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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

(Mark One)

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

For the quarterly period ended September 30, 2001
or

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

For the transition period from to

Commission File Number 000-24505

COLLATERAL THERAPEUTICS, INC.
(Exact name of Registrant as specified in its charter)

Delaware (State or other jurisdiction of incorporation or organization)		33-0661290 (IRS Employer Identification Number)
11622 El Camino Real, San Diego, California (Address of principal executive offices)		92130 (ZIP Code)

Registrant's telephone number, including area code: 858-794-3400

Indicate by a check 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 filing requirements for the past 90 days. Yes /x/ No / /

As of November 5, 2001, Registrant had 13,320,604 shares of its common stock outstanding.

Collateral Therapeutics, Inc.

INDEX

			Page No.
PART I—FINANCIAL INFORMATION			1
	Item 1.	Financial Statements (unaudited)	1
		Statements of Operations	1
		Balance Sheets	2
		Statements of Cash Flows	3
		Notes to Financial Statements	4
	Item 2.	Management's Discussion and Analysis of Financial Condition and Results of Operations	5
	Item 3.	Quantitative and Qualitative Disclosures About Market Risk	23
PART II—OTHER INFORMATION			24
	Item 2.	Changes in Securities and Use of Proceeds	24
	Item 6.	Exhibits and Reports on Form 8-K	24
SIGNATURES			25

Part I FINANCIAL INFORMATION

Item 1. Financial Statements

COLLATERAL THERAPEUTICS, INC.
STATEMENTS OF OPERATIONS

		Three months ended September 30,						Nine months ended September 30,
		2001			2000			2001			2000
		(Unaudited)						(Unaudited)
Revenues under collaborative research and development agreement with a related party		$	4,000,000		$	461,449		$	5,211,000		$	1,867,654
Expenses:
	Research and development		3,468,854			3,075,758			10,256,681			8,608,031
	General and administrative		1,769,509			1,363,596			4,998,625			4,804,216

Total operating expenses			5,238,363			4,439,354			15,255,306			13,412,247

Loss from operations			(1,238,363	)		(3,977,905	)		(10,044,306	)		(11,544,593	)
Interest income			235,069			538,982			932,974			1,698,524
Interest expense			(38,059	)		(27,074	)		(97,968	)		(81,706	)
Other income (expense), net			6,132			—			6,132			—

Net loss		$	(1,035,221	)	$	(3,465,997	)	$	(9,203,168	)	$	(9,927,775	)

Net loss per share (basic and diluted)		$	(0.08	)	$	(0.27	)	$	(0.70	)	$	(0.76	)

Weighted average shares used in computing net loss per share (Basic and diluted)			13,266,016			13,068,161			13,239,059			13,006,427

See Accompanying Notes to Financial Statements

COLLATERAL THERAPEUTICS, INC.
BALANCE SHEETS

			September 30, 2001			December 31, 2000
			(Unaudited)			(Note)
Assets
Current assets:
	Cash and cash equivalents		$	7,304,357		$	10,308,244
	Short-term investments			8,015,716			16,857,935
	Prepaid expenses			328,749			339,763
	Other current assets			304,371			536,623

Total current assets				15,953,193			28,042,565
Restricted cash—noncurrent				272,600			272,600
Other assets				270,878			200,126
Property and equipment, net				5,137,427			3,053,158

		Total Assets	$	21,634,098		$	31,568,449

Liabilities and Stockholders' Equity
Current liabilities:
	Accounts payable		$	495,237		$	580,189
	Accrued compensation and benefits			998,361			1,217,004
	Accrued expenses			570,554			380,553
	Notes payable to a related party, including accrued interest			—			697,457
	Note payable, current portion			434,188			321,725

Total current liabilities				2,498,340			3,196,928
Note payable, net of current portion				1,100,416			426,447
Stockholders' equity:
	Preferred stock, par value $.001; 5,000,000 shares authorized; none outstanding;			—			—
	Common Stock, par value $.001; 40,000,000 shares authorized; 13,316,437 and 13,197,112 shares issued and outstanding at September 30, 2001 and December 31, 2000, respectively			13,316			13,197
	Additional paid-in capital			57,826,137			57,495,792
	Deferred compensation			(18,350	)		(189,027	)
	Notes receivable from stockholders			(1,240,500	)		—
	Accumulated other comprehensive loss			80,041			47,246
	Accumulated deficit			(38,625,302	)		(29,422,134	)

Total stockholders' equity				18,035,342			27,945,074

		Total Liabilities and Stockholders' Equity	$	21,634,098		$	31,568,449

Note:

The balance sheet at December 31, 2000 has been derived from the audited financial statements at that date but does not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements.

See Accompanying Notes to Financial Statements

COLLATERAL THERAPEUTICS ,INC.
STATEMENTS OF CASH FLOWS

				Nine months ended September 30 ,
				2001			2000
				(Unaudited)
Operating activities:
	Net loss			$	(9,203,168	)	$	(9,927,775	)
	Adjustments to reconcile net loss to net cash
		used for operating activities:
		Depreciation and amortization			1,252,241			677,988
		Stock compensation			154,115			580,925
		Changes in operating assets and liabilities:
			Issuance of notes receivable from stockholders		(1,200,000	)		—
			Prepaid expenses and other current assets		243,266			(184,241	)
			Accounts payable and accrued expenses		(92,626	)		95,001
			Deferred revenue		—			132,346
		Other			(46,245	)		(193,256	)

Net cash used in operating activities					(8,892,417	)		(8,819,012	)

Investing activities:
	Purchases of property and equipment				(3,338,835	)		(289,240	)
	Purchases of short-term investments				(4,457,991	)		(7,024,430	)
	Proceeds from sales and maturities of short-term investments				13,270,320			4,500,000

Net cash provided by (used for) investing activities					5,473,494			(2,813,670	)

Financing activities:
	Proceeds from issuance of common stock				347,026			533,100
	Proceeds from notes payable				1,495,613			—
	Payments on notes payable				(709,180	)		(166,667	)
	Payment on notes payable to a related party				(718,423	)		—

Net cash provided by financing activities					415,036			366,433

Net decrease in cash and cash equivalents					(3,003,887	)		(11,266,249	)
Cash and cash equivalents at beginning of period					10,308,244			17,897,563

Cash and cash equivalents at end of period				$	7,304,357		$	6,631,314

Supplementary cash flow disclosure:
	Non-cash financing activities:
		Repurchase of common stock in exchange for cancellation of note receivable secured by common stock		$	—		$	185,000

See Accompanying Notes to Financial Statements

COLLATERAL THERAPEUTICS, INC.
NOTES TO FINANCIAL STATEMENTS

1. Organization and Basis of Presentation

Organization and Business

Collateral Therapeutics, Inc. is focused on the discovery and development of non-surgical gene therapy products for the potential treatment of cardiovascular diseases, including coronary artery disease, peripheral vascular disease, congestive heart failure and heart attack. The Company currently intends to focus on research and development of products while leveraging our technology through the establishment of product development, manufacturing and marketing collaborations with select pharmaceutical and biotechnology companies. Collateral was incorporated in California on April 3, 1995 and reincorporated in Delaware on May 28, 1998.

Interim Condensed Financial Statements

The balance sheet as of September 30, 2001, the statements of operations for the three and nine months ended September 30, 2001 and 2000 and the statements of cash flows for the nine months ended September 30, 2001 and 2000 are unaudited. In the opinion of management, all adjustments, consisting only of normal recurring accruals, considered necessary for a fair presentation have been included. Interim results are not necessarily indicative of the results to be expected for the full year. These unaudited financial statements should be read in conjunction with the financial statements and footnotes contained in the Company's latest Form 10-K.

