation or organization) |  | (I.R.S. EmployerIdentification No.)





|75 Fifth Street, Suite 313, Atlanta GA   |  | 30308     
|---------------------------------------- |  | ----------
|(Address of principal executive offices) |  | (Zip code)



(404) 526-6200

Registrant s Telephone Number, including area code



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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 whether the registrant is an accelerated filer (as defined in Rule
12b-2 of the Exchange Act).



Yes ̈No x



The number of shares of the Common Stock of the registrant outstanding as of November 12, 2003, was 10,013,459.



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##### Table of Contents

CORAUTUS GENETICS INC.

(A DEVELOPMENT STAGE ENTERPRISE)



INDEX TO FORM 10-Q



|                              |  | Page No.                                                                                                                                                                    
|----------------------------- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|                              | 
|PART I. FINANCIAL INFORMATION |  |                                                                                                                                                                             
|                              |  |                                                                                                                                                                             
|Item 1.                       |  | Financial Statements                                                                                                                                                        
|                              |  |                                                                                                                                                                             
|                              |  | Consolidated Balance Sheets September 30, 2003 (Unaudited) and December 31, 2002                                                                                            
|                              |  |                                                                                                                                                                             
|                              |  | Consolidated Statements of Operations (Unaudited) Three and Nine months Ended September 30, 2003 and 2002 and the period from July 1, 1991 (inception) to September 30, 2003
|                              |  |                                                                                                                                                                             
|                              |  | Consolidated Statements of Cash Flows (Unaudited) Three and Nine months Ended September 30, 2003 and 2002 and the period from July 1, 1991 (inception) to September 30, 2003
|                              |  |                                                                                                                                                                             
|                              |  | Notes to Unaudited Consolidated Financial Statements                                                                                                                        
|                              |  |                                                                                                                                                                             
|Item 2.                       |  | Managements Discussion and Analysis of Financial Condition and Results of Operations                                                                                       
|                              |  |                                                                                                                                                                             
|Item 3.                       |  | Quantitative and Qualitative Disclosures about Market Risk                                                                                                                  
|                              |  |                                                                                                                                                                             
|Item 4.                       |  | Controls and Procedures                                                                                                                                                     
|                              | 
|PART II. OTHER INFORMATION    |  |                                                                                                                                                                             
|                              |  |                                                                                                                                                                             
|Item 1.                       |  | Legal Proceedings                                                                                                                                                           
|                              |  |                                                                                                                                                                             
|Item 2.                       |  | Changes in Securities and Use of Proceeds                                                                                                                                   
|                              |  |                                                                                                                                                                             
|Item 3.                       |  | Defaults Upon Senior Securities                                                                                                                                             
|                              |  |                                                                                                                                                                             
|Item 4.                       |  | Submission of Matters to a Vote of Security Holders                                                                                                                         
|                              |  |                                                                                                                                                                             
|Item 5.                       |  | Other Information                                                                                                                                                           
|                              |  |                                                                                                                                                                             
|Item 6.                       |  | Exhibits and Reports on Form 8-K                                                                                                                                            
|                              | 
|Signatures                    |  |                                                                                                                                                                             



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##### Table of Contents

PART I. FINANCIAL INFORMATION



|Item 1. |  | Financial Statements
|------- |  | --------------------



CORAUTUS GENETICS INC.

(A DEVELOPMENT STAGE ENTERPRISE)

CONSOLIDATED BALANCE SHEETS



|                                                                                                                                                                                                            |  | September 30,2003 |             |   | December 31,2002 |  
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ----------------- | ----------- | - | ---------------- | -
|                                                                                                                                                                                                            |  | (unaudited)       |             |   |                  |  
|ASSETS                                                                                                                                                                                                      |  |                   |             |   |                  |  
|Current assets:                                                                                                                                                                                             |  |                   |             |   |                  |  
|Cash and cash equivalents                                                                                                                                                                                   |  | $                 | 6,808,861   |   |                  | $
|Short-term investments                                                                                                                                                                                      |  |                   |            |   |                  |  
|Accounts receivable                                                                                                                                                                                         |  |                   | 23,118      |   |                  |  
|Other current assets                                                                                                                                                                                        |  |                   | 358,084     |   |                  |  
|                                                                                                                                                                                                            |  |                   |             |   |                  |  
|Total current assets                                                                                                                                                                                        |  |                   | 7,190,063   |   |                  |  
|Property and equipment, net                                                                                                                                                                                 |  |                   | 303,587     |   |                  |  
|Deferred merger expenses                                                                                                                                                                                    |  |                   |            |   |                  |  
|Restricted cash                                                                                                                                                                                             |  |                   |            |   |                  |  
|Deferred loan fee                                                                                                                                                                                           |  |                   |            |   |                  |  
|Other assets                                                                                                                                                                                                |  |                   | 134,593     |   |                  |  
|                                                                                                                                                                                                            |  |                   |             |   |                  |  
|                                                                                                                                                                                                            |  | $                 | 7,628,243   |   |                  | $
|                                                                                                                                                                                                            |  |                   |             |   |                  |  
|                                                                                                                                                                                                            |  |                  
|LIABILITIES AND STOCKHOLDERS EQUITY                                                                                                                                                                        |  |                   |             |   |                  |  
|Current liabilities:                                                                                                                                                                                        |  |                   |             |   |                  |  
|Accounts payable                                                                                                                                                                                            |  | $                 | 1,032,220   |   |                  | $
|Accrued employee benefits                                                                                                                                                                                   |  |                   | 76,028      |   |                  |  
|Other accrued liabilities                                                                                                                                                                                   |  |                   | 271,097     |   |                  |  
|Accrued lease termination settlement, current portion                                                                                                                                                       |  |                   | 1,590,030   |   |                  |  
|Capital lease obligation, current portion                                                                                                                                                                   |  |                   | 513,090     |   |                  |  
|Notes payable, current portion                                                                                                                                                                              |  |                   |            |   |                  |  
|Deferred revenue, current portion                                                                                                                                                                           |  |                   | 83,333      |   |                  |  
|                                                                                                                                                                                                            |  |                   |             |   |                  |  
|Total current liabilities                                                                                                                                                                                   |  |                   | 3,565,798   |   |                  |  
|Accrued lease termination settlement, net of current portion                                                                                                                                                |  |                   | 1,829,042   |   |                  |  
|Capital lease obligation, net of current portion                                                                                                                                                            |  |                   |            |   |                  |  
|Notes payable, net of current portion                                                                                                                                                                       |  |                   |            |   |                  |  
|Other long-term liabilities                                                                                                                                                                                 |  |                   | 13,160      |   |                  |  
|Deferred compensation                                                                                                                                                                                       |  |                   | 67,667      |   |                  |  
|Deferred revenue, net of current portion                                                                                                                                                                    |  |                   | 902,778     |   |                  |  
|Commitments                                                                                                                                                                                                 |  |                   |             |   |                  |  
|Stockholders equity:                                                                                                                                                                                       |  |                   |             |   |                  |  
|Convertible Preferred Stock - $0.001 par value, 5,000,000 shares authorized:                                                                                                                                |  |                   |             |   |                  |  
|Series A Preferred Stock, none and 5,830 shares issued and outstanding, liquidation preference of $58,300                                                                                                   |  |                   |            |   |                  |  
|Series B Preferred Stock, none and 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 |  |                   |            |   |                  |  
|Series C Preferred Stock, 2,000 shares issued and outstanding, liquidation preference of $2,000,000 prior to any distribution to
holders of Series A Preferred Stock and holders of Common Stock            |  |                   | 2           |   |                  |  
|Series D Preferred Stock, 1,385,377 shares issued and outstanding, liquidation preference of $9,000,000 prior to any distribution
to holders of Series A Preferred stock                                    |  |                   | 1,385       |   |                  |  
|Common Stock - $0.001 par value, 100,000,000 shares authorized; 9,994,066 and 3,431,393 shares issued and
outstanding                                                                                       |  |                   | 9,994       |   |                  |  
|Additional paid-in capital                                                                                                                                                                                  |  |                   | 75,093,323  |   |                  |  
|Deficit accumulated during development stage                                                                                                                                                                |  |                   | (73,854,906 | ) |                  |  
|Accumulated other comprehensive income (loss)                                                                                                                                                               |  |                   |            |   |                  |  
|                                                                                                                                                                                                            |  |                   |             |   |                  |  
|Total stockholders equity                                                                                                                                                                                  |  |                   | 1,249,798   |   |                  |  
|                                                                                                                                                                                                            |  |                   |             |   |                  |  
|                                                                                                                                                                                                            |  | $                 | 7,628,243   |   |                  | $
|                                                                                                                                                                                                            |  |                   |             |   |                  |  



