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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549




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FORM 10-K

|  |  |                                                                                         
|- |  | ----------------------------------------------------------------------------------------
|x |  | ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934    
|  |  | For the fiscal year ended December 31, 2003                                             
|  |  | OR                                                                                      
|o |  | 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 No. 0-23930



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TARGETED GENETICS CORPORATION

(Exact name of Registrant as specified in its charter)


|                                    |  |                                             
|----------------------------------- |  | --------------------------------------------
|Washington
(State of Incorporation) |  | 91-1549568
(IRS Employer Identification No.)

1100 Olive Way, Suite 100
Seattle, WA 98101
(Address of principal executive offices, including, zip code)

(206) 623-7612
(Registrants telephone number, including area code)



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

None

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

Common Stock, $0.01 Par Value



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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 o

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

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

The aggregate market value of common stock held by non-affiliates of the
Registrant as of June 30, 2003 was approximately $81 million based on the
closing price of $1.82 per share of the Registrants common stock as listed on
the NASDAQ SmallCap Market.

Indicate the number of shares outstanding of each of the Registrants
classes of common stock as of March 1, 2004

|                                             |  |                            
|-------------------------------------------- |  | ---------------------------
|Title of Class
Common Stock, $0.01 par value |  | Number of shares
77,244,183

DOCUMENTS INCORPORATED BY REFERENCE

(1)  The information required by Part III of this report, to the extent not
set forth in this report, is incorporated by reference from the Proxy Statement
for the Annual Meeting of Shareholders to be held on May 20, 2004. The
definitive proxy statement will be filed with the Securities and Exchange
Commission within 120 days after December 31, 2003, the end of the fiscal year
to which this report relates.



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TABLE OF CONTENTS



|              |                                                                                                                      |  |  |  |  |  |  | 
|------------- | -------------------------------------------------------------------------------------------------------------------- |  |  |  |  |  |  | 
|PART I       
|              | Item 1. Business                                                                                                    
|              | Item 2. Properties                                                                                                  
|              | Item 3. Legal Proceedings                                                                                           
|              | Item 4. Submission of Matters to a Vote of Security Holders                                                         
|PART II      
|              | Item 5. Market for Registrants Common Equity, Related Shareholder Matters and Issuer Purchases of Equity Securities
|              | Item 6. Selected Financial Data                                                                                     
|              | Item 7. Managements Discussion and Analysis of Financial Condition and Results of Operations                       
|              | Item 7A. Quantitative and Qualitative Disclosures About Market Risk                                                 
|              | Item 8. Financial Statements and Supplementary Data                                                                 
|              | Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure                        
|              | Item 9A. Controls and Procedures                                                                                    
|PART III     
|              | Item 10. Directors and Executive Officers of Registrant                                                             
|              | Item 11. Executive Compensation                                                                                     
|              | Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Shareholder Matters             
|              | Item 13. Certain Relationships and Related Transactions                                                             
|              | Item 14. Principal Accountant Fees and Services                                                                     
|PART IV      
|              | Item 15. Exhibits, Financial Statement Schedules and Reports on Form 8-K                                            
|SIGNATURES   
|EXHIBIT INDEX
|EXHIBIT 10.52
|EXHIBIT 21.1 
|EXHIBIT 23.1 
|EXHIBIT 31.1 
|EXHIBIT 31.2 
|EXHIBIT 32.1 
|EXHIBIT 32.2 



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TARGETED GENETICS CORPORATION
ANNUAL REPORT ON FORM 10-K

TABLE OF CONTENTS

|         |  |                                                                                                                  |  |     
|-------- |  | ---------------------------------------------------------------------------------------------------------------- |  | ----
|         |  |                                                                                                                  |  | Page
|         |  |                                                                                                                  |  |     
|         |  | PART I                                                                                                           |  |     
|Item 1.  |  | Business                                                                                                         |  | 1   
|Item 2.  |  | Properties                                                                                                       |  | 18  
|Item 3.  |  | Legal Proceedings                                                                                                |  | 18  
|Item 4.  |  | Submission of Matters to a Vote of Security Holders                                                              |  | 18  
|         |  | PART II                                                                                                          |  |     
|Item 5.  |  | Market for the Registrants Common Equity, Related Shareholder Matters and Issuer Purchases of
Equity Securities |  | 19  
|Item 6.  |  | Selected Financial Data                                                                                          |  | 20  
|Item 7.  |  | Managements Discussion and Analysis of Financial Condition and Results of Operations                            |  | 21  
|Item 7A. |  | Quantitative and Qualitative Disclosures About Market Risk                                                       |  | 38  
|Item 8.  |  | Financial Statements and Supplementary Data                                                                      |  | 39  
|Item 9.  |  | Changes in and Disagreements with Accountants on Accounting and Financial Disclosure                             |  | 58  
|Item 9A  |  | Controls and Procedures                                                                                          |  | 58  
|         |  | PART III                                                                                                         |  |     
|Item 10. |  | Directors and Executive Officers of Registrant                                                                   |  | 59  
|Item 11. |  | Executive Compensation                                                                                           |  | 59  
|Item 12. |  | Security Ownership of Certain Beneficial Owners and Management and Related Shareholder Matters                   |  | 59  
|Item 13. |  | Certain Relationships and Related Transactions                                                                   |  | 59  
|Item 14. |  | Principal Accounting Fees and Services                                                                           |  | 59  
|         |  | PART IV                                                                                                          |  |     
|Item 15. |  | Exhibits, Financial Statement Schedules and Reports on Form 8-K                                                  |  | 60  



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PART I




Item 1. Business

This annual report on Form 10-K contains forward-looking statements that
involve risks and uncertainties. Forward-looking statements include statements
about our product development and commercialization goals and expectations,
potential market opportunities, our plans for and anticipated results of our
clinical development activities and the potential advantage of our product
candidates, and other statements that are not historical facts. Words such as
may, will, believes, estimates, expects, anticipates, plans,
intends, or statements concerning potential or opportunity and other
words of similar meaning or the negative thereof may identify forward-looking
statements, but the absence of these words does not mean that the statement is
not forward-looking. In making these statements, we rely on a number of
assumptions and make predictions about the future. Our actual results could
differ materially from those stated in or implied by forward-looking statements
for a number of reasons, including the risks described in the section entitled
Factors Affecting Our Operating Results, Our Business and Our Stock Price in
Part II, Item 7 of this annual report.

You should not unduly rely on these forward-looking statements, which
speak only as of the date of this annual report. We undertake no obligation to
publicly revise any forward-looking statement after the date of this annual
report to reflect circumstances or events occurring after the date of this
annual report or to conform the statement to actual results or changes in our
expectations. You should, however, review the factors, risks and other
information we provide in the reports we file from time to time with the
Securities and Exchange Commission, or SEC.

Business Overview

Targeted Genetics Corporation develops gene therapy products and
technologies for treating both acquired and inherited diseases. Our gene
therapy product candidates are designed to treat disease by regulating cellular
function at a genetic level. This involves introducing genetic material into
target cells and activating the inserted gene in a manner that provides the
desired effect. We have assembled a broad base of proprietary intellectual
property that we believe gives us the potential to address the significant
diseases that are the primary focus of our business. Our proprietary
intellectual property includes genes, methods of transferring genes into cells,
processes to manufacture our gene delivery product candidates and other
proprietary technologies and processes. In addition, we have established
expertise and development capabilities focused in the areas of preclinical
research and biology, manufacturing and manufacturing process scale-up, quality
control, quality assurance, regulatory affairs and clinical trial design and
implementation. We believe that our focus and expertise will enable us to
develop products based on our proprietary intellectual property.

Gene therapy products involve the use of delivery vehicles, called
vectors, to place genetic material into target cells. Our proprietary vector
technologies include both viral and synthetic vectors. Our viral vector
development activities, which use modified viruses to deliver genes into cells,
focus primarily on adeno-associated virus, or AAV, a common human virus that
has not been associated with any human disease or illness. We believe that AAV
provides a number of safety and gene delivery advantages over other viruses for
several of our potential gene therapy products. Our synthetic vectors deliver
genes into cells using lipids, which are fatty, water-insoluble organic
substances that can promote gene uptake through cell membranes. We believe that
synthetic vectors may provide a number of gene delivery advantages for
repeated, efficient delivery of therapeutic genes into rapidly dividing cells,
such as certain types of tumor cells. Although our current product development
candidates utilize AAV as the delivery vector, we believe that possessing
capabilities in both viral and synthetic approaches provides advantages in our
corporate partnering efforts and increases the range of our potential products
that may reach the market.

We have an AAV-based product candidate under development for treating
cystic fibrosis that has been evaluated in a Phase II clinical trial. In June
2003, final data from this repeat dosing trial was presented that indicated
that our cystic fibrosis product candidate met safety and tolerability targets.
In addition, final data from the Phase II trial indicated a statistically
significant improvement in lung function and a decrease in levels of an
inflammatory cytokine. In July 2003, we initiated a larger confirmatory Phase
IIb clinical trial for this cystic fibrosis product candidate. We designed this
trial to enroll up to 100 patients and are conducting it in collaboration with
the Cystic Fibrosis Foundation, or CF Foundation. We expect to complete patient
accrual and dosing by the end of 2004.

We are developing an AAV-based vaccine product candidate for high-risk
populations to protect against the progression of Human Immunodeficiency Virus,
or HIV, infection to Acquired Immune Deficiency Syndrome, or AIDS, in
partnership with the International AIDS Vaccine Initiative, or IAVI, a
non-profit organization and The Childrens Research Institute, or CRI, at
Childrens Hospital in Columbus, Ohio. In December 2003, we initiated a Phase I
initial dose escalation safety study in humans for our AIDS vaccine product
candidate in Europe. This dose-escalation safety trial is designed to enroll up
to 50 volunteers who are uninfected with HIV and in good health. Each
participant in this study will receive a single injection of the vaccine
candidate and they will be monitored for safety and immune response. We expect
to complete the dose-escalation phase of this study by the end of 2004.

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We are also developing an AAV-based product candidate for the treatment of
rheumatoid arthritis. In June 2003, we announced preclinical results that
support the initiation of clinical trials. In January 2004, we received
regulatory approval from the U.S. Food and Drug Administration, or FDA, and
Health Canada to begin a Phase I clinical trial and we plan to dose the first
patient during the first quarter of 2004. This dose-escalation safety trial is
designed to enroll up to 32 patients with rheumatoid arthritis and will be
conducted in up to eight sites in the United States and Canada. Patients will
be monitored for safety and secondarily for improvements in arthritis signs and
symptoms. We expect to complete patient accrual and dosing in this study by
the first quarter of 2005. We also have additional product candidates focused
on treating cancer and hemophilia; however, we have suspended further
development of these programs until we can find other sources of funding for
the programs.

We believe that our successes in assembling a broad platform of
proprietary intellectual property for developing and manufacturing potential
products support our potential to develop and manufacture gene therapy product
candidates to treat a range of diseases. We have developed processes to
manufacture our potential products using methods and at a scale amenable to
clinical development and expandable to large-scale production for advancing our
potential products to clinical evaluation and commercialization. These methods
are similar to the methods used to manufacture other biologics. As a result,
we evaluated and continue to evaluate opportunities to utilize excess capacity
to manufacture biologics for other companies. In March 2003, we entered into a
manufacturing services agreement with GenVec, Inc., or GenVec, to conduct
initial feasibility studies to evaluate our ability to manufacture clinical
supply of GenVecs cancer product candidate,
TNFeradeTM, an adeno-viral-based
gene therapy product. In October 2003, we successfully completed this
feasibility study and began manufacturing TNFeradeTM for clinical use. In
January 2004, we completed our manufacturing work for GenVec.

A wide range of diseases potentially may be treated, or prevented, with
gene-based products, including cancer, genetic diseases and infectious
diseases. We believe that there is also a significant opportunity to treat
diseases currently treated using recombinant DNA proteins and monoclonal
antibodies or small molecules that may be more effectively treated by
gene-based therapies due to their ability to provide a long-term or a localized
method of treatment. Our business strategy is to develop multiple gene delivery
systems, which we believe will maximize our product opportunities. Using these
gene delivery systems, we are developing product candidates across multiple
diseases with the belief that gene-based therapies may provide a means to treat
diseases not fully treatable with current biologic and pharmaceutical drugs. We
believe that, if successful, we can establish significant market potential for
our product candidates. There are no commercially available gene therapy
products in the United States. We intend to pursue product development
programs to enable us to demonstrate proof of concept and eventually
commercialize gene-based therapeutics to address currently unmet medical needs
in treating disease.

The development of pharmaceutical products involves extensive preclinical
development followed by human clinical trials that take several years or more
to complete. The length of time required to completely develop any product
candidate varies substantially according to the type, complexity and novelty of
the product candidate; the degree of involvement by a development partner; and
the intended use of the product candidate. Our commencement and rate of
completion of clinical trials may vary or be delayed for many reasons,
including those discussed in the section entitled Factors Affecting Our
Operating Results, Our Business and Our Stock Price in Item 7 of this annual
report.

Our business strategy includes:

Multiple gene delivery systems to maximize product opportunities.Our
experience indicates that different disease targets will require different
methods of gene delivery. The best gene delivery method for a particular
disease will depend on the gene to be delivered, the type of cell to be
modified, the duration of gene expression desired and the need for in vivo
(inside the body) or ex vivo(outside the body) delivery. Our primary viral
vector development activities focus on AAV vectors, which we and others have
shown to be efficient in transferring genes to a wide variety of target cells.
Because AAV vectors can deliver genes in a way that allows for expression of
genetic information for long periods of time, we believe that these vectors may
have particular utility in treating chronic diseases, such as cystic fibrosis,
hemophilia and arthritis, which require long-term expression of the gene that
is delivered to the cell. Additionally, the efficient gene
transfer and the robust and
durable expression profile of AAV vectors may support the development of
vaccines capable of conferring protection against a number of infectious
diseases. Our synthetic vectors deliver genes using lipids. Lipid-based vectors
may have advantages in certain applications, such as some types of cancer, in
which insertion of genetic material into rapidly dividing cells and
shorter-term gene expression may be desired. We believe that using both types
of vectors gives us one of the broadest gene delivery technology platforms in
the field, and ultimately will give us the flexibility to develop products
addressing a much broader range of diseases than we could develop using any
single gene delivery system. We also have rights to certain intellectual
property relating to adenoviruses, which can also be used to deliver genes into
cells.

Significant manufacturing facilities and expertise.We have an
established manufacturing facility that complies with current Good
Manufacturing Practices. Our proprietary manufacturing process for our
AAV-based products utilizes processes, operations and equipment common to the
biopharmaceutical industry. These processes, operations and equipment are
broadly applicable to the production of viral vectors for gene therapy as well
as recombinant proteins and monoclonal antibodies.

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Although we do not
anticipate having any excess manufacturing capacity in 2004, when we do have
excess capacity we may seek
to generate additional revenue by providing contract manufacturing
services to other companies such as our manufacturing relationship with GenVec
to produce TNFeradeTM.

Broad intellectual property portfolio.To date, we have filed or
exclusively licensed over 400 patent or patent applications with the United
States Patent and Trademark Office, or USPTO, including foreign counterparts of
some of these applications in Europe, Japan and other countries. Of these
patent applications, over 100 patents have been issued or allowed. This
proprietary intellectual property includes genes, formulations, methods of
transferring genes into cells, processes to manufacture and purify our gene
delivery product candidates and other proprietary technologies and processes.

Diverse product development pipeline. We have multiple product
development programs in various stages of preclinical or clinical development.
Each of these product candidates addresses a market where we believe that there
is significant medical need for new or improved therapies. We are currently
focusing our resources on three of these programs: a treatment for cystic
fibrosis, a vaccine to protect against the progression of HIV infection to AIDS
and a treatment for rheumatoid arthritis. We have significant regulatory
expertise in both viral and non-viral gene therapy products with the FDA and
other foreign regulatory bodies. We have generated proof of concept data for
the use of gene therapy in treating other diseases, including hemophilia,
ovarian cancer and head and neck cancer. We are not pursuing development of
these programs at this time unless or until we have alternative sources of
funding for these programs.

We are currently focused on the development of our cystic fibrosis, AIDS
vaccine and rheumatoid arthritis programs. Our products candidates are in the
following stages of development:

|                                       |  |                      |  |                    |  |         |  |          |  |           |  |         |  |                
|-------------------------------------- |  | -------------------- |  | ------------------ |  | ------- |  | -------- |  | --------- |  | ------- |  | ---------------
|                                       |  |                      |  | Development Status |  |         |  |         
|                                       |  |                      |  |                    |  |         |  |         
|                                       |  |                      |  | Research &         |  |         |  |          |  |           |  |         |  |                
|Product Candidate                      |  | Indication           |  | Preclinical        |  | Phase I |  | Phase II |  | Phase III |  | Gene    |  | Delivery System
|                                       |  |                      |  |                    |  |         |  |          |  |           |  |         |  |                
|Programs Under
Active Development:     |  |                      |  |                    |  |         |  |          |  |           |  |        
|                                      
|                                      
|                                      
|                                      
|tgAAVCF                                |  | Cystic Fibrosis      |  |                    |  |         |  |          |  |           |  | CFTR    |  | AAV            
|tgAAC09                                |  | AIDS                 |  |                    |  |         |  |          |  |           |  | HIV     |  | AAV            
|tgAAC94                                |  | Rheumatoid Arthritis |  |                    |  |         |  |          |  |           |  | TNFR:Fc |  | AAV            
|___________                            |  | Hyperlipidemia       |  |                    |  |         |  |          |  |           |  | VLDLR   |  | AAV            
|                                      
|                                      
|                                      
|                                      
|                                      
|Programs Not Under
Active Development: |  |                      |  |                    |  |         |  |          |  |           |  |        
|                                      
|                                      
|                                      
|                                      
|                                      
|                                      
|tgDCC-E1A                              |  | Head & Neck Cancer   |  |                    |  |         |  |          |  |           |  | E1A     |  | DCC            
|tgDCC-E1A                              |  | Ovarian Cancer       |  |                    |  |         |  |          |  |           |  | E1A     |  | DCC            
|tgLPD-E1A                              |  | Metastatic Cancer    |  |                    |  |         |  |          |  |           |  | E1A     |  | LPD            
|AAV-FVIII                              |  | Hemophilia A         |  |                    |  |         |  |          |  |           |  | F-VIII  |  | AAV            
|AAV-FIX                                |  | Hemophilia B         |  |                    |  |         |  |          |  |           |  | F-IX    |  | AAV            
|                                      
|                                      
|                                      
|                                      
|                                      
|                                      
|Programs Developed
by a Third Party:   |  |                      |  |                    |  |         |  |          |  |           |  |        
|                                      
|                                      
|                                      
|                                      
|___________                            |  | Glioma               |  |                    |  |         |  |          |  |           |  | IFNb    |  | Adeno-Virus    

Programs Under Active Development

tgAAVCF for Cystic Fibrosis

Cystic fibrosis is one of the most common single-gene deficiencies
particularly affecting the Caucasian population, afflicting approximately
30,000 people in the United States and 60,000 people worldwide. The disease is
caused by a defective cystic fibrosis transmembrane regulator, or CFTR gene,
which interferes with normal lung function and results in a buildup of mucus in
the lungs, leading to chronic infections, scarring of the lung, loss of lung
function and early patient death. Current treatments for cystic fibrosis
relieve the symptoms of the disease, but do not cure the underlying genetic
defect that causes the disease or stop its progression.

tgAAVCF, our cystic fibrosis product candidate, is comprised of a DNA
sequence, or gene, that codes for a functional CFTR protein delivered in an AAV
vector. The objective of this gene therapy is to deliver the CFTR gene to cells
of the lung,

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which can then produce the protein that is missing in cystic
fibrosis patients. Based on our research and development activities to
date, we believe that tgAAVCF may be superior to other gene therapies for
treating cystic fibrosis, because the drug appears to have a good safety
profile and an ability to deliver the CFTR gene to the airway cells in the lung
and support production of the missing protein over an extended period. tgAAVCF
has been granted orphan drug status by the FDA, which provides for seven years
of market exclusivity and certain tax credits.

In June 2003, we announced the final results of a Phase II clinical trial
to explore the safety and clinical impact of repeated doses of aerosolized
tgAAVCF delivered to the lungs of cystic fibrosis patients. These final results
indicated that tgAAVCF met its primary endpoint demonstrating safety and
tolerability in this first-ever repeat dosing study for an AAV-gene therapy
product to treat cystic fibrosis. In this trial, which was a randomized,
double-blind, placebo-controlled clinical trial that included 37 patients with
mild cystic fibrosis, patients received treatment at days 0, 30 and 60 of the
trial. The results suggested that the aerosolized product, administered via
nebulizer to the lung, was safe and well tolerated by patients. Following
approvals from an independent data safety monitoring board, the entry criteria
for patients included in the clinical trial was reduced successively from 18
years old to 15 years old to 12 years old. No clinically significant
differences in adverse events or laboratory safety parameters between placebo
and tgAAVCF-treated patients were observed. Patients were also monitored at
regular intervals for overall lung function using FEV1, a standard measure of
lung function, from two weeks before initial dosing through day 150 of the
trial. Aggregate patient data from patients receiving tgAAVCF showed a
statistically significant improvement in FEV1 lung function at 30 days after
treatment compared to patients receiving placebo. Levels of IL-8, a cytokine
associated with inflammation, were lower in tgAAVCF-treated patients at 14 days
after treatment compared to patients in the placebo group. Excellent gene
transfer was also observed in all patients tested, as measured by DNA
polymerase chain reaction, a method for amplifying a specific AAV-CFTR DNA
sequence, on cells removed from the lung. Gene expression was not observed
within the level of detection by the assays used to measure gene expression and
AAV-neutralizing antibody response occurred systemically and locally. There was
no apparent correlation between the clinical response that patients receiving
tgAAVCF experienced with the presence, or levels, of neutralizing antibodies to
AAV. In a subset analysis of results from this study, we observed that 22% of
the patients receiving tgAAVCF in this trial experienced a 5% or greater
sustained improvement in lung function over the 90-day course of treatment.
Similar results were not observed in patients receiving placebo in the trial.

In July 2003, we initiated a larger confirmatory Phase II clinical trial
for this cystic fibrosis product candidate. This Phase IIb, double-blind,
randomized, placebo-controlled study, is being conducted through the CF
Foundation and its Therapeutics Development Network and will include bi-monthly
evaluation of changes in lung function after repeat dosing of tgAAVCF. We will
also assess the impact of tgAAVCF on inflammation and biologic markers over
time when compared to placebo. The study will continue to monitor the safety
and tolerability profile of the product candidate. A total of 100 patients, 12
years of age and older, will be evaluated, 50 in the treatment group and 50 in
the placebo group. Study participants will receive two doses of
1013 DNAse
resistant particles of tgAAVCF delivered via a nebulizer at day 0 and
day 30 of the study and will be evaluated for a total of 90 days. Study
participants will be monitored for safety for seven months after the last dose.
We expect to complete patient enrollment and dosing in this study by the end
of 2004. An interim analysis is scheduled after 50 patients have been treated
in the study to determine whether the study will be continued or terminated.
If it is apparent, statistically, that significant differences between placebo
and treated groups upon full patient enrollment cannot be reached then the
study will be terminated.

AIDS Vaccine

According to IAVI, more than 40 million people worldwide suffer from AIDS
or are infected with HIV. Approximately 5 million men, women and children
worldwide were newly infected with HIV in 2003. More than 30 million people
have died from AIDS, which now kills more people worldwide than any other
infectious disease. While current drug therapies such as protease inhibitors
and reverse transcriptase inhibitors have helped many patients with AIDS to
manage their disease, these therapies have not been shown to be curative, have
significant and often treatment-limiting side effects and are costly. We
believe that a vaccine to protect against the progression of HIV infection to
AIDS could have significant market potential. To date, no company has applied
for regulatory approval of a prophylactic AIDS vaccine, although several
vaccines are under clinical development.

We are collaborating with IAVI and CRI to develop a vaccine to protect
against the progression of HIV to AIDS. The vaccine will utilize our AAV
vectors to deliver multiple HIV genes that express viral proteins. Under the
terms of this collaboration, IAVI is funding work at Targeted Genetics and at
CRI focused on preclinical and clinical development of a vaccine candidate. We
have the right to commercialize in industrialized countries any vaccine that
may result from this development collaboration, and we have the right to
manufacture the vaccine for non-industrialized nations. The section below
entitled Research and Development Collaborations provides a detailed
description of this collaboration.

Under this vaccine approach, we use an AAV vector to deliver certain genes
from the HIV genome to muscle cells in a healthy individual. The objective of
this vaccine is to express HIV viral genes as proteins by the muscle cells. The
HIV proteins are detected by the immune system to elicit a strong immune
response against HIV without exposing the vaccinated individual to HIV. Based
on our pre-clinical animal studies, we believe that a single dose of an
AAV-based vaccine containing HIV genes

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could allow for a sustained and high
level of gene expression of HIV proteins in vivo, thereby eliciting a robust
and sustained
immune response. Further, data from studies in nonhuman primates suggest
that this vaccine approach may hold significant promise by triggering both an
antibody and a T-cell immune response. Monkeys immunized with AAV vectors
carrying SIV genes, the primate equivalent of HIV, develop immune responses
that provide protection against disease progression after challenge with a
pathogenic SIV virus. These data and additional preclinical data support the
Phase I clinical trials in humans.

In June 2003, we announced preclinical results that supported commencement
of clinical trials of our AIDS vaccine candidate. In December 2003, we and IAVI
initiated a Phase I initial dose escalation safety study in humans for our AIDS
vaccine product candidate in Europe. This dose-escalation safety trial is
designed to enroll up to 50 volunteers who are uninfected with HIV and in good
health. Each participant in this study will receive a single injection of the
vaccine candidate or placebo and they will be monitored for safety and immune
response. We expect to complete the dose-escalation phase of this study by the
end of 2004.