2. Comprehensive Loss

Total comprehensive loss was $1,064,936 and $9,140,659 for the three and nine months ended September 30, 2001, respectively, and $3,426,272 and $9,903,826 for the three and nine months ended September 30, 2000, respectively.

3. Net Loss Per Share

Basic and diluted net loss per share is computed using the weighted average number of common shares outstanding. Equivalent shares arising from outstanding stock options have not been included in the computation of net loss per share as their effect would be anti-dilutive.

4. Collaborative Research and Development Agreement

In August 2001, Collateral received a $4.0 million payment from its development partner, Schering AG, for the clinical advancement of Collateral's non-surgical angiogenic gene therapy product candidates, GENERX™ and GENVASCOR™.

5. New Accounting Requirements

In July 2001, the Financial Accounting Standards Board (FASB) issued FASB Statements Nos. 141 and 142 (FAS 141 and FAS142), "Business Combinations" and "Goodwill and Other Intangible Assets." FAS 141 replaces APB 16 and eliminates pooling-of-interests accounting prospectively. It also provides guidance on purchase accounting related to the recognition of intangible assets and accounting for negative goodwill. FAS 142 changes the accounting for goodwill from an amortization method to an impairment-only approach. Under FAS 142, goodwill will be tested annually and whenever events or circumstances occur indicating that goodwill might be impaired. FAS 141 and FAS 142 are effective for all business combinations completed after June 30, 2001. Upon adoption of FAS 142, amortization of goodwill recorded for business combinations consummated prior to July 1, 2001 will cease, and intangible assets acquired prior to July 1, 2001 that do not meet the criteria for recognition under FAS 141 will be reclassified to goodwill. Companies are required to adopt FAS 142 for fiscal years beginning after December 15, 2001, but early adoption is permitted under certain circumstances. The adoption of these standards is not expected to have a material impact on the Company's results of operations and financial position.

Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations

This information should be read in conjunction with the financial statements and the related notes included in Item 1 of this quarterly report on Form 10-Q and the audited financial statements and related notes and Management's Discussion and Analysis of Financial Condition and Results of Operations contained in our annual report on Form 10-K for the year ended December 31, 2000. See "Risks and Uncertainties" for a discussion of factors we believe could cause reported financial information not to be necessarily indicative of future results. We are not obligated to publicly release the results of any revisions to forward-looking statements to reflect events and circumstances arising after the date this report is filed.

Overview

Collateral is focused on the discovery and development of non-surgical gene therapy products for the potential treatment of cardiovascular diseases, including coronary artery disease, peripheral vascular disease, congestive heart failure and heart attack. Our initial non-surgical gene therapy product candidates are designed to promote and enhance angiogenesis, a natural biological process that results in the growth of additional blood vessels which can carry blood flow to oxygen-deprived tissues. We intend to continue to focus on research and development of cardiovascular products, while leveraging our technology through the establishment of product development, manufacturing and marketing collaborations with select pharmaceutical and biotechnology companies. We currently have two angiogenic gene therapy product candidates, GENERX™ and GENVASCOR™, which are advancing in clinical studies supported by our development partner, Schering AG, based on the human Fibroblast Growth Factor-4 (FGF-4) gene. We are currently considering the independent commercial development of a third non-surgical angiogenic gene therapy product candidate, GENEVX™, for the potential treatment of ischemic heart disease based on the Vascular Endothelial Growth Factor-145 (VEGF-145) gene. In addition, with the successful advancements of our non-surgical angiogenic gene therapy candidates, we are also evaluating other ways to further leverage our knowledge and development expertise in the field of cardiovascular medicine which could include the external acquisition of registered brand-name specialty cardiovascular pharmaceutical products to potentially accelerate the generation of revenue opportunities for Collateral.

Our lead product candidate, GENERX™, is a non-surgical angiogenic gene therapy which is being developed as a potential treatment for patients with stable exertional angina. According to the American Heart Association, angina affects approximately 6.2 million Americans. GENERX™ is now being evaluated in a worldwide clinical development program by our development partner Schering AG. The objective of these clinical trials will be to establish definitive proof of safety and efficacy of GENERX™ in large-scale patient populations. The GENERX™ clinical development program, which seeks to enroll up to about 1,000 patients, is intended to include two pivotal Phase 2b/3 clinical trials, one in the U.S. and one in Europe. Upon completion, it is expected that results of these studies, along with data from other development activities, could be used to support a marketing application for product registration to the U.S. Food and Drug Administration (FDA) and the European Agency for the Evaluation of Medicinal Products (EMEA). Under our collaboration, license and royalty agreement with Schering AG, either Schering AG or its affiliates would be responsible for manufacturing clinical materials as well as for conducting and funding these clinical trials. Upon the successful commercial development of GENERX™ under our agreement with Schering AG, we would receive a royalty on sales of GENERX™ ranging from 15% to 20% depending on cost of goods and overall sales levels.

Our second product candidate, GENVASCOR™, a non-surgical angiogenic gene therapy designed for the potential treatment of patients with peripheral vascular disease, is advancing to Phase ¹/2 clinical trials which seek to enroll up to 130 patients at ten major European medical centers in six countries. The objective of these clinical trials will be to evaluate the therapeutic potential and safety of GENVASCOR™. Under our collaboration, license and royalty agreement with Schering AG, either Schering AG or its affiliates would be responsible for manufacturing clinical material and for

conducting and funding these clinical trials. Upon the successful commercial development of GENVASCOR™ under our agreement with Schering AG, we would receive a royalty on sales of GENVASCOR™ ranging from 15% to 20% depending on cost of goods and overall sales levels.

Under our 1996 collaboration, license and royalty agreement with Schering AG, Schering AG has also made equity investments in Collateral. In addition, during the initial five-year term of our agreement with Schering AG, we conducted certain preclinical research and development activities that were funded by Schering AG under the agreement. Since we have now successfully completed the required preclinical research to advance GENERX™ and GENVASCOR™ into human clinical studies, we no longer anticipate requiring recurring financial support for such preclinical activities. To the extent that Collateral performs additional studies for Schering AG, such work would be done on a contract study-by-study basis.

Having successfully completed the initial five-year term of our agreement with Schering AG with the advancement of two product candidates to clinical trials, Collateral is no longer under its contractual obligation to conduct research and development in the field of angiogenic gene therapy solely with Schering AG. For those product candidates such as GENERX™ and GENVASCOR™ that have already been presented to and accepted by Schering AG for clinical development, Schering AG or its affiliates remain responsible for the manufacture of clinical materials as well as for the conduct and funding of any clinical trials of product candidates. If such products are successfully commercialized, Schering AG would also be responsible for making royalty payments to Collateral based upon sales of the resulting products. For example, in the event of the successful development of GENERX™ in the U.S., to the extent that U.S. sales are covered by various issued U.S. patents related to methods of gene therapy, our agreement with Schering AG would cover the payment of royalties on sales of GENERX™ throughout the lives of such patents, which could extend to 2015 and potentially beyond.

Since inception, we have also conducted research in the area of non-surgical cardiovascular gene therapy that is not funded by our collaboration with Schering AG. Accordingly, our operating expenses have increased and have exceeded revenues each year. Losses have resulted principally from costs incurred in research and development activities related to our efforts to develop our technologies and from administrative costs required to support our efforts, which would be expected to increase with expanded product development and/or commercialization efforts.