See accompanying notes.



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CORAUTUS GENETICS INC.

(A DEVELOPMENT STAGE ENTERPRISE)

CONSOLIDATED STATEMENTS OF OPERATIONS

(UNAUDITED)



|                                                                                              |  | For the Three Months Ended |            |   | For the Nine Months Ended |   |            | July 1, 1991(inception) toSeptember 30,2003 | 
|--------------------------------------------------------------------------------------------- |  | -------------------------- | ---------- | - | ------------------------- | - | ---------- | ------------------------------------------- | 
|                                                                                              |  | September 30,2003          |            |   | September 30,2002         |   |            | September 30,2003                           | 
|Revenue                                                                                       |  | $                          | 13,889     |   |                           | $ | 422,565    |                                             | 
|                                                                                              |  |                            |            |   |                           |   |            |                                             | 
|Costs and expenses:                                                                           |  |                            |            |   |                           |   |            |                                             | 
|Cost of sales                                                                                 |  |                            |           |   |                           |   |           |                                             | 
|Research and development                                                                      |  |                            | 419,665    |   |                           |   | 2,282,487  |                                             | 
|Write-off of property and equipment                                                           |  |                            | 17,869     |   |                           |   |           |                                             | 
|Write-off of acquired in-process technology                                                   |  |                            |           |   |                           |   |           |                                             | 
|General and administrative                                                                    |  |                            | 3,807,135  |   |                           |   | 776,978    |                                             | 
|                                                                                              |  |                            |            |   |                           |   |            |                                             | 
|Total costs and expenses                                                                      |  |                            | 4,244,669  |   |                           |   | 3,059,465  |                                             | 
|                                                                                              |  |                            |            |   |                           |   |            |                                             | 
|Loss from operations                                                                          |  |                            | (4,230,780 | ) |                           |   | (2,636,900 | )                                           | 
|Other income (expense), net                                                                   |  |                            | 14,092     |   |                           |   |           |                                             | 
|Interest expense                                                                              |  |                            | (27,782    | ) |                           |   | (119,162   | )                                           | 
|Interest income                                                                               |  |                            | 53,174     |   |                           |   | 67,503     |                                             | 
|                                                                                              |  |                            |            |   |                           |   |            |                                             | 
|Net loss                                                                                      |  | $                          | (4,191,296 | ) |                           | $ | (2,688,559 | )                                           | 
|                                                                                              |  |                            |            |   |                           |   |            |                                             | 
|Basic and diluted loss per share                                                              |  | $                          | (0.42      | ) |                           | $ | (0.79      | )                                           | 
|                                                                                              |  |                            |            |   |                           |   |            |                                             | 
|Number of weighted-average shares used in the computation of basic and diluted loss per share |  |                            | 9,907,624  |   |                           |   | 3,414,136  |                                             | 
|                                                                                              |  |                            |            |   |                           |   |            |                                             | 



See accompanying notes.



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CORAUTUS GENETICS INC.

(A DEVELOPMENT STAGE ENTERPRISE)

CONSOLIDATED STATEMENTS OF CASH FLOWS

(UNAUDITED)