Rheumatoid Arthritis

Rheumatoid arthritis, or RA, is a chronic disease that causes pain,
stiffness, swelling and loss of function in the joints and inflammation in
other organs. According to the Arthritis Foundation, RA affects more than two
million people in the United States, with disease onset occurring most
frequently in people between the ages of 20 and 45. While the exact cause of
the disease remains unknown, autoimmune and inflammatory processes lead to
chronic and progressive joint damage. Researchers have found that the cytokine
called tumor necrosis factor-alpha, or TNFǟ, plays a pivotal role in this
disease process and have shown anti-TNFǟtherapies to be a valuable strategy to
treat RA. RA is currently treated with protein therapies such as Amgen Inc.s
etanercept; a variety of systemic treatments, including steroid and non-steroid
anti-inflammatory drugs, and monoclonal antibody therapies such as Johnson and
Johnsons infliximab and Abbotts adalimumab; and other drugs such as
methotrexate and cyclosporine. According to the publication Medical
Advertising News, the estimated worldwide market for anti-TNFǟtherapies is
expected to reach $7 billion by 2011.

TNFǟis an important cytokine of the immune system. TNFǟis a critical
component of the inflammatory process launched as part of the immune response
to a variety of perceived bodily threats such as infection, injury, and other
disease. While anti-TNFǟtherapies are now widely used in the treatment of RA,
there are a number of patients on systemic anti-TNFǟtherapies who do not fully
respond to those therapies and still have one or several joints that cause them
pain or impact their daily lives. We are developing a locally delivered
AAV-based anti-TNFǟproduct as a potential supplement to systemic protein
therapy for use in patients with RA symptoms where one or several joints do not
respond to systemic protein therapy. We believe that local administration of a
DNA sequence encoding an anti-TNFǟprotein may be a potentially useful
supplement to currently used drugs in a number of inflammatory conditions
including RA. The characteristics of AAV vectors make them well suited for
delivery of genes to joints and other local environments. In addition, a
locally administered anti-TNFǟtherapy could also be useful in patients with a
limited number of joints impacted by RA who may not require systemic therapy.

Our product candidate, tgAAC94, is comprised of an AAV vector that
contains a gene that encodes the soluble anti-TNFǟprotein TNFR:Fc. In
preclinical animal models, we have administered AAV-rat TNFR:Fc to the muscle
or the joint of rats with experimentally induced RA. Data from these animal
studies have shown that a single injection of a vector carrying the soluble
TNFR gene into the ankles of arthritic rats resulted in a significant reduction
in ankle and hind paw swelling as measured by arthritis index scores. Data also
suggested that animals treated in a single joint experienced a reduction in
swelling in both the treated joint as well as the contra-lateral joint.
Following injection to the joint, we observed beneficial results without
accompanying elevated levels of systemic protein expression and these results
suggest, at least in animal models, that a benefit may be possible with this
treatment approach without the potential negative implications of a reduction
of TNFǟprotein observed in the blood.

In June 2003, we announced preclinical results for tgAAC94 that support
the initiation of clinical trials. In January 2004, we received regulatory
approval from the FDA and Health Canada to begin a Phase I clinical trial and
we plan to dose the first patient during the first quarter of 2004. This
dose-escalation safety trial is designed to enroll up to 32 patients with
rheumatoid arthritis and will be conducted in up to eight sites in the United
States and Canada. Patients will be monitored for safety and improvements in
arthritis signs and symptoms. We expect to complete patient accrual and dosing
for this study by the first quarter of 2005.

Hyperlipidemia

We are exploring gene therapies for cardiovascular disease by applying our
AAV vector technology to treating hyperlipidemia, the elevation of lipids, or
fats, such as cholesterol in the bloodstream. Approximately four million people
in the United States have a genetic predisposition to some form of
hyperlipidemia, such as familial hypercholesterolemia, familial combined
hyperlipidemia and polygenic hypercholesterolemia. Approximately 10% of these
patients have severe forms of the disease and do not respond to standard drug
therapy, such as statins. If untreated, disease progression can lead to
morbidity and

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death from heart attack or stroke. As part of our acquisition of
Genovo, Inc., we acquired a product development program aimed
at assessing the delivery of genes to treat dyslipidemia, a condition of
increased levels of LDL-type cholesterol. We have a sponsored research
agreement with an academic laboratory to assess the potential clinical utility
of an AAV vector product candidate expressing the gene for vLDL, a receptor
protein that binds to LDL, for treating hyperlipidemia. We have exclusive
rights to certain intellectual property related to the use of AAV-based gene
therapy for treating hypercholesterolemia.

Programs Not Under Active Development

In addition to our core product development programs in cystic fibrosis,
rheumatoid arthritis and our AIDS vaccine, we have generated proof of concept
data in several other diseases. We believe that several of these programs
provide opportunities for establishing development partnerships that may
provide us with additional revenue or sources of funding. We are not pursuing
the further development of these programs unless and until we can secure other
sources of funding for these programs.

tgDCC-E1A for Cancer

Cancer is the second leading cause of death in the United States, with
over one million new cases diagnosed each year. Cancer arises from the
disruption of normal cell growth and division, which are regulated by cellular
proteins and genes. Cancer can result from the structural alteration or
abnormal expression of these genes or from mutation, or deletion, of tumor
inhibitor genes.

In 1996, we acquired certain worldwide rights to the E1A gene and to
issued patents covering the use of the E1A gene in cancer therapy. Some of
these rights are subject to our continued development of a cancer program using
the E1A gene. E1A is gene derived from a common virus called an adenovirus. E1A
regulates the expression of viral and cellular genes within cells infected by
the virus. We deliver this gene using a synthetic delivery system called
DC-Cholesterol which is a lipid. We recognized that if E1A could be delivered
into cancerous cells, its ability to influence gene expression might be useful
in slowing the growth of tumors and sensitizing them to chemotherapeutic drugs
and radiation. Research data indicate that E1A can function as an inhibitor of
the HER-2/neu oncogene, which is known to be over-expressed in many cancers.
Other preclinical studies indicate that tgDCC-E1A sensitizes tumor cells to
certain chemotherapeutic agents or radiation used to destroy the tumor cell.

We completed a series of Phase I and Phase II clinical trials of our
tgDCC-E1A product candidate as a single agent in several different cancers
before testing the product candidate in combination with chemotherapy and
radiation treatments. In these trials, we delivered tgDCC-E1A into the
peritoneal cavity of ovarian cancer patients and into the pleural cavity of
breast cancer patients. The results indicated that clinicians could safely
administer the drug in biologically active amounts and that the E1A gene was
present and active in tumor cells. Additionally, in some patients, we observed
decreased levels of HER-2/neu expression and decreased numbers of tumor cells.
In Phase I and Phase II clinical trials in head and neck cancer patients who
had failed to respond to previous chemotherapy and radiation treatments, we
delivered tgDCC-E1A as a single agent by direct injection into their tumors.
The results of the Phase I trial also indicated that clinicians could safely
administer the drug in biologically active amounts and that the E1A gene was
present and active in tumor cells.

In late 1999, we began the first clinical trial of tgDCC-E1A administered
in combination with chemotherapeutic drugs. In this Phase I clinical trial, we
treated advanced-stage ovarian cancer patients with a combination of tgDCC-E1A
and two chemotherapy products, Taxol® and Cisplatin, at increasing dosage
levels. tgDCC-E1A and Cisplatin are administered directly to the peritoneal
cavity and Taxol® is administered intravenously. This trial was designed to
evaluate drug safety and to assess maximum tolerable dose levels, as well as
measure the biologic activity of E1A. In this trial, a maximum tolerated dose
was not reached and the trial showed a good safety profile of the drug and
efficient transfer of the E1A gene into the targeted cells. The trial also
showed a decrease in the level of CA-125, a marker for ovarian cancer.

In late 2000, we began a multi-center Phase II clinical trial of tgDCC-E1A
administered together with radiation therapy to patients with recurrent or
inoperable head and neck cancer. Patients were treated with injections of
tgDCC-E1A twice a week throughout six to seven weeks of radiation therapy.
Primary endpoints of this trial included tumor response, as measured by CT scan
12 weeks following completion of therapy, and safety and tolerability of
tgDCC-E1A in combination with radiation. Other endpoints included
time-to-progression of treated tumors, length of relapse-free periods, overall
survival rates and comparison of responses of tumor sites treated with both
tgDCC-E1A and radiation to tumors treated with radiation alone. This trial was
closed to patient enrollment.

During 2002, we suspended further clinical development of our cancer
program to focus our activities on our AAV-based development programs. We may
resume development of our oncology program, but do not plan to do so until we
can find other sources of funding for the program.

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tgLPD-E1A for Metastatic Cancer

We believe that our clinical testing of tgDCC-E1A, our synthetic
vector-based product candidate for treating cancer, has demonstrated the
potential of E1A as a tumor inhibitor. We therefore believe that if we are able
to deliver E1A systemically to reach tumor sites throughout the body, we could
significantly expand the utility of E1A as a potential cancer treatment. We
have therefore pursued the development of new formulations of E1A, which we
believe have the potential to target cancer cells when administered
systemically.

One of these formulations in preclinical development, tgLPD-E1A, uses LPD
technology and results in the formation of stable DNA particles of a small and
defined size encapsulated in a lipid shell. This formulation appears to
significantly contribute to the stability of the compound and enables vector
particles delivered via intravenous administration to travel throughout the
body with greatly reduced rates of degradation, thus improving gene transfer
efficiency. We believe that this condensed DNA delivery platform provides the
basis for developing a systemic delivery system for administering E1A or other
genes to tumors. Several preclinical animal studies of tgLPD-E1A formulations
indicate promising results. In a mouse model of human breast cancer tumors, we
administered tgLPD-E1A systemically to evaluate its ability to inhibit tumor
growth. The results indicated that the impact of tgLPD-E1A on tumor growth in
these mice was comparable to the impact observed when administering
Taxol®, a
chemotherapeutic drug. Additionally, administering both
Taxol® and tgLPD-E1A
inhibited tumor growth in mice significantly better than administering either
agent alone. Furthermore, additional preclinical studies suggest that the LPD
platform could be modified to provide an enhanced efficacy and safety profile
by incorporating targeting molecules that can direct delivery of the gene to
specific tissue types and cells. Consequently, should we continue development
of this product candidate, we intend to perform evaluations of these alternate
formulations before deciding which formulation, if any, will advance into a
clinical development phase.

Hemophilia

Hemophilia is a hereditary disorder caused by the absence or severe
deficiency of blood proteins that are essential for proper coagulation. In the
case of hemophilia A the missing protein is Factor VIII and in the case of
hemophilia B, the missing protein is Factor IX. According to the National
Hemophilia Foundation approximately 7,000 people in the United States suffer
from hemophilia A and approximately 3,600 people in the United States suffer
from hemophilia B. Hemophilia patients face spontaneous, uncontrolled bleeding
that can lead to restricted mobility, pain and, if left untreated, death.
Serious, acute bleeding incidents are generally treated by administering either
manufactured or naturally-derived coagulation proteins. If slow, chronic
bleeding is not treated, progressive, irreparable physical damage may result.
Because both manufactured and naturally-derived coagulation proteins are
expensive, protein therapy is generally limited to treating acute bleeding
episodes in patients with hemophilia. Further, proteins derived from human
serum may carry blood-borne pathogens such as HIV, Epstein Barr virus and
hepatitis C.

We believe that there are several reasons for developing a gene therapy
product that could be administered to hemophilia patients to prevent
spontaneous bleeding incidents. Both hemophilia A and hemophilia B result from
a single gene defect that is well understood, and replacement of the missing
protein has been used as an effective therapy for the disease. Overproduction
of the Factor VIII or Factor IX protein has not been shown to be harmful, which
reduces the need for precise regulation of gene expression. Researchers believe
that production of as little as 5% of normal levels of the missing protein
could effectively prevent chronic bleeding incidents in hemophilia patients.
The high cost of protein therapy generally limits its use to treating acute
bleeding incidents, which may provide a significant market opportunity for
gene-based products that address the underlying disease. We believe the current
global market for Factor VIII protein products, which is estimated at $1.2
billion not including hospitalization costs, represents a significant market
opportunity. While the global market for Factor IX protein products is
substantially smaller than the Factor VIII market, we believe it also
represents a significant market opportunity.

We believe that AAV vectors represent a promising means of delivering a
gene to trigger production of the Factor VIII protein for treating hemophilia A
or the Factor IX protein for treating hemophilia B. We have generated proof of
concept data for Factor VIII gene therapy in mouse models of hemophilia A and
for Factor IX gene therapy in mouse and dog models of hemophilia B. In these
models, the use of AAV vectors to deliver the Factor VIII or Factor IX gene
resulted in decreased bleeding times for extended periods of time. A
non-invasive route of administration such as pulmonary delivery may be
particularly attractive for the treatment of a disease in which invasive
procedures may increase the risk of bleeding episodes. Given our experience
with pulmonary delivery of AAV vectors for the treatment of cystic fibrosis, we
believe that we can adapt our product development infrastructure to support
pulmonary delivery of genes to treat diseases that manifest themselves outside
the lung. Since November 2000, we had been developing our Factor VIII gene
therapy with Wyeth Pharmaceuticals, or Wyeth. However, in November 2002, Wyeth
notified us of its decision to terminate our development collaboration to
support development of our product development program for hemophilia. We
entered into an agreement for the termination of the collaboration in February
2003. We have suspended further development of this program until we obtain
other sources of funding.

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Programs Developed by a Third Party

Glioma

Glioma is a type of brain cancer that affects an estimated 17,000 people
in the United States each year. Current treatment options for glioma include
surgery, radiation therapy, chemotherapy or a combination of these treatments.
As part of our collaboration with Biogen, Inc., or Biogen, which concluded in
2003, we provided Biogen with limited manufacturing process development support
for its product development program directed at treating glioma using an
adenoviral vector to deliver the gene for interferon beta. Interferon beta is a
potent stimulator of the immune system, and sustained expression of this
protein at the site of brain tumors may help the body rid itself of cancer
cells. Localized, sustained production of interferon beta may result in
superior anti-tumor efficacy with little or no systemic toxicity. We believe
that preclinical studies in several animal cancer models validate this
approach. Biogen owns worldwide rights to product candidates resulting from
this research and has initiated a Phase I clinical trial for this product
candidate. Prior to the merger of Biogen and IDEC Pharmaceuticals in November
2003, Biogen had licensed its rights to this program to IDEC as part of a
co-development agreement covering multiple oncology product development
programs. Under the term of our agreement with Biogen, we are no longer
involved in the clinical development of this Glioma product candidate but we
are entitled to receive a royalty on any future sales resulting from this
product candidate.

Gene Therapy

Overview.Gene therapy is an approach to treating or preventing genetic
and acquired diseases that involves introducing a functional gene into target
cells to modulate disease conditions. To be transferred into cells, a gene is
incorporated into a delivery system called a vector, which may be either viral
or synthetic. The process of gene transfer can be accomplished ex vivo, whereby
cells are genetically modified outside of the body and infused into the
patient, or in vivo, whereby vectors are introduced directly into the patients
body.

Once delivered into the cell, the gene can express or direct production of
the specific proteins encoded by the gene. Proteins are fundamental components
of all living cells and are essential to controlling cellular structure, growth
and function. Cells produce proteins from a set of genetic instructions encoded
in DNA, which contains all the information necessary to control cellular
biological processes. DNA is organized into segments called genes, with each
gene containing the information required to express a protein. When genes are
expressed, the sequence of DNA is transcribed into RNA, which is then
translated into a sequence of amino acids that constitutes the resulting
protein.

An alteration in the gene, or an absence of specific genes, causes
proteins to be over-produced, under-produced, or produced incorrectly, any of
which events may cause disease. These diseases include cystic fibrosis, in
which a defective protein is produced, and hemophilia, in which a protein is
under-produced. Deficient or absent genes can also cause cells to incorrectly
regulate gene expression, which can cause diseases such as certain types of
cancer and inflammatory disease. Gene therapy may be used to treat disease by
replacing the missing or defective gene to facilitate the normal protein
production or gene regulation capabilities of cells. In addition, gene delivery
may be used to enable cells to perform additional roles in the body. For
example, by delivering DNA sequences that encode proteins that are usually not
expressed in the target cell, thus conferring new function to these cells, gene
therapy could enhance the ability of the immune system to fight infectious
diseases or cancer. Gene therapy may also be used to inhibit production of
undesirable proteins or viruses that cause disease, by suppressing expression
of their related genes within cells.

A key factor in the progress of gene therapy has been the development of
safer and more efficient methods of transferring genes into cells. A common
gene delivery approach uses modified viruses to transfer the desired genetic
material into a target cell. The use of viruses takes advantage of their
natural ability to introduce genes into cells and, once present in the target
cell, to use the cells metabolic machinery to produce the desired protein. In
some gene therapy applications, viruses are genetically modified to inhibit the
ability of the virus to reproduce itself. Successful viral gene transfer for
diseases requiring long-term gene expression involves meeting a number of
essential technical requirements, including the ability of the vector to carry
the desired genes, transfer the genes into a sufficient number of target cells
and enable the delivered genes to persist in the host cell and produce proteins
for a long duration. We are using viral vectors such as AAV for potential gene
therapy applications requiring long-term gene expression.

Our AAV Viral Vectors.With our scientific collaborators, we have
developed significant expertise in designing and using AAV vectors in gene
therapy. We believe that our AAV vectors are particularly well suited for
treating a number of diseases for the following reasons:



| |  |  | AAV does not appear to cause human disease;                                                                                                  
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------
|
| |  |  | our AAV vectors do not contain viral genes that could produce
unwanted cellular immune responses leading to side effects or reduced
efficacy;

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| |  |  | AAV vectors can introduce genes into non-dividing or slowly dividing cells;                                       
| | - |  | ------------------------------------------------------------------------------------------------------------------
|
| |  |  | AAV vectors can persist in the host cell to provide relatively long-term gene expression; and                     
|
| |  |  | our AAV vectors can be manufactured using methods utilized in the
manufacture of other biopharmaceutical products.

We are building our proprietary position in AAV-based technology through
our development or acquisition of rights to inventions that:



| |  |  | provide important enhancements to AAV vectors;                               
| | - |  | -----------------------------------------------------------------------------
|
| |  |  | demonstrate novel approaches to the use of AAV vectors for gene therapy; and 
|
| |  |  | establish new and improved methods for large-scale production of AAV vectors.

We have conducted preclinical experiments to assess the potential for
using AAV vectors to deliver therapeutic genes to a variety of target cells,
including joints, muscles, the lung, the liver and the cardiovascular system
(heart and blood vessels). We are currently developing three product
candidates that utilize AAV as the delivery vector: a cystic fibrosis
treatment, an AIDS vaccine and an arthritis treatment.

Synthetic Vectors.Synthetic vector systems generally consist of DNA
incorporating the desired gene, combined with various compounds designed to
enable the DNA to be taken up by the host cell. Synthetic in vivogene delivery
approaches include:



| |  |  | injecting pure plasmid, or naked, DNA in an aqueous solution;                                                      
| | - |  | ---------------------------------------------------------------------------------------------------------------------
|
| |  |  | encapsulating genes into lipid carriers such as liposomes, which facilitate the entry of DNA into cells;             
|
| |  |  | combining negatively charged DNA with positively charged (cationic) lipids; and                                      
|
| |  |  | directing DNA to receptors on target cells by combining the gene with molecules (ligands) that bind to the receptors.

While we are not currently developing any product candidates using
synthetic vectors, we have exclusive rights to a significant body of synthetic
gene delivery technology based on cationic lipids. These synthetic vectors,
such as DCC-Cholesterol, are formulated by mixing negatively charged DNA with
positively charged cationic lipids, which promotes uptake of genes by cells.
These vectors appear to have a good safety profile for use in vivo. We believe
that synthetic vectors have several characteristics that make them particularly
well-suited for treating certain diseases, including:



| |  |  | ability to transfer relatively large segments of DNA;                  
| | - |  | -----------------------------------------------------------------------
|
| |  |  | ability to deliver genes in rapidly dividing or non-dividing cells; and
|
| |  |  | ability to target to specific cell receptors.                          

Cell Therapy

In November 2000, we established CellExSys, Inc., a majority-owned
subsidiary, to further develop our ex vivocell therapy capabilities.
CellExSys portfolio of intellectual property includes patents and patent
applications relating to modification of T-cells with chimeric receptors, the
use of T-cells as gene delivery vehicles and other proprietary technologies
related to cell therapy.

Cell therapy involves delivering living cells into a patient to treat
disease, either in place of, or in combination with, other pharmaceuticals. One
type of cell therapy involves the use of cytotoxic T lymphocytes, also known as
CTLs, which are a type of immune system cell. The function of CTLs is to
destroy foreign or diseased cells in the body. CellExSys is developing
technology and expertise that enables the isolation of potent, disease-specific
CTLs from small samples of patient blood, which can then be grown into a larger
number of cells and used to treat disease. We have exclusive rights to a
proprietary rapid expansion method, or REM, patent that was issued to the Fred
Hutchinson Cancer Research Center in October 1998. Using the REM process,
CellExSys can grow large numbers of CTLs from small quantities of starting
cells over several weeks, while preserving the cells specific disease-fighting
capabilities. We believe that CellExSys technology and expertise could support
development of a series of cell-based therapies to treat infectious diseases
and cancer. In addition to the potential therapeutic uses of the REM
technology, we believe that REM also has utility in new drug discovery and
vaccine development.

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The applications of the REM technology, an ex vivotherapeutic approach,
are quite distinct from our in vivogene delivery technologies and product
development programs. As a result, we transferred our interests in our cell
therapy and ex vivotherapy-related patents and patent applications to
CellExSys. As a separate subsidiary focused on patient-specific cell therapy
and other applications of REM technology, we believe that CellExSys is
positioned to identify and take advantage of desirable product, partnership and
financial opportunities that fall outside the field of in vivogene therapy. We
have funded the majority of CellExSys activity since forming CellExSys in 2000
with the expectation of exploiting our cell therapy investment over the medium-
to long-term. We are presently pursuing strategic opportunities to realize
near-term benefit for our investment in CellExSys. These options may include
selling all or a portion of our interest in CellExSys to another company,
obtaining third party investment in CellExSys or licensing the CellExSys
technology to other companies. In the event we do not sell all or a portion of
our interest in CellExSys to another company, obtain third-party investment in
CellExSys or license the CellExSys technology to other companies, we may cease
funding of CellExSys, which would halt the development of its product
candidates.

In October 2002 CellExSys and Itochu Corporation, or Itochu, announced an
agreement to form an alliance in the field of cellular therapy in Japan. Under
the terms of the agreement, CellExSys and Itochu agreed to investigate the
economics of forming a Japanese joint venture company that would have been
responsible for the development, sales, marketing and manufacturing of
CellExSys potential cell therapy products in Japan. The agreement expired on
December 31, 2002, without the formation of the Japanese joint venture. As a
result, Itochus funding under the agreement was converted into a Series A
Preferred Stock interest in CellExSys amounting to approximately 5% of
CellExSys capital stock on a fully diluted basis. In February 2004, as part of
a mutual settlement of claims we sold 158,764 shares of our common stock to
Itochu valued at $375,000, Itochus releases of claims related to its
additional funding of CellExSys and the return of any Itochu interest in
CellExSys to us.

Research and Development Collaborations

We have entered into various collaborations with pharmaceutical and
biotechnology companies, and a non-profit organization to develop several of
our product candidates. Our collaborations typically provide us with
reimbursement of research and development costs, together with funding through
purchases of our equity securities, loans, payments of milestone fees or direct
funding of clinical trial costs. If the product candidate covered by the
collaboration is successfully commercialized, we are generally entitled to
manufacturing and royalty-based revenue. Substantially all of our revenue, and
substantially all of our expected revenue for the next several years, is
derived from our product development collaborations. We have ongoing
collaborations with IAVI and with the CF Foundation. In 2003 our collaboration
with Biogen concluded and in 2002 our collaborations with Celltech Group plc,
Elan Corporation plc, Genzyme Corporation and Wyeth concluded.

International AIDS Vaccine Initiative

In February 2000, we entered into a three year research collaboration with
IAVI and CRI to develop an AIDS vaccine for use in non-industrialized
countries. Effective December 2003, this collaboration was extended through the
end of 2006. Under the terms of this public-private collaboration, IAVI funds
work at Targeted Genetics and at CRI focused on development and preclinical
studies and Phase I clinical trials of a vaccine candidate. We have the right
to commercialize any vaccine that may result from this development
collaboration in industrialized countries, and we have the right to manufacture
the vaccine for non-industrialized nations and sell it to IAVI at full cost of
manufacturing plus a reasonable public sector profit.

The vaccines, which will utilize our AAV vectors to deliver selected HIV
genes, are designed to elicit a protective immune response against HIV and
prevent its progression to AIDS. We anticipate that these vaccines, if
successfully developed, would be provided to the developing countries of the
world through the public health sector which includes organizations such as the
World Health Organization and IAVI. IAVI funds our development activities based
upon an agreed upon annual work plan and budget. Under the terms of the
agreement any of the parties can terminate this collaboration, without cause,
with ninety day advance notice. If IAVI terminates the collaboration for
certain reasons, including our failure to continue to develop an AIDS vaccine,
IAVI has the right to develop and commercialize AIDS vaccines utilizing
intellectual property owned by us for use in manufacturing and commercializing
AIDS vaccines in the developing and developed world. IAVI however does not
have this termination right if the reason for the termination is due to our
failure to continue to develop an AIDS vaccine because IAVI has stopped funding
the development program.

During 2004, we, IAVI and CRI plan to coordinate efforts to complete the
dose escalation phase of the Phase I clinical trial, which we initiated in
December 2003 and pursue the development of other vaccine candidates that
contain multiple genes from the HIV genome. Through December 31, 2003, we have
earned $12.0 million in research and development revenue from IAVI under this
collaboration. Assuming full implementation of the program work plan for 2004,
we expect to receive up to $10.7 million of research and development funding
from IAVI in 2004.

Under the terms of the collaboration, IAVI has retained rights to ensure
that any safe and efficacious AIDS vaccines developed as part of this
collaboration will be distributed in developing countries at a reasonable price
to be determined by IAVI. If we are not able or decline to produce the vaccine
for developing countries in reasonable quantities and at a reasonable price,

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IAVI has rights that will allow IAVI to contract with other manufacturers
to make the vaccines available at a reasonable price in those countries. We
currently have rights to develop the technology utilized in or developed as a
result of the IAVI collaboration for development, manufacture and
commercialization of AIDS vaccines in the developed world.