Recent Developments

On September 20, 2001, we announced that our Board of Directors adopted a Stockholder Rights Plan ("Rights Plan") in which Preferred Stock Purchase Rights were distributed as a dividend at the rate of one Right for each share of Common Stock held of record as of the close of business on October 1, 2001. The Rights Plan is intended to enable all stockholders to realize the long-term value of their investment in the Company. The plan is designed to guard against partial tender offers and other coercive tactics that might be used in an attempt to gain control of the Company without paying stockholders a fair premium or to otherwise deprive stockholders of their full interest in the long-term value of the Company. The Rights Plan will not prevent a takeover attempt, but is intended to encourage anyone seeking to acquire the Company to negotiate with our Board of Directors prior to attempting a takeover. Under the terms of the Rights Plan, the Rights would become exercisable on the tenth day following a person or group acquiring 20% or more of Collateral's Common Stock, or announcing a tender or exchange offer for Collateral's Common Stock that would result in the ownership of 20% or more of the Company's Common Stock by one person or group. Each Right will entitle stockholders to buy one one-thousandth of a share of newly created Series A Preferred Stock of the Company at an exercise price of $85.00 subject to adjustment. Until the Rights become exercisable, the Rights will be represented by, and will automatically trade with, the Company's Common Stock certificates.

On October 1, 2001, we announced that Jack W. Reich, Ph.D. chairman and chief executive officer of Collateral Therapeutics addressed investors as part of the Bear Stearns "Virtual" Health Care Conference on Friday, September 28, 2001. Slides from the presentation are available and may be accessed on Collateral's Web site.

On October 23, 2001, we announced that the University of California had been issued U.S. Patent No. 6,306,830, entitled "Gene Therapy for Congestive Heart Failure" by the U.S. Patent and Trademark office. We have exclusive rights to this patent, which relates to methods of in vivo gene transfer via non-surgical administration for the potential treatment of congestive heart failure. The patent is directed to methods employing a gene delivery vector and a therapeutic gene encoding a beta-adrenergic signaling element, particularly a cardiac adenylylcyclase (AC) gene to enhance cardiac function for patients with congestive heart failure. In our preclinical studies, use of a cardiac AC gene to enhance the myocardial adrenergic signaling pathway resulted in statistically significant increases in cardiac function, as reported in the journal Circulation last year.

On October 25, 2001, we reported that the U.S. portion of the GENERX development program was underway and that patients are now being enrolled at an initial twelve U.S. medical centers. In addition, we announced that our development partner, Schering AG, had informed us that the Medicines Control Agency in the United Kingdom (U.K.) authorized the initiation of the large-scale Phase 2b/3 clinical trial in the U.K. as part of the European clinical development for GENERX, Collateral's lead product candidate for the potential treatment of stable exertional angina due to coronary artery disease. Patient enrollment for the European trial is expected to begin in January 2002.

Results of Operations

Three Months Ended September 30, 2001 and 2000

Collateral reported revenues of $4.0 million for the three months ended September 30, 2001 compared to revenues of $0.5 million for the comparable quarter in 2000. The increase in revenues was associated with a $4.0 million development payment from Schering AG for the clinical advancement of Collateral's non-surgical angiogenic gene therapy product candidates, GENERX™ and GENVASCOR™.

Research and development expenses for the three months ended September 30, 2001 rose to $3.5 million from $3.1 million for the three months ended September 30, 2000. In order to strengthen Collateral's internal development capabilities, we expanded our research and development center. The corresponding expenses included depreciation and amortization expense of laboratory equipment and building improvements, personnel costs and laboratory supplies. These increases were partially offset by lower amounts due under license agreements and reduced stock compensation costs.

General and administrative expenses were $1.8 million for the three months ended September 30, 2001 compared to $1.4 million for the three months ended September 30, 2000. The increase was mainly due to higher personnel costs to support our research and development efforts.

Interest income decreased to $0.2 million for the three months ended September 30, 2001 compared to $0.5 million for the three months ended September 30, 2000. This decrease was primarily due to lower average cash and investment balances coupled with lower average interest rates for the three months ended September 30, 2001.

Nine Months Ended September 30, 2001 and 2000

Our revenue was $5.2 million and $1.9 million for the nine months ended September 30, 2001 and 2000, respectively. The increase in revenues was primarily due to a $4.0 million development payment from Schering AG for the clinical advancement of Collateral's non-surgical angiogenic gene therapy product candidates, GENERX™ and GENVASCOR™.

Research and development expenses for the nine months ended September 30, 2001 rose to $10.3 million from $8.6 million for the nine months ended September 30, 2000. Higher research and development expenses were mainly due to increased personnel costs, rent, depreciation and amortization expense and laboratory supplies associated with the expansion of our research and development center. This increase was partially offset by lower amounts due under license agreements and reduced stock compensation costs.

General and administrative expenses were $5.0 million for the nine months ended September 30, 2001 compared to $4.8 million for the nine months ended September 30, 2000. General and administrative expenses increased primarily due to higher personnel costs to support our research and development efforts which was partially offset by lower costs associated with investor relations activities.

Interest income decreased to $0.9 million for the nine months ended September 30, 2001 compared to $1.7 million for the nine months ended September 30, 2000. This decrease was primarily due to lower average cash and investment balances coupled with lower average interest rates in the first nine months of 2001.

Liquidity and Capital Resources

From inception through September 30, 2001, we have primarily financed our operations through the private and public offering of our equity securities and collaborative research and development revenues from Schering AG. We have raised $31.3 million in net proceeds from a private placement of equity securities, $13.0 million in net proceeds from our initial public offering of our common stock and aggregate net proceeds of $9.9 million from other private sales of equity securities. As of September 30, 2001, Schering AG has paid us an aggregate of $32.0 million, of which $26.3 million was for research and development support and milestone payments, and $5.7 million for equity investments.

As of September 30, 2001, Collateral had a total of $1.5 million outstanding in equipment loans. The first loan had a balance of $0.1 million. This loan bears interest at 10.17% and is secured by certain equipment. In May 2001, Collateral signed an agreement for a second equipment loan of up to $2.1 million, of which $1.4 million is outstanding. This loan is being used to purchase new equipment primarily for the research and development center expansion. This loan bears interest at 10.35%, is secured by equipment, and will be repaid monthly over a four-year term. In the third quarter of 2001, Collateral repaid its loans from Schering AG of $0.7 million, which included principal and interest. Collateral also repaid its bank loan of $0.4 million in the third quarter of 2001.

As of September 30, 2001, cash, cash equivalents and short-term investments were $15.3 million compared to $27.2 million at December 31, 2000. Decreases in cash, cash equivalents and short-term investments were primarily due to the expansion of our research and development center as well as research and development expenses and general and administrative expenses not funded under our collaboration with Schering AG.

During the initial five-year term of our agreement with Schering AG, we conducted certain preclinical research and development activities that were funded by Schering AG under the agreement. Since we have now successfully completed the required preclinical research to advance GENERX™ and GENVASCOR™ into human clinical studies, we no longer anticipate requiring recurring financial support for such activities. To the extent that Collateral performs additional studies for Schering AG, such work would be done on a contract study-by-study basis. In addition, having successfully completed the initial five-year term of our agreement with Schering AG, with the advancement of two product candidates into clinical trials, Collateral is no longer under its contractual obligation to conduct its research and development in the field of angiogenic gene therapy solely with Schering AG. For those product candidates such as GENERX™ and GENVASCOR™ that have already been presented to and accepted by Schering AG for clinical development, Schering AG or its affiliates remains responsible for manufacturing clinical materials and for conducting and funding any clinical trials of product

candidates, and if successfully commercialized, for making royalty payments based upon sales of the resulting products. Pursuant to the terms of our agreement with Schering AG, we also submitted two additional product opportunities to Schering AG; however, agreement has not been reached regarding those additional product opportunities. In that regard, we may consider advancing the first of these new product opportunities, GENEVX™, into Phase ¹/2 clinical development as our own product candidate. If we should decide at some point to partner the development of GENEVX™ with a third party other than Schering AG, under the terms of our agreement, Schering AG may retain a right of last negotiation to undertake the commercial development of GENEVX™ on substantially the same business and financial terms and conditions that we agreed to with such third party. If we were to successfully develop GENEVX™ alone or with a third party, Schering AG may be entitled to receive a reciprocal cross-royalty on sales of GENEVX™.