|                                                                                        |  | For the Nine Months EndedSeptember 30, |             |   | July 1, 1991(inception) toSeptember 30,2003 |  
|--------------------------------------------------------------------------------------- |  | -------------------------------------- | ----------- | - | ------------------------------------------- | -
|                                                                                        |  | 2003                                   |             |   | 2002                                        |  
|Cash flows from operating activities:                                                   |  |                                        |             |   |                                             |  
|Net loss                                                                                |  | $                                      | (28,572,383 | ) |                                             | $
|Adjustments to reconcile net loss to net cash used in operating activities:             |  |                                        |             |   |                                             |  
|Non-cash portion of write-off of in-process technology                                  |  |                                        | 16,862,188  |   |                                             |  
|Expenses satisfied via advances from related party                                      |  |                                        |            |   |                                             |  
|Depreciation and amortization                                                           |  |                                        | 340,791     |   |                                             |  
|Stock and options issued for services and other                                         |  |                                        | 139,500     |   |                                             |  
|Accrued interest satisfied through issuance of common stock                             |  |                                        |            |   |                                             |  
|Loss on disposal of property & equipment                                                |  |                                        | 1,950,455   |   |                                             |  
|Amortization of debt discount and loan fee                                              |  |                                        | 45,049      |   |                                             |  
|Deferred rent                                                                           |  |                                        | (539,354    | ) |                                             |  
|Deferred revenue                                                                        |  |                                        | 986,111     |   |                                             |  
|Change in operating assets and liabilities, net of VGI assets and liabilities acquired: |  |                                        |             |   |                                             |  
|Accounts receivable                                                                     |  |                                        | 148,633     |   |                                             |  
|Other current assets                                                                    |  |                                        | (6,823      | ) |                                             |  
|Other assets                                                                            |  |                                        | 1,167,978   |   |                                             |  
|Accounts payable                                                                        |  |                                        | (1,310,397  | ) |                                             |  
|Other current liabilities                                                               |  |                                        | 688,621     |   |                                             |  
|Other long-term liabilities                                                             |  |                                        | 1,788,709   |   |                                             |  
|Deferred compensation                                                                   |  |                                        | (86,349     | ) |                                             |  
|Deferred merger costs                                                                   |  |                                        | 1,323,854   |   |                                             |  
|                                                                                        |  |                                        |             |   |                                             |  
|Net cash used in operating activities                                                   |  |                                        | (5,073,417  | ) |                                             |  
|Cash flows from investing activities:                                                   |  |                                        |             |   |                                             |  
|Purchase of short-term investments                                                      |  |                                        | (168,899    | ) |                                             |  
|Sale of short-term investments                                                          |  |                                        | 4,387,840   |   |                                             |  
|Proceeds from sale of property and equipment                                            |  |                                        | 54,931      |   |                                             |  
|Purchase of property and equipment                                                      |  |                                        | (88,185     | ) |                                             |  
|                                                                                        |  |                                        |             |   |                                             |  
|Net cash provided by (used in) investing activities                                     |  |                                        | 4,185,687   |   |                                             |  
|Cash flows from financing activities:                                                   |  |                                        |             |   |                                             |  
|Advances from related party                                                             |  |                                        |            |   |                                             |  
|Repayment of note receivable from stockholder                                           |  |                                        |            |   |                                             |  
|Proceeds from investors short-swing profit                                             |  |                                        |            |   |                                             |  
|Proceeds from capital leases and other                                                  |  |                                        |            |   |                                             |  
|Repayment of capital lease and notes payable                                            |  |                                        | (1,108,604  | ) |                                             |  
|Proceeds from issuance of common stock upon exercise of options and warrants            |  |                                        | 26,806      |   |                                             |  
|Proceeds from sale of common stock, net of issuance costs                               |  |                                        |            |   |                                             |  
|Proceeds from issuance of Series C preferred stock                                      |  |                                        |            |   |                                             |  
|Proceeds from issuance of Series D preferred stock, net of issuance costs               |  |                                        | 8,084,376   |   |                                             |  
|Repurchase of restricted shares of common stock                                         |  |                                        |            |   |                                             |  
|Net advances from Medstone                                                              |  |                                        |            |   |                                             |  
|Capital contribution by Medstone                                                        |  |                                        |            |   |                                             |  
|                                                                                        |  |                                        |             |   |                                             |  
|Net cash provided by (used in) financing activities                                     |  |                                        | 7,002,578   |   |                                             |  
|                                                                                        |  |                                        |             |   |                                             |  
|Net increase (decrease) in cash and equivalents                                         |  |                                        | 6,114,848   |   |                                             |  
|Cash and equivalents, beginning of period                                               |  |                                        | 694,013     |   |                                             |  
|                                                                                        |  |                                        |             |   |                                             |  
|Cash and equivalents, end of period                                                     |  | $                                      | 6,808,861   |   |                                             | $
|                                                                                        |  |                                        |             |   |                                             |  



See accompanying notes.



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CORAUTUS GENETICS INC.

(A DEVELOPMENT STAGE ENTERPRISE)



NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

SEPTEMBER 30, 2003



|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 Corautus Genetics Inc. as of and for the periods indicated. Corautus presumes that users of the interim financial information have read or have access to
Corautus audited consolidated financial statements and Managements Discussion and Analysis of Financial Condition and Results of Operations for the year ended December 31, 2002, 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 that would substantially duplicate the disclosures contained in Form 10-K for
the year ended December 31, 2002, filed on March 28, 2003, by Corautus have been omitted. The financial information herein is not necessarily representative of a full years operations.
|-- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



Corautus consolidated financial statements for the nine months ended
September 30, 2003 have been prepared on a going concern basis, which contemplates the realization of assets and the settlement of liabilities and commitments in the normal course of business for the foreseeable future.



Corautus is currently transitioning its finance and administrative
operations from its San Diego, California location to its Atlanta, Georgia location. The Companys headquarters will be in Atlanta and clinical operations will be based in Atlanta as well. Research and development activities will remain in
California.



Corautus incurred net losses of $28,572,000 for
the nine months ended September 30, 2003 and had an accumulated deficit of $73,855,000 at September 30, 2003. Although the receipt of $10 million (as discussed in Note 2 below) had a favorable impact on our working capital, our ability to continue
as a going concern is dependent on the ability to achieve profitable operations and to obtain additional capital. These factors raise substantial doubt about Corautus ability to continue as a going concern. Corautus is seeking further funding
in order to satisfy its projected needs. The outcome of this matter cannot be predicted at this time. Further, there is no assurance, assuming Corautus raises additional funds, that it will achieve positive cash flows. If Corautus is not able to
secure additional funding, it will be required to further scale back its research and development programs, pre-clinical studies and clinical trials, and general and administrative activities, and may not be able to continue in business. These
consolidated statements do not include any adjustments to the specific amounts and classifications of assets and liabilities, which might be necessary should Corautus be unable to continue in business.