Cystic Fibrosis Foundation

In April 2003, we established a collaboration with the CF Foundation
related to our current Phase II clinical trial for our product candidate for
treating cystic fibrosis. The CF Foundation is providing funding of up to $1.7
million directly to the sites conducting the study to cover their direct trial
costs. Under this collaboration, in return for funding of the external trial
costs by the CF Foundation, we have agreed to provide the CF Foundation with a
multiple of their funding contribution from future sales of this product
candidate, if the product candidate is commercialized. This agreement expires
upon conclusion of all payment obligations related to this trial by the CF
Foundation or may be terminated earlier by the CF Foundation with sixty days
advance notice.

Biogen, Inc.

In connection with our acquisition of Genovo in September 2000, we
established a three-year, multiple-product development and commercialization
collaboration with Biogen. This collaboration ended in September 2003 upon the
completion of the development period.

Under this collaboration Biogen paid us $8 million in research funding and
upfront payments and $1 million per year in research and development funding
over the initial three-year development period. Biogen also agreed to provide
us with loans of up to $10 million and to purchase up to $10 million of our
common stock under an equity purchase commitment, each at our discretion.
During 2001, we borrowed $10 million from Biogen under the loan commitment. The
loan is due in August 2006 and bears interest at the one-year LIBOR rate plus
1%, reset quarterly. In 2002, we raised $4 million through the sale of 5,804,673
shares of our common stock to Biogen at a price of $0.69 per share and in
August 2003, we raised $4.8 million through the sale of 2,515,843 shares of our
common stock to Biogen at a price of $1.91 per share. The equity purchase
commitment with Biogen has expired.

Upon the completion of this development collaboration in September 2003,
we recognized $2.6 million in revenue which represented the remainder of
previously deferred payments received from Biogen. Through December 31, 2003,
we earned $11.0 million in revenue from Biogen under this collaboration and
have received $18.8 million in proceeds from the issuance of debt and equity
securities.

Emerald Gene Systems, Ltd.

In July 1999, we formed Emerald Gene Systems, Ltd., or Emerald, our joint
venture with Elan International Services, Ltd., a wholly-owned subsidiary of
Elan Corporation plc, or Elan. We and Elan formed Emerald to develop enhanced
gene delivery systems, based on a combination of our gene delivery technologies
and Elans drug delivery technologies. These gene delivery systems potentially
could be administered systemically or orally to deliver genes targeting the
desired cells within the body. The initial three-year development period for
Emerald ended during 2002 and since August 2002, there have been no operating
activities within the joint venture. We and Elan funded the expenses of Emerald
in proportion to our respective ownership interests. Through the completion of
Emeralds operating activities, we had provided $7.5 million of cash funding to
the Emerald joint venture. Emerald reimbursed each company for the costs of
research and development and related expenses, plus a profit percentage. We do
not expect that there will be any further development activities in the Emerald
joint venture.

We own 80.1% of Emeralds common stock and 80.1% of Emeralds preferred
stock and Elan owns the remaining 19.9% of Emeralds common and preferred
stock. The common stock of Emerald held by Elan is similar in all respects to
the common stock held by us, except that those shares held by Elan do not have
voting rights. The common shares held by Elan may be converted into voting
common shares at Elans election. Although we currently own 100% of the voting
stock, Elan and its subsidiaries have retained significant minority investor
rights that are considered participating rights under the Financial Accounting
Standards Board, or FASB, Emerging Issues Task Force, or EITF, Bulletin 96-16,
Investors Accounting for an Investee When the Investor Has a Majority of the
Voting Interest but the Minority Shareholder Has Certain Approval or Veto
Rights. Because Elans participating rights prevent us from exercising control
over Emerald, we have not consolidated the financial statements of Emerald, but
instead have accounted for our investment in Emerald under the equity method of
accounting.

In January 2003, the FASB issued FIN No. 46, Consolidation of Variable
Interest Entities.This interpretation of Accounting Research Bulleting No.
51, Consolidated Financial Statementsaddresses consolidation of business
enterprises of variable interest entities in which: (1) the equity investment
at risk is not sufficient to permit the entity to finance its activities
without additional subordinated financial support from other parties, which is
provided through other interests that will absorb

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some or all of the expected losses of the entity and (2) the equity
investors lack one or more of certain essential characteristics of a
controlling interest. FIN No. 46 applies immediately to variable interest
entities created after January 31, 2003, and to variable interest entities in
which an enterprise obtains an interest after that date. In December 2003, the
FASB revised FIN No. 46 to modify the effective date for applying this
interpretation, which made it effective for us on January 1, 2004. We will
adopt the provisions of FIN No. 46 in the first quarter of 2004 and do not
expect the provisions of FIN No. 46 to have a significant effect on our
financial position or operating results. We are currently evaluating
additional disclosures, if any, that may be required for Emerald.

As part of our agreements related to Emerald, Elan provided us funding as
follows:



| |  |  | Elan purchased $5 million of our common stock in 1999 at the
closing of the joint venture agreements and purchased an additional $5
million of our common stock in 2000;                                                                                                                                                                                                                                                                                                    
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  |  | During 2001 and 2002, we drew an aggregate amount of $7.9 million
under a $12 million convertible note commitment by Elan to fund a
portion of our investment in Emerald, which convertible note commitment
has now expired. In September 2003, we elected to convert the entire
outstanding principal and interest under this note commitment, which
totaled $9.4 million, into 5,203,244 shares of our common stock in
accordance with the original terms of the note; and
|
| |  |  | In 1999, at the closing of the joint venture agreements, Elan
received $12 million of our Series B convertible preferred stock in
exchange for our 80.1% interest in Emerald.                                                                                                                                                                                                                                                                                               

Elan may convert the Series B convertible preferred stock, at its option,
into shares of our common stock. The Series B preferred stock will
automatically convert into common stock upon the occurrence of specified
transactions involving a change of control of Targeted Genetics. Compounding
dividends on the Series B preferred stock accrue at 7% per year on the $1,000
per share face value of the preferred stock until July 2005. The holder of
Series B preferred stock, is not entitled to vote together with the holders of
our common stock, including with respect to the election of directors, or as a
separate class, except as otherwise provided by the Washington Business
Corporation Act.

The agreements relating to the joint venture generally require that Elan
obtain our consent in order to assign or transfer shares of our common or
preferred stock that it holds. As of December 31, 2003 Elan holds a total of
approximately 7.7 million shares of our common stock, representing 11.7% of our
currently issued and outstanding common stock. Elan also holds 12,015 shares of
Targeted Genetics Series B convertible preferred stock that as of December 31,
2003, was convertible into approximately 4.8 million shares of our common
stock. If at any time Elans ownership exceeds 10% of our common stock, Elan
has the right to nominate one director, who must be acceptable to Targeted
Genetics, for election to Targeted Genetics board of directors.

Wyeth

In November 2000, we entered into a collaboration with Wyeth to develop
AAV vector-based gene therapy products for treating hemophilia A and,
potentially, hemophilia B. In November 2002, Wyeth elected to terminate this
hemophilia collaboration and related agreements. Under the terms of our
agreements with Wyeth, all rights that we granted or otherwise extended to
Wyeth related to the hemophilia technology have returned to us. In connection
with the termination of our collaboration with Wyeth, we entered into a
settlement agreement with Wyeth in February 2003, and in March 2003, we
received $3.2 million in settlement of outstanding expenses incurred by us
under the collaboration and as an early termination payment. As part of this
settlement agreement we extended the time frame until July 31, 2004 in which we
may exercise an option to access certain technology and rights of Wyeth, which
may be useful in the development of a hemophilia gene therapy.

Through December 31, 2003, we earned $18.4 million in upfront fees,
research and development revenue and termination fees from Wyeth under this
collaboration.

Research and development expenses for our internally-funded research and
development activities were $10.1 million in 2003, $14.7 million in 2002 and
$15.7 million in 2001. Research and development expenses for our
externally-funded research and development activities were $4.8 million in
2003, $14.7 million in 2002 and $13.5 million in 2001.

Licensing Arrangements

Alkermes, Inc.

In June 1999, we entered into a license agreement with Alkermes, Inc., or
Alkermes, in which we received exclusive rights to an issued patent and other
pending patent applications related to AAV vector manufacturing. The license
broadly covers a manufacturing method that we believe is critical to making
AAV-based products in a commercially viable, cost-effective manner. The license
to this technology, developed by Childrens Hospital in Columbus, Ohio, covers
the use of cell lines for

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manufacturing AAV vectors in multiple disease areas. Under the terms of
the license agreement, we issued to Alkermes 500,000 shares of our common stock
warrants to purchase 2,000,000 additional shares of our common stock, which
warrants expire from June 2007 to June 2009. Alkermes will also receive
milestone payments and royalties on the sale of any products manufactured using
the licensed technology and is entitled to a portion of any sub-licensing
payments that we may receive.

Relationship with Amgen, Inc.

Targeted Genetics was formed in 1989 as a subsidiary of Immunex
Corporation, a biopharmaceutical company developing recombinant proteins as
therapeutics. In connection with our formation, we issued Immunex shares of our
preferred stock that were subsequently converted into 1,920,000 shares of our
common stock. In exchange, we received rights from Immunex under a Gene
Transfer Technology License Agreement, including an exclusive worldwide license
to certain Immunex proprietary technology specifically applicable to gene
therapy applications. The licensed technology relates to gene identification
and cloning, panels of retroviral vectors, packaging cell technology,
recombinant cytokines, DNA constructs, cell lines, promoter/enhancer elements
and immunological assays. In July 2002, Immunex was acquired by Amgen, Inc. Our
license to the Immunex technology was not affected by the acquisition and we
retain all rights granted under the original license.

Prior to Amgens acquisition of Immunex, we exchanged sporadic
correspondence and engaged in discussions with Immunex regarding the terms,
scope and possible amendment of the Gene Transfer Technology License Agreement.
Some of these communications have included, among other things, differing
views about our rights to the gene construct coding for TNFR:Fc used in the
development of our rheumatoid arthritis product candidate tgAAC94. These
communications did not lead to either a final resolution or an active dispute
regarding our differences with Immunex. Following Amgens acquisition of
Immunex, we communicated to Amgen our desire to resume discussions seeking
clarification of our relationship with Amgen. Our subsequent communications
with Amgen have not yet resulted in a resolution of our differences. In
February 2004, in response to our January 2004 announcement that we had
received regulatory approval for a Phase I clinical study for tgAAC94, Amgen
sent a letter to us taking the position that we were not licensed, either
exclusively or non-exclusively, under Immunex intellectual property covering
TNFR:Fc or therapeutic uses for TNFR:Fc. We have responded with a letter
confirming our confidence that the Gene Transfer Technology License Agreement gives us an
exclusive worldwide license to use the gene construct coding for TNFR:Fc for
gene therapy applications. We expect to have further communications with Amgen
regarding our differences. Notwithstanding our confidence, it is possible that
a resolution of those differences, through litigation or otherwise, could cause
delay or discontinuation of our development of tgAAC94 or our inability to
commercialize any resulting product.

Patents and Proprietary Rights

Patents and licenses are important to our business. Our strategy is to
file or license patent applications to protect technology, inventions and
improvements to inventions that we consider important to developing our
business. To date, we have filed or exclusively licensed over 400 patent or
patent applications with the USPTO, including foreign counterparts of some of
these applications in Europe, Japan and other countries. Of these patent
applications, over 100 patents have been issued or allowed. This proprietary
intellectual property includes genes, formulations, methods of transferring
genes into cells, processes to manufacture and purify gene delivery product
candidates and other proprietary technologies and processes. We also rely on
unpatented proprietary technology such as trade secrets, know-how and
continuing technological innovations to develop and maintain our competitive
position.

The patent positions of pharmaceutical and biotechnology firms, including
our patent positions, are uncertain and involve complex legal and factual
questions for which important legal principles are largely unresolved,
particularly with regard to human therapeutic uses. Patent applications may not
result in the issuance of patents, and the coverage claimed in a patent
application may be significantly reduced before a patent is issued. If any
patents are issued, the patents may be subjected to further proceedings
limiting their scope, may not provide significant proprietary protection and
may be circumvented or invalidated. Patent applications in the United States
and other countries generally are not published until more than 18 months after
they are filed, and because publication of discoveries in scientific or patent
literature often lags behind actual discoveries, we cannot be sure that we
were, or our licensor was, the first creator of inventions covered by pending
patent applications or the first to file patent applications for these
inventions.

We have licensed technology underlying several issued and pending patents.
Among these are two key patents that relate to the use of AAV vectors for gene
delivery, which we non-exclusively licensed from the National Institutes of
Health, or NIH, and the University of Florida Research Foundation. In addition,
we have acquired nonexclusive rights to the CFTR gene being delivered in our
tgAAVCF product candidate for cystic fibrosis, which uses our proprietary AAV
delivery technology to deliver a copy of the CFTR gene. Licensing of
intellectual property critical to our business involves complex legal, business
and scientific issues. If disputes over intellectual property that we have
licensed prevent or impair our ability to maintain our current licensing
arrangements on acceptable terms, we may be unable to successfully develop or
commercialize the affected product candidates.
For example, in July 1997 the licensor of our licensed CFTR gene and related
vector was notified that the USPTO had declared an interference proceeding to
determine whether our licensor or an opposing party has the right to the patent
application on the

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CFTR gene and related vector. Although we are not a party to the interference
proceeding, its outcome could affect our license to the CFTR gene and related
vector. If the USPTO or the U.S. Circuit Court of Appeals ultimately determines
that our licensor does not have rights to both the CFTR gene and the vector, we
believe that we will be subject to one of several outcomes:



| |  |  | our licensor could agree to a settlement arrangement under which we
continue to have rights to the gene and the vector at our current
license royalties;                                          
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  |  | the prevailing party could require us to pay increased license
royalties to maintain our access to the gene, the vector or both, as
applicable, which licensing royalties could be substantial; or
|
| |  |  | we could lose our license to the gene, the vector or both.                                                                                                                                        

If our licensor does not retain its right to the CFTR gene and the vector,
and we cannot obtain access at a reasonable cost or develop or license a
replacement gene and vector at a reasonable cost, we will be unable to
commercialize our potential tgAAVCF product candidate. For a more detailed
description of this risk, see the section entitled Factors Affecting Our
Operating Results, Our Business and Our Stock Price-Litigation involving
intellectual property, product liability or other claims and product recalls
could strain our resources, subject us to significant liability, damage our
reputation or result in the invalidation of our proprietary rights in Part II,
Item 7 of this annual report.

In addition to patent protection, we rely on trade secret protection for
our confidential and proprietary information and technology. To protect our
trade secrets, we generally require our employees, consultants, scientific
advisors and parties to collaborative agreements to execute confidentiality
agreements. In the case of employees and consultants, the agreements also
provide that all inventions resulting from work performed by them while
employed by us will be our exclusive property. Despite these agreements, and
other precautions we take to protect our trade secrets and other proprietary
unpatented intellectual property, we may be unable to meaningfully protect our
trade secrets and other intellectual property from unauthorized use or
misappropriation by a third party. These agreements may not provide adequate
remedies in the event of unauthorized use or disclosure of our confidential
information. In addition, our competitors could obtain rights to our
nonexclusively licensed proprietary technology or may independently develop
substantially equivalent proprietary information and technology. If our
competitors develop and market competing products using our unpatented or
nonexclusively licensed intellectual property or substantially similar
technology or processes, our products could suffer a reduction in sales or be
forced out of the market.

A number of pharmaceutical and biotechnology companies and research and
academic institutions have developed technologies, filed patent applications or
received patents for technologies that may be related to our business. Some of
these technologies, applications or patents may conflict with our technologies
or patent applications. This conflict could limit the scope of any patents that
we may obtain for our technologies or result in denial of our patent
applications. In addition, if patents or patent applications that cover our
activities are or have been issued to other companies, we may be required to
either obtain a license from the owner or develop or obtain alternative
technology. A license may not be available on acceptable terms, if at all, and
we may be unable to develop or obtain alternative technology.

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. These other parties 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. If we are found by a court to have infringed on the
proprietary rights of others, we could also face potential liability for
significant damages and be required to obtain a license to the proprietary
technology at issue if we continue to commercialize. A required license may not
be available on acceptable terms, if at all, which could impair our ability to
commercialize our product candidates. Similarly, administrative proceedings,
litigation or both may be necessary to enforce patents issued to us, to protect
trade secrets or know-how owned by us or to determine the enforceability, scope
and validity of the proprietary rights of others. This type of litigation,
regardless of its merit, could result in substantial expense to us and
significantly divert the efforts of our technical and management personnel. An
adverse outcome could adversely affect our business.

Competition

A number of companies and institutions are developing or considering the
development of potential gene therapy and cell therapy treatments, including
other gene delivery companies, biotechnology companies, pharmaceutical
companies, universities, research institutions, governmental agencies and other
healthcare providers. In addition to competition from these sources, our
potential products will compete with more traditional therapies for the
diseases on which we focus, including pharmaceutical products, medical devices
and surgery. If our product candidates become commercial gene therapy products,
they may compete with other analogous protein or pharmaceutical therapies. As
a result, disputes including lawsuits, demands, threats or patent challenges
may arise in an effort to slow our development. We also compete with others to
acquire products or technology from research institutions or universities.

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Many of our competitors have substantially more financial and other
resources, larger research and development staffs and more experience and
capabilities in researching, developing and testing products in clinical
trials, obtaining FDA and other regulatory approvals and manufacturing,
marketing and distributing products. In addition, the competitive positions of
other companies may be strengthened through collaborative relationships, such
as those with large pharmaceutical companies or academic institutions. As a
result, our competitors may develop, obtain patent protection for, receive FDA
and other regulatory approvals for or commercialize products more rapidly than
we do or may manufacture and market their products more successfully than we
do. Our competitors technologies and products may be more effective or
economically feasible than our potential products. 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. These developments could limit the prices we are able to charge for
any products we are able to commercialize or render our products less
competitive or obsolete.

Governmental Regulation

All of our potential products must receive regulatory approval before they
can be marketed. Human therapeutic products are subject to rigorous preclinical
and clinical testing and other pre-market approval procedures administered by
the FDA and similar authorities in foreign countries. In accordance with the
federal Food, Drug and Cosmetics Act, the FDA exercises regulatory authority
over the development, testing, formulation, manufacture, labeling, storage,
record keeping, reporting, quality control, advertising, promotion, export and
sale of our potential products. Similar requirements are imposed by foreign
regulatory agencies. In some cases, state regulation may also apply.

Gene therapy and cell therapy are both relatively new technologies that
have not been extensively tested or shown to be effective in humans. The FDA
reviews all product candidates for safety at each stage of clinical testing.
Safety standards must be met before the FDA permits clinical testing to proceed
to the next stage. Also, efficacy must be demonstrated before the FDA grants
product approval. Obtaining approval from the FDA and other regulatory
authorities for a new therapeutic product candidate, if approval is ever
obtained, is likely to take several years. We may encounter difficulties or
unanticipated costs in our efforts to secure necessary governmental approvals,
which could delay or prevent the marketing of our product candidates. In
addition, the regulatory requirements governing gene and cell therapy product
candidates and commercialized products are subject to change. The approval
process, and ongoing compliance with applicable regulations after approval,
involves substantial expenditures of financial and other resources.

Preclinical studies generally require studies in the laboratory or in
animals to assess the potential products safety and effectiveness. Preclinical
studies include laboratory evaluation of toxicity, pharmacokinetics, or how the
body processes and reacts to the drug, and pharmacodynamics, or whether the
drug is actually having the expected effect on the body. Preclinical studies
must be conducted in accordance with the FDAs Good Laboratory Practice
regulations and, before any proposed clinical testing in humans can begin, the
FDA must review the results of these preclinical studies as part of an
Investigational New Drug application.

If preclinical studies of a product candidate, including animal studies,
demonstrate safety, and laboratory test results are acceptable, then the
potential product will undergo clinical trials to test the therapeutic agent in
humans. Human clinical trials are subject to numerous governmental regulations
that provide detailed procedural and administrative requirements designed to
protect the trial participants. Each institution that conducts human clinical
trials has an Institutional Review Board or Ethics Committee charged with
evaluating each trial and any trial amendments to ensure that the trial is
ethical, patients are protected and the trial meets the institutional
requirements. These evaluations include reviews of how the institution will
communicate the risks inherent in the clinical trial to potential participants,
so that the patients may give their informed consent. Clinical trials must be
conducted in accordance with the FDAs Good Clinical Practices regulations and
the protocols the company establishes to govern the trial objectives, the
parameters to be used for monitoring safety, the criteria for evaluating the
efficacy of the potential product and the rights of each trial participant with
respect to safety. FDA regulations require us to submit these protocols as part
of the application. A FDA review or approval of the protocols, however, does
not necessarily mean that the trial will successfully demonstrate safety and/or
efficacy of the potential product.

Institutions that receive NIH funding for gene therapy clinical trials
must also comply with the NIH Recombinant DNA Guidelines, and the clinical
trials are subject to a review by the NIHs Office of Biotechnology Activities
Recombinant DNA Advisory Committee, or RAC. The outcome of this review can be
either an approval to initiate the trial without a public review or a
requirement that the proposed trial be reviewed at a quarterly committee
meeting. A clinical trial will be publicly reviewed when at least three of the
committee members or the Director of the Office of Biotechnology Activities
recommends a public review. Should the RAC require a public hearing, the start
of the trial must be delayed until after the hearing date. Although the NIH
guidelines do not have regulatory status, the RAC review process can impede the
initiation of the trial, even if the FDA has reviewed the trial and approved
its initiation. Additionally, before any clinical trial can be initiated at an
NIH-funded site, the Institutional Biosafety Committee of that site must
perform a review of the proposed clinical trial and ensure there are no safety
issues associated with the trial.

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Clinical trials are typically conducted in three phases often involving
multiple clinical trials in each phase. In Phase I, clinical trials generally
involve a small number of patients, who may or may not be afflicted with the
target disease, to determine the preliminary safety profile. In Phase II,
clinical trials are conducted with larger groups of patients afflicted with the
target disease in order to establish preliminary effectiveness and optimal
dosages and to obtain additional evidence of safety. In Phase III, large-scale,
multi-center, comparative clinical trials are conducted with patients afflicted
with the target disease in order to provide enough data for the statistical
proof of efficacy and safety required by the FDA and other regulatory agencies
for market approval. We report our progress in each phase of clinical testing
to the FDA, which may require modification, suspension or termination of the
clinical trial if it deems patient risk too high. The length of the clinical
trial period, the number of trials conducted and the number of enrolled
patients per trial vary, depending on our results and FDA requirements for the
particular clinical trial. Although we and other companies in our industry have
made progress in the field of gene therapy, we cannot predict what the FDA will
require in any of these areas to establish to its satisfaction the safety and
effectiveness of the product candidate.

If we successfully complete clinical trials for a product candidate, we
must obtain FDA approval or similar approval required by foreign regulatory
agencies, as well as the approval of several other governmental and
nongovernmental agencies, before we can market the product in the United States
or in foreign countries. Current FDA regulations relating to biologic
therapeutics require us to submit an acceptable Biologics License Application,
or BLA, to the FDA and receive approval before the FDA will permit commercial
marketing. The BLA includes a description of our product development
activities, the results of preclinical studies and clinical trials and detailed
manufacturing information. Unless the FDA gives expedited review status, this
stage of the review process generally takes at least one year. Should the FDA
have concerns with respect to the potential products safety and efficacy, it
may request additional data, which could delay product review or approval. The
FDA may ultimately decide that the BLA does not satisfy its criteria for
approval and might require us to do any or all of the following:



| |  |  | modify the scope of our desired product claims;         
| | - |  | --------------------------------------------------------
|
| |  |  | add warnings or other safety-related information; and/or
|
| |  |  | perform additional testing.                             

Because the FDA has not yet approved any gene therapy products, it is not
clear what, if any, unforeseen issues may arise during the approval process.
While we expect this regulatory structure to continue, we also expect the FDAs
regulatory approach to product approval, and its requirements with respect to
product testing, to become more predictable as its scientific knowledge and
experience in the field of gene therapy increase. Adverse events in the field
of gene therapy or other biotechnology-related fields, however, could result in
greater governmental regulation, stricter labeling requirements and potential
regulatory delays in the testing or approval of gene therapy products.

Once approved by the FDA, marketed products are subject to continual FDA
review. Later discovery of previously unknown problems or failure to comply
with applicable regulatory requirements may result in restrictions on marketing
a product or in its withdrawal from the market, as well as potential criminal
penalties or sanctions. In addition, the FDA requires that manufacturers of a
product comply with current Good Manufacturing Practices requirements, both as
a condition to product approval and on a continuing basis. In complying with
these requirements, we expend significant amounts of time, money and effort in
production, record keeping and quality control. Our manufacturing facilities
are subject to periodic inspections by the FDA. If major problems are
identified during these inspections that could impact patient safety, the FDA
could subject us to possible action, such as the suspension of product
manufacturing, product seizure, withdrawal of approval or other regulatory
sanctions. The FDA could also require us to recall a product.

We 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 federal, state and local
regulations. For example, our controlled use of hazardous materials in our
research and development activities must comply with standards prescribed by
state and federal law.

Employees

As of December 31, 2003 we had approximately 90 full-time-equivalent
employees, which included approximately 10 employees of our majority-owned
subsidiary, CellExSys. Included in this employee base are approximately 70
that are involved in research and development, or support our research
and development efforts. Fourteen of these employees have Ph.D. or M.D. degrees
and a significant number of our management and professional employees have
prior experience with other biotechnology or pharmaceutical companies.

Competition among biotechnology and pharmaceutical companies for highly
skilled scientific and management personnel is intense. We believe that we have
compensation and benefit programs in place that will allow us to be competitive
in this environment. If we are ineffective, however, in retaining our existing
workforce and scientific advisors or in attracting additional

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qualified employees and advisors, our business will not succeed. None of
our employees are covered by a collective bargaining agreement.