We generally invest excess cash in high credit quality debt instruments of corporations and financial institutions. Working capital decreased by $11.3 million to $13.5 million for the nine months ended September 30, 2001. This decrease is primarily due to cash of $8.9 million used for operating activities and $3.0 million used for the expansion of our research and development center.

We have entered into certain technology license agreements related to our methods of gene therapy, therapeutic genes and gene delivery vectors. To retain certain licensing rights under these cancelable agreements, we anticipate that we may be required to make aggregate payments of approximately $0.3 million through the remainder of 2001.

Our core technologies are focused on the development of non-surgical cardiovascular gene therapy products that promote angiogenesis, enhance myocardial adrenergic signaling or promote heart muscle regeneration. We have in-licensed certain technologies covering methods of gene therapy and therapeutic genes for use with our methods of gene therapy. We have currently designated one gene, fibroblast growth factor-4, licensed from New York University, for use in the development of two angiogenic gene therapy products: (1) GENERX™, a non-surgical angiogenic gene therapy product designed as a treatment for patients with stable exertional angina due to coronary artery disease, and (2) GENVASCOR™, a non-surgical angiogenic gene therapy product designed as a treatment for patients with peripheral vascular disease. Under the terms of our agreement with Schering AG, Collateral is entitled to milestone payments when a product reaches certain stages in the commercial development process. As of September 30, 2001, Collateral had received $6.0 million in milestone payments for the clinical advancement of GENERX™ and GENVASCOR™. Upon any successful commercialization of these two angiogenic gene therapy products using the fibroblast growth factor-4 gene, the total financial milestone obligations, licensing fees and other related amounts payable by us under license agreements with New York University, covering the use of the fibroblast growth factor-4 gene, and the University of California, covering certain technology relating to methods of gene therapy, could total up to $5.3 million. This amount includes $1.9 million which we have paid through September 30, 2001. We are currently considering the independent commercial development of a third non-surgical angiogenic gene therapy product candidate, GENEVX™, for the potential treatment of ischemic heart disease based on the Vascular Endothelial Growth Factor-145 (VEGF-145) gene. Upon any successful commercialization of this angiogenic gene therapy product using the VEGF-145 gene, the total financial milestone obligations, licensing fees and other related amounts payable by us under a license agreement with Dimotech Ltd., covering the use of the VEGF-145 gene, could total up to $0.7 million. This amount includes $0.3 million which we have paid through September 30, 2001. In addition, upon any successful commercialization of our angiogenic gene therapy products, we would be required under the foregoing license agreement to make royalty payments based on sales of products.

In addition to GENERX™, GENVASCOR™ and GENEVX™, we have another non-surgical angiogenic gene therapy product candidate, GENECOR™, which is progressing through our preclinical research. The angiogenic gene to be designated by us for use in development of GENECOR™ will not be finalized until we have progressed further in our evaluation process. We are also conducting

preclinical studies for CORGENIC™, a product candidate based on our myocardial adrenergic signaling technology in order to support a potential investigational new drug application. Based on our current agreements covering in-licensed technology, if our non-surgical cardiovascular gene therapy products are successfully commercialized, our total financial obligations pursuant to licensing agreements with respect to all five of our products which are currently beyond the research stage could range from between $7.8 million to $9.6 million, of which $2.9 million has been paid through September 30, 2001. Our financial obligations will vary depending on the selections of therapeutic genes for use in our gene therapy products. However, these amounts could be significantly increased or decreased depending on the outcome of our research and commercialization activities pursuant to the collaboration with Schering AG and/or the outcome of our internally-funded research. In addition, we would be required to pay a royalty on net sales of products that utilize in-licensed technology. In August 2000, we entered into an agreement with the University of Texas to exclusively license certain human genes and to sponsor additional research focused on cardiac cell differentiation. We would pay licensing fees and royalties based on sales of products that Collateral may develop based on technology licensed under the agreement. Under this agreement, we agreed to pay up to $1.0 million for research support and licensing fees, excluding royalties, of which $0.7 million has been paid. The information set forth above with respect to potential fees payable by us for in-licensed technology involves many variables and is subject to a high degree of potential variation. We may also elect or be required to obtain license rights to other methods of gene therapy, therapeutic genes and/or vectors based on our product development and commercialization requirements.

To date, substantially all revenue received by us has been from our collaboration with Schering AG, and we expect that substantially all revenue for the next several years would come from this and/or other potential collaborations. However, we may not be able to extend the Schering arrangement or establish other collaborations on acceptable terms, if at all, or assure that current or future collaborations will be successful and provide adequate funding to meet our needs. We expect to incur increases in operating expenses over the next two years as we accelerate our research and development activities and potentially initiate or expand other product development activities and collaborations. We may also elect or need to purchase additional technologies or enter into other corporate transactions which may require substantial cash outlays. Increases in operating expenses will include, but are not limited to, increased personnel costs, rent, payments to research institutions and consultants, supplies and other costs resulting from operating our facilities, as well as expenses associated with other product development and/or commercialization activities that we undertake. To the extent these costs are incurred in fields other than angiogenic gene therapy or are otherwise not reimbursable under any existing or new arrangement with Schering AG, we currently intend to use our available cash and future debt or equity financings to cover such expenses.

Based on our current business strategy, the development of non-surgical cardiovascular gene therapy products will require our continued commitment of substantial resources to conduct research, preclinical studies and clinical trials, and to augment quality control, regulatory and administrative capabilities. Our future capital requirements will depend on many factors, including the pace of scientific progress in our research and development programs, the magnitude of these programs, the scope and results of preclinical testing and clinical trials, the time and costs involved in obtaining regulatory approvals, the costs involved in preparing, filing, prosecuting, maintaining and enforcing patent claims, the costs of any potential litigation or other dispute resolution, competing technological and market developments, our dependence on third parties for activities related to the development and commercialization of our potential products (including our need to establish additional collaborations and potential changes to our existing collaboration with Schering AG), our potentially independent commercialization efforts, the cost of third-party manufacturing arrangements and the effectiveness of our product commercialization activities. We believe that our available cash and anticipated sources of funding will be adequate to satisfy our anticipated capital requirements for at least a year. We expect that we will seek any additional capital needed to fund our operations through

new collaborations, the extension of our existing collaboration, and/or through public or private equity or debt financings. We may not be able to obtain additional financing on acceptable terms if at all. Any inability to obtain additional financing could have a material adverse effect on us.

Risks and Uncertainties

Both our business and our industry are subject to a high degree of risk and uncertainty. Since very few biotechnology companies have become profitable, and a gene therapy product has yet to be successfully commercialized, you should regard investments in biotechnology companies such as ours as being speculative. We believe that such investments should only be made within the context of a balanced and diversified investment portfolio, and only after careful consideration of the risks and uncertainties that impact our business and our industry, including those described below.

Risks Related to Our Business

We have incurred losses since inception and may never be profitable.

We formed Collateral in 1995 and have only a limited operating history to review in evaluating our business and prospects. We have incurred operating losses since our inception in 1995. As of September 30, 2001, our accumulated deficit was approximately $38.6 million. We expect to incur additional losses for the foreseeable future. We also expect our losses to increase as our research and development efforts and clinical trials progress.