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



|3. |  | On February 5, 2003, GenStar Therapeutics Corporation completed a merger with Vascular Genetics Inc. and concurrently changed its name to Corautus Genetics Inc. The focus of the
combined entity is the clinical development of gene therapy products using VEGF-2 for the treatment of severe cardiovascular disease.
|-- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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



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The acquisition has been accounted for as a purchase of assets by Corautus for financial reporting
purposes, in accordance with generally accepted accounting principles. After February 5, 2003, the results of Vascular Genetics have been included in the consolidated financial statements of Corautus. The purchase price has been allocated based on
the fair value of the assets acquired and the liabilities assumed as follows:



|Acquired workforce                  |  | $ | 80,000    
|----------------------------------- |  | - | ----------
|Tangible assets acquired            |  |   | 710,000   
|In-process research and development |  |   | 17,699,863
|                                    |  |   |           
|Total purchase price                |  | $ | 18,489,863
|                                    |  |   |           



Pursuant to the
Emerging Issues Task Forces Issue No. 98-3 Determining Whether a Nonmonetary Transaction Involves the Receipt of Productive Assets or of a Business, Vascular Genetics does not meet the criteria necessary to qualify as a business.
Therefore, Corautus acquisition of Vascular Genetics does not qualify as a business combination under Statement of Financial Accounting Standards No. 141, Business Combinations, and no goodwill will result from the recording of the
transaction. The value of the in-process research and development has been charged to operations upon the close of the merger. The value allocated to acquired workforce is being amortized over two years.



|4. |  | Immediately before consummation of the merger, the 12,890 shares of Series B Preferred Stock outstanding and held by Baxter Healthcare were converted into 287,274 shares of common
stock. Additionally, on February 4, 2003, the stockholders approved an amendment to the certificate of designation of the Series A Preferred Stock that provided Corautus with the ability to convert all outstanding shares of the Series A Preferred
Stock to common stock at its option. On March 6, 2003, the Board of Directors approved a resolution to convert the Series A Preferred Stock into 832,857 shares of Corautus common stock.
|-- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|5. |  | On February 7, 2003, the Board of Directors approved a one-for-seven reverse stock split of the Corautus common stock that was effective on March 10, 2003. All share and per share
amounts in these financial statements have been adjusted to reflect the reverse stock split.
|-- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|6. |  | During the first quarter of 2003, Corautus decided to abandon its manufacturing facility and move operations to a smaller facility, which had previously been subleased by Corautus
to a third party. Due to this decision, all tenant improvements related to the manufacturing facility and certain equipment specifically related to the building were identified as having no future use. A charge of $1,358,000, net of an estimated
salvage value of $12,500, was taken during the first quarter of 2003, and an additional charge of $456,000 net of an estimated salvage value of $200,000 was taken during the second quarter of 2003 related to the disposal of excess furniture and
equipment. Additionally, Corautus has forfeited the deposit on the manufacturing facility of $700,000.
|-- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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



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



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



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



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



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



Corautus will
deliver to the landlord a standby letter of credit for $681,000, securing a portion of its obligations under the agreement. Corautus has agreed to file a registration statement to register the shares delivered to the landlord, including the shares
underlying the warrants, pursuant to the Securities Act of 1933, on or before June 1, 2004. Effective with the delivery of the letter of credit and the $650,000 cash payment due on or before April 15, 2004, Corautus will be released from its
obligations under the lease.



The net present value of this
settlement amount of $3.4 million has been accrued as of September 30, 2003, of which $1,590,000 is included in current liabilities and $1,829,000 is included in long-term liabilities.



Additionally, due to our restrained cash situation prior to receiving $10 million from Boston Scientific related to an
investment in Series D Preferred Stock and a license payment, we discontinued making payments on a capital lease obligation. Subsequent to receiving the funds from Boston Scientific, we paid the originally scheduled amounts due on the capital lease
obligation and are currently negotiating with the lender regarding terms for security and repayment of the remaining balance. Until such negotiations are complete, the remaining balance of $484,000 has been classified on the balance sheet as a
current liability.



|7. |  | Corautus has elected to follow Accounting Principles Board (APB) Opinion No. 25 Accounting for Stock Issued to Employees and related interpretations in
accounting for its employee stock options. Under APB No. 25, because the exercise price of Corautus employee stock options equals the estimated market price of the underlying stock on the date of grant, no compensation has been recorded.
|-- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



The estimated weighted average fair value of
options granted during the three and nine months ended September 30, 2003 was $1.65 and $0.77, respectively. The estimated weighted average fair value of options granted during the nine months ended September 30, 2002 was $0.40. There were no
options granted during the three months ended September 30, 2002. The fair value of each option grant for disclosure under FAS 123 was estimated on the date of grant using the Black-Scholes option-pricing model.



The Black-Scholes option-pricing model was developed for the use in
estimating the fair value of traded options that have no vesting restrictions and are fully transferable. Because the Companys employee stock option plans have characteristics significantly different from those of traded options, the resulting
pro forma compensation cost may not be representative of that to be expected in future years.



Had compensation cost for Corautus stock option plans been determined based on the fair value at the grant date for awards for the three and nine months ended September 30, 2003 and 2002, consistent with the
provisions of SFAS No. 123, Corautus net loss and loss per share would have been as indicated below.



The assumptions used for grants for the three and nine months ended September 30, 2003 and 2002 were: risk-free interests rate of 2.5%, expected life of
1.5 to 5 years; expected volatility of 90% and a dividend rate of zero.



|                                               |  | Three monthsEndedSeptember 30, 2003 |            |   | Three monthsEndedSeptember 30, 2002 |   |            | Nine monthsEndedSeptember 30, 2003 |  |   | Nine monthsEndedSeptember 30, 2002 |  
|---------------------------------------------- |  | ----------------------------------- | ---------- | - | ----------------------------------- | - | ---------- | ---------------------------------- |  | - | ---------------------------------- | -
|Net loss  as reported                         |  | $                                   | (4,191,000 | ) |                                     | $ | (2,689,000 | )                                  |  | $ | (28,572,000                        | )
|Net loss  pro forma                           |  | $                                   | (4,272,000 | ) |                                     | $ | (2,816,000 | )                                  |  | $ | (28,780,000                        | )
|Basic and diluted loss per share  as reported |  | $                                   | (0.42      | ) |                                     | $ | (0.79      | )                                  |  | $ | (3.20                              | )
|Basic and diluted loss per share  pro forma   |  | $                                   | (0.43      | ) |                                     | $ | (0.82      | )                                  |  | $ | (3.22                              | )