Available Information

We were incorporated in the state of Washington in 1989. Our executive
offices are located at 1100 Olive Way, Suite 100, Seattle, Washington 98101,
and our telephone number is (206) 623-7612. We file annual, quarterly and
current reports, proxy statements and other information with the SEC. We make
available in the investor relations portion of our website, free of charge,
copies of our annual report on Form 10-K, quarterly reports on Form 10-Q,
current reports on Form 8-K and amendments to these reports after filing these
reports to the SEC. Our website is located at www.targetedgenetics.com. You may
also inspect and copy the documents that we have filed with the SEC, at
prescribed rates, at the SECs Public Reference Room at 450 Fifth Street, N.W.,
Washington, D.C. 20549. You may obtain information regarding the operation of
the Public Reference Room by calling the SEC at 1-800-SEC-0330. In addition,
the SEC maintains a Web site that contains reports, proxy and information
statements and other information regarding issuers that file with the SEC at
http://www.sec.gov.

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Item 2. Properties.

We have leased approximately 49,000 square feet of laboratory,
manufacturing and office space in two buildings in Seattle, Washington. The
lease on our primary laboratory, manufacturing and office space expires in
March 2009 and has one option to renew for a five-year period. The lease on
our administrative office space expires in March 2009 and includes two options
to extend the lease for a total of five additional years and includes an option
to cancel at any time between April 2006 and March 2009 with certain early
termination penalties. The Seattle facility is sufficient to support our
research, manufacturing and administrative needs under our current operating
plan.

In July 2000, we leased approximately 76,000 square feet of space in
Bothell, Washington for future large-scale manufacturing of our products. The
lease on this facility expires in September 2015 and includes an option for us
to extend its term for one additional five-year period. As of December 31,
2002, we had never occupied this facility, and did not have a current need for
the facility; therefore, during 2003 we began to pursue ways to secure a
sublease tenant. To date, we have not sublet the facility. If we proceed with
further development or commercialization of any of our product candidates, we
may need to resume use of the Bothell facility to fulfill our
manufacturing requirements.

We also have a lease on a 30,000 square foot laboratory and office
facility in Sharon Hill, Pennsylvania which expires in November 2005. We
assumed this lease following our acquisition of Genovo, Inc. in 2000. In
February 2003, we closed our operations in Sharon Hill and began to pursue ways
to terminate the lease or to secure a sublease tenant for the remainder of the
term.

As of December 31, 2003, we have not been able to terminate the leases or
secure sublease tenants for the Bothell or Sharon Hill facilities. As a
result, we continue to have an accrued restructure liability for the future
lease obligations of these facilities.




Item 3. Legal Proceedings.

We are not a party to any material legal proceedings.




Item 4. Submission of Matters to a Vote of Security Holders.

No matters were submitted to a vote of our security holders during the
fourth quarter of 2003.

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PART II




Item 5. Market for Registrants Common Equity, Related Shareholder Matters and Issuer Purchases of Equity Securities.

Market Information.Our common stock trades on the NASDAQ SmallCap Market
under the symbol TGEN. From May 20, 1994 until January 8, 2003, our common
stock was traded on the NASDAQ National Market, under the symbol TGEN.

The following table lists, for each calendar quarter indicated, the high
and low bid quotations for our common stock, as quoted on the NASDAQ SmallCap
Market or National Market as applicable. These quotes reflect inter-dealer
prices, without retail mark-up or commission, and may not necessarily represent
actual transactions.

|      |  |             |  |   |      |      |  |     |      |  |  | 
|----- |  | ----------- |  | - | ---- | ---- |  | --- | ---- |  |  | 
|      |  |             |  |   |      | High |  | Low
|      |  |             |  |   |      |      |  |    
|2003: |  |             |  |   |      |      |  |     |      |  |  | 
|      |  | 4th Quarter |  | $ | 3.00 |      |  | $   | 1.98 | 
|      |  | 3rd Quarter |  |   | 3.20 |      |  |     | 1.59 | 
|      |  | 2nd Quarter |  |   | 4.43 |      |  |     | 0.41 | 
|      |  | 1st Quarter |  |   | 0.70 |      |  |     | 0.25 | 
|2002: |  |             |  |   |      |      |  |     |      |  |  | 
|      |  | 4th Quarter |  | $ | 1.40 |      |  | $   | 0.30 | 
|      |  | 3rd Quarter |  |   | 1.19 |      |  |     | 0.49 | 
|      |  | 2nd Quarter |  |   | 2.09 |      |  |     | 1.04 | 
|      |  | 1st Quarter |  |   | 3.24 |      |  |     | 1.90 | 

The last reported bid quotation for our common stock, as quoted on the
NASDAQ SmallCap Market on March 1, 2004 was $2.32 per share.

Holders.As of March 1, 2004, we had 362 shareholders of record and
approximately 26,000 beneficial holders of our common stock.

Dividends.We have never paid cash dividends and do not anticipate paying
them in the foreseeable future. In addition, our loan agreement with Biogen
restricts the amount of cash dividends we could pay.

Securities Authorized for Issuance under Equity Compensation Plans.The
following table lists our equity compensation plans, including individual
compensation arrangements, under which equity securities are authorized for
issuance as of December 31, 2003:

|                                                           |       |  |                            |           |                               |   |                                |      |                      |  |         |         | 
|---------------------------------------------------------- | ----- |  | -------------------------- | --------- | ----------------------------- | - | ------------------------------ | ---- | -------------------- |  | ------- | ------- | 
|                                                           |       |  | Number of securities to be |           |                               |   |                                |      | Number of securities
|                                                           |       |  | issued upon exercise of    |           | Weighted-average exercise     |   | remaining available for future
|                                                           |       |  | outstanding options,       |           | price of outstanding options, |   | issuance under equity         
|                                                           |       |  | warrants and rights        |           | warrants and rights           |   | compensation plans            
|                                                           |       |  |                            |           |                               |   |                               
|Equity compensation
plans approved by
security holders     |       |  | 4,097,687                  |           |                               | $ | 3.07                           |      |                      |  | 322,927 |        
|Equity compensation
plans not approved
by security holders |       |  | 2,003,826                  |           |                               |   | 3.33                           |      |                      |  |        |        
|                                                           |       |  |                            |           |                               |   |                                |      |                      |  |         |        
|                                                           | Total |  |                            | 6,101,513 |                               |   | $                              | 3.15 |                      |  |         | 322,927 | 
|                                                           |       |  |                            |           |                               |   |                                |      |                      |  |         |        

Under technology licensing, equity financing and equipment financing
arrangements, we have issued stock purchase warrants to purchase a total of
2,003,826 shares of our common stock. These are presented in the table above as
Equity compensation plans not approved by security holders and include:



| |  |  | In 1999, in connection with a technology license agreement, we
issued to Alkermes, Inc. a warrant to purchase 1,000,000 shares of our
common stock at an exercise price of $2.50 per share, expiring in June
2007, and a warrant to purchase 1,000,000 shares of our common stock at
an exercise price of $4.16 per share, expiring in June 2009.
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  |  | We have outstanding warrants to purchase a total of 3,826 shares of
our common stock related to a technology license agreement. These
warrants have an exercise price of $4.50 per share and expire in March
2004. Warrants to purchase 21,315 shares of our common stock issued in
connection with equipment financing expired in December 2003.

19



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In March 2004, our board of directors approved an increase in the number
of shares available for issuance under our 1999 Stock Option Plan. Subject to
shareholder approval at our annual meeting, the number of shares available for
grant under this plan will be increased by 6,000,000 shares to 9,500,000
shares.




Item 6. Selected Financial Data.

|                             |                                                                           |                                                                 |                                             |             |                         |       |             |             |       |       |             |             |          |       |   |             |       |       |   |             |       |             |  
|---------------------------- | ------------------------------------------------------------------------- | --------------------------------------------------------------- | ------------------------------------------- | ----------- | ----------------------- | ----- | ----------- | ----------- | ----- | ----- | ----------- | ----------- | -------- | ----- | - | ----------- | ----- | ----- | - | ----------- | ----- | ----------- | -
|                             |                                                                           |                                                                 |                                             |             | Year Ended December 31,
|                             |                                                                           |                                                                 |                                             |             |                        
|                             |                                                                           |                                                                 |                                             |             | 2003 (4)                |       | 2002 (3)(4) |             | 2001  |       | 2000 (1)(2) |             | 1999 (1)
|                             |                                                                           |                                                                 |                                             |             |                         |       |             |             |       |       |             |             |         
|Statement of Operations Data |                                                                           |                                                                 |                                             |             |                         |       |             |             |       |       |             |             |          |       |   |             |       |       |   |            
|                             | Revenue                                                                   |                                                                 | $                                           | 14,073,000  |                         |       | $           | 19,333,000  |       |       | $           | 18,880,000  |          |       | $ | 11,403,000  |       |       | $ | 6,848,000   |      
|                             | Operating expenses                                                        |                                                                 |                                             | 27,877,000  |                         |       |             | 42,074,000  |       |       |             | 47,484,000  |          |       |   | 57,208,000  |       |       |   | 33,694,000  |      
|                             |                                                                           |                                                                 |                                             |             |                         |       |             |             |       |       |             |             |          |       |   |             |       |       |   |             |      
|                             | Loss from operations                                                      |                                                                 |                                             | (13,804,000 | )                       |       |             | (22,741,000 | )     |       |             | (28,604,000 | )        |       |   | (45,805,000 | )     |       |   | (26,846,000 | )    
|                             |                                                                           |                                                                 |                                             |             |                         |       |             |             |       |       |             |             |          |       |   |             |       |       |   |             |      
|                             | Loss before cumulative effect of
change in accounting principle           |                                                                 |                                             | (14,833,000 | )                       |       |             | (23,767,000 | )     |       |             | (27,170,000 | )        |       |   | (43,973,000 | )     |       |   | (26,655,000 | )    
|                             | Cumulative effect of change in
accounting principle                       |                                                                 |                                             |            |                         |       |             |            |       |       |             |            |          |       |   | (3,682,000  | )     |       |   |            |      
|                             |                                                                           |                                                                 |                                             |             |                         |       |             |             |       |       |             |             |          |       |   |             |       |       |   |             |      
|                             | Net loss                                                                  |                                                                 | $                                           | (14,833,000 | )                       |       | $           | (23,767,000 | )     |       | $           | (27,170,000 | )        |       | $ | (47,655,000 | )     |       | $ | (26,655,000 | )    
|                             |                                                                           |                                                                 |                                             |             |                         |       |             |             |       |       |             |             |          |       |   |             |       |       |   |             |      
|                             | Basic and diluted net loss per
share:                                     |                                                                 |                                             |             |                         |       |             |             |       |       |             |             |          |       |   |             |       |       |   |             |      
|                             |                                                                           | Loss before cumulative effect
of change in accounting
principle |                                             | $           | (0.26                   | )     |             | $           | (0.52 | )     |             | $           | (0.62    | )     |   | $           | (1.16 | )     |   | $           | (0.83 | )          
|                             |                                                                           | Cumulative effect of change in
accounting principle             |                                             |             |                        |       |             |             |      |       |             |             |         |       |   |             | (0.10 | )     |   |             |      |            
|                             |                                                                           |                                                                 |                                             |             |                         |       |             |             |       |       |             |             |          |       |   |             |       |       |   |             |      
|                             |                                                                           |                                                                 | Net loss per basic and
diluted common share |             | $                       | (0.26 | )           |             | $     | (0.52 | )           |             | $        | (0.62 | ) |             | $     | (1.26 | ) |             | $     | (0.83       | )
|                             |                                                                           |                                                                 |                                             |             |                         |       |             |             |       |       |             |             |          |       |   |             |       |       |   |             |      
|                             | Shares used in computing basic and
diluted net loss per common share      |                                                                 |                                             | 57,486,000  |                         |       |             | 45,767,000  |       |       |             | 43,928,000  |          |       |   | 37,752,000  |       |       |   | 32,174,000  |      
|                             |                                                                           |                                                                 |                                             |             |                         |       |             |             |       |       |             |             |          |       |   |             |       |       |   |             |      
|                             | Proforma amounts assuming the
accounting change is applied
retroactively: |                                                                 |                                             |             |                         |       |             |             |       |       |             |             |          |       |   |             |       |       |   |             |      
|                             |                                                                           |                                                                 | Net loss                                    |             |                         |      |             |             |       |      |             |             |          |      |   |             |       |      |   |             | $     | (24,555,000 | )
|                             |                                                                           |                                                                 | Net loss per common share                   |             |                         |      |             |             |       |      |             |             |          |      |   |             |       |      |   |             | $     | (0.77       | )

|                   |                                                     |   |              |            |      |   |            |            |      |   |            |            |  |   |            |            |  |   |           |            |  
|------------------ | --------------------------------------------------- | - | ------------ | ---------- | ---- | - | ---------- | ---------- | ---- | - | ---------- | ---------- |  | - | ---------- | ---------- |  | - | --------- | ---------- | -
|                   |                                                     |   | December 31,
|                   |                                                     |   |             
|                   |                                                     |   | 2003         |            | 2002 |   | 2001       |            | 2000 |   | 1999      
|                   |                                                     |   |              |            |      |   |            |            |      |   |           
|Balance Sheet Data |                                                     |   |              |            |      |   |            |            |      |   |            |            |  |   |            |            |  |   |           |           
|                   | Cash and cash equivalents                           | $ | 21,057,000   |            |      | $ | 12,606,000 |            |      | $ | 25,186,000 |            |  | $ | 38,630,000 |            |  | $ | 7,153,000 |           
|                   | Total assets                                        |   |              | 57,672,000 |      |   |            | 52,713,000 |      |   |            | 71,038,000 |  |   |            | 87,974,000 |  |   |           | 13,692,000 |  
|                   | Long-term obligations                               |   |              | 11,227,000 |      |   |            | 20,494,000 |      |   |            | 16,403,000 |  |   |            | 2,447,000  |  |   |           | 2,088,000  |  
|                   | Preferred stock (5)                                 |   |              | 12,015,000 |      |   |            | 12,015,000 |      |   |            | 12,015,000 |  |   |            | 12,015,000 |  |   |           | 12,015,000 |  
|                   | Total shareholders equity (net capital deficiency) |   |              | 33,479,000 |      |   |            | 5,896,000  |      |   |            | 25,386,000 |  |   |            | 51,417,000 |  |   |           | (5,049,000 | )



---

|(1) |  | Effective January 1, 2000, we changed our method of accounting for
nonrefundable up-front license fees.                                                                                                                         
|--- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|   
|(2) |  | In 2000, operating expenses include a charge for acquired in-process
research and development of $28.0 million recorded in connection with our
acquisition of Genovo.                                                           
|   
|(3) |  | Effective January 1, 2002, we changed our method of accounting for
goodwill and other intangible assets and costs associated with exit or
disposal activities. See Note 1 of the Notes to our Consolidated Financial
Statements.
|   
|(4) |  | Operating expenses include restructure charges of $2.3 million in 2002
and $5.2 million in 2003.                                                                                                                                
|   
|(5) |  | As a result of the expiration of the exchange right in April 2003, we
have reclassified the Series B preferred stock from mezzanine equity to
shareholders equity.                                                             

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Item 7. Managements Discussion and Analysis of Financial Condition and Results of Operations.

Overview

We develop gene therapy products and technologies to treat both acquired
and inherited diseases on our own and through various research and development
collaborations with others. We have financed our product development activities
and general corporate functions primarily through proceeds from public and
private sales of our equity securities, through cash payments received from our
collaborative partners and proceeds from the issuance of debt. To a lesser
degree, we have also financed our operations through interest earned on cash
and short-term investments, loan funding under equipment leasing agreements and
research grants. These financing sources have historically allowed us to
maintain adequate levels of cash and investments. A significant portion of our
operating expenses has been funded through collaborations with third parties
which are summarized as follows:

Ongoing collaborations:



| |  |  | a collaboration with the International AIDS Vaccine Initiative, or
IAVI, to develop an AIDS vaccine, which will conclude in December 2006,
unless extended; and                                                                                                                                                                                                                                  
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  |  | a development collaboration with the Cystic Fibrosis Foundation, or
CF Foundation, established in April 2003 that provides funding to
support our current Phase IIb clinical trial for our product candidate
for treating cystic fibrosis. Under this collaboration, the CF
Foundation is providing funding directly to the sites conducting this
study to cover their direct costs of the trial.

Collaborations that ended in 2003 and 2002:



| |  |  | a multiple-product collaboration with Biogen, Inc., or Biogen,
which concluded in September 2003;                                                                               
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  |  | a collaboration with Wyeth Pharmaceuticals, or Wyeth, to develop
treatments for hemophilia, which was terminated in February 2003;                                              
|
| |  |  | a collaboration with Celltech Group plc, or Celltech, to develop
our product candidate for the treatment of cystic fibrosis, which was
terminated in November 2002;             
|
| |  |  | a research and development joint venture with Elan, called Emerald
Gene Systems, or Emerald, to develop enhanced gene delivery
technologies, which concluded in August 2002; and
|
| |  |  | a collaboration with Genzyme to develop treatments for lysosomal
storage diseases, which concluded in August 2002.                                                              

Our development collaborations have typically provided us with funding,
including purchases of our equity securities, loans, payments for reimbursement
of research and development costs and milestone fees and payments. We and our
partner typically agree on a target disease and create a development plan for
the product candidate, which often extends for multiple years and subject to
termination or extension. The product candidates progress is periodically
reviewed with the partner. We generally maintain manufacturing and
royalty-based interests in successfully developed product candidates.

We have an adeno-associated virus, or AAV-based product candidate under
development for treating cystic fibrosis that we have evaluated in a Phase II
clinical trial. In June 2003, final data from this repeat dosing trial was
presented that indicated that our cystic fibrosis product candidate met safety
and tolerability targets. In addition, final data from the Phase II trial
indicated a statistically significant improvement in lung function and a
decrease in levels of inflammatory cytokine. In July 2003, we initiated a
larger confirmatory Phase IIb clinical trial for this cystic fibrosis product
candidate. We designed this trial to enroll up to 100 patients and are
conducting it in collaboration with the CF Foundation. We expect to complete
patient accrual and dosing by the end of 2004.

We are developing an AAV-based vaccine product candidate for high-risk
populations to protect against the progression of HIV infection to AIDS in
partnership with IAVI, a non-profit organization. In December 2003, we
initiated a Phase I initial dose escalation safety trial in humans in Europe,
which is designed to enroll up to 50 volunteers who are uninfected with HIV and
in good health. Each participant in this trial will receive a single injection
of the vaccine candidate and they will be monitored for safety and immune
response. We expect to complete the dose-escalation phase of this trial by the
end of 2004.

We are also developing an AAV-based product candidate for the treatment of
arthritis. In January 2004, we received regulatory approval from the U.S. Food
and Drug Administration, or FDA, and Health Canada to begin a Phase I clinical
trial and we plan to dose the first patient during the first quarter of 2004.
This dose-escalation safety trial is designed to enroll up to 32 patients with
rheumatoid arthritis and will be conducted in up to eight sites in the United
States and Canada. We will monitor

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patients for safety and improvements in arthritis signs and symptoms. We
expect to complete patient accrual and dosing in this study in the first
quarter of 2005. We also have additional product candidates focused on
treating cancer and hemophilia, however, we have suspended further development
of these programs until we can find other sources of funding for the programs.

We believe that our successes in assembling a broad platform of
proprietary intellectual property support our potential to develop and
manufacture gene therapy product candidates to treat a range of diseases. We
have developed processes to manufacture our potential products using methods
and at a scale amenable to clinical development and expandable to large-scale
production for advancing our potential products to clinical evaluation and
commercialization. These methods are similar to the methods used to manufacture
other biologics. As a result, we can evaluate opportunities to utilize excess
capacity to manufacture biologics for others companies. In March 2003, we
entered into a manufacturing services agreement with GenVec Inc., or GenVec, to
conduct initial feasibility studies to evaluate our ability to manufacture
clinical supply of GenVecs cancer product candidate,
TNFeradeTM, an
adeno-viral-based gene therapy product. In October 2003, we successfully
completed this feasibility study and began manufacturing
TNFeradeTM for
clinical use. In January 2004, we completed our manufacturing work for GenVec.

A wide range of diseases potentially may be treated, or prevented, with
gene-based products, including cancer, genetic diseases and infectious
diseases. We believe that there is also a significant opportunity to treat
diseases currently treated using recombinant DNA proteins and monoclonal
antibodies or small molecules that may be more effectively treated by
gene-based therapies due to their ability to provide a long-term or a localized
method of treatment. Our business strategy is to develop multiple gene delivery
systems, which we believe will maximize our product opportunities. Using these
gene delivery systems, we are developing product candidates across multiple
diseases with the belief that gene-based therapies may provide a means to treat
disease not fully treatable with current biologic and pharmaceutical drugs. We
believe that, if successful, we can establish significant market potential for
our product candidates. Because there are no commercially available gene
therapy products in the United States, we intend to pursue product development
programs to enable us to demonstrate proof of concept and eventually
commercialize gene-based therapeutics to address currently unmet medical needs
in treating disease.

Although we believe that our technology appears promising, we do not know
whether any commercially viable products will result from our research and
development efforts or those of our collaborators. We anticipate that we will
not generate revenue from the sale of commercial products for at least the next
several years. Unless and until we successfully commercialize one or more
product candidates, we expect to generate revenue primarily through research
funding from our current collaborators, and research funding, milestone
payments and licensing fees from potential future corporate collaborators. The
timing and amount of our future revenue will be subject to significant
fluctuations, based in part on the success of our research activities, the
receipt of necessary regulatory approvals, the timing of achievement of
milestones and the extent to which associated costs are reimbursed under our
collaborative arrangements. Each of our product candidates combines different
licensed technology from several licensors. We will have an obligation to our
licensors to pay royalties on products that utilize their technologies. Because
each product may require a different set of technologies, third-party royalties
will be determined and paid on a product-by-product basis. Royalty payment
rates may also vary between products depending on the extent of licensed
technology or because some technology licenses provide for lower royalties when
the licensed technologies are combined with other royalty-bearing technologies.
The royalty payment rates that we owe to our licensors will significantly
influence the price and viability of our potential products.

Our research and development expenses fluctuate due to the timing of
expenditures for the varying stages of our research, product development and
clinical development programs and the availability of capital resources.
Because a significant portion of our revenue and expense is directly tied to
our research and development activities, our revenue will fluctuate with the
level of future research and development activities. We expect that our revenue
and expense will continue to fluctuate as we proceed with our current
development collaborations, enter into potential new development collaborations
and licensing agreements and earn milestone payments.

As of December 31, 2003, our accumulated deficit totaled approximately
$217.0 million. We expect to generate substantial additional losses for the
foreseeable future, primarily due to the costs associated with our preclinical
and clinical development programs, developing our manufacturing capabilities
and preparing our products under development for commercialization. Our
expenses are driven by the size and scope of our development programs, our
staffing levels, outside costs for supplies and materials and clinical trial
activities. We significantly decreased our staffing, outside costs and clinical
trial activities in late 2002 as a result of terminated collaborations and the
need to narrow our focus on key development programs. This led to decrease of
approximately 40% in our research and development and general and
administrative expenses from 2002 to 2003. We and IAVI have extended our
ongoing AIDS vaccine product development collaboration through December 2006
and we expect to receive funding of up to $10.7 million in 2004 to support
product development and manufacturing efforts. As a result of the extension
and expansion of our IAVI collaboration, and clinical trials for our cystic
fibrosis and arthritis product candidates, we expect moderate increases in our
expenses in 2004 compared to 2003.

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We may be unable to achieve profitability on a sustained basis, if at all.
Further, successful development of our product candidates will require that we
access significantly higher amounts of capital than we currently have. We may
be unable to obtain required funding when needed or on acceptable terms, obtain
or maintain corporate partnerships or complete acquisition transactions
necessary or desirable to complete the development of our product candidates.

Critical Accounting Policies

Note 1 of the Notes to our Consolidated Financial Statements, Description
of Business and Summary of Significant Accounting Policies summarizes our
significant accounting policies that we believe are critical to the
presentation of our consolidated financial statements. Our most critical
accounting policies are:

Revenue Recognition

We generate revenue from technology licenses, collaborative research
arrangements and cost reimbursement agreements. Revenue under technology
licenses and collaborative agreements typically consists of nonrefundable,
up-front license fees, collaborative research funding, technology access fees
and various other payments. Revenue from nonrefundable, up-front license fees
and technology access payments is recognized systematically over the related
service period, which is often the development period, in the collaborative
agreement. Revenue associated with performance milestones is recognized as
earned, based upon the achievement of the milestones defined in the applicable
agreements. Revenue under research and development cost-reimbursement contracts
is recognized as the related costs are incurred. Advance payments received in
excess of amounts earned are classified as deferred revenue.

Restructuring Charges Associated with the Reorganization of our Operations

We have adopted the provisions of Statement of Financial Accounting
Standards No. 146, or SFAS 146, Accounting for Costs Associated with Exit or
Disposal Activities,as it relates to our facilities in Bothell, Washington
and Sharon Hill, Pennsylvania and we have recorded restructure charges on the
related operating leases. Accrued restructuring charges, and in particular,
those charges associated with exiting a facility, are subject to many
assumptions and estimates. Under SFAS 146, an accrued liability for lease
termination costs is initially measured at fair value, based on the remaining
lease payments due under the lease and other costs, reduced by sublease rental
income that could be reasonably obtained from the property, and discounted
using a credit-adjusted risk-free interest rate. The assumptions as to
estimated sublease rental income, the period of time and concessions necessary
to enter into a sublease significantly impact the accrual and may differ from
what actually occurs. We review these estimates quarterly and adjust the
accrual if necessary.

If we proceed with further development and commercialization of any of our
product candidates, we may need to resume use of the Bothell facility to
fulfill our manufacturing requirements. If we decide to resume use of this
facility, any remaining accrued restructure charges related to the facility
will be reversed. This will be reflected as a one-time credit to restructuring
expenses, reflected in the period in which use is resumed. We will continue to
evaluate any additional information that may become available with respect to
the estimates and assumptions as they relate to these facilities, which may
result in further significant charges to our results of operations.