Our revenues to date have consisted of payments under our collaborative arrangements and interest income. Payments under our collaborative agreements are subject to substantial risks, as described below, and interest income would be reduced as our cash decreases as a result of ongoing expenses and other capital outlays. To date, we have not generated any revenue from product sales. We do not expect to generate any revenue from our products for a number of years, if at all. If we, alone or with our collaborators, do not successfully develop, manufacture and commercialize our products, we may never achieve profitability. Even if we do achieve profitability, we cannot predict the level of such profitability.

If we need additional funds and are unable to raise them, we would have to curtail or cease operations.

We will need substantial additional resources to develop our products. Our future capital requirements will depend on many factors, including:

•: the pace of scientific progress in our research and development programs,
•: the magnitude of our research and development programs,
•: the scope and results of preclinical studies and clinical trials,
•: the time and costs involved in obtaining regulatory approvals,
•: the costs involved in preparing, filing, prosecuting, maintaining and enforcing patent claims,
•: the costs involved in any potential litigation,
•: competing technological and market developments,
•: the willingness and ability of third parties such as Schering AG to support the development and commercialization of our potential products,
•: changes to our existing collaborations and our potential need to establish additional collaborations or other strategic relationships,
•: the cost of manufacturing, and

•: the effectiveness of our commercialization activities.

We believe that our cash and anticipated sources of funding will be adequate to satisfy our anticipated capital needs for at least a year. We expect that we will need to seek additional funding through new collaborations, an extension of our existing collaboration, or through public or private equity or debt financings. However, we may be unable to extend or expand our collaborations, and additional financing may not be available on acceptable terms or at all.

If products we are now developing do not advance beyond early-stage testing, our potential revenues would be reduced.

Our potential products are in the early stages of development. Either we or a collaborative partner must undertake the time-consuming and costly processes of completing development and testing for each of our potential products. To date, only two of our potential products, GENERX™ and GENVASCOR™, have advanced to clinical trials, and those trials are not yet complete. Our other potential products have not yet advanced to clinical trials, and it is uncertain whether we or a collaborative partner will be able to complete product development.

There are many reasons that our potential products may not advance beyond early-stage testing, including the possibility that:

•: our potential products may be ineffective, unsafe or associated with unacceptable side effects;
•: our potential products may be too expensive to develop or manufacture;
•: our collaborators may withdraw support for or otherwise impair the development and commercialization of our potential products;
•: others may hold or acquire proprietary rights that could prevent us or our collaborators from developing our products; or
•: others may develop equivalent or superior products.

Even if our potential products advance in preclinical development, we or our partners may not succeed in carrying these potential products forward to clinical testing. The uncertainties inherent in the development of our potential products are especially significant in view of their early-stage nature.

If our product candidates do not successfully complete the clinical trial process, we will not be able to market them.

For product candidates that advance to clinical testing, we cannot be certain that we or a collaborator will successfully complete the clinical trials necessary to receive regulatory product approvals. This process is lengthy and expensive. To obtain regulatory approvals, we or a collaborative partner must demonstrate through preclinical studies and clinical trials that our potential products are safe and effective for use in at least one medical indication. Promising results in preclinical studies and initial clinical trials do not ensure successful results in later clinical trials, which test broader human use of our products. Many companies in our industry have suffered significant setbacks in advanced clinical trials, despite promising results in earlier trials. Even successful clinical trials may not result in a marketable product.

Many factors can adversely affect clinical trials. For example, clinical trials are often conducted with patients who have the most advanced stages of disease. During the course of treatment, these patients can die or suffer other adverse events for reasons that may or may not be related to the proposed product being tested. For instance, as reported in December 1999, the death of a patient enrolled in the Phase ¹/2 trial for GENERX™, which occurred approximately five months after the one-time product administration, was determined to have been unlikely to be causally related to the therapy. However, even if unrelated to our product, such events can nevertheless adversely impact our clinical trials. As a result, our ability to ultimately develop and market the products and obtain revenues would suffer.

Our clinical trials may also be adversely impacted by patient deaths or problems that occur in other trials. For example, the death of a patient in another trial in 1999 who had received an adenoviral gene delivery vector expressing an ornithine transcarbamylase gene triggered several government investigations and reviews of past and ongoing gene therapy trials.

Deaths and other adverse events that occur in the conduct of clinical trials may result in an increase in governmental regulation or litigation, and could result in delays or halts being imposed upon clinical trials including our own. In addition, patients involved in clinical trials such as ours often have unknown as well as known health risks and pre-existing conditions. An adverse event may therefore appear to have been caused or exacerbated by the administration of study product, even if it was not actually related. Such consequences can also increase the risk that any potential adverse event in our trial could give rise to claims for damages against us, or could cause further delays or a halt of our clinical trial, any of which results would negatively affect us. In addition, fears regarding the potential consequences of gene therapy trials or the conduct of such trials could dissuade investigators or patients from participating in our trials, which could substantially delay or prevent our product development efforts.

In addition, our ability to complete clinical trials depends on many factors, including obtaining adequate clinical supplies and having a sufficient rate of patient recruitment. For example, patient recruitment is a function of many factors, including:

•: the size of the patient population,
•: the proximity of patients to clinical sites,
•: the eligibility criteria for the trial,
•: the perceptions of investigators and patients regarding safety, and
•: the availability of other treatment options.

Even if patients are successfully recruited, we cannot be sure that they will complete the treatment process. Delays in patient enrollment or treatment in clinical trials may result in increased costs, program delays or both.

With respect to markets in other countries, we or a partner will also be subject to regulatory requirements governing clinical trials in those countries. Even if we complete clinical trials, we may not be able to submit a marketing application. If we submit an application, the regulatory authorities may not review or approve it in a timely manner, if at all.

Our potential products may have unacceptable side effects which could delay or prevent product approval.

Possible side effects of gene therapy technologies may be serious and life-threatening. The occurrence of any unacceptable side effects during or after preclinical and clinical testing of our potential products could delay or prevent approval of our products and our revenues would suffer. For example, possible serious side effects of viral vector-based gene transfer include viral infections resulting from contamination with replication-competent viruses and inflammation or other injury to the heart or other parts of the body. In addition, the development or worsening of cancer in a patient may be a perceived or actual side effect of gene therapy technologies such as our own. Furthermore, there is a possibility of side effects or decreased effectiveness associated with an immune response toward any viral vector or gene used in gene therapy. The possibility of such response may increase if there is a need to deliver the viral vector more than once.

Our collaborators may control aspects of our clinical trials which could result in delays or other obstacles to the commercialization of these products.

Our collaborative partners may have or acquire rights to control aspects of our product development and clinical programs. For example, Schering AG currently controls the planning and implementation of product development and clinical programs related to certain angiogenic gene therapy products, including our lead product candidate GENERX™. As a result, we may not be able to conduct these programs in the manner or on the time schedule we currently contemplate. In addition, if any problems or delays occur in the conduct of our clinical trials, or if Schering AG or any other collaborative partner that we depend upon were to withdraw support for our products or otherwise impair their development, our business could be negatively affected.

Risks Related to Patents and Proprietary Information

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

Our business success will depend in part on our ability and that of our licensors to:

•: obtain patent protection for our methods of gene therapy, therapeutic genes and/or gene-delivery vectors both in the U.S. and in other countries with substantial markets,
•: defend patents once obtained,
•: maintain trade secrets and operate without infringing upon the patents and proprietary rights of others, and
•: obtain appropriate licenses to patents or proprietary rights held by others with respect to our technology, both in the U.S. and in other countries with substantial markets.

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

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

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

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

In addition, some of our products rely on patented inventions developed using U.S. government resources. The U.S. government retains rights in such patents, and may choose to exercise its rights.