|8. |  | 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.
|-- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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|9. |  | 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 and nine month periods ended September 30, 2003 and 2002. 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.
|-- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|10. |  | Cash paid for interest during the nine-month periods ended September 30, 2003 and 2002 was $96,000 and $115,000, respectively, primarily related to equipment financing.
|--- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|11. |  | SFAS No. 130, Reporting Comprehensive Income, reporting and displaying comprehensive income (loss) and its components which, for Corautus, 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 stockholders equity. For the three and nine months ended September 30, 2003, and 2002,
respectively, the comprehensive loss consisted of:
|--- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|                                      |  | Three months EndedSeptember 30, |            |   | Nine months EndedSeptember 30, |  
|------------------------------------- |  | ------------------------------- | ---------- | - | ------------------------------ | -
|                                      |  | 2003                            |            |   | 2002                           |  
|Net loss                              |  | $                               | (4,191,296 | ) |                                | $
|Other comprehensive loss:             |  |                                 |            |   |                                |  
|Unrealized gain (loss) on investments |  |                                 | (525       | ) |                                |  
|                                      |  |                                 |            |   |                                |  
|Comprehensive loss                    |  | $                               | (4,191,821 | ) |                                | $
|                                      |  |                                 |            |   |                                |  



|12. |  | Corautus is involved in various litigation and administrative proceedings arising in the normal course of business, including a lawsuit filed by a former employee against Corautus
and one of its directors. In the opinion of management, any liabilities that may result from these claims will not, individually or in the aggregate, have a material adverse effect on Corautus financial position, results of operations, or cash
flows.
|--- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|13. |  | Certain amounts in prior year financial statements have been reclassified to conform with current year presentation.
|--- |  | --------------------------------------------------------------------------------------------------------------------



|14. |  | In November 2002, the EITF reached a consensus on Issue No. 00-21, Revenue Arrangements with Multiple Deliverables. EITF Issue No. 00-21 provides guidance on how to account
for arrangements that involve the delivery or performance of multiple products, services and/or rights to use assets. We are required to adopt this provision for revenue arrangements entered into in fiscal periods beginning after June 15, 2003. The
adoption of EITF Issue No. 00-21 did not have a material effect on the Companys results of operations and financial condition.
|--- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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



In May 2003, the FASB issued SFAS No 150, Accounting for Certain Instruments with Characteristics of Both Liabilities and Equity. SFAS No. 150
requires that certain financial instruments issued in the form of shares that are mandatorily redeemable as well as certain other financial instruments be classified as liabilities in the financial statements. SFAS No 150 is effective for financial
instruments entered into or modified after May 31, 2003 and otherwise is effective at the beginning of the first interim period beginning after June 15, 2003. Adoption of this standard is not expected to have a material impact on the Companys
financial position, results of operations or cash flows.



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|Item 2. |  | Managements Discussion and Analysis of Financial Condition and Results of Operation
|------- |  | ------------------------------------------------------------------------------------



This report may contain forward-looking statements made pursuant to the safe harbor provisions of the Private Securities Litigation
Reform Act of 1995. Such statements are subject to certain factors, risks and uncertainties that may cause actual results, events and performances to differ materially from those referred to in such statements. These risks include statements that
address operating performance, events or developments that we expect or anticipate will occur in the future, such as projections about our future results of operations or our financial condition, benefits from the alliance with Boston Scientific,
synergies from the merger between GenStar and Vascular Genetics, research, development and commercialization of our product candidates, anticipated trends in our business, approval of our product candidates and other risks that could cause actual
results to differ materially. These risks are discussed in Corautus Genetics Inc.s and GenStar Therapeutics Corporations Securities and Exchange Commission filings, including, but not limited to, the risks discussed in Corautus
Annual Report on Form 10-K (File No. 001-15833) filed March 28, 2003, all of which are incorporated by reference into this report. All forward-looking statements included in this document are based on information available to Corautus on the date
hereof, and Corautus assumes no obligation to update any such forward-looking statements.



OVERVIEW



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



Corautus commenced operations as a stand-alone entity in January 1996 under the name UroGen Corp. and has been in the development stage since inception. UroGen
subsequently changed its name to GenStar Therapeutics Corporation in February 2000. Our original mission was to develop products to treat diseases in urology, with a particular interest in prostate cancer. We had licensed technology that used 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 was used to enhance our existing technology and to develop products to deliver other genes. 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 June 2001.



On February 5, 2003, GenStar Therapeutics Corporation completed a merger with Vascular
Genetics Inc. and concurrently changed its name to Corautus Genetics Inc. The focus of the combined entity is the clinical development of gene therapy products using VEGF-2 for the treatment of severe cardiovascular disease.



The shares of our common stock and options and warrants to purchase our common stock issued
to the Vascular Genetics stockholders in connection with the merger represented approximately 50% of our outstanding common stock immediately after the merger, assuming exercise of all outstanding options and warrants to purchase common stock and
the conversion of all preferred stock, but excluding the conversion of our Series C preferred stock. Because our Series C preferred stock is convertible at the fair value at the date it becomes convertible, which has not yet occurred, and the merger
was structured as a merger of equals, the total shares issued to Vascular Genetics stockholders included an additional 71,429 shares in lieu of shares attributable to the conversion of the Series C preferred stock.



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



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The acquisition has been accounted for as a purchase of assets by Corautus for financial reporting purposes, in
accordance with generally accepted accounting principles. After February 5, 2003, the results of Vascular Genetics have been included in the consolidated financial statements of Corautus. The purchase price has been allocated based on the fair value
of the assets acquired and the liabilities assumed as follows:



|Acquired workforce                  |  | $ | 80,000    
|----------------------------------- |  | - | ----------
|Tangible assets acquired            |  |   | 710,000   
|In-process research and development |  |   | 17,699,863
|                                    |  |   |           
|Total purchase price                |  | $ | 18,489,863
|                                    |  |   |           



Pursuant to the Emerging Issues Task
Forces Issue No. 98-3 Determining Whether a Nonmonetary Transaction Involves the Receipt of Productive Assets or of a Business, Vascular Genetics does not meet the criteria necessary to qualify as a business. Therefore,
Corautus acquisition of Vascular Genetics does not qualify as a business combination under Statement of Financial Accounting Standards No. 141, Business Combinations, and no goodwill will result from the recording of the
transaction. The value of the in-process research and development has been charged to operations upon the close of the merger. The value allocated to acquired workforce is being amortized over two years.