Application of Assumptions and Estimates in Accounting for Acquired
In-Process Research and Development Costs and the Valuation of Our Intangible
Assets

We have adopted SFAS No. 142, Goodwill and Other Intangible Assetsas it
relates to our goodwill, which consists of acquired technology that is core to
our development programs.SFAS No. 142 discontinues the amortization of
goodwill and certain indefinite lived intangibles. This accounting standard
required us to complete a transitional impairment test upon adoption to
determine if an impairment in the value of goodwill existed. We performed a
transitional impairment test as of January 1, 2002 and no impairment in the
value of our goodwill existed as of that date. In accordance with SFAS No. 142,
we test goodwill for impairment in value at least annually and more frequently
if impairment indicators arise, and if goodwill is impaired, we will write down
the value of goodwill through a charge to expense. We performed annual
impairment tests as of October 1, 2003 and October 1, 2002 and concluded that
no impairment in the value of our goodwill had occurred.

Our estimates are based on assumptions we believe to be reasonable at the
time we perform these estimates. Changes in the underlying assumptions may
result in substantially different accounting estimates. For example, when we
acquired Genovo in September 2000, we assigned value to the acquired assets on
the basis of several estimates and assumptions. Changes in these underlying
estimates may result in substantially different allocation of the overall
purchase price and the amount of expenses recorded on our balance sheet as
acquired in-process property research and development and intangible assets. In
addition, we will make assumptions and estimates on a periodic basis when we
evaluate the carrying value of goodwill for evidence of impairment and the
estimation of costs associated with exit or disposal activities.

23



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Accounting and Presentation For Our Unconsolidated Joint Venture Interest
in Emerald

While currently inactive, we own 80.1% of Emeralds common stock and 80.1%
of Emeralds preferred stock and Elan owns the remaining 19.9% of Emeralds
common and preferred stock. The common stock of Emerald held by Elan is similar
in all respects to the common stock held by us, except that those shares held
by Elan do not have voting rights. The common shares held by Elan may be
converted into voting common shares at Elans election. Although we currently
own 100% of the voting stock, Elan and its subsidiaries have retained
significant minority investor rights that are considered participating rights
under the FASBs EITF Bulletin 96-16, Investors Accounting for an Investee
When the Investor Has a Majority of the Voting Interest but the Minority
Shareholder Has Certain Approval or Veto Rights. Because Elans participating
rights prevent us from exercising control over Emerald, we have not
consolidated the financial statements of Emerald, but instead have accounted
for our investment in Emerald under the equity method of accounting.

In January 2003, the FASB issued FIN No. 46, Consolidation of Variable
Interest Entities.This interpretation of Accounting Research Bulleting No.
51, Consolidated Financial Statementsaddresses consolidation of business
enterprises of variable interest entities in which: (1) the equity investment
at risk is not sufficient to permit the entity to finance its activities
without additional subordinated financial support from other parties, which is
provided through other interests that will absorb some or all of the expected
losses of the entity and (2) the equity investors lack one or more of certain
essential characteristics of a controlling interest. FIN No. 46 applies
immediately to variable interest entities created after January 31, 2003, and
to variable interest entities in which an enterprise obtains an interest after
that date. In December 2003, the FASB revised FIN No. 46 to modify the
effective date for applying this interpretation, which made it effective for us
on January 1, 2004. We will adopt the provisions of FIN No. 46 in the first
quarter of 2004 and do not expect the provisions of FIN No. 46 to have a
significant effect on our financial position or operating results. We are
currently evaluating additional disclosures, if any, that may be required for
Emerald.

The summary of significant accounting policies should be read in
conjunction with our consolidated financial statements and related notes and
this discussion of our results of operations and liquidity and capital
resources.

Results of Operations

Revenue

Total revenue in 2003 totaled $14.1 million compared to $19.3 million in
2002. This decrease reflects the completion of activities in 2002 under our
former collaborations with Wyeth, Celltech, and Emerald, partially offset by
higher revenue under our collaboration with Biogen, which ended in September
2003. Revenue in 2003 includes $3.9 million of revenue recognized in 2003
related to the termination of our collaboration with Wyeth and $2.6 million in
revenue recognized in connection with the completion of our collaboration with
Biogen. The decrease in revenue during 2003 also reflects lower revenue earned
under our AIDS vaccine collaboration with IAVI, which resulted from the
completion of certain development activities as the program progressed toward
the initiation of human clinical trials that began in December 2003. Our
deferred revenue decreased from $6.0 million at December 31, 2002 to $1.2
million at December 31, 2003 primarily as the result of recognizing previously
deferred revenue at the conclusion of our collaborations with Biogen and Wyeth.
Total revenue in 2002 totaled $19.3 million compared to $18.9 million in 2001.
This increase in revenue reflects higher revenue earned under our hemophilia
product development collaboration with Wyeth and our AIDS vaccine collaboration
with IAVI, partially offset by lower revenue earned under our development
program with Celltech for the treatment of cystic fibrosis. Development
activities for our cystic fibrosis program decreased in 2002 as we transitioned
into clinical trial evaluation of data for our initial Phase II trial, the
final results of which were presented in June 2003.

|                                                                                                              |          |   |                         |           |      |   |            |           |  |   |            |           | 
|------------------------------------------------------------------------------------------------------------- | -------- | - | ----------------------- | --------- | ---- | - | ---------- | --------- |  | - | ---------- | --------- | 
|                                                                                                              |          |   | Year Ended December 31,
|                                                                                                              |          |   |                        
|                                                                                                              |          |   | 2003                    |           | 2002 |   | 2001      
|                                                                                                              |          |   |                         |           |      |   |           
|Revenue from collaborative agreements:                                                                        |          |   |                         |           |      |   |            |           |  |   |            |          
|                                                                                                              | Biogen   |   | $                       | 5,112,000 |      |   | $          | 2,871,000 |  |   | $          | 2,587,000 | 
|                                                                                                              | IAVI     |   |                         | 4,409,000 |      |   |            | 5,662,000 |  |   |            | 1,866,000 | 
|                                                                                                              | Wyeth    |   |                         | 3,894,000 |      |   |            | 7,543,000 |  |   |            | 6,513,000 | 
|                                                                                                              | Celltech |   |                         |          |      |   |            | 1,280,000 |  |   |            | 5,030,000 | 
|                                                                                                              | Other    |   |                         | 658,000   |      |   |            | 6,000     |  |   |            | 121,000   | 
|                                                                                                              |          |   |                         |           |      |   |            |           |  |   |            |          
|Revenue from collaborative agreements                                                                         |          |   | 14,073,000              |           |      |   | 17,362,000 |           |  |   | 16,117,000 |          
|Revenue
from collaborative agreement withunconsolidated, majority-owned
researchand development joint venture |          |   |                        |           |      |   | 1,971,000  |           |  |   | 2,763,000  |          
|                                                                                                              |          |   |                         |           |      |   |            |           |  |   |            |          
|Total revenue                                                                                                 |          | $ | 14,073,000              |           |      | $ | 19,333,000 |           |  | $ | 18,880,000 |          
|                                                                                                              |          |   |                         |           |      |   |            |           |  |   |            |          

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Our collaborations with Biogen and Wyeth have concluded and as a result,
revenue earned under these collaborations for research and development
performed by us will not continue in 2004. As a result, we expect that total
revenue in 2004 will be less than 2003. We expect substantially all of our
2004 revenue to consist of research and development revenue from our
collaboration with IAVI. Our revenue for the next several years will be
dependent on the continuation of our current IAVI collaboration and whether we
enter into any new collaborations.

Operating Expenses

Research and Development.Research and development expenses decreased
to $17.2 million in 2003 from $29.4 million in 2002. This decrease represents
the planned reductions in expenses that we implemented in 2002 and early 2003
and our focus on our cystic fibrosis, AIDS vaccine and arthritis development
programs. These reductions included suspension of our hemophilia and cancer
programs and reduced investments in our technology development activities.
Research and development expenses increased to $29.4 million in 2002 from $29.2
million in 2001. The increase in research and development expense reflects
expanded activities in our research and preclinical product development
programs for the treatment of hemophilia and arthritis and our AIDS vaccine
program, in addition to increased project-related support and technology
development activities. These increases were partially offset by lower product
and clinical development costs in our cancer and cystic fibrosis programs
during 2002.

We expect our research and development expenses to increase in 2004 as the
result of expanded development and manufacturing activities for our AIDS
vaccine product candidate, our Phase I clinical trial for our rheumatoid
arthritis product candidate that we initiated in the first quarter of 2004 and
related development activities, and further development work and manufacturing
costs associated with our cystic fibrosis development program.

Our research and development expenses for the years ended December 31,
2003, 2002 and 2001 were as follows:

|                                                     |                                                                |   |                         |         |      |   |            |           |  |   |            |           | 
|---------------------------------------------------- | -------------------------------------------------------------- | - | ----------------------- | ------- | ---- | - | ---------- | --------- |  | - | ---------- | --------- | 
|                                                     |                                                                |   | Year Ended December 31,
|                                                     |                                                                |   |                        
|                                                     |                                                                |   | 2003                    |         | 2002 |   | 2001      
|                                                     |                                                                |   |                         |         |      |   |           
|Programs in clinical development:                    |                                                                |   |                         |         |      |   |            |           |  |   |            |          
|                                                     | Cystic fibrosis                                                |   | $                       | 566,000 |      |   | $          | 1,096,000 |  |   | $          | 2,793,000 | 
|                                                     | Cancer products                                                |   |                         | 14,000  |      |   |            | 1,714,000 |  |   |            | 2,942,000 | 
|                                                     | AIDS vaccine (initiated human clinical trial in December 2003) |   |                         | 19,000  |      |   |            |          |  |   |            |          | 
|                                                     | Indirect costs                                                 |   |                         | 888,000 |      |   |            | 2,957,000 |  |   |            | 6,245,000 | 
|                                                     |                                                                |   |                         |         |      |   |            |           |  |   |            |          
|Total clinical development program expense           |                                                                |   | 1,487,000               |         |      |   | 5,767,000  |           |  |   | 11,980,000 |          
|Research and preclinical development program expense |                                                                |   | 15,710,000              |         |      |   | 23,622,000 |           |  |   | 17,238,000 |          
|                                                     |                                                                |   |                         |         |      |   |            |           |  |   |            |          
|Total research and development expense               |                                                                | $ | 17,197,000              |         |      | $ | 29,389,000 |           |  | $ | 29,218,000 |          
|                                                     |                                                                |   |                         |         |      |   |            |           |  |   |            |          

Research and development costs attributable to clinical programs include
costs of salaries, benefits, clinical trial sites, outside services, materials
and supplies incurred to support the clinical programs. Indirect costs
allocated to clinical programs include facility and occupancy costs, research
and development administrative costs, and license and royalty payments. Costs
attributed to research and preclinical programs largely represent our product
pipeline-generating activities. Because we conduct multiple research projects
and utilize resources across several programs, the majority of our research and
preclinical development costs are not directly assigned to individual programs,
but are instead allocated among multiple programs. For purposes of
reimbursement from our collaboration partners, we capture the level of effort
expended on a program through our project management system, which is based
primarily on human resource time allocated to each program, supplemented by an
allocation of indirect costs and other specifically identifiable costs, if any.
As a result, the costs allocated to a program do not necessarily reflect the
actual costs of the program.

Costs associated with our clinical development programs decreased in 2003
and 2002 compared to the preceding year reflecting completion of our cystic
fibrosis Phase II clinical trial in 2002 as well as our decision in mid-2002 to
suspend further development of our cancer product candidates pending the
identification of a development partner to help fund development costs. The
external costs of our ongoing Phase IIb cystic fibrosis clinical trial are
being paid for directly by the CF Foundation. Costs associated with our
preclinical program activities decreased to $15.7 million in 2003 compared to
$23.6 million 2002 primarily due to decreased activity in our AIDS vaccine
program as we prepared to initiate human clinical trials in December 2003.
Costs associated with our preclinical program activities increased to $23.6
million in 2002 compared to $17.2 million in 2001 primarily due to increased
activity in our AIDS vaccine program.

The size and scope of our research programs is dependent on the
availability of resources, such as funding provided by our partners under our
collaborative agreements. During 2004, we expect research and development costs
to be somewhat higher than in 2003 as we will be conducting clinical trials in
our key development programs.

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General and Administrative.We incurred general and administrative
expenses of $5.5 million in 2003 compared to $8.1 million in 2002. This
decrease primarily reflects lower administrative support for our collaborative
partnerships, reduced patent
costs due to the consolidation of our patent portfolio and the
implementation of cost reduction measures in late 2002 and early 2003. We
incurred general and administrative expenses of $8.1 million in 2002 compared
to $8.5 million in 2001. The decrease primarily reflects decreased
administrative support for our collaborative partnerships and nonrecurring
expenses that we incurred in early 2001 in connection with our acquisition of
Genovo.

Restructure Charges.We implemented cost reduction measures in December
2002, in response to general business conditions, the lack of additional
funding at that time and collaborations that ended, to lower our fixed
operating costs and to focus our resources on our key product development
programs. As a result, we recorded restructure charges of $2.3 million in 2002
to account for ongoing lease payments related to our abandoned lease facility
located in Bothell, Washington, and termination benefits paid to former
employees. In addition, we reclassified the deferred rent liability of $1.5
million, related to the Bothell facility, to accrued restructure costs.
Therefore, the balance of our accrued restructure liability at December 31,
2002, was $3.4 million.

During 2003, we vacated the Sharon Hill facility and recorded restructure
charges for the ongoing lease payments of that facility. We are using a real
estate broker to assist us in identifying suitable sublease tenants for both
our Bothell and Sharon Hill facilities in response to continued poor market
conditions and to assist us in determining reasonable assumptions for
subleasing the facilities. During 2003, we have updated our original
assumptions to reflect the continued poor market conditions for subleasing the
facilities, the additional time that we estimate it will take us to secure
sublease tenants and concessions that we believe may be required to secure
sublease tenants. In total, we recorded $5.2 million in restructuring charges
during 2003 related to these facilities. As of December 31, 2003, our accrued
restructure liability balance was $6.9 million.

If we proceed with further development and commercialization of any of our
product candidates, we may need to resume use of the Bothell facility to
fulfill our manufacturing requirements. If we decide to resume use of this
facility, any remaining restructuring accrual related to the facility will be
reversed. This will be reflected as a one-time credit to restructuring charges,
reflected in the period in which use is resumed. Any decision to resume use of
the facility will be based on a number of factors including the progress of our
product candidates in clinical development, the estimated duration of design
and construction, the estimated timing of manufacturing requirements, the
ability of our current manufacturing capabilities to meet demand and the
availability of resources. Unless a decision is made to resume use of this
facility, we will continue to evaluate any additional information that may
become available with respect to the estimates and assumptions, which may
result in further significant charges to our results of operations.

Equity in Net Loss of Unconsolidated, Majority-Owned Research and
Development Joint Venture.Our net loss in Emerald decreased to zero in
2003, compared to a loss of $1.9 million in 2002 and $3.7 million in 2001.
Losses reflect our 80.1% equity share in the losses generated by Emerald.
Emeralds initial development period concluded in August 2002 and no further
operating activities have been performed. As a result, we do not expect that
losses resulting from our equity in the net loss of Emerald will be significant
in the future.

Amortization of Acquisition-Related Intangibles.Amortization expense
decreased to zero in 2003, compared to $365,000 in 2002 as our intangible
assets that were subject to amortization were fully amortized as of September
30, 2002. We recorded amortization expense of $365,000 in 2002 for
non-competition agreements acquired in connection with our acquisition of
Genovo in 2000, compared to $6.1 million in 2001 to amortize Genovo goodwill,
non-competition agreements and assembled workforce. This decrease is the result
of our adoption of SFAS No. 142, Goodwill and Other Intangible Assets, as of
January 1, 2002, under which most goodwill is no longer amortized.

Other Income and Expense

Investment Income.Investment income was $183,000 in 2003 compared to
$398,000 in 2002. This decrease resulted from lower investment returns and a
lower yield from our short-term bond mutual fund. Investment income was
$398,000 in 2002, compared to $1.9 million in 2001. This decrease resulted
from lower average cash balances during the period and decreases in the yield
of our short-term bond mutual fund.

Interest Expense.Interest expense relates to interest on outstanding
loans from our collaborative partners, notes and obligations under equipment
financing arrangements and installment loans we use to finance purchases of
laboratory and computer equipment, furniture and leasehold improvements.
Interest expense decreased to $1.2 million in 2003 from $1.4 million in 2002.
This decrease resulted from lower debt balances due to the conversion of $9.4
million owed to Elan into equity. Interest expense increased to $1.4 million
in 2002 from $452,000 in 2001. This increase resulted from higher average debt
balances in 2002 due to borrowings under loan commitments from Biogen and Elan.

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Liquidity and Capital Resources

Our cash and cash equivalents increased to $21.1 million at December 31,
2003, compared to $12.6 million at December 31, 2002. Our principal sources of
cash were $21.0 million in net proceeds from the issuance of shares of our
common stock in June and August 2003. The principal uses of cash were $11.2
million for operations and $1.3 million in scheduled debt payments. In
February 2004, we completed the sale of approximately 10.9 million shares of
our common stock at a price of $2.35 per share and received net proceeds of
$23.8 million.

Our shareholders equity increased to $33.5 million at December 31, 2003,
compared to $5.9 million at December 31, 2002. This increase includes $21.0
million from sale of common stock, $9.4 million from the conversion of debt
payable to Elan into 5,203,244 shares of our common stock and the
reclassification of $12.0 million of Series B convertible preferred stock from
mezzanine equity to shareholders equity. This reclassification was the result
of the expiration of Elans right to exchange the Series B preferred stock for
all shares of preferred stock that we hold in Emerald.

We have financed our product development activities and general corporate
functions primarily through proceeds from public and private sales of our
equity securities, through cash payments received from our collaborative
partners and proceeds from the issuance of debt. To a lesser degree, we have
also financed our operations through interest earned on cash and short-term
investments, loan funding under equipment leasing agreements and research
grants. These financing sources have historically allowed us to maintain
adequate levels of cash and investments.

Our cystic fibrosis product candidate is in a confirmatory Phase II
clinical trial and our AIDS vaccine candidate is in a Phase I clinical trial.
We expect to dose the first patient in a Phase I clinical trial for our
rheumatoid arthritis product candidate during the first quarter of 2004. We
expect to continue incurring significant expense in advancing our product
candidates toward commercialization. As a result, we do not expect to generate
sustained positive cash flow from our operations for at least the next several
years and only then if we can successfully develop and commercialize our
product candidates. We will require substantial additional financial resources
to fund the development and commercialization of our product candidates and
expand research and development of our product candidates for treating
additional diseases.

Over the past several years, we have scaled our development activities to
the level of available cash resources and financial support from collaboration
partners. Research and development and general and administrative expenses
decreased by approximately 40 percent in 2003, compared to 2002 and reflect the
Companys focus on its lead development programs. We expect to maintain this
focus in 2004 and we believe that our cash needs will increase by approximately
20% to support the advancement of our clinical development programs. During
2003, we received funding from our collaborators totaling approximately $8.5
million. We expect to continue to receive financial support for specific
programs to offset some of the costs of development.

We have an ongoing collaboration with IAVI and Childrens Research
Institute to develop an AIDS vaccine. The term of this collaboration has been
extended through December 2006. Assuming that we complete all of the planned
development activities, we expect to receive up to $10.7 million in funding
from IAVI to cover the costs of this program in 2004. We also have a
collaboration with the CF Foundation related to our current Phase II clinical
trial for our product candidate for treating cystic fibrosis. Under this
collaboration, the CF Foundation is providing funding to the sites conducting
this study to cover their direct costs of the trial.

We expect that our cash and cash equivalents at December 31, 2003, plus
the $23.8 million of proceeds from our equity financing completed in February
2004 and the funding expected from IAVI to fund 2004 work activities under our
AIDS vaccine collaboration will be sufficient to fund our operations until at
least the beginning of 2006. We believe that this will be sufficient time to
complete each of our current clinical trials, evaluate the results, and
assuming satisfactory results, to initiate further clinical testing. Although
our development collaboration with IAVI has been extended through the end of
2006, the development plan and budget under the collaboration is established on
an annual basis. While we expect this program to continue through at least the
duration of the collaboration term, we have not established the work plan and
budget for 2005 and 2006 with IAVI and have therefore not yet made an
assumption as to the level of funding that we may receive from IAVI in 2005 and
2006.

We expect the level of our future operating expenses to be driven by the
needs of our product development programs balanced by the availability of funds
through partner funded collaborations, equity offerings or other financing
activities. The size, scope and pace of our development activities depend on
the availability of these resources. Our future cash requirements will depend
on many factors, including:



| |  |  | the rate and extent of scientific progress in our research and
development programs;                                                              
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  |  | the timing, costs and scope of, and our success in, clinical
trials, obtaining regulatory approvals and filing, prosecuting and
enforcing patents;

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| |  |  | competing technological and market developments;                                                                                                                                         
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  |  | the timing and costs of, and our success in, any product
commercialization activities and facility expansions, if and as
required; and                                                   
|
| |  |  | the expense and outcome of any litigation or administrative
proceedings involving our intellectual property, or access to third
party intellectual property through licensing agreements.

IAVI has the right to terminate our collaboration and its obligation to
provide research funding at any time for any reason with 90 days notice. If we
were to lose the collaborative funding expected from IAVI and were unable to
obtain alternative sources of funding for the AIDS vaccine product candidate,
we may be unable to continue our research and development program for that
product candidate. The CF Foundation has the right to terminate our funding
agreement at any time for any reason. If we were to lose the funding for our
confirmatory Phase II clinical trial from the CF Foundation and were unable to
obtain alternative sources of funding to continue the trial, we may choose not
to complete it.

We are evaluating other opportunities to obtain additional capital to fund
our future operations. Additional sources of financing could involve one or
more of the following:



| |  |  | entering into additional product development and funding
collaborations or other strategic transactions, or extending or
expanding our current collaborations;
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  |  | selling or licensing our technology or product candidates;                                                                                                    
|
| |  |  | issuing equity in the public or private markets; or                                                                                                           
|
| |  |  | issuing debt.                                                                                                                                                 

Additional funding may not be available to us on reasonable terms, if at
all. Depending on our ability to successfully access additional funding, we may
be forced to implement significant cost reduction measures. These adjustments
may include scaling back, delaying or terminating one or more research and
development programs, curtailing capital expenditures or reducing other
operating activities. We may also be required to relinquish some rights to our
technology or product candidates or grant licenses on unfavorable terms, either
of which would reduce the ultimate value to us of the technology or product
candidates.

Tabular Disclosure of Contractual Obligations

We have significant lease commitments and long-term obligations which draw
on our cash resources. The following are our contractual commitments
associated with our debt and lease obligations:

|                                |       |      |                                              |           |  |      |           |           |  |      |            |            |  |       |           |           |  |   |           |           |  |   |            |            |  |   |            |            | 
|------------------------------- | ----- | ---- | -------------------------------------------- | --------- |  | ---- | --------- | --------- |  | ---- | ---------- | ---------- |  | ----- | --------- | --------- |  | - | --------- | --------- |  | - | ---------- | ---------- |  | - | ---------- | ---------- | 
|                                |       |      | Payments Due through Year Ended December 31:
|                                |       |      |                                             
|Contractual Obligations         |       | 2004 |                                              | 2005      |  | 2006 |           | 2007      |  | 2008 |            | Thereafter |  | Total
|                                |       |      |                                              |           |  |      |           |           |  |      |            |            |  |      
|Long-term debt obligations      |       | $    | 65,000                                       |           |  | $    | 590,000   |           |  | $    | 10,000,000 |            |  | $     |          |           |  | $ |          |           |  | $ |           |            |  | $ | 10,655,000 |           
|Equipment financing
obligations |       |      | 864,000                                      |           |  |      | 484,000   |           |  |      | 140,000    |            |  |       | 13,000    |           |  |   |          |           |  |   |           |            |  |   | 1,501,000  |           
|Operating lease obligations     |       |      | 2,526,000                                    |           |  |      | 2,436,000 |           |  |      | 2,318,000  |            |  |       | 2,345,000 |           |  |   | 2,373,000 |           |  |   | 10,817,000 |            |  |   | 22,815,000 |           
|Purchase obligations            |       |      | 40,000                                       |           |  |      |          |           |  |      |           |            |  |       |          |           |  |   |          |           |  |   |           |            |  |   | 40,000     |           
|Other long-term obligations     |       |      | 361,000                                      |           |  |      |          |           |  |      |           |            |  |       |          |           |  |   |          |           |  |   |           |            |  |   | 361,000    |           
|                                |       |      |                                              |           |  |      |           |           |  |      |            |            |  |       |           |           |  |   |           |           |  |   |            |            |  |   |            |           
|                                | Total |      | $                                            | 3,856,000 |  |      | $         | 3,510,000 |  |      | $          | 12,458,000 |  |       | $         | 2,358,000 |  |   | $         | 2,373,000 |  |   | $          | 10,817,000 |  |   | $          | 35,372,000 | 
|                                |       |      |                                              |           |  |      |           |           |  |      |            |            |  |       |           |           |  |   |           |           |  |   |            |            |  |   |            |           

Long-term obligations decreased from $20.5 million at December 31, 2002 to
$11.2 million at December 31, 2003. In September 2003, we converted $9.4
million in outstanding debt and interest payable to Elan into approximately 5.2
million shares of our common stock. We will need to raise additional capital
in order to repay the $10.0 million of notes payable to Biogen that is due in
August 2006.

Impact of New Accounting Pronouncements

In July 2000, the Financial Accounting Standards Board, or FASB, issued
Emerging Issues Task Force, or EITF, Issue No. 00-21, Revenue Arrangements
with Multiple Deliverables.This issue addresses accounting for revenue under
agreements with multiple revenue-generating activities and became effective for
revenue arrangements entered into after September 1, 2003. We will adopt the
provisions of EITF No. 00-21 for any new revenue arrangements and do not expect
the provisions of EITF No. 00-21 to have a significant effect on our financial
position or operating results.