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

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

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

If there were an adverse outcome of any litigation or interference proceeding, we could have potential liability for significant damages. In addition, we could be required to obtain a license to continue to make or market the affected product or use the affected process. Costs of a license may be

substantial and could include ongoing royalties. We may not be able to obtain such a license on acceptable terms.

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

We also rely on trade secrets, know-how, continuing technological innovations and licensing opportunities to develop and maintain our competitive position. However, others may independently develop substantially equivalent proprietary information and techniques or otherwise gain access to our trade secrets or disclose our technology. To protect our trade secrets, we generally require confidentiality agreements upon beginning employment, consulting or collaboration with us. Agreements with employees also generally provide that all inventions resulting from work performed by them while in our employ will be our exclusive property. However, these agreements may not provide meaningful protection of our trade secrets or adequate remedies in the event of unauthorized use or disclosure of such information. Likewise, our trade secrets or know-how may become known through other means or be independently discovered by our competitors. Any of these events could prevent us from developing or commercializing our products.

Other Risks Related to Our Business

We may not be able to successfully establish and maintain collaborative and licensing arrangements which could hinder or prevent our ability to develop and commercialize our potential products.

Our strategy for the development, testing, manufacturing and commercialization of our potential products relies on our establishing and maintaining collaborations with corporate partners, licensors, licensees and others. At present we have a collaboration with Schering AG in the area of angiogenic gene therapy. We may not be able to maintain or expand this collaboration or establish additional collaborations or licensing arrangements necessary to develop and commercialize potential products based on our technology. Even if we are able to maintain or establish additional collaborations or licensing arrangements, they may not be on favorable terms. Any failure to maintain or establish additional collaborative or licensing arrangements on favorable terms could adversely affect our revenues. In addition, the development programs contemplated by the collaborations or licensing arrangements may not ultimately be successful.

We expect to rely on collaborative partners to develop and/or market our products. As a result, we may depend on collaborators to perform some or all of the following activities:

•: fund preclinical studies,
•: fund clinical development,
•: obtain regulatory approvals, and
•: manufacture and market any successfully developed products.

If we are unable to maintain or expand such collaborative relationships, it could negatively affect our business. To the extent that we instead undertake any of these activities ourselves, our expenses would increase.

If we are not able to control the amount and timing of resources, our current and future collaborators devote to our programs or potential products, our product development could be delayed or terminated, which would adversely affect our revenues.

Our collaborators such as Schering AG have significant discretion over whether or not to pursue development activities with us. We also cannot be certain that our collaborators will not pursue alternative technologies, on their own or with others, to develop competitive gene therapy products. If our collaborators develop competitive products, they may withdraw support for our programs. Our collaborative partners may also breach or terminate our agreements, fail to conduct their collaborative activities successfully or otherwise act in ways that impair or block the development of our potential products. As a result, our product development could be delayed or terminated, which would adversely affect our revenues and valuation. In addition, revenues we receive from marketed products under our collaborations may depend on the marketing and sales efforts of our collaborators, which may or may not be successful.

Disputes may arise with our collaborators about who has ownership rights to any technology developed. These disputes could have the following results:

•: delay achievement of milestones or receipt of milestone payments,
•: adversely affect collaborative research, development and commercialization of potential products, or
•: lead to litigation or arbitration.

Any of these results could be time consuming, expensive and disruptive to our operations, and if not successfully resolved could adversely impact our revenues and valuation.

If Schering AG terminates our collaboration agreement or product development programs, we may not be able to develop our products on commercially reasonable terms, if at all.

We have entered into a research and development collaboration with Schering AG in the field of angiogenic gene therapy. Under this agreement, Schering AG has the following rights that could adversely affect the development of potential products under our collaboration:

•: discretion to pursue or not to pursue any development programs with us,
•: the right to terminate the agreement at any time if we materially breach the agreement or on 60 days written notice subject to the payment of a termination fee, and
•: the right to terminate the agreement upon 90 days written notice, without payment of a termination fee, if a competitor of Schering AG or us acquires substantially all of our assets or 49% or more of our voting stock.

We cannot be certain that this collaboration will continue or will be successful. If Schering AG terminated clinical development of our products, we may have to fund clinical trials, product development and commercialization ourselves by using additional resources or by scaling back or terminating other research and development programs. We also may need to seek alternative collaborations or financing sources or sell or license rights to some of our proprietary technology that we consider valuable to our business. If Schering AG withdraws support, we may be unable to complete our product development programs.

If our operating results fluctuate significantly, it could materially adversely affect your investment and our ability to raise additional capital as needed.

We expect that our operating results will fluctuate from quarter to quarter based on when we incur expenses and receive revenues from our collaborative arrangements and other sources. We believe that some of these fluctuations may be significant. The level of funding by Schering AG may vary or they may withdraw funding altogether from one or more of our products. If Schering AG were to withdraw funding, our revenues and our ability to develop and commercialize our products would suffer.

We depend on third-party manufacturers or collaborators to manufacture our products which may delay or impair our ability to develop and commercialize products on a timely and competitive basis or adversely affect our potential future profitability.

We do not have internal manufacturing capabilities. Our current strategy is to establish relationships with our collaborators and others to manufacture our products for clinical trials and commercial sales. To date, we have established a manufacturing relationship as part of our collaboration with Schering AG. The agreement provides that Schering AG is solely responsible for manufacturing gene therapy products developed under our collaboration. We cannot be certain, however, that we will be able to maintain our relationship with Schering AG or establish relationships with other manufacturers on commercially acceptable terms. Any failure to do so would adversely affect our potential future profitability.

Further, our manufacturers may experience a variety of problems in manufacturing our products, including:

•: an inability to manufacture commercial quantities of our products on a cost-effective basis,
•: non-compliance with current Good Manufacturing Practices mandated by the FDA or by any other regulatory authority,
•: manufacturing or quality control problems, or
•: an inability to obtain or maintain the governmental licenses and approvals required to manufacture our products.

We will need to rely on third parties to market, sell and distribute our products and those third parties may not perform successfully. We do not have internal marketing and sales capabilities and may not be able to successfully market and sell our products. Our current strategy is to market and sell our products through collaborative partners. For example, our current collaboration with Schering AG provides that they will be solely responsible for marketing and selling gene therapy products we develop together. We cannot be certain, however, that we will be able to maintain our relationship with Schering AG or establish relationships with other drug or healthcare companies with distribution systems and direct sales forces on commercially acceptable terms. If we are required to market and sell our products directly, we will need to develop a marketing and sales force with technical expertise and distribution capability. Creating a marketing and sales infrastructure is expensive and time-consuming and thus could divert resources from other aspects of our business. In addition, to the extent we enter into co-promotion or other licensing arrangements, any revenues we receive will be dependent on the efforts of others, and we cannot be certain that their efforts will be successful.

Our products may not be commercially successful because physicians and patients may not accept them.

Our success will depend on the market acceptance of our products. The degree of market acceptance will depend upon a number of factors, including:

•: the receipt and scope of regulatory approval,

•: the establishment and demonstration in the medical community of the safety and effectiveness of our products and their potential advantages over other treatments, and
•: reimbursement policies of government and healthcare payors.

In the past, parts of the medical community have been concerned with the potential safety and effectiveness of gene therapy products derived from disease-causing viruses, such as adenoviruses, which we use in our proposed gene therapy products. Physicians, patients, payors or the medical community in general may not accept our products as safe or may not use any product that we may develop.

If we are not able to attract and retain key personnel and advisors, it may adversely affect our ability to obtain financing or develop our products.

Our success depends on the key members of our scientific and management staff. The loss of one or more of these key members could impede our development objectives. We do not generally have employment agreements with our scientific or management staff. Certain key scientific staff members have entered into scientific advisory consulting agreements with us. However, these agreements may be terminated at any time by either party.