On July 30, 2003, we entered into a strategic alliance with Boston Scientific Corporation to
develop and commercialize VEGF-2 gene therapy products to treat cardiovascular disease. Boston Scientific made a $9,000,000 investment in exchange for 1,385,377 shares of Series D Preferred Stock, which is convertible into the same number of shares
of common stock, subject to adjustment. Additionally, Boston Scientific paid a $1,000,000 license fee for certain intellectual property, which is being recognized as revenue over the anticipated term of the license of 12 years. Boston Scientific has
also committed to purchasing up to $15 million of convertible debt from us based on achievement of certain milestones as further discussed herein. Boston Scientific has obtained exclusive rights to distribute our VEGF-2 gene therapy products once
regulatory approval is obtained.



CRITICAL ACCOUNTING POLICIES AND ESTIMATES



Our discussion and analysis of our financial condition and results of
operations are based upon Corautus 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.



Revenue recognition



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



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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 and a related valuation allowance is established.



Stock based compensation



Corautus 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, and are periodically remeasured as the
options vest. Warrants for common stock are valued at the date of issuance and are recorded to the expense category related to the services provided.



RESULTS OF OPERATIONS



Revenues



Total revenues for the nine
months ended September 30, 2003 and 2002 were $14,000 and $863,000, respectively, and for the three months ended September 30, 2003 and 2002 were $14,000 and $423,000, respectively. We do not anticipate revenues from products for at least five
years. Product revenues are contingent on the success of our clinical trials and acquired in-process technology.



Research and development and acquired in-process technology



Research and development expenses during the nine months ended September 30, 2003 and 2002 were $2,718,000 and $7,017,000, respectively, and for the three months ended
September 30, 2003 and 2002 were $420,000 and $2,282,000, respectively. Research and development expense decreased $4,299,000, or 61%, during the nine months ended September 30, 2003 compared to the same period of 2002 and decreased $1,862,000, or
82%, in the second quarter of 2003 compared to 2002. Additionally, during the nine months ended September 30, 2003, a charge of $17,700,000 was taken for the write-off on acquired in-process technology related to the merger with Vascular Genetics.



During the nine months ended September 30, 2002, research and development
activities consisted primarily of research for the MAX-AD, DUAL-AD and lentiviral systems. The majority of the research and development costs related to pre-clinical research in these programs areas. Additionally, research and development expense
included costs related to the Phase I clinical trial for the FVIII MAX-AD program.



Beginning in 2003, research and development costs consist primarily of the in-process research and development charge related to the merger with Vascular Genetics, the cost to manufacture the VEGF-2 materials for clinical use and the costs
to prepare for the VEGF-2 clinical trials. Research on the MAX-AD, DUAL-AD and lentiviral systems has been terminated. We have substantially completed the manufacturing of the VEGF-2 materials and believe that we have all of the VEGF-2 material
expected to be needed through the Phase IIb clinical trial.



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Corautus filed its Protocol for its Phase II(b) clinical trial of the VEGF-2 gene on September 23, 2003. Because the
thirty day period provided by the U.S. Food and Drug Administration for comments and questions on the Protocol has expired, Corautus is proceeding with the site specific filings associated with the first site of its Phase II(b) clinical trial.
Corautus expects to initiate its Phase II(b) clinical trial in the fourth quarter of 2003. As filed with the FDA, the Phase II(b) clinical trial is proposed to be a greater than 400 patient, multi-center, randomized, double-blind, dose ranging
placebo-controlled study. As in earlier trials, the primary endpoint will be the measurement of any difference in Exercise Tolerance Time (treadmill time) and the two secondary endpoints are to be Nuclear Perfusion Imaging (SPECT) to show a decrease
in ischemic tissue and a decrease in angina. This study is being designed for Class III and Class IV angina patients who have been unresponsive to conventional therapy, such as medication, surgery or minimally invasive interventional procedures.



Once clinical trials commence, research and development costs are expected to
increase significantly. As of September 30, 2003, we employed 15 persons. Due to the expected commencement of the clinical trials, we anticipate increasing our employees to approximately 25 persons by early 2004. We estimate that it will take
approximately 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 clinical
testing necessary to bring our products to market. Currently, we estimate the cost to conduct the Phase IIb clinical trials for VEGF-2 gene therapy in accordance with the protocol will be approximately $30 million. However, additional cost may be
associated with any change in the protocol.



Write-off of property and
equipment



The write-off of property and equipment of $1,832,000 in the
nine months ended September 30, 2003 relates to the decision to abandon our manufacturing facility and outsource our manufacturing operations. The charge relates to tenant improvement costs and certain equipment related to the manufacturing
operations.



General and administrative expense



General and administrative expense during the nine months ended September 30, 2003 and 2002
was $6,402,000 and $2,394,000, respectively, and during the three months ended September 30, 2003 and 2002 was $3,807,000 and $777,000, respectively. General and administrative expense increased $4,008,000, or 167%, in the first nine months of 2003
compared to the first nine months of 2002, $3,030,000, or 390%, in the third quarter of 2003 compared to the third quarter of 2002, primarily due to the accrual of $3.4 million related to the settlement of a lease obligations (see Note 6 to the
financial statements), legal fees related to the merger with Vascular Genetics and various fund-raising activities and to severance costs recorded during 2003. 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 the number of financial and administrative employees to remain relatively constant and overall general and administrative
expenses to increase once clinical trials commence. The corporate headquarters including all financial and administrative operations are currently being transitioned from San Diego, California to Atlanta, Georgia.



Interest income and expense



Interest income during the nine months ended September 30, 2003 and 2002 was $86,000 and
$513,000, respectively, and during the three months ended September 30, 2003 and 2002 was $53,000 and $68,000, respectively. Interest income is a result of investment of excess cash in money market accounts, corporate and international notes and
certificates of deposit. The decrease is primarily due to a decline in the average balances in those investments.



Interest expense for the nine months ended September 30, 2003 and 2002 was $145,000 and $350,000, respectively, and during the three months ended September 30, 2003 and
2002 was $28,000 and $119,000, respectively. Interest expense in both periods relates to equipment financing, amortization of deferred loan fees and the interest accrued on the deferred compensation liability. The decrease for both the nine and
three month periods is due to the decline in principal balances of our debt instruments.