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In January 2003, the FASB issued FIN No. 46, Consolidation of Variable
Interest Entities.This interpretation of Accounting Research Bulleting No.
51, Consolidated Financial Statementsaddresses consolidation of business
enterprises of variable interest entities in which: (1) the equity investment
at risk is not sufficient to permit the entity to finance its activities
without additional subordinated financial support from other parties, which is
provided through other interests that will absorb some or all of the expected
losses of the entity and (2) the equity investors lack one or more of certain
essential characteristics of a controlling interest. FIN No. 46 applies
immediately to variable interest entities created after January 31, 2003, and
to variable interest entities in which an enterprise obtains an interest after
that date. In December 2003, the FASB revised FIN No. 46 to modify the
effective date for applying this interpretation, which made it effective for us
on January 1, 2004. We will adopt the provisions of FIN No. 46 in the first
quarter of 2004 and do not expect the provisions of FIN No. 46 to have a
significant effect on our financial position or operating results. We are
currently evaluating additional disclosures, if any, that may be required for
Emerald.

In December 2003, the Securities and Exchange Commission, or SEC, released
Staff Accounting Bulletin, or SAB, No. 104, Revenue Recognition. The staff
updated and revised the existing revenue recognition guidance to make its
interpretive guidance consistent with current accounting guidance. We do not
expect the provisions of SAB No. 104 to have a significant effect on our
financial position or operating results.

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Factors Affecting Our Operating Results, Our Business and Our Stock Price

In addition to the other information contained in this annual report, you
should carefully read and consider the following risk factors. If any of these
risks actually occur, our business, operating results or financial condition
could be harmed. This could cause the trading price of our stock to decline,
and you could lose all or part of your investment.

Risks Related to Our Business

We expect to continue to operate at a loss and may never become profitable,
which could result in a decline in the value of our common stock and a loss of
your investment.

Substantially all of our revenue has been derived under collaborative
research and development agreements relating to the development of our
potential product candidates. We have incurred, and will continue to incur for
the foreseeable future, significant expense to develop our research and
development programs, conduct preclinical studies and clinical trials, seek
regulatory approval for our product candidates and provide general and
administrative support for these activities. As a result, we have incurred
significant net losses since inception, and we expect to continue to incur
substantial additional losses in the future. As of December 31, 2003, we had an
accumulated deficit of approximately $217 million. We may never generate
profits and, if we do become profitable, we may be unable to sustain or
increase profitability.

All of our product candidates are in early-stage clinical trials or preclinical
development, and if we are unable to successfully develop and commercialize our
product candidates we will be unable to generate sufficient capital to maintain
our business.

In July 2003, we initiated a confirmatory Phase II clinical trial for our
cystic fibrosis product candidate. In December 2003, we initiated a Phase I
trial for our AIDS vaccine in Belgium. We also plan to dose the first patient
in our rheumatoid arthritis product candidate Phase I clinical trial during the
first quarter of 2004. Our product candidates for cancer have been evaluated
in Phase I and Phase II clinical trials. In connection with the operational
changes that we implemented in 2002 and the termination of our collaboration
with Wyeth in February 2003, we suspended further development of our cancer and
hemophilia product development programs. We will not generate any product
revenue for at least several years and then only if we can successfully develop
and commercialize our product candidates. Commercializing our potential
products depends on successful completion of additional research and
development and testing, in both preclinical development and clinical trials.
Clinical trials may take several years or more to complete. The commencement,
cost and rate of completion of our clinical trials may vary or be delayed for
many reasons, including the risks discussed elsewhere in this section. If we
are unable to successfully complete preclinical and clinical development of
some or all of our product candidates in a timely manner, we may be unable to
generate sufficient product revenue to maintain our business.

Even if our potential products succeed in clinical trials and are approved
for marketing, these products may never achieve market acceptance. If we are
unsuccessful in commercializing our product candidates for any reason,
including greater effectiveness or economic feasibility of competing products
or treatments, the failure of the medical community or the public to accept or
use any products based on gene delivery, inadequate marketing and distribution
capabilities or other reasons discussed elsewhere in this section, we will be
unable to generate sufficient product revenue to maintain our business.

The regulatory approval process for our product candidates is costly,
time-consuming and subject to unpredictable changes and delays, and our product
candidates may never receive regulatory approval.

To our knowledge, no gene therapy products have received regulatory
approval for marketing from the FDA. Because our product candidates involve new
and unproven technologies, we believe that the regulatory approval process may
proceed more slowly compared to clinical trials involving traditional drugs.
The FDA and applicable state and foreign regulators must conclude at each stage
of clinical testing that our clinical data suggest acceptable levels of safety
in order for us to proceed to the next stage of clinical trials. In addition,
gene therapy clinical trials conducted at institutions that receive funding for
recombinant DNA research from the National Institutes of Health, or NIH, are
subject to review by the NIHs Office of Biotechnology Activities Recombinant
DNA Advisory Committee, or RAC. Although NIH guidelines do not have regulatory
status, the RAC review process can impede the initiation of the trial, even if
the FDA has reviewed the trial and approved its initiation. Moreover, before a
clinical trial can begin at an NIH-funded institution, that institutions
Institutional Biosafety Committee must review the proposed clinical trial to
assess the safety of the trial.

The regulatory process for our product candidates is costly,
time-consuming and subject to unpredictable delays. The clinical trial
requirements of the FDA, NIH and other agencies and the criteria these
regulators use to determine the safety and efficacy of a product candidate vary
substantially according to the type, complexity, novelty and intended use of
the potential products. In addition, regulatory requirements governing gene and
cell therapy products have changed frequently and may change in the future.
Accordingly, we cannot predict how long it will take or how much it will cost
to obtain regulatory approvals for clinical trials or for manufacturing or
marketing our potential products. Some or all of our product candidates may
never receive regulatory approval. A product candidate that appears promising
at an early stage of research or development may not result in a

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commercially successful product. Our clinical trials may fail to
demonstrate the safety and efficacy of a product candidate or a product
candidate may generate unacceptable side effects or other problems during or
after clinical trials. Should this occur, we may have to delay or discontinue
development of the product candidate, and the corporate partner that supports
development of that product candidate may terminate its support. Delay or
failure to obtain, or unexpected costs in obtaining, the regulatory approval
necessary to bring a potential product to market could decrease our ability to
generate sufficient product revenue to maintain our business.

If we are unable to raise additional capital when needed, we will be unable to
conduct our operations and develop our potential products.

Because internally generated cash flow will not fund development and
commercialization of our product candidates, we will require substantial
additional financial resources. Our future capital requirements will depend on
many factors, including:



| |  |  | the rate and extent of scientific progress in our research and
development programs;                                                            
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  |  | the timing, costs and scope of, and our success in, conducting
clinical trials, obtaining regulatory approvals and pursuing patent
prosecutions;
|
| |  |  | competing technological and market developments;                                                                                                
|
| |  |  | the timing and costs of, and our success in, any commercialization
activities and facility expansions, if and as required; and                  
|
| |  |  | the existence and/or outcome of any litigation or administrative
proceedings involving our intellectual property.                               

As of December 31, 2003, we had approximately $21.1 million in cash and
cash equivalents. We expect that our cash resources at December 31, 2003, plus
the proceeds from our equity financing completed in February 2004 and the
funding expected from IAVI to fund 2004 work activities under our AIDS vaccine
collaboration will be sufficient to fund our operations until at least the
beginning of 2006. We are evaluating opportunities to obtain additional capital
to fund our operations beyond that time. Additional sources of financing could
involve one or more of the following:



| |  |  | extending or expanding our current collaborations;          
| | - |  | ------------------------------------------------------------
|
| |  |  | entering into additional product development collaborations;
|
| |  |  | selling or licensing our technology or product candidates;  
|
| |  |  | issuing equity; or                                          
|
| |  |  | issuing debt.                                               

Additional funding may not be available to us on reasonable terms, if at
all.

The funding that we expect to receive from IAVI depends on continued
scientific progress under the collaboration and IAVIs ability and willingness
to continue or extend the collaboration. If we are unable to successfully
access additional capital, we may need to scale back, delay or terminate one or
more of our key development programs, curtail capital expenditures or reduce
other operating activities. We may also be required to relinquish some rights
to our technology or product candidates or grant or take licenses on
unfavorable terms, either of which would reduce the ultimate value to us of our
technology or product candidates.

If we are unable to obtain or maintain licenses for necessary third-party
technology on acceptable terms or to develop alternative technology, we may be
unable to develop and commercialize our product candidates.

We have entered into exclusive and nonexclusive license agreements that
give us and our partners rights to use technologies owned or licensed by
commercial and academic organizations in the research, development and
commercialization of our potential products. For example, we have a Gene
Transfer Technology License Agreement with Amgen as the successor to Immunex
under which we have license rights to certain Immunex proprietary technology
specifically applicable to gene therapy applications. In a February 2004
letter, Amgen has taken the position that we are not licensed, either
exclusively or non-exclusively, under Immunex intellectual property covering
TNFR:Fc or therapeutic uses for TNFR:Fc. We have responded with a letter
confirming our confidence that the Gene Transfer Technology License Agreement
gives us an exclusive worldwide license to use the gene construct coding for
TNFR:Fc for gene therapy applications. We expect to have further communications
with Amgen regarding our differences. Notwithstanding our confidence, it is
possible that a resolution of those differences, through litigation or
otherwise, could cause delay or discontinuation of our development of tgAAC94
or our inability to commercialize any resulting product.

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We believe that we will need to obtain additional licenses to use patents
and unpatented technology owned or licensed by others for compositions,
methods, processes to manufacture compositions, processes to manufacture and
purify gene delivery product candidates and other technologies and processes
for our present and potential product candidates. If we are unable to maintain
our current licenses for third-party technology or obtain additional licenses
on acceptable terms, we may be required to expend significant time and
resources to develop or license replacement technology. If we are unable to do
so, we may be unable to develop or commercialize the affected product
candidates. In addition, the license agreements for technology for which we
hold exclusive licenses typically contain provisions that require us to meet
minimum development milestones in order to maintain the license on an exclusive
basis for some or all fields of the license. We also have license agreements
for some of our technologies, which may require us to sublicense certain of our
rights. If we do not meet these requirements, our licensor may convert all or
a portion of the license to a nonexclusive license or in some cases, terminate
the license.

In many cases, patent prosecution of our licensed technology is controlled
solely by the licensor. If our licensors fail to obtain and maintain patent or
other protection for the proprietary intellectual property we license from
them, we could lose our rights to the intellectual property or our exclusivity
with respect to those rights, and our competitors could market competing
products using the intellectual property. Licensing of intellectual property is
of critical importance to our business and involves complex legal, business and
scientific issues and is complicated by the rapid pace of scientific discovery
in our industry. Disputes may arise regarding intellectual property subject to
a licensing agreement, including:



| |  |  | the scope of rights granted under the license agreement and other
interpretation-related issues;                                                        
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  |  | the extent to which our technology and processes infringe on
intellectual property of the licensor that is not subject to the
licensing agreement;      
|
| |  |  | the sublicensing of patent and other rights under our collaborative
development relationships;                                                          
|
| |  |  | the ownership of inventions and know-how resulting from the joint
creation or use of intellectual property by our licensors and us and
our partners; and
|
| |  |  | the priority of invention of patented technology.                                                                                                       

If disputes over intellectual property that we have licensed prevent or
impair our ability to maintain our current licensing arrangements on acceptable
terms, we may be unable to successfully develop and commercialize the affected
product candidates.

Litigation involving intellectual property, product liability or other claims
and product recalls could strain our resources, subject us to significant
liability, damage our reputation or result in the invalidation of our
proprietary rights.

As our product development efforts progress, especially in potentially
significant markets such as AIDS or rheumatoid arthritis therapies, the risk
increases that others may claim that our processes and potential products
infringe on their intellectual property rights. In addition, administrative
proceedings, litigation or both may be necessary to enforce our intellectual
property rights or determine the rights of others. Defending or pursuing these
claims, regardless of their merit, would be costly and would likely divert
managements attention and resources away from our operations. If there were
to be an adverse outcome in litigation or an interference proceeding, we could
face potential liability for significant damages or be required to obtain a
license to the patented process or technology at issue, or both. If we are
unable to obtain a license on acceptable terms, or to develop or obtain
alternative technology or processes, we may be unable to manufacture or market
any product or potential product that uses the affected process or technology.

Clinical trials and the marketing of any potential products may expose us
to liability claims resulting from the testing or use of our products. Gene
therapy treatments are new and unproven, and potential known and unknown side
effects of gene therapy may be serious and potentially life-threatening.
Product liability claims may be made by clinical trial participants, consumers,
healthcare providers or other sellers or users of our products. Although we
currently maintain liability insurance, the costs of product liability and
other claims against us may exceed our insurance coverage. In addition, we may
require increased liability coverage as additional product candidates are used
in clinical trials and commercialized. Liability insurance is expensive and
may not continue to be available on acceptable terms. A product liability or
other claim or product recall not covered by or exceeding our insurance
coverage could significantly harm our financial condition. In addition,
adverse publicity resulting from a product recall or a liability claim against
us, one of our partners or another gene therapy company could significantly
harm our reputation and make it more difficult to obtain the funding and
collaborative partnerships necessary to maintain our business.

If we lose either IAVI or the CF Foundation as partners or if our collaborative
relationships are unsuccessful, we may be unable to develop our potential
products.

A significant portion of our operating and clinical trial expenses are
funded through our collaborative agreements with IAVI and, to a lesser extent,
the CF Foundation. We have a collaborative development agreement with IAVI,
which expires in December 2006 that we expect to provide us with funding to
reimburse research and development and manufacturing expenses

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we incurred in connection with the collaboration. In addition, our
collaboration with IAVI provides funding for our Phase I clinical trial for our
AIDS vaccine candidate. We also have a collaboration with the CF Foundation
related to our current confirmatory Phase II clinical trial for our product
candidate for treating cystic fibrosis. Under this collaboration, the CF
Foundation is providing funding to the sites conducting this study to cover
their direct costs of the trial.

If we were to lose the collaborative funding relationship with IAVI and
were unable to obtain alternative sources of funding for the AIDS vaccine
product candidate covered by the IAVI collaboration, we may be unable to
continue our research and development or clinical program for this product
candidate. If we were to lose funding for our confirmatory Phase II clinical
trial from the CF Foundation and were unable to obtain alternative sources of
funding to continue the trial, we may choose not to complete it. In addition,
the loss of significant amounts of collaborative or clinical trial funding
could cause the delay, reduction or termination of the related research and
development programs, and a reduction in capital expenditures and other
operating activities necessary to support general operations. Such a reduction
could further impede our ability to develop our product candidates. IAVI has
the right to terminate the collaboration or its obligation to provide funding
at any time for any reason with 90 days notice. The CF Foundation has the
right to terminate our funding agreement at any time for any reason.
Termination of our IAVI collaboration would significantly affect our operating
activities and termination of our CF Foundation collaboration could
significantly affect the development of our cystic fibrosis product candidate.

If our partners or scientific consultants terminate, reduce or delay our
relationships with them, we may be unable to develop our potential products.

Our partners provide funding, manage regulatory filings, aid and augment
our internal research and development efforts and provide access to important
intellectual property and know-how. Their activities include, for example,
support in the processing of the regulatory filings our product candidates and
funding of clinical trials. Our outside scientific consultants and contractors
perform research, develop technology and processes to advance and augment our
internal efforts and provide access to important intellectual property and
know-how. Their activities include, for example, clinical evaluation of our
product candidates, product development activities performed under our research
collaborations, research under sponsored research agreements and contract
manufacturing services. Collaborations with established pharmaceutical and
biotechnology companies and academic, research and public health organizations,
often provide a measure of validation of our product development efforts in the
eyes of securities analysts, investors and the medical community. The
development of certain of our potential products, and therefore the success of
our business, depends on the performance of our partners, consultants and
contractors. If they do not dedicate sufficient time, regulatory or other
technical resources to the research and development programs for our product
candidates or if they do not perform their obligations as expected, we may
experience delays in, and may be unable to continue, the preclinical or
clinical development of those product candidates. Each of our collaborations
and scientific consulting relationships concludes at the end of the term
specified in the applicable agreement unless we and our partners agree to
extend the relationship. Any of our partners may decline to extend the
collaboration, or may be willing to extend the collaboration only with a
significantly reduced scope, for a number of scientific or business reasons.
Competition for scientific consultants and partners in gene therapy is intense.
We may be unable to successfully maintain our existing relationships or
establish additional relationships necessary for the development of our product
candidates on acceptable terms, if at all. If we are unable to do so, our
research and development programs may be delayed or we may lose access to
important intellectual property or know-how.

If we do not attract and retain qualified personnel, we may be unable to
develop and commercialize some of our potential products.

Our future success depends in large part on our ability to attract and
retain key technical and management personnel. All of our employees, including
our executive officers, can terminate their employment with us at any time. We
have programs in place designed to retain personnel, including competitive
compensation packages and programs to create a positive work environment. Other
companies, research and academic institutions and other organizations in our
field compete intensely for employees, however, and we may be unable to retain
our existing personnel or attract additional qualified employees and
consultants. If we experience significant turnover or difficulty in recruiting
new personnel, our research and development of product candidates could be
delayed and we could experience difficulty in generating sufficient revenue to
maintain our business.

The success of our clinical trials and preclinical studies may not be
indicative of results in a large number of patients or predictive of long-term
efficacy.

The successful results of our technology in preclinical studies using
animal models may not be predictive of the results that we will see in our
clinical trials. In addition, results in early-stage clinical trials are based
on limited numbers of patients and generally test for drug safety rather than
efficacy. Our reported progress and results from our early phases of clinical
testing of our product candidates may not be indicative of progress or results
that will be achieved from larger populations, which could be less favorable.
Moreover, we do not know if the favorable results we have achieved in clinical
trials will have a lasting effect. If a larger group of patients does not
experience positive results, or if any favorable results do not demonstrate a
beneficial effect, our

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product candidate for cystic fibrosis, or any other
potential products that we advance to clinical trials, may not receive approval
from the FDA for further clinical trials or commercialization. Any report
of clinical trial results that are below the expectations of financial analysts
or investors could result in a decline in our stock price.

Failure to recruit patients could delay or prevent clinical trials of our
potential products, which could delay or prevent the development of potential
products.

Identifying and qualifying patients to participate in clinical trials of
our potential products is critically important to our success. The timing of
our clinical trials depends on the speed at which we can recruit patients to
participate in testing our product candidates. We have experienced delays in
some of our clinical trials, and we may experience similar delays in the
future. If patients are unwilling to participate in our gene therapy trials
because of negative publicity from adverse events in the biotechnology or gene
therapy industries or for other reasons, including competitive clinical trials
for similar patient populations, the timeline for recruiting patients,
conducting trials and obtaining regulatory approval of potential products will
be delayed. These delays could result in increased costs, delays in advancing
our product development, delays in testing the effectiveness of our technology
or termination of the clinical trials altogether.

We may be unable to adequately protect our proprietary rights domestically or
overseas, which may limit our ability to successfully market any product
candidates.

Our success depends substantially on our ability to protect our
proprietary rights and operate without infringing on the proprietary rights of
others. We own or license patents and patent applications, and may need to
license additional patents, for genes, processes, practices and techniques
critical to our present and potential product candidates. If we fail to obtain
and maintain patent or other intellectual property protection for this
technology, our competitors could market competing products using those genes,
processes, practices and techniques. The patent process takes several years and
involves considerable expense. In addition, patent applications and patent
positions in the field of biotechnology are highly uncertain and involve
complex legal, scientific and factual questions. Our patent applications may
not result in issued patents and the scope of any patent may be reduced both
before and after the patent is issued. Even if we secure a patent, the patent
may not provide significant protection and may be circumvented or invalidated.

We also rely on unpatented proprietary technology and technology that we
have licensed on a nonexclusive basis. While we take precautions to protect our
proprietary unpatented technology, we may be unable to meaningfully protect
this technology from unauthorized use or misappropriation by a third party. Our
competitors could also obtain rights to our nonexclusively licensed proprietary
technology. In any event, other companies may independently develop
substantially equivalent proprietary information and techniques. If our
competitors develop and market competing products using our unpatented or
nonexclusively licensed proprietary technology or substantially similar
technology, our products, if successfully developed, could suffer a reduction
in sales or be forced out of the market.

If we do not develop adequate manufacturing, sales, marketing and distribution
capabilities, either alone or with our business partners, we will be unable to
generate sufficient product revenue to maintain our business.

We currently do not have the physical capacity to manufacture large-scale
quantities of our potential products. This could limit our ability to conduct
large clinical trials of a product candidate and to commercially launch a
successful product candidate. In order to manufacture product at such scale, we
will need to expand or improve our current facilities and staff or supplement
them through the use of contract providers. If we are unable to obtain and
maintain the necessary manufacturing capabilities, either alone or through
third parties, we will be unable to manufacture our potential products in
quantities sufficient to sustain our business. Moreover, we are unlikely to
become profitable if we, or our contract providers, are unable to manufacture
our potential products in a cost-effective manner.

In addition, we have no experience in sales, marketing and distribution.
To successfully commercialize any products that may result from our development
programs, we will need to develop these capabilities, either on our own or with
others. We intend to enter into collaborations with other entities to utilize
their mature marketing and distribution capabilities, but we may be unable to
enter into marketing and distribution agreements on favorable terms, if at all.
If our current or future collaborative partners do not commit sufficient
resources to timely marketing and distributing our future products, if any, and
we are unable to develop the necessary marketing and distribution capabilities
on our own, we will be unable to generate sufficient product revenue to sustain
our business.

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Post-approval manufacturing or product problems or failure to satisfy
applicable regulatory requirements could prevent or limit our ability to market
our products.

Commercialization of any products will require continued compliance with
FDA and other federal, state and local regulations. For example, our current
manufacturing facility, which is designed for manufacturing our AAV vectors for
clinical and development purposes, is subject to the Good Manufacturing
Practices requirements and other regulations of the FDA, as well as to other
federal, state and local regulations such as the Occupational Health and Safety
Act, the Toxic Substances Control Act, the Resource Conservation and Recovery
Act and the Environmental Protection Act. Any future manufacturing facilities
that we may construct for large-scale commercial production will also be
subject to regulation. We may be unable to obtain regulatory approval for or
maintain in operation this or any other manufacturing facility. In addition, we
may be unable to attain or maintain compliance with current or future
regulations relating to manufacture, safety, handling, storage, record keeping
or marketing of potential products. If we fail to comply with applicable
regulatory requirements or discover previously unknown manufacturing,
contamination, product side effects or other problems after we receive
regulatory approval for a potential product, we may suffer restrictions on our
ability to market the product or be required to withdraw the product from the
market.

Risks Related to Our Industry

Adverse events in the field of gene therapy could damage public perception of
our potential products and negatively affect governmental approval and
regulation.

Public perception of our product candidates could be harmed by negative
events in the field of gene therapy. For example, in late 2002, two patients in
a French academic clinical study being treated for x-linked severe combined
immunodeficiency in a gene therapy trial using a retroviral vector developed
leukemia. Patient deaths, related and unrelated to gene therapy, have occurred
in other clinical trials. These adverse events and the resulting publicity, as
well as any other adverse events in the field of gene therapy that may occur in
the future, could result in a decrease in demand for any products that we may
develop. The commercial success of our product candidates will depend in part
on public acceptance of the use of gene therapy for preventing or treating
human diseases. If public perception is influenced by claims that gene therapy
is unsafe, our product candidates may not be accepted by the general public or
the medical community. The public and the medical community may conclude that
our technology is unsafe.

Future adverse events in gene therapy or the biotechnology industry could
also result in greater governmental regulation, unfavorable public perception,
stricter labeling requirements and potential regulatory delays in the testing
or approval of our potential products. Any increased scrutiny could delay or
increase the costs of our product development efforts or clinical trials.

Our use of hazardous materials exposes us to liability risks and regulatory
limitations on their use, either of which could reduce our ability to generate
product revenue.

Our research and development activities involve the controlled use of
hazardous materials, including chemicals, biological materials and radioactive
compounds. Our safety procedures for handling, storing and disposing of these
materials must comply with federal, state and local laws and regulations,
including, among others, those relating to solid and hazardous waste
management, biohazard material handling, radiation and air pollution control.
We may be required to incur significant costs in the future to comply with
environmental or other applicable laws and regulations. In addition, we cannot
eliminate the risk of accidental contamination or injury from hazardous
materials. If a hazardous material accident were to occur, we could be held
liable for any resulting damages, and this liability could exceed our financial
resources. Accidents unrelated to our operations could cause federal, state or
local regulatory agencies to restrict our access to hazardous materials needed
in our research and development efforts, which could result in delays in our
research and development programs. Paying damages or experiencing delays caused
by restricted access could reduce our ability to generate revenue and make it
more difficult to fund our operations.

The intense competition and rapid technological change in our market may result
in pricing pressures and failure of our potential products to achieve market
acceptance.

We face increasingly intense competition from a number of commercial
entities and institutions that are developing gene therapy and cell therapy
technologies. Our competitors include early-stage and more established gene
delivery companies, other biotechnology companies, pharmaceutical companies,
universities, research institutions and government agencies developing gene
therapy products or other biotechnology-based therapies designed to treat the
diseases on which we focus. We also face competition from companies using more
traditional approaches to treating human diseases, such as surgery, medical
devices and pharmaceutical products. As our product candidates become
commercial gene therapy products that may affect commercial markets of the
analogous protein or traditional pharmaceutical therapy, disputes including
lawsuits, demands, threats or patent challenges may arise in an effort to slow
our development. In addition, we compete with other companies to acquire
products or technology from research institutions or universities. Many of our
competitors have substantially more financial and infrastructure

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resources and larger research and development staffs than we do. Many of
our competitors also have greater experience and capabilities than we do in:



| |  |  | research and development;                    
| | - |  | ---------------------------------------------
|
| |  |  | clinical trials;                             
|
| |  |  | obtaining FDA and other regulatory approvals;
|
| |  |  | manufacturing; and                           
|
| |  |  | marketing and distribution.                  

In addition, the competitive positions of other companies, institutions
and organizations, including smaller competitors, may be strengthened through
collaborative relationships. Consequently, our competitors may be able to
develop, obtain patent protection for, obtain regulatory approval for, or
commercialize new products more rapidly than we do, or manufacture and market
competitive products more successfully than we do. This could limit the prices
we could charge for the products that we are able to market or result in our
products failing to achieve market acceptance.