Our future success also depends on recruiting additional qualified management, operations and scientific personnel. To pursue our research and development programs, we will need to hire additional qualified scientists and managers. There is intense competition for these qualified personnel among numerous pharmaceutical and biotechnology companies, universities and other research institutions. We may not be able to continue to attract and retain the personnel necessary to develop our business. If we are not able to attract and retain key personnel, we may not successfully develop our products or achieve our other business objectives.

In addition, we rely on the members of our scientific advisory board to help formulate our research and development strategy. All of our scientific advisors are employed by others and may have commitments to, or consulting contracts with, other entities that may limit their availability to us. Each scientific advisor has agreed not to perform services for us that might conflict with services the advisor performs for another entity. However, a conflict of interest could result from these services which could impede our ability to develop our products.

If we become subject to product liability claims in connection with our ongoing clinical trials or following commercialization, it may result in reduced demand for our products or damages that exceed our insurance limitations or resources.

Our business exposes us to potential product liability risks that are inherent in the testing, manufacture and sale of human healthcare products. Failure to obtain sufficient product liability insurance or to otherwise protect against product liability claims could prevent or delay the commercialization of our products. In addition, any product liability claim, even if shown to be invalid, or a product recall or halt in product use, could divert our resources and result in significant expenses to us.

We may incur substantial costs related to our use of hazardous materials.

We and our agents and suppliers are subject to federal, state and local laws and regulations governing the use, manufacture, storage, handling and disposal of biohazardous and other hazardous materials. Even if our activities currently comply with these laws and regulations, the risk of contamination or injury still exists. For example, if an accident occurs we could be responsible for any damages and the amount of the damages could exceed our resources. In addition, we may incur significant costs to comply with existing and/or expanded environmental laws and regulations in the future.

Our stock price is subject to significant fluctuations which could adversely affect your investment and our ability to raise additional capital.

The market prices and trading volumes for securities of emerging companies in our industry have historically been highly volatile and have experienced significant fluctuations. These fluctuations may be unrelated or disproportionate to the operating performance of companies. Our common stock has been publicly traded since July 1998. As of September 30, 2001, our common stock has traded as low as $2.81 per share and as high as $50.125 per share. In addition to factors related to the volatility of our industry and the stock market, the market price of our common stock may be affected by announcements regarding:

•: results of research in our laboratories or in other laboratories,
•: technological innovations or new products introduced by us or by competitors,
•: development testing and clinical trial progress of our own or our competitors' product candidates,
•: changes in government regulations or their implementation,
•: developments concerning our own or competitors' proprietary rights,
•: litigation or other adverse proceedings,
•: public perception regarding the safety of our products or of gene therapy in general, or
•: securities analysts' expectations or other financial factors.

Since our common stock is thinly traded, its price can also fluctuate significantly as a result of sales of a relatively large number of shares of our common stock or the perception that these sales could occur. Such sales also might make it more difficult for us to sell equity securities in the future at a price we deem appropriate.

Our charter and bylaws and stockholder rights plan contain provisions that may prevent transactions that could be beneficial to stockholders.

Our charter and bylaws restrict how our stockholders can act to affect us. For example:

•: Our stockholders can only act at a duly-called annual or special meeting and they may not act by written consent;
•: Special meetings can only be called by our chief executive officer, president, or chairman of the board or by our president or secretary at the written request of a majority of the board of directors; and
•: Stockholders also must give advance notice to the secretary of any nominations for director or other business to be brought by stockholders at any stockholders' meeting.

Some of these restrictions can only be amended by a super-majority vote of members of the board and/or the stockholders. These and other provisions of our charter and bylaws, as well as our stockholder rights plan and provisions of Delaware law, could prevent changes in our management and discourage, delay or prevent a merger, tender offer or proxy contest, even if the events could be beneficial to our stockholders. These provisions could also limit the price that investors might be willing to pay for our stock.

In addition, our charter authorizes our board of directors to issue shares of undesignated preferred stock without stockholder approval on terms that the board may determine. The issuance of preferred stock could decrease the amount of earnings and assets available for distribution to our other stockholders or otherwise adversely affect their rights and powers, including voting rights. Moreover,

the issuance of preferred stock or the triggering of rights under our stockholder rights plan may make it more difficult for another party to acquire, or may discourage another party from acquiring, voting control of us.

Our management and controlling stockholders, which together control a large portion of our common stock, may control our operations and make decisions which you do not consider in your best interest.

Our present directors, executive officers and principal stockholders and their affiliates beneficially own a significant portion of our outstanding common stock. As a result, if all or some of these stockholders were to act together, they would be able to exercise significant influence over all matters requiring stockholder approval, including the election of directors and approval of significant corporate transactions. Such concentration of ownership may also have the effect of delaying or preventing a change in our control that may be favored by other stockholders.

Risks Related to Our Industry

We face intense competition in our industry which could render our potential products less competitive or obsolete.

There are a number of potential gene therapies, cell therapy treatments and angiogenic protein infusion therapies which could compete with our potential products. Our products would also be forced to compete with drugs or other pharmaceutical products. In addition, a number of new surgical procedures could compete with our potential products, including:

•: catheter-based treatments such as balloon angioplasty, atherectomy and coronary stenting, and
•: laser-based systems to stimulate angiogenesis in the heart.

Many of our competitors have larger research and development staffs and substantially more financial and other resources. These competitors also have more experience and capability in researching, developing and testing products in clinical trials, in obtaining FDA and other regulatory approvals and in manufacturing, marketing and distribution.

In addition, the competitive positions of other early-stage companies may be enhanced significantly through their collaborative arrangements with large pharmaceutical companies, biotechnology companies or academic institutions, which may be more beneficial than our collaborative arrangements. Our competitors may succeed in developing, obtaining patent protection for, receiving regulatory approvals for, or commercializing products at a more rapid pace. If we are successful in commercializing our products, we will be required to compete with respect to manufacturing efficiency and marketing capabilities, areas in which we have no experience. Our competitors may develop or acquire new technologies and products from research institutions, universities or others that are available for sale before our potential products or are more effective than our potential products.

Any of these developments could render our potential products less competitive or obsolete, and could delay or prevent our commercialization of products. Furthermore, gene therapy in general is a new and rapidly developing technology. We expect this technology to undergo significant change in the future. If there is rapid technological development, our current and future products or methods may become obsolete before we can successfully commercialize them.

We are subject to extensive government regulation which could prevent or delay the commercialization of our products.

We and our collaborators are subject to extensive government regulation. The FDA and other regulatory authorities require rigorous preclinical testing, clinical trials and other product approval procedures. As gene therapy has come under increased scrutiny in the U.S. and elsewhere, the risk

increases that changes in regulatory policies or procedures could slow or block the development and/or clinical testing of potential gene therapy products such as our own. In addition, the testing of potential therapeutic products such as gene therapy products typically involves the use of preclinical animal models. To the extent that such activities elicit adverse attention or increased regulation, our business could be harmed by slowing or interrupting our product development activities.

Numerous regulations also govern the manufacturing, safety, labeling, storage, record keeping, reporting and marketing of our drug products. The requirements governing the conduct of clinical trials, product licensing, pricing and reimbursement vary greatly from country to country. The process of seeking these approvals and complying with applicable government regulations is time consuming and expensive, and approvals may not be obtained. Even if approvals are obtained for certain products, any subsequent discovery of problems with a product, manufacturer or facility may result in restrictions on the product or manufacturer, including withdrawal of the product from the market.