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LIQUIDITY AND CAPITAL RESOURCES



From inception through September 30, 2003, we have primarily financed our operations through private placements of equity and convertible
debt securities, research grants and through our collaboration with Baxter Healthcare. We have raised approximately $1.4 million in convertible debt offerings, $34.3 million in private equity financings, equity funding of $14.9 million related to
our relationship with Baxter Healthcare and $9 million in equity financing related to our relationship with Boston Scientific. Additionally, we have financed equipment purchases under capital leases and secured notes payable totaling $1.9 million



Net cash used in operating activities during the nine months ended September
30, 2003 and 2002 was $5,073,000 and $6,998,000, respectively. Net cash used in operating activities consists of expenditures for research and development and general and administrative expenses and is net of the non-cash portion of write-off of
in-process technology of $16,862,000. Net cash provided by investing activities during the nine months ended September 30, 2003 and 2002 was $4,186,000 and $6,448,000, respectively, which consists of sales of short-term investments net of purchases
of short-term investments, proceeds from the sale of property and equipment and the purchase of property and equipment. Net cash provided by financing activities for the nine months ended September 30, 2003 was $7,003,000 which consists of proceeds
from the sale of Series D Preferred Stock to Boston Scientific offset by repayments of capital leases and notes payable. Net cash used in financing activities for the nine months ended September 30, 2002 was $141,000, which consists primarily of
proceeds from our capital lease agreement, offset by repayments of capital leases and notes payable.



Due to our restrained cash situation prior to receiving the $10 million from Boston Scientific related to an investment in Series D Preferred Stock and a license payment (see Note 2 to the financial statements), we
discontinued making payments on a capital lease obligation and a operating lease for our manufacturing facility (see Note 6 to the financial statements). Subsequent to receiving the funds from Boston Scientific, we paid the originally scheduled
amounts due on the capital lease obligation and are currently negotiating with the lender regarding terms for security and repayment of the balance. Until such negotiations are complete, the balance of $484,000 has been classified on the balance
sheet as a current liability. We have also terminated the lease for our manufacturing facility and have entered into a settlement and release agreement with the landlord for the settlement of the remaining payments that would have been due for the
original term of such lease. Pursuant to the settlement and release agreement, dated as of November 7, 2003, Corautus is obligated to pay or deliver to the landlord the following:



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



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



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



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



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



Corautus will deliver to the landlord a standby letter of credit for $681,000, securing a portion of its obligations under the agreement.
Corautus has agreed to file a registration statement to register the shares delivered to the landlord, including the shares underlying the warrants, pursuant to the Securities Act of 1933, on or before June 1, 2004. Effective with the delivery of
the letter of credit and the $650,000 cash payment due on or before April 15, 2004, Corautus will be released from its obligations under the lease.



The net present value of this settlement amount of $3.4 million has been accrued as of September 30, 2003, of which $1,590,000 is included in current liabilities and
$1,829,000 is included in long-term liabilities.



As of September 30, 2003, we
had cash and cash equivalents totaling $6,809,000. 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.



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Our future capital requirements will depend on many factors including the progress of our research and development
programs; the progress, scope and results of our preclinical and clinical testing; the time and cost involved in obtaining regulatory approvals; the cost of manufacturing for our proposed products; the cost of filing, prosecuting, defending and
enforcing patent claims and other intellectual property rights; competing technological and market developments; and our ability to establish and maintain collaborative and other arrangements with third parties, such as licensing and manufacturing
agreements, and the cost of such arrangements.



We expect that our existing
capital resources, including the $10 million received from Boston Scientific in July 2003, and assuming that we receive a $5 million milestone-based convertible loan from Boston Scientific upon starting the Phase IIb clinical trials (pursuant to the
Loan Agreement), will enable us to maintain our current and planned operations into the third quarter of 2004. 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. We do not have any commitments or arrangements assuring us of any
additional funds in the future, and there is no assurance that we will be able to obtain additional capital on acceptable terms, or at all. Failure to successfully address ongoing liquidity requirements will have a material adverse effect upon our
business. In the event that we are unable to obtain additional capital, we will be required to take actions that will harm our business and our ability to achieve cash flow in the future. To the extent we raise additional cash by issuing equity
securities, our existing stockholders will be diluted. If additional funds are raised through the issuance of debt securities, these securities are likely to have rights, preferences and privileges senior to our common stock and preferred stock.



Technology Licenses



Human Genome Sciences License for VEGF-2



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



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



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



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



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



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



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



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The license agreement with Human Genome Sciences will terminate when all patent rights licensed under the agreement
expire. Human Genome Sciences may also terminate the license if, after Human Genome Sciences gives notice to us, we fail to make a payment, fail to maintain specified insurance, incur specified financial problems or breaches any of our obligations
under the agreement. We may terminate the license by giving 30 days advance written notice to Human Genome Sciences.



Vical License for Gene Therapy Delivery Methods



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



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



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



Biosense
Webster Collaboration Agreement



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



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



Boston Scientific Development Agreement



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



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



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



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Boston Scientific Distribution Agreement



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



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



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



Boston Scientific Patent
Sublicense Agreement



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



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



MAX-AD FVIII License



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



|Item 3. |  | 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. Corautus does not conduct
business with foreign entities, and does not have any foreign exchange risk.



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|Item 4. |  | Controls and Procedures
|------- |  | -----------------------



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



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



PART II. OTHER INFORMATION



|Item 1. |  | Legal Proceedings
|------- |  | -----------------



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



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William C. Raschke v. GenStar Therapeutics, Inc., Corautus Genetics Inc., and Paul D. Quadros, Superior Court, State
of California, County of San Diego. On June 27, 2003, Dr. William Raschke, a former officer and employee of Corautus, filed a lawsuit against Corautus and one of its directors, Paul D. Quadros, asserting, among other matters, that we refused to
allow him to sell shares of Corautus common stock he held while he was employed by us. He asserts that he suffered substantial damages because our stock price was much lower after he was no longer employed by us than during the time he was our
employee. Dr. Raschke seeks to be compensated for such alleged losses. We currently anticipate that the parties will participate in non-binding mediation to seek to resolve the dispute.



|Item 2. |  | Changes In Securities
|------- |  | ---------------------



Series D Preferred Stock



In July 2003, we designated 1,400,000 shares of our authorized preferred stock, par value $0.001 per share, as Series D preferred stock. On July 30, 2003, we issued
1,385,377 shares of such Series D preferred stock to Boston Scientific for an aggregate consideration of $9 million in cash, or approximately $6.50 per share. The Series D preferred stock generally has the following rights and preferences:



Dividends.The holders of the Series D preferred stock are entitled to
receive dividends, if and when such dividends are declared, in an amount that such holders would have received had they converted such shares of Series D preferred stock into common stock before the record date for such dividend.