Gene therapy is a rapidly evolving field and is expected to continue to
undergo significant and rapid technological change and competition. Rapid
technological development by our competitors, including development of
technologies, products or processes that are more effective or more
economically feasible than those we have developed, could result in our actual
and proposed technologies, products or processes losing market share or
becoming obsolete.

Healthcare reform measures and the unwillingness of third-party payors to
provide adequate reimbursement for the cost of our products could impair our
ability to successfully commercialize our potential products and become
profitable.

Sales of medical products and treatments depends substantially, both
domestically and abroad, on the availability of reimbursement to the consumer
from third-party payors. Our potential products may not be considered
cost-effective by third-party payors, who may not provide coverage at the price
set for our products, if at all. If purchasers or users of our products are
unable to obtain adequate reimbursement, they may forego or reduce their use of
our products. Even if coverage is provided, the approved reimbursement amount
may not be high enough to allow us to establish or maintain pricing sufficient
to realize a sufficient return on our investment.

Increasing efforts by governmental and third-party payors, such as
Medicare, private insurance plans and managed care organizations, to cap or
reduce healthcare costs will affect our ability to commercialize our product
candidates and become profitable. We believe that third-party payors will
attempt to reduce healthcare costs by limiting both coverage and level of
reimbursement for new products approved by the FDA. There have been and will
continue to be a number of federal and state proposals to implement government
controls on pricing, the adoption of which could affect our ability to
successfully commercialize our product candidates. Even if the government does
not adopt any such proposals or reforms, their announcement could impair our
ability to raise capital.

Risks Related to Our Common Stock

Concentration of ownership of our common stock may give certain shareholders
significant influence over our business and the ability to disproportionately
affect our stock price.

A small number of investors own a significant number of shares of our
common stock. As of March 1, 2004, Biogen held approximately 12.1 million
shares, or 15.7% of our current common shares outstanding, and Elan and its
affiliates held approximately 7.7 million shares, or 10.0% of our current
common shares outstanding. Elan also holds convertible preferred stock that, if
converted, would result in Elan obtaining approximately 4.9 million additional
shares. At any time that Elans ownership exceeds 10% of our common stock, it
has the right to nominate one director, who shall be a member of the senior
management of Elan or otherwise acceptable to us, for election to our board of
directors. This concentration of stock ownership may allow these shareholders
to exercise significant control over our strategic decisions and block, delay
or substantially influence all matters requiring shareholder approval, such as:



| |  |  | election of directors;                                                                           
| | - |  | -------------------------------------------------------------------------------------------------
|
| |  |  | amendment of our charter documents; or                                                           
|
| |  |  | approval of significant corporate transactions, such as a change of control of Targeted Genetics.

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The interests of these shareholders may conflict with the interests of
other holders of our common stock with regard to such matters. Furthermore,
this concentration of ownership of our common stock could allow these
shareholders to delay, deter or prevent a third party from acquiring control of
Targeted Genetics at a premium over the then-current market price of our common
stock, which could result in a decrease in our stock price.

Further, Elan has registration rights with respect to its holdings
pursuant to a registration rights agreement dated July 21, 1999. If we permit
the registration of Elans shares for resale, this would allow Elan to sell
large quantities of stock which could adversely impact the price of our common
stock. In connection with the filing of a shelf registration statement in
August 2003, Elan was entitled to written notice of such filing, which we did
not provide on a timely basis. We have since provided such notice and can not
determine the impact of not providing the written notice on a timely basis.

Market fluctuations or volatility could cause the market price of our common
stock to decline and limit our ability to raise capital.

The stock market in general and the market for biotechnology-related
companies in particular have experienced extreme price and volume fluctuations,
often unrelated to the operating performance of the affected companies. The
market price of the securities of biotechnology companies, particularly
companies such as ours without earnings and product revenue, has been highly
volatile and is likely to remain so in the future. We believe that in the past,
similar levels of volatility have contributed to the decline in the market
price of our common stock, and may do so again in the future. Trading volumes
of our common stock can increase dramatically, resulting in a volatile market
price for our common stock. In addition, the trading price of our common stock
could decline significantly as a result of sales of a substantial number of
shares of our common stock, or the perception that significant sales could
occur. In the past, securities class action litigation has been brought against
companies that experience volatility in the market price of their securities.
Market fluctuations in the price of our common stock could also adversely
affect our collaborative opportunities and our future ability to sell equity
securities at a price we deem appropriate. As a result, you could lose all or
part of your investment.

Our future capital-raising activities could involve the issuance of equity
securities, which would dilute your investment and could result in a decline in
the trading price of our common stock.

To meet all or a portion of our long-term funding requirements, we may
sell securities in the public or private equity markets if and when conditions
are favorable, even if we do not have an immediate need for additional capital
at that time. Raising funds through the issuance of equity securities will
dilute the ownership of our existing shareholders. Furthermore, we may enter
into financing transactions at prices that represent a substantial discount to
market price. A negative reaction by investors and securities analysts to any
discounted sale of our equity securities could result in a decline in the
trading price of our common stock.

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Item 7A. Quantitative and Qualitative Disclosures About Market Risk

Short-term investments: Because of the short-term nature of our
investments, we believe that our exposure to market rate fluctuations on those
investments is minimal. Currently, we do not use any derivative or other
financial instruments or derivative commodity instruments to hedge any market
risks and do not plan to employ these instruments in the future. At December
31, 2003, we held $21.1 million in cash and cash equivalents, which are
primarily invested in a short-term bond fund that invests in securities that,
on the average, mature in less than 12 months. An analysis of the impact on
these securities of a hypothetical 10% change in short-term interest rates from
those in effect at December 31, 2003, indicates that such a change in interest
rates would not have a significant impact on our financial position or on our
expected results of operations in 2004.

Notes payable: Our results of operations are affected by changes in
short-term interest rates as a result of a loan from Biogen that contains a
variable interest rate. Interest payments on this loan are determined by the
LIBOR plus a margin of 1%. The carrying amounts of the notes payable and
equipment financing arrangements approximate fair value because the interest
rates on these instruments change with, or approximate, market rates. The
following table provides information as of December 31, 2003, about our
obligations that are sensitive to changes in interest rate fluctuations:

|                                     |                                |       |   |                        |           |      |   |         |           |      |   |            |            |  |   |        |        |  |   |            |            | 
|------------------------------------ | ------------------------------ | ----- | - | ---------------------- | --------- | ---- | - | ------- | --------- | ---- | - | ---------- | ---------- |  | - | ------ | ------ |  | - | ---------- | ---------- | 
|                                     |                                |       |   | Expected Maturity Date
|                                     |                                |       |   |                       
|                                     |                                |       |   | 2004                   |           | 2005 |   | 2006    |           | 2007 |   | Total     
|                                     |                                |       |   |                        |           |      |   |         |           |      |   |           
|Maturities of long-term
obligations: |                                |       |   |                        |           |      |   |         |           |      |   |            |            |  |   |        |        |  |   |           
|                                     | Variable rate note             |       | $ |                       |           |      | $ |        |           |      | $ | 10,000,000 |            |  | $ |       |        |  | $ | 10,000,000 |           
|                                     | Fixed rate notes               |       |   | 65,000                 |           |      |   | 590,000 |           |      |   |           |            |  |   |       |        |  |   | 655,000    |           
|                                     | Fixed rate equipment financing |       |   | 864,000                |           |      |   | 484,000 |           |      |   | 140,000    |            |  |   | 13,000 |        |  |   | 1,501,000  |           
|                                     | Other                          |       |   | 361,000                |           |      |   |        |           |      |   |           |            |  |   |       |        |  |   | 361,000    |           
|                                     |                                |       |   |                        |           |      |   |         |           |      |   |            |            |  |   |        |        |  |   |           
|                                     |                                | Total |   | $                      | 1,290,000 |      |   | $       | 1,074,000 |      |   | $          | 10,140,000 |  |   | $      | 13,000 |  |   | $          | 12,517,000 | 
|                                     |                                |       |   |                        |           |      |   |         |           |      |   |            |            |  |   |        |        |  |   |           

38



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##### Table of Contents






Item 8. Financial Statements and Supplementary Data.

|                                                                                                                         |  |      |    | 
|------------------------------------------------------------------------------------------------------------------------ |  | ---- | -- | 
|                                                                                                                         |  | Page
|                                                                                                                         |  |     
|Report of Ernst & Young LLP, Independent Auditors                                                                        |  |      | 40 | 
|Consolidated Balance Sheets as of December 31, 2003 and 2002                                                             |  |      | 41 | 
|Consolidated Statements of Operations for the years ended December
31, 2003, 2002 and 2001                               |  |      | 42 | 
|Consolidated Statements of Preferred Stock and Shareholders Equity
for the years ended December 31, 2003, 2002 and 2001 |  |      | 43 | 
|Consolidated Statements of Cash Flows for the years ended December
31, 2003, 2002 and 2001                               |  |      | 44 | 
|Notes to Consolidated Financial Statements                                                                               |  |      | 45 | 

39



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##### Table of Contents



REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS

The Board of Directors and Shareholders
Targeted Genetics Corporation

We have audited the accompanying consolidated balance sheets of Targeted
Genetics Corporation as of December 31, 2003 and 2002, and the related
consolidated statements of operations, preferred stock and shareholders
equity, and cash flows for each of the three years in the period ended December
31, 2003. These financial statements are the responsibility of the Companys
management. Our responsibility is to express an opinion on these financial
statements based on our audits.

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

In our opinion, the financial statements referred to above present fairly,
in all material respects, the consolidated financial position of Targeted
Genetics Corporation at December 31, 2003 and 2002, and the consolidated
results of its operations and its cash flows for each of the three years in the
period ended December 31, 2003 in conformity with accounting principles
generally accepted in the United States.

As discussed in Note 1 to the consolidated financial statements, in 2002
the Company changed its method of accounting for goodwill and other intangible
assets.

ERNST & YOUNG LLP

Seattle, Washington
February 13, 2004

40



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##### Table of Contents



TARGETED GENETICS CORPORATION

CONSOLIDATED BALANCE SHEETS

|                                                   |                                                                                                                                                                                               |                                                                                  |                                      |              |            |              |            |              |            |  |  | 
|-------------------------------------------------- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- | -------------------------------------------------------------------------------- | ------------------------------------ | ------------ | ---------- | ------------ | ---------- | ------------ | ---------- |  |  | 
|                                                   |                                                                                                                                                                                               |                                                                                  |                                      |              |            | December 31,
|                                                   |                                                                                                                                                                                               |                                                                                  |                                      |              |            |             
|                                                   |                                                                                                                                                                                               |                                                                                  |                                      |              |            | 2003         |            | 2002        
|                                                   |                                                                                                                                                                                               |                                                                                  |                                      |              |            |              |            |             
|                                                   |                                                                                                                                                                                               |                                                                                  |                                      | ASSETS       |            |              |            |              |            |  |  | 
|Current assets:                                    |                                                                                                                                                                                               |                                                                                  |                                      |              |            |              |            |             
|                                                   | Cash and cash equivalents                                                                                                                                                                     |                                                                                  | $                                    | 21,057,000   |            |              | $          | 12,606,000   |           
|                                                   | Accounts receivable                                                                                                                                                                           |                                                                                  |                                      | 166,000      |            |              |            | 1,170,000    |           
|                                                   | Prepaid expenses and other                                                                                                                                                                    |                                                                                  |                                      | 409,000      |            |              |            | 452,000      |           
|                                                   |                                                                                                                                                                                               |                                                                                  |                                      |              |            |              |            |             
|                                                   |                                                                                                                                                                                               | Total current assets                                                             |                                      |              | 21,632,000 |              |            |              | 14,228,000 | 
|Property and equipment, net                        |                                                                                                                                                                                               |                                                                                  | 3,423,000                            |              |            |              | 5,520,000  |             
|Goodwill, net                                      |                                                                                                                                                                                               |                                                                                  | 31,649,000                           |              |            |              | 31,649,000 |             
|Other assets                                       |                                                                                                                                                                                               |                                                                                  | 968,000                              |              |            |              | 1,316,000  |             
|                                                   |                                                                                                                                                                                               |                                                                                  |                                      |              |            |              |            |             
|Total assets                                       |                                                                                                                                                                                               | $                                                                                | 57,672,000                           |              |            | $            | 52,713,000 |             
|                                                   |                                                                                                                                                                                               |                                                                                  |                                      |              |            |              |            |             
|                                                   |                                                                                                                                                                                               |                                                                                  | LIABILITIES AND SHAREHOLDERS EQUITY |              |            |              |            |              |            |  | 
|Current liabilities:                               |                                                                                                                                                                                               |                                                                                  |                                      |              |            |              |            |             
|                                                   | Accounts payable and accrued expenses                                                                                                                                                         |                                                                                  | $                                    | 1,271,000    |            |              | $          | 2,012,000    |           
|                                                   | Accrued employee expenses                                                                                                                                                                     |                                                                                  |                                      | 1,564,000    |            |              |            | 729,000      |           
|                                                   | Accrued restructure charges                                                                                                                                                                   |                                                                                  |                                      | 1,404,000    |            |              |            | 1,202,000    |           
|                                                   | Deferred revenue                                                                                                                                                                              |                                                                                  |                                      | 1,180,000    |            |              |            | 6,041,000    |           
|                                                   | Current portion of long-term obligations                                                                                                                                                      |                                                                                  |                                      | 1,290,000    |            |              |            | 1,298,000    |           
|                                                   |                                                                                                                                                                                               |                                                                                  |                                      |              |            |              |            |             
|                                                   |                                                                                                                                                                                               | Total current liabilities                                                        |                                      |              | 6,709,000  |              |            |              | 11,282,000 | 
|Accrued restructure charges and deferred rent      |                                                                                                                                                                                               |                                                                                  | 5,507,000                            |              |            |              | 2,276,000  |             
|Long-term obligations                              |                                                                                                                                                                                               |                                                                                  | 11,227,000                           |              |            |              | 20,494,000 |             
|Commitments (Note 9)                               |                                                                                                                                                                                               |                                                                                  |                                      |              |            |              |            |             
|Minority interest in preferred stock of subsidiary |                                                                                                                                                                                               |                                                                                  | 750,000                              |              |            |              | 750,000    |             
|Series B convertible exchangeable preferred stock  |                                                                                                                                                                                               |                                                                                  |                                     |              |            |              | 12,015,000 |             
|Shareholders equity:                              |                                                                                                                                                                                               |                                                                                  |                                      |              |            |              |            |             
|                                                   | Preferred stock, $0.01 par value, 6,000,000 shares authorized:                                                                                                                                |                                                                                  |                                      |              |            |              |            |              |           
|                                                   |                                                                                                                                                                                               | Series A preferred stock, 800,000 shares designated, none issued and
outstanding |                                      |              |           |              |            |              |           | 
|                                                   |                                                                                                                                                                                               | Series B preferred stock, 12,015 shares designated, issued and outstanding       |                                      |              |           |              |            |              |           | 
|                                                   | Common stock, $0.01 par value, 120,000,000 shares authorized, 66,206,230 shares
issued and outstanding at December 31, 2003 and 50,566,348 shares issued and
outstanding at December 31, 2002 |                                                                                  |                                      | 662,000      |            |              |            | 506,000      |           
|                                                   | Additional paid-in capital                                                                                                                                                                    |                                                                                  |                                      | 249,399,000  |            |              |            | 207,139,000  |           
|                                                   | Accumulated deficit                                                                                                                                                                           |                                                                                  |                                      | (216,582,000 | )          |              |            | (201,749,000 | )         
|                                                   |                                                                                                                                                                                               |                                                                                  |                                      |              |            |              |            |             
|                                                   |                                                                                                                                                                                               | Total shareholders equity                                                       |                                      |              | 33,479,000 |              |            |              | 5,896,000  | 
|                                                   |                                                                                                                                                                                               |                                                                                  |                                      |              |            |              |            |             
|Total liabilities and shareholders equity         |                                                                                                                                                                                               | $                                                                                | 57,672,000                           |              |            | $            | 52,713,000 |             
|                                                   |                                                                                                                                                                                               |                                                                                  |                                      |              |            |              |            |             

See accompanying notes to consolidated financial statements

41



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TARGETED GENETICS CORPORATION

CONSOLIDATED STATEMENTS OF OPERATIONS

|                                                                         |                                                                                                   |                          |             |                         |            |      |             |            |            |   |             |            |            | 
|------------------------------------------------------------------------ | ------------------------------------------------------------------------------------------------- | ------------------------ | ----------- | ----------------------- | ---------- | ---- | ----------- | ---------- | ---------- | - | ----------- | ---------- | ---------- | 
|                                                                         |                                                                                                   |                          |             | Year Ended December 31,
|                                                                         |                                                                                                   |                          |             |                        
|                                                                         |                                                                                                   |                          |             | 2003                    |            | 2002 |             | 2001      
|                                                                         |                                                                                                   |                          |             |                         |            |      |             |           
|Revenue:                                                                 |                                                                                                   |                          |             |                         |            |      |             |            |            |   |             |           
|                                                                         | Collaborative agreements                                                                          |                          | $           | 14,073,000              |            |      | $           | 17,362,000 |            |   | $           | 16,117,000 |           
|                                                                         | Collaborative
agreement with unconsolidated,
majority-owned
research anddevelopment joint venture |                          |             |                        |            |      |             | 1,971,000  |            |   |             | 2,763,000  |           
|                                                                         |                                                                                                   |                          |             |                         |            |      |             |            |            |   |             |           
|                                                                         |                                                                                                   | Total revenue            |             |                         | 14,073,000 |      |             |            | 19,333,000 |   |             |            | 18,880,000 | 
|                                                                         |                                                                                                   |                          |             |                         |            |      |             |            |            |   |             |           
|Operating expenses:                                                      |                                                                                                   |                          |             |                         |            |      |             |            |            |   |             |           
|                                                                         | Research and development                                                                          |                          |             | 17,197,000              |            |      |             | 29,389,000 |            |   |             | 29,218,000 |           
|                                                                         | General and administrative                                                                        |                          |             | 5,490,000               |            |      |             | 8,067,000  |            |   |             | 8,531,000  |           
|                                                                         | Restructure charges                                                                               |                          |             | 5,190,000               |            |      |             | 2,327,000  |            |   |             |           |           
|                                                                         | Equity
in net loss of unconsolidated,majority-owned research
anddevelopment joint venture         |                          |             |                        |            |      |             | 1,926,000  |            |   |             | 3,666,000  |           
|                                                                         | Amortization of acquisition-related intangibles                                                   |                          |             |                        |            |      |             | 365,000    |            |   |             | 6,069,000  |           
|                                                                         |                                                                                                   |                          |             |                         |            |      |             |            |            |   |             |           
|                                                                         |                                                                                                   | Total operating expenses |             |                         | 27,877,000 |      |             |            | 42,074,000 |   |             |            | 47,484,000 | 
|                                                                         |                                                                                                   |                          |             |                         |            |      |             |            |            |   |             |           
|Loss from operations                                                     |                                                                                                   |                          | (13,804,000 | )                       |            |      | (22,741,000 | )          |            |   | (28,604,000 | )         
|Investment income                                                        |                                                                                                   |                          | 183,000     |                         |            |      | 398,000     |            |            |   | 1,886,000   |           
|Interest expense                                                         |                                                                                                   |                          | (1,212,000  | )                       |            |      | (1,424,000  | )          |            |   | (452,000    | )         
|                                                                         |                                                                                                   |                          |             |                         |            |      |             |            |            |   |             |           
|Net loss                                                                 |                                                                                                   | $                        | (14,833,000 | )                       |            | $    | (23,767,000 | )          |            | $ | (27,170,000 | )         
|                                                                         |                                                                                                   |                          |             |                         |            |      |             |            |            |   |             |           
|Net loss per common share (basic and diluted)                            |                                                                                                   | $                        | (0.26       | )                       |            | $    | (0.52       | )          |            | $ | (0.62       | )         
|                                                                         |                                                                                                   |                          |             |                         |            |      |             |            |            |   |             |           
|Shares
used in computation of basic and dilutednet loss per common share |                                                                                                   |                          | 57,486,000  |                         |            |      | 45,767,000  |            |            |   | 43,928,000  |           
|                                                                         |                                                                                                   |                          |             |                         |            |      |             |            |            |   |             |           

See accompanying notes to consolidated financial statements

42



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##### Table of Contents



TARGETED GENETICS CORPORATION CONSOLIDATED STATEMENTS OF PREFERRED STOCK
AND SHAREHOLDERS EQUITY Series BPreferred Stock
    
    
    Common Stock
    
    Additional Paid
    
    Accumulated
    
    TotalShareholders'Shares
    
    Amount
    
    
    Shares
    
    Amount
    
    In Capital
    
    Deficit
    
    EquityBalance at January 1, 2001
    
    
    12,015
    
    
    $
    12,015,000
    
    
    
    
    42,608,943
    
    
    $
    426,000
    
    
    $
    201,803,000
    
    
    $
    (150,812,000
    )
    
    $
    51,417,000Net loss and comprehensive
loss2001
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (27,170,000
    )
    
    
    (27,170,000
    )Cancellation of shares held in
escrow related to Genovo acquisition
    
    
    
    
    
    
    
    
    
    
    
    (155,649
    )
    
    
    (2,000
    )
    
    
    (1,998,000
    )
    
    
    
    
    
    
    (2,000,000
    )Exercise of stock options
    
    
    
    
    
    
    
    
    
    
    
    672,383
    
    
    
    7,000
    
    
    
    1,052,000
    
    
    
    
    
    
    
    1,059,000Exercise of warrants
    
    
    
    
    
    
    
    
    
    
    
    1,000,000
    
    
    
    10,000
    
    
    
    1,990,000
    
    
    
    
    
    
    
    2,000,000Stock based compensation
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    80,000
    
    
    
    
    
    
    
    80,000Balance at December 31, 2001
    
    
    12,015
    
    
    
    12,015,000
    
    
    
    
    44,125,677
    
    
    
    441,000
    
    
    
    202,927,000
    
    
    
    (177,982,000
    )
    
    
    25,386,000Net loss and comprehensive
loss2002
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (23,767,000
    )
    
    
    (23,767,000
    )Cancellation of shares held in
escrow related to Genovo acquisition
    
    
    
    
    
    
    
    
    
    
    
    (1,549
    )
    
    
    
    
    
    
    (20,000
    )
    
    
    
    
    
    
    (20,000
    )Exercise of stock options
    
    
    
    
    
    
    
    
    
    
    
    35,053
    
    
    
    1,000
    
    
    
    37,000
    
    
    
    
    
    
    
    38,000Issuance of common stock to Biogen
for cash
    
    
    
    
    
    
    
    
    
    
    
    5,804,673
    
    
    
    58,000
    
    
    
    3,919,000
    
    
    
    
    
    
    
    3,977,000Issuance of common stock related to
Genovo acquisition
    
    
    
    
    
    
    
    
    
    
    
    602,494
    
    
    
    6,000
    
    
    
    276,000
    
    
    
    
    
    
    
    282,000Balance at December 31, 2002
    
    
    12,015
    
    
    
    12,015,000
    
    
    
    
    50,566,348
    
    
    
    506,000
    
    
    
    207,139,000
    
    
    
    (201,749,000
    )
    
    
    5,896,000Net loss and comprehensive
loss2003
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (14,833,000
    )
    
    
    (14,833,000
    )Reclassification of Series B
convertible preferred stock
    
    
    
    
    
    
    (12,015,000
    )
    
    
    
    
    
    
    
    
    
    
    
    12,015,000
    
    
    
    
    
    
    
    12,015,000Issuance of shares in public offering
    
    
    
    
    
    
    
    
    
    
    
    7,777,778
    
    
    
    78,000
    
    
    
    16,037,000
    
    
    
    
    
    
    
    16,115,000Issuance of common stock to Biogen
for cash
    
    
    
    
    
    
    
    
    
    
    
    2,515,843
    
    
    
    25,000
    
    
    
    4,768,000
    
    
    
    
    
    
    
    4,793,000Issuance of common stock to Elan for
debt conversion
    
    
    
    
    
    
    
    
    
    
    
    5,203,244
    
    
    
    52,000
    
    
    
    9,315,000
    
    
    
    
    
    
    
    9,367,000Exercise of stock options
    
    
    
    
    
    
    
    
    
    
    
    143,017
    
    
    
    1,000
    
    
    
    125,000
    
    
    
    
    
    
    
    126,000Balance at December 31, 2003
    
    
    12,015
    
    
    $
    
    
    
    
    
    66,206,230
    
    
    $
    662,000
    
    
    $
    249,399,000
    
    
    $
    (216,582,000
    )
    