In addition, gene therapies such as those we are developing are relatively new and are only beginning to be tested in humans. Regulatory authorities may require us or our partners to demonstrate that our products are improved treatments relative to other therapies or may significantly modify the requirements governing gene therapies, which could result in regulatory delays or rejections. Also, even if we obtain regulatory product approval, the approval could limit the uses for which we may market the product which could have the effect of restricting our ability to commercialize the product and reducing our potential revenues.

We and our agents and suppliers are also subject to regulation under the Occupational Safety and Health Act, the Environmental Protection Act, the Toxic Substances Control Act, the Resource Conservation and Recovery Act and other present and potential future federal, state or local laws and regulations. We or our partners may also be subject to similar regulations in other countries. Failure to comply with such regulatory requirements or to obtain product approvals could impair our ability to develop and market our products and our revenues would suffer.

If the cost of our products is not reimbursed by third parties, it could harm our commercial success.

Our commercial success will depend heavily upon whether consumers will be reimbursed for the use of our products. Third-party payors, such as government and private insurance plans, may not authorize or otherwise budget reimbursement for our products. Additionally, third-party payors, including Medicare, are increasingly challenging the prices charged for medical products and services. We may be required to provide substantial cost-benefit data to demonstrate that our products are cost-effective. Third-party payors may not pay the prices set for our products or reimburse consumers for the use of our products. Federal and state regulations also affect the reimbursement to healthcare providers of fees and capital equipment costs in connection with medical treatment.

Healthcare reform measures and reimbursement procedures may adversely impact the commercialization of our products.

The efforts of governments and third-party payors to contain or reduce the cost of healthcare will continue to affect our business and financial condition as a biotechnology company. In the U.S., government and other third-party payors are increasingly attempting to contain healthcare costs by limiting both coverage and the level of reimbursement for new products approved for marketing by the FDA. These cost containment efforts are currently increasing in response to recent initiatives to reform healthcare delivery. As managed care organizations continue efforts to contain health care costs, we believe these organizations may attempt to restrict the use of or limit coverage and reimbursements for new products such as those being developed by us. Internationally, where national healthcare systems are prevalent, little if any funding may be available for new products, and cost containment and cost reduction efforts can be more pronounced than in the U.S. These cost controls may have a material

adverse effect on our revenues and profitability and may affect our ability to raise additional capital in a number of ways, including:

•: decreasing the price we, or any of our partners or licensees, receive for any of our products,
•: preventing the recovery of development costs, which could be substantial, and
•: minimizing profit margins.

Further, our commercialization strategy depends on our collaborators. As a result, our ability to commercialize our products and realize royalties may be hindered if cost control initiatives adversely affect our collaborators.

SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS

We are a development stage company with products in the early stages of development. As a result, a substantial number of statements contained in this quarterly report on Form 10-Q and the 2000 annual report on Form 10-K, including without limitation, statements containing the words "believes," "anticipates," "expects" and words of similar import, may constitute forward-looking statements. Such forward-looking statements involve known and unknown risks, uncertainties and other factors which may cause our actual results, performance or achievements, or industry results, to be materially different from any future results, performance or achievements expressed or implied by such forward-looking statements. Such factors include, among others, those discussed under the caption "Risks and Uncertainties" as well as those factors addressed in our annual report on Form 10-K filed with the Securities and Exchange Commission. Given these uncertainties, investors and prospective investors are cautioned not to place undue reliance on such forward-looking statements. We undertake no obligation to release publicly the results of any revisions to these forward-looking statements to reflect events and circumstances arising after the date hereof.

Item 3. Quantitative and Qualitative Disclosures About Market Risk

As of September 30, 2001 we had cash and cash equivalents and short-term investments of $15.3 million. We invest our excess cash in high credit quality debt instruments of corporations and financial institutions. These investments are not held for trading or other speculative purposes. Generally, our investments mature in less than 18 months. Due to the short-term nature of these investments, we believe that we have no material exposure to interest rates arising from our investments.

At September 30, 2001 we had equipment financing loans with a total balance of $1.5 million. These loans bear interest ranging from 10.17% to 10.35% and are repaid monthly.

A hypothetical 100 basis point adverse move in interest rates along the entire interest rate yield curve would not be considered to materially affect the fair value of our interest sensitive financial instruments. Declines in interest rates over time will, however, reduce our investment income while increases in interest rates over time will increase our interest expense. We are not directly exposed to risks for changes in foreign currency exchange rates, commodity prices, or any other market rates.

PART II—OTHER INFORMATION

Item 2. Changes in Securities and Use of Proceeds

On September 19, 2001, the Board of Directors declared a dividend distribution of one preferred stock purchase right for each outstanding share of Collateral's common stock held by stockholders of record on October 1, 2001. Each right entitles the registered holder to purchase from Collateral a unit composed of one one-thousandth of a share of Series A Junior Participating Preferred Stock of the Company, at a price of $85.00 per one one-thousandth of a share, subject to adjustment.

The Rights would become exercisable on the tenth day following a person or group acquiring 20% or more of Collateral's common stock, or announcing a tender or exchange offer for Collateral's common stock that would result in the ownership of 20% or more of the Company's common stock by one person or group. At any time on or prior to the close of business on the tenth day following the first date of a public announcement that a person or group has acquired beneficial ownership of 20% or more of the Company's common stock, the Rights are redeemable for one cent per Right at the option of the Board of Directors. The Rights expire on September 19, 2011. For a more complete description of the terms of the Rights, please see the Rights Agreement, dated as of September 19, 2001 by and between the Company and American Stock Transfer & Trust Company, as rights agent, filed as an exhibit to Collateral's Registration Statement on Form 8-A (000-24505) filed on September 20, 2001.

Item 6. Exhibits and Reports on Form 8-K.

(a): Exhibits.

		3.1		Incorporated by reference to the Second Restated Certificate of Incorporation of the Company filed as Exhibit 3.1 to the Form 10-Q for the quarter ended June 30, 1998, filed on August 6, 1998.
		3.2		Incorporated by reference to the Restated Bylaws of the Company filed as Exhibit 3.4 to Registration Statement No. 333-51029 on Form S-1 filed on April 24, 1998, as amended.
		3.3		Incorporated by reference to the Certificate of Designations of Series A Junior Participating Preferred Stock included as an exhibit to Exhibit 4.0 to our Registration Statement on Form 8-A (000-24505) filed on September 20, 2001.
		4.0		Rights Agreement, dated as of September 19, 2001, between the Company and American Stock Transfer & Trust Company. Incorporated by reference to the same numbered exhibit filed with our Registration Statement on Form 8-A (000-24505) filed on September 20, 2001.

(b): Reports on Form 8-K.

A report on Form 8-K was filed on September 20, 2001 regarding the adoption of a Stockholder Rights Plan by our Board of Directors

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has caused this report to be signed on its behalf by the undersigned.

COLLATERAL THERAPEUTICS, INC.
Date: November 14, 2001		/s/ CHRISTOPHER J. REINHARD Christopher J. Reinhard President Chief Operating and Financial Officer (Principal Financial and Accounting Officer)

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Collateral Therapeutics, Inc.

Part I FINANCIAL INFORMATION

Item 1. Financial Statements

COLLATERAL THERAPEUTICS, INC. STATEMENTS OF OPERATIONS
COLLATERAL THERAPEUTICS, INC. BALANCE SHEETS
COLLATERAL THERAPEUTICS ,INC. STATEMENTS OF CASH FLOWS
COLLATERAL THERAPEUTICS, INC. NOTES TO FINANCIAL STATEMENTS

Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations

SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS

PART II—OTHER INFORMATION

Item 2. Changes in Securities and Use of Proceeds

Item 6. Exhibits and Reports on Form 8-K.

SIGNATURES

COLLATERAL THERAPEUTICS INC 10-Q