Liquidation Preference. The liquidation preference of the Series D preferred stock
ranks equal to the Series C preferred stock and senior to the common stock. The liquidation preference of the Series D preferred stock is equal to the greater of (a) $6.50 per share (subject to appropriate adjustments for stock splits or
combinations) plus all declared and unpaid dividends and (b) the amount that the holders of such Series D preferred stock would have received had such Series D preferred stock been converted into common stock prior to liquidation. After payment in
full of such liquidation preference, no further amounts will be paid with respect to the Series D preferred stock.



Voting Rights.The shares of Series D preferred stock will be voted equally with the shares of common stock, voting together as a class. Each holder of Series D
preferred stock is entitled to the number of votes equal to the number of shares of common stock into which such holders Series D preferred stock are convertible. We must obtain the vote or written consent of at least two-thirds of the
outstanding shares of the Series D preferred stock prior to (a) amending or repealing any provision of our certificate of incorporation, by merger or otherwise, so as to adversely affect the preferences and rights of the Series D preferred stock,
(b) increasing the authorized amount of or issuing any additional shares of Series D preferred stock, (c) creating, authorizing, increasing the authorized amount of or issuing any securities that are senior to the Series D preferred stock as to the
payment of dividends or the distribution of assets upon liquidation, of (d) effecting any split or reverse stock split of the Series D preferred stock.



Terms of Conversion and Adjustments.Each share of outstanding Series D preferred stock is convertible into common stock at any time at the election of the holder.
Each share of Series D preferred stock is convertible into one share of common stock, subject to adjustment of such conversion rate for stock splits, combinations and other reclassifications and reorganizations. The holders of the Series D preferred
stock also have an anti-dilution right pursuant to which the conversion rate for the Series D preferred stock will generally be increased upon the issuance by us of any common stock, preferred stock or other securities for a consideration per share
less than $4.50 (as adjusted for any splits or combinations for the common stock). The issuance of options to directors, officers, employees and consultants pursuant to approved stock option plans and certain other specified issuances are excluded
from this anti-dilution right.



Other Protective Provisions. If we issue
any other class or series of preferred stock, except certain senior securities approved by the holders of the Series D preferred stock, the rights and preferences of the Series D preferred stock will be automatically amended to incorporate the
following rights and preferences of such additional preferred stock to the extent such terms are more favorable, as determined in good faith by our Board of Directors: (a) the right to vote as a single class or together with any other class on any
matter other than designated matters specific to such additional preferred stock; (b) the right to treat any event, such as a change of control, as a liquidation event entitling such preferred stock to a distribution of its liquidation preference;
(c) the right to receive an adjustment to the conversion rate of such preferred into common stock pursuant to a more favorable formula upon the issuance of



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additional securities, a distribution of assets or spin-off transaction or the consummation of a tender offer by us for the common stock; (d) the right of
such preferred stock to be redeemed at the option of its holders; (e) the right to receive dividends or other distributions; and (f) any covenant relating to the operation, business, capitalization or sale of the company.



|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
|------- |  | --------------------------------



| | (a) |  | Exhibits
| | --- |  | --------



|Exhibit No. |  | Description                                                                                                                                                                                               
|----------- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|            | 
|3.1         |  | Certificate of Incorporation together with Certificate of Designation for Series D Preferred Stock (incorporated by reference from Exhibit 3.1 of our Form 10-Q filed August 14,
2003).                   
|            | 
|4.1         |  | Certificate of Designation for Series D Preferred Stock (incorporated by reference from Exhibit 3.1 of our Form 10-Q filed August 14, 2003).                                                              
|            | 
|10.1        |  | Investment Agreement by and between Corautus and Boston Scientific Corporation, dated July 30, 2003 (incorporated by reference from Exhibit 10.1 of our Form 10-Q filed August 14,
2003).                 
|            | 
|10.2        |  | Investor Rights Agreement by and between Corautus and Boston Scientific Corporation, dated July 30, 2003 (incorporated by reference from Exhibit 10.2 of our Form 10-Q filed August
14, 2003).            
|            | 
|10.3        |  | Loan Agreement by and among Corautus, Boston Scientific Corporation, and Vascular Genetics Inc., dated July 30, 2003 (incorporated by reference from Exhibit 10.3 of our Form 10-Q
filed August 14, 2003).
|            | 
|10.4        |  | Development Agreement by and between Corautus and Boston Scientific Corporation, dated July 30, 2003 (incorporated by reference from Exhibit 10.4 of our Form 10-Q filed August 14,
2003).                
|            | 
|10.5        |  | Distribution Agreement by and between Corautus and Boston Scientific Corporation, dated July 30, 2003 (incorporated by reference from Exhibit 10.5 of our Form 10-Q filed August
14, 2003).               
|            | 
|10.6        |  | Employment Letter by and between Corautus and Jack W. Callicutt, dated August 27, 2003                                                                                                                    
|            | 
|10.7        |  | Employment Letter by and between Corautus and Nina Vincent Sewell, dated August 26, 2003.                                                                                                                 
|            | 
|10.8        |  | Employment Letter by and between Corautus and Yawen Chiang, dated September 22, 2003.                                                                                                                     
|            | 
|10.9        |  | Settlement Agreement by and between Corautus and PMSI Barnes Canyon, LLC dated November 7, 2003.                                                                                                          
|            | 
|31.1        |  | Section 302 Certifications of Richard E. Otto, Chief Executive Officer and Robert T. Atwood, Chief Financial Officer.                                                                                     
|            | 
|32.1        |  | Section 906 Certifications of Richard E. Otto, Chief Executive Officer and Robert T. Atwood, Chief Financial Officer.                                                                                     



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(b) Reports on Form 8-K.



Current report on Form 8-K dated July 30, 2003, regarding the issuance of a news release pertaining to transaction with Boston Scientific Corporation.



Current report on Form 8-K dated July 30, 2003, to announce a conference call on July 31,
2003 regarding the Boston Scientific Corporation transaction and strategic initiatives.



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Signatures



Pursuant to the requirements of the
Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized on November 13, 2003.



CORAUTUS GENETICS INC. a Delaware Corporation/s/ JACK W. CALLICUTTJack W. Callicutt Vice President, Finance & Administration (Principal accounting officer)