    $
    33,479,000
 See accompanying notes to consolidated financial statements 43




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##### Table of Contents



See accompanying notes to consolidated financial statements

TARGETED GENETICS CORPORATION

CONSOLIDATED STATEMENTS OF CASH FLOWS

|                                                     |                                                                                     |                                                                                             |                                                                                                                       |             |                         |            |             |             |           |            |             |             |           |            |  
|---------------------------------------------------- | ----------------------------------------------------------------------------------- | ------------------------------------------------------------------------------------------- | --------------------------------------------------------------------------------------------------------------------- | ----------- | ----------------------- | ---------- | ----------- | ----------- | --------- | ---------- | ----------- | ----------- | --------- | ---------- | -
|                                                     |                                                                                     |                                                                                             |                                                                                                                       |             | Year Ended December 31,
|                                                     |                                                                                     |                                                                                             |                                                                                                                       |             |                        
|                                                     |                                                                                     |                                                                                             |                                                                                                                       |             | 2003                    |            | 2002        |             | 2001     
|                                                     |                                                                                     |                                                                                             |                                                                                                                       |             |                         |            |             |             |          
|Operating activities:                                |                                                                                     |                                                                                             |                                                                                                                       |             |                         |            |             |             |           |            |             |            
|                                                     | Net loss                                                                            |                                                                                             | $                                                                                                                     | (14,833,000 | )                       |            | $           | (23,767,000 | )         |            | $           | (27,170,000 | )        
|                                                     | Adjustments to reconcile net loss to net cash used in operating
activities:         |                                                                                             |                                                                                                                       |             |                         |            |             |             |           |            |             |             |          
|                                                     |                                                                                     | Depreciation and amortization                                                               |                                                                                                                       |             | 2,420,000               |            |             |             | 3,252,000 |            |             |             | 2,623,000 |           
|                                                     |                                                                                     | Non cash interest expense                                                                   |                                                                                                                       |             | 822,000                 |            |             |             | 825,000   |            |             |             | 120,000   |           
|                                                     |                                                                                     | Equity in net loss of unconsolidated, majority-owned research
and development joint venture |                                                                                                                       |             |                        |            |             |             | 1,926,000 |            |             |             | 3,666,000 |           
|                                                     |                                                                                     | Amortization of acquisition-related intangibles                                             |                                                                                                                       |             |                        |            |             |             | 365,000   |            |             |             | 6,069,000 |           
|                                                     |                                                                                     | Loss on disposal of assets                                                                  |                                                                                                                       |             |                        |            |             |             | 99,000    |            |             |             |          |           
|                                                     |                                                                                     | Stock-based compensation expense                                                            |                                                                                                                       |             |                        |            |             |             |          |            |             |             | 80,000    |           
|                                                     |                                                                                     | Changes in assets and liabilities:                                                          |                                                                                                                       |             |                         |            |             |             |           |            |             |             |           |           
|                                                     |                                                                                     |                                                                                             | Decrease (increase) in accounts receivable                                                                            |             |                         | 1,004,000  |             |             |           | (816,000   | )           |             |           | (1,388,000 | )
|                                                     |                                                                                     |                                                                                             | Decrease (increase) in prepaid expenses and other                                                                     |             |                         | 43,000     |             |             |           | 482,000    |             |             |           | (643,000   | )
|                                                     |                                                                                     |                                                                                             | Decrease in other assets                                                                                              |             |                         | 348,000    |             |             |           | 174,000    |             |             |           | 178,000    |  
|                                                     |                                                                                     |                                                                                             | Increase (decrease) in current liabilities                                                                            |             |                         | 394,000    |             |             |           | (1,609,000 | )           |             |           | 121,000    |  
|                                                     |                                                                                     |                                                                                             | Decrease in deferred revenue                                                                                          |             |                         | (4,861,000 | )           |             |           | (3,555,000 | )           |             |           | (6,719,000 | )
|                                                     |                                                                                     |                                                                                             | Increase in accrued restructure expenses and deferred rent                                                            |             |                         | 3,433,000  |             |             |           | 1,635,000  |             |             |           | 236,000    |  
|                                                     |                                                                                     |                                                                                             | Decrease (increase) in accounts receivable from
unconsolidated, majority-owned research and development
joint venture |             |                         |           |             |             |           | 893,000    |             |             |           | (716,000   | )
|                                                     |                                                                                     |                                                                                             |                                                                                                                       |             |                         |            |             |             |           |            |             |            
|Net cash used in operating activities                |                                                                                     |                                                                                             | (11,230,000                                                                                                           | )           |                         |            | (20,096,000 | )           |           |            | (23,543,000 | )          
|                                                     |                                                                                     |                                                                                             |                                                                                                                       |             |                         |            |             |             |           |            |             |            
|Investing activities:                                |                                                                                     |                                                                                             |                                                                                                                       |             |                         |            |             |             |           |            |             |            
|                                                     | Purchases of property and equipment                                                 |                                                                                             |                                                                                                                       | (316,000    | )                       |            |             | (563,000    | )         |            |             | (4,411,000  | )        
|                                                     | Investment in unconsolidated, majority-owned research and
development joint venture |                                                                                             |                                                                                                                       |            |                         |            |             | (1,926,000  | )         |            |             | (2,805,000  | )        
|                                                     |                                                                                     |                                                                                             |                                                                                                                       |             |                         |            |             |             |           |            |             |            
|Net cash used in investing activities                |                                                                                     |                                                                                             | (316,000                                                                                                              | )           |                         |            | (2,489,000  | )           |           |            | (7,216,000  | )          
|                                                     |                                                                                     |                                                                                             |                                                                                                                       |             |                         |            |             |             |           |            |             |            
|Financing activities:                                |                                                                                     |                                                                                             |                                                                                                                       |             |                         |            |             |             |           |            |             |            
|                                                     | Net proceeds from sales of capital stock                                            |                                                                                             |                                                                                                                       | 21,028,000  |                         |            |             | 4,014,000   |           |            |             | 3,059,000   |          
|                                                     | Proceeds from leasehold improvements and equipment financing
arrangements           |                                                                                             |                                                                                                                       | 229,000     |                         |            |             | 607,000     |           |            |             | 2,401,000   |          
|                                                     | Payments under leasehold improvements and equipment financing
arrangements          |                                                                                             |                                                                                                                       | (1,260,000  | )                       |            |             | (1,316,000  | )         |            |             | (1,145,000  | )        
|                                                     | Loan proceeds from collaborative partners                                           |                                                                                             |                                                                                                                       |            |                         |            |             | 5,950,000   |           |            |             | 13,000,000  |          
|                                                     | Minority interest contribution                                                      |                                                                                             |                                                                                                                       |            |                         |            |             | 750,000     |           |            |             |            |          
|                                                     |                                                                                     |                                                                                             |                                                                                                                       |             |                         |            |             |             |           |            |             |            
|Net cash provided by financing activities            |                                                                                     |                                                                                             | 19,997,000                                                                                                            |             |                         |            | 10,005,000  |             |           |            | 17,315,000  |            
|                                                     |                                                                                     |                                                                                             |                                                                                                                       |             |                         |            |             |             |           |            |             |            
|Net increase (decrease) in cash and cash equivalents |                                                                                     |                                                                                             | 8,451,000                                                                                                             |             |                         |            | (12,580,000 | )           |           |            | (13,444,000 | )          
|Cash and cash equivalents, beginning of year         |                                                                                     |                                                                                             | 12,606,000                                                                                                            |             |                         |            | 25,186,000  |             |           |            | 38,630,000  |            
|                                                     |                                                                                     |                                                                                             |                                                                                                                       |             |                         |            |             |             |           |            |             |            
|Cash and cash equivalents, end of year               |                                                                                     | $                                                                                           | 21,057,000                                                                                                            |             |                         | $          | 12,606,000  |             |           | $          | 25,186,000  |            
|                                                     |                                                                                     |                                                                                             |                                                                                                                       |             |                         |            |             |             |           |            |             |            
|Supplemental information:                            |                                                                                     |                                                                                             |                                                                                                                       |             |                         |            |             |             |           |            |             |            
|                                                     | Cash paid for interest                                                              |                                                                                             | $                                                                                                                     | 459,000     |                         |            | $           | 439,000     |           |            | $           | 269,000     |          
|                                                     | Acquisition-related common stock issued (recovered)                                 |                                                                                             |                                                                                                                       |            |                         |            |             | 282,000     |           |            |             | (2,000,000  | )        

See accompanying notes to consolidated financial statements

44



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TARGETED GENETICS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 1. Description of Business and Summary of Significant Accounting Policies Description of Business Targeted Genetics was incorporated in the state of Washington in March
1989. We operate our business in one reportable segment: research and product
development. On both our own behalf and in connection with various
collaborative agreements with others, we conduct research and development of
gene therapy products and technologies for treating both acquired and inherited
diseases. Basis of Presentation Our consolidated financial statements include the accounts of Targeted
Genetics, our wholly-owned subsidiaries Genovo, Inc., or Genovo, and TGCF
Manufacturing Corporation (inactive), and our majority-owned subsidiary,
CellExSys, Inc. The consolidated financial statements do not include Emerald
Gene Systems, Ltd., or Emerald, our unconsolidated, majority-owned research and
development joint venture with Elan International Services Ltd., a wholly-owned
subsidiary of Elan Corporation plc, or Elan, because we do not have operating
control of the joint venture. The operations of Emerald terminated during 2002
and there are no ongoing operating activities. All significant inter-company
transactions have been eliminated in consolidation. Cash Equivalents Cash equivalents include short-term investments that have a maturity at
the time of purchase of three months or less, are readily convertible into cash
and have insignificant interest rate risk. Our cash equivalents are recorded at
cost, which approximates fair market value, and consist principally of shares
in a limited-maturity mutual fund and money market accounts. Fair Value of Financial Instruments We believe that the carrying amounts of financial instruments such as cash
and cash equivalents, accounts receivable and accounts payable approximate fair
value, because of the short-term nature of these items. We believe that the
carrying amounts of the notes payable and equipment financing obligations
approximate fair value because the interest rates on these instruments change
with, or approximate, market interest rates. Property and Equipment Property
and equipment is stated at cost less
accumulated depreciation. We compute depreciation of property and equipment
using the straight-line method over the assets estimated useful life, which
ranges from three to seven years. Leasehold improvements are amortized over the
assets estimated useful life or the lease term, whichever is shorter.
Depreciation expense was $1.1 million in 2003, $1.3 million in 2002 and $1.2
million in 2001. Goodwill Goodwill consists of acquired technology that is core to our development
programs. On January 1, 2002, we adopted Statement of Financial Accounting
Standards, or SFAS, No. 142, Goodwill and Other Intangible Assets.SFAS No.
142 discontinues the amortization of goodwill and certain indefinite lived
intangibles. This accounting standard required us to complete a transitional
impairment test upon adoption to determine if an impairment in the value of
goodwill existed. We performed a transitional impairment test as of January 1,
2002 and no impairment in the value of our goodwill existed as of that date. In
accordance with SFAS No. 142, we test goodwill for impairment in value at least
annually and more frequently if impairment indicators arise, and if goodwill is
impaired, we will write down the value of goodwill through a charge to expense.
We performed annual impairment tests as of October 1, 2003 and October 1, 2002
and concluded that no impairment in the value of our goodwill had occurred. 45




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TARGETED GENETICS CORPORATION NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS - (Continued) The following table presents our results of operations for the years ended
December 31, 2003, 2002 and 2001 and reconciles the results of operations we
reported for the year ended December 31, 2001 to the amounts adjusted for the
elimination of goodwill amortization that we would have recorded had we adopted
SFAS No. 142 as of the beginning of 2001: Year ended December 31,2003
    
    2002
    
    2001Net loss
    
    $
    (14,833,000
    )
    
    $
    (23,767,000
    )
    
    $
    (27,170,000
    )Elimination of goodwill amortization
    
    
    
    
    
    
    
    
    
    
    5,564,000Net loss, as adjusted
    
    $
    (14,833,000
    )
    
    $
    (23,767,000
    )
    
    $
    (21,606,000
    )Net loss per common share:Net loss per common share, as reported
    
    $
    (0.26
    )
    
    $
    (0.52
    )
    
    $
    (0.62
    )Elimination of goodwill amortization
    
    
    
    
    
    
    
    
    
    
    0.13Net loss per common share, as adjusted
    
    $
    (0.26
    )
    
    $
    (0.52
    )
    
    $
    (0.49
    )
 Other Assets We have reported a $400,000 certificate of deposit in other assets as it
is collateral for the operating lease of our Bothell, Washington facility. Long-Lived Assets On January 1, 2002, we adopted SFAS No. 144, Accounting for the
Impairment or Disposal of Long-Lived Assets. In accordance with SFAS No. 144,
we review the carrying value and fair value of long-lived assets whenever
events or changes in circumstances indicate that there may be impairment in
value. Conditions that would necessitate an impairment assessment include a
significant decline in the observable market value of an asset, a significant
change in the extent or manner in which an asset is used, or a significant
adverse change that would indicate that the carrying amount of an asset or
group of assets is not recoverable. Accrued Restructure Charges We have adopted the provisions of SFAS No. 146, Accounting for Costs
Associated with Exit or Disposal Activities,as it relates to our facilities
in Bothell, Washington and Sharon Hill, Pennsylvania and we have recorded
restructuring charges on the related operating leases. SFAS 146 was effective
for exit or disposal activities initiated after December 31, 2002; however, as
allowed for, we early adopted this pronouncement in the fourth quarter of 2002.
Accrued restructuring charges, and in particular, those charges associated
with exiting a facility, are subject to many assumptions and estimates. Under
SFAS 146, an accrued liability for lease termination costs is initially
measured at fair value, based on the remaining lease payments due under the
lease and other costs, reduced by sublease rental income that could be
reasonably obtained from the property, and discounted using a credit-adjusted
risk-free interest rate. We use a risk free annual interest rate of 10%. The
assumptions as to estimated sublease rental income, the period of time, costs,
and concessions necessary to enter into a sublease significantly impact the
accrual and may differ from what actually occurs. We review these estimates
quarterly and adjust the accrual if necessary. Series B Convertible Preferred Stock In July 1999, we issued shares of our Series B convertible exchangeable
preferred stock, valued at $12 million, to Elan in exchange for our 80.1%
interest in Emerald. The Series B preferred stock and accrued dividends are
convertible at Elans option into shares of our common stock, at a conversion
price of $3.32 per share. Compounding dividends accrue semi-annually at 7% per
year on the $1,000 per share face value of the preferred stock until July 2005.
Dividends are not paid in cash, but rather result in an increase in the number
of shares of common stock to be issued upon conversion. The Series B preferred
stock and accrued dividends were convertible into 4,765,500 shares of our
common stock at December 31, 2003, and unless converted earlier, will become
convertible into approximately 5.5 million shares of our common stock in July
2005 when the accrual of dividends ends. 46




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TARGETED GENETICS CORPORATION NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS - (Continued) Elan was entitled to exchange the Series B preferred stock for all shares
of preferred stock that we hold in Emerald until this exchange right expired in
April 2003. As a result of the expiration of the exchange right, we have
reclassified the Series B preferred stock from mezzanine equity to
shareholders equity. Stock Compensation As permitted by the provisions of SFAS No. 123, Accounting for
Stock-Based Compensation, we have elected to follow Accounting Principles
Board Opinion No. 25, Accounting for Stock Issued to Employees,and related
interpretations in accounting for employee stock option grants. In addition,
we follow the disclosure requirements of SFAS No. 148, Accounting for
Stock-Based Compensation  Transition and Disclosure  an amendment of SFAS No.
123,which require prominent disclosures in both annual and interim financial
statements about the method of accounting for stock-based employee compensation
and the effect of the method used on reported results. We provide this
disclosure in Note 6 to the Consolidated Financial Statements. We do not
recognize any compensation expense for options granted to employees because we
grant all options at fair market value on the date of grant. Options granted to
consultants are recorded as an expense over their vesting term based on their
fair value, which is determined using the Black-Scholes method. As
allowed by SFAS No.1 23, we do not recognize compensation expense on
stock options granted to employees and directors. If we had elected to
recognize compensation expense based on the fair market value at the grant
dates for stock options granted, the pro forma net loss and net loss per common
share would have been as follows: 2003
    
    2002
    
    2001Net loss:as reported
    
    $
    (14,833,000
    )
    
    $
    (23,767,000
    )
    
    $
    (27,170,000
    )stock-based compensation under SFAS 123
    
    
    (780,000
    )
    
    
    (2,532,000
    )
    
    
    (3,599,000
    )pro forma
    
    $
    (15,613,000
    )
    
    $
    (26,299,000
    )
    
    $
    (30,769,000
    )Basic net loss per share:as reported
    
    $
    (0.26
    )
    
    $
    (0.52
    )
    
    $
    (0.62
    )pro forma
    
    
    (0.27
    )
    
    
    (0.57
    )
    
    
    (0.70
    )
 Revenue Recognition under Collaborative Agreements We generate revenue from technology licenses, collaborative research
arrangements and cost reimbursement contracts. Revenue under technology
licenses and collaborative agreements typically consists of nonrefundable,
up-front license fees, collaborative research funding, technology access fees
and various other payments. Revenue from nonrefundable, up-front license fees and technology access
payments is initially deferred and then recognized systematically over the
service period of the collaborative agreement, which is often the development
period. Revenue associated with performance milestones is recognized as earned,
based upon the achievement of the milestones defined in the applicable
agreements. Revenue under research and development cost-reimbursement contracts
is recognized as the related costs are incurred. Payments received in excess of
amounts earned are classified as deferred revenue in the accompanying
Consolidated Balance Sheets. Relationships with Strategic Partners In connection with our collaborations with Biogen, Inc., Celltech Group
plc and Genzyme Corporation and our joint venture with Elan, each strategic
partner purchased shares of our common stock. The number of shares of our
common stock that we issued to each of our strategic partners represented less
than 20% of our total shares then outstanding. Our collaborations with Biogen,
Celltech and Genzyme have concluded and our Emerald Gene Systems joint venture
with Elan is inactive. Generally, we cannot control or monitor shares of our
stock that these partners and former partners may buy or sell in open market
transactions. Although each of our former collaborative partners influenced the
activities specific to their collaborations with us, our partners did not
influence our management or operating policies generally or otherwise
significantly influence our operating activities. Significant Revenue Relationships and Concentration of Risk Biogen, Celltech, IAVI and Wyeth accounted for substantially all of the
revenue we recorded from collaborative agreements in 2003, 2002 and 2001. All
of our revenue from the collaborative agreement with unconsolidated,
majority-owned research and development joint venture is from Emerald, our
80.1%-owned joint venture with Elan. Our collaborations with Biogen,
Celltech, Wyeth and our joint venture with Elan 47




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TARGETED GENETICS CORPORATION NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS - (Continued) have concluded and
these sources of revenue have ended leaving IAVI as our primary source of
revenue for 2004. A change in the level of work or funding received from IAVI
could disrupt our business and adversely affect our cash flow and results of
operations. Research and Development Costs Research and development costs include salaries, costs of outside
collaborators and outside services, clinical trial expenses, royalty and
license costs and allocated facility, occupancy and utility expenses. We
expense research and development costs as incurred. Costs and expenses related
to programs conducted under collaborative agreements that result in
collaborative revenue totaled approximately $9.7 million in
2003, $14.7 million in 2002 and $13.5 million in 2001. Net Loss per Common Share Net loss per common share is based on net loss divided by the weighted
average number of common shares outstanding during the period. Our diluted net
loss per share is the same as our basic net loss per share because all stock
options, warrants and other potentially dilutive securities are antidilutive
and therefore excluded from the calculation of diluted net loss per share. The
total number of shares that we excluded from the calculations of net loss per
share were 10,867,013 shares in 2003, 17,284,151 shares in 2002 and 13,871,348
shares in 2001. Use of Estimates The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the amounts reported in the financial statements and
accompanying notes. Our actual results may differ from those estimates. Recently Issued Accounting Standards In July 2000, the Financial Accounting Standards Board, or FASB, issued
Emerging Issues Task Force, or EITF, Issue No. 00-21, Revenue Arrangements
with Multiple Deliverables.This issue addresses accounting for revenue under
agreements with multiple revenue-generating activities and became effective for
revenue arrangements entered into after September 1, 2003. We will adopt the
provisions of EITF No. 00-21 for any new revenue arrangements and do not expect
the provisions of EITF No. 00-21 to have a significant effect on our financial
position or operating results. In January 2003, the FASB issued FIN No. 46, Consolidation of Variable
Interest Entities.This interpretation of Accounting Research Bulleting No.
51, Consolidated Financial Statementsaddresses consolidation of business
enterprises of variable interest entities in which: (1) the equity investment
at risk is not sufficient to permit the entity to finance its activities
without additional subordinated financial support from other parties, which is
provided through other interests that will absorb some or all of the expected
losses of the entity and (2) the equity investors lack one or more of certain
essential characteristics of a controlling interest. FIN No. 46 applies
immediately to variable interest entities created after January 31, 2003, and
to variable interest entities in which an enterprise obtains an interest after
that date. In December 2003, the FASB revised FIN No. 46 to modify the
effective date for applying this interpretation, which made it effective for us
on January 1, 2004. We will adopt the provisions of FIN No. 46 in the first
quarter of 2004 and do not expect the provisions of FIN No. 46 to have a
significant effect on our financial position or operating results. We are
currently evaluating additional disclosures, if any, that may be required for
Emerald. In December 2003, the Securities and Exchange Commission, or SEC, released
Staff Accounting Bulletin, or SAB, No. 104, Revenue Recognition. The SEC staff
updated and revised the existing revenue recognition guidance to make its
interpretive guidance consistent with current accounting guidance. The
provisions of SAB No. 104 did not have a significant effect on our financial
position or operating results. Reclassifications Certain reclassifications have been made to conform prior year results to
the current year presentation. 48




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TARGETED GENETICS CORPORATION NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS - (Continued) 2. Property and Equipment Property and equipment consisted of the following: December 31,2003
    
    2002Furniture and equipment
    
    $
    7,270,000
    
    
    $
    7,055,000Leasehold improvements
    
    
    9,635,000
    
    
    
    9,527,00016,905,000
    
    
    
    16,582,000Less accumulated depreciation and amortization
    
    
    (13,482,000
    )
    
    
    (11,062,000
    )$
    3,423,000
    
    
    $
    5,520,000
 We finance a portion of our equipment through equipment financing
arrangements and pledge the equipment as security for the financing. The cost
of equipment that has been pledged under financing arrangements totaled $5.4
million at December 31, 2003 and $5.1 million at December 31, 2002. 3. Goodwill and Other Intangibles Goodwill and other purchased intangibles consisted of the following: December 31,2003
    
    2002Goodwill
    
    $
    38,154,000
    
    
    $
    38,154,000Other purchased intangibles
    
    
    605,000
    
    
    
    605,00038,759,000
    
    
    
    38,759,000Less accumulated amortization
    
    
    (7,110,000
    )
    
    
    (7,110,000
    )$
    31,649,000
    
    
    $
    31,649,000
 4. Accrued Restructure Charges We implemented cost reduction measures in December 2002; in response to
general business conditions, the lack of funding at that time and
collaborations that ended, to lower our fixed operating costs and to focus our
resources on our key product development programs. As a result, we recorded
restructure charges of $2.3 million in 2002 to account for ongoing lease
payments related to our abandoned lease facility located in Bothell,
Washington, and termination benefits paid to former employees. In addition, we
reclassified the deferred rent liability of $1.5 million, related to the
Bothell facility, to accrued restructure costs. Therefore, the balance of our
accrued restructure liability at December 31, 2002, was $3.4 million. This
represented our best estimate at the time of the fair value of the liability as
determined under SFAS No. 146, Accounting for Costs Associated with Exit or
Disposal Activities. During 2003 we closed our Sharon Hill, Pennsylvania facility and we began
marketing the facility for a sublease tenant. As a result, we recognized a
restructure charge for the difference between the remaining lease payments due
on the lease and the estimated sub-lease market rates. As 2003 progressed, the
market conditions for subleasing both the Sharon Hill and Bothell facilities
declined substantially. Due to the relatively short remaining lease term for
the Sharon Hill facility, which expires in November 2005, we substantially
decreased the rates at which we are offering the Sharon Hill facility in an
effort to secure a tenant for the remaining term of the lease and recorded an
additional restructure charge to reflect our updated assumptions. In 2003 we
also concluded that additional concessions will be required from us, including
additional rent abatement periods and tenant improvement allowances, in order
to sub-lease the Bothell facility. As a result of our decision to abandon the
Sharon Hill facility and changes in market conditions for both facilities
during 2003, we recorded restructuring charges totaling $5.2 million in 2003. If we proceed with further development or commercialization of any of our
product candidates, we may need to resume use of the Bothell facility to fulfill our
manufacturing requirements. If we decide to resume use of this facility, any
remaining restructuring accrual related to the facility will be reversed. This
will be reflected as a one-time credit to restructuring charges, reflected in
the period in which use is resumed. Any decision to resume use of the facility
will be based on a number of factors including the progress of our product
candidates in clinical development, the estimated duration of design and
construction, the estimated timing of manufacturing requirements, the ability
of our current manufacturing capabilities to meet demand, and the availability
of resources. However, unless we resume use of Bothell facility, we will
continue to account for the lease in accordance with SFAS No. 146 and will periodically evaluate the assumptions and
record additional restructure charges if necessary. 49




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TARGETED GENETICS CORPORATION NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS - (Continued) The tables below present our total estimated restructuring charges and a
reconciliation of the associated liability: Incurred in
    
    Incurred in
    
    Estimated
    
    Total expected toRestructure charges
    
    2002
    
    2003
    
    future charges
    
    be incurredEmployee termination
benefits
    
    $
    725,000
    
    
    $
    5,000
    
    
    $
    
    
    
    $
    730,000Contract termination costs
    
    
    1,601,000
    
    
    
    5,153,000
    
    
    
    
    
    
    
    6,754,000Other associated costs
    
    
    
    
    
    
    32,000
    
    
    
    
    
    
    
    32,000Total
    
    $
    2,326,000
    
    
    $
    5,190,000
    
    
    $
    
    
    
    $
    7,516,000
 Beginning
    
    Incurred in
    
    Paid in
    
    
    
    
    
    EndingReconciliation
    
    liability
    
    2003
    
    2003
    
    Adjustments
    
    liabilityEmployee termination
benefits
    
    $
    284,000
    
    
    $
    5,000
    
    
    $
    (289,000
    )
    
    $
    
    
    
    $
    Contract termination costs
    
    
    3,140,000
    
    
    
    5,153,000
    
    
    
    (1,423,000
    )
    
    
    
    
    
    
    6,870,000Other associated costs
    
    
    
    
    
    
    32,000
    
    
    
    (32,000
    )
    
    
    
    
    
    
    Total
    
    $
    3,424,000
    
    
    $
    5,190,000
    
    
    $
    (1,744,000
    )
    
    $
    
    
    
    $
    6,870,000
 We record payments of rent related to these facilities as a reduction in the
amount of the accrued restructure liability. We recognize accretion expense
due to the passage of time, which is also reflected as a restructure charge. 5. Long-Term Obligations Long-term obligations consisted of the following: December 31,2003
    
    2002Loan payable to Biogen, due August 2006
    
    $
    10,000,000
    
    
    $
    10,000,000Equipment financing obligations
    
    
    1,501,000
    
    
    
    2,383,000Other long-term obligations
    
    
    1,016,000
    
    
    
    760,000Convertible loans payable to Elan
    
    
    
    
    
    
    7,950,000Accrued interest payable to Elan
    
    
    
    
    
    
    699,00012,517,000
    
    
    
    21,792,000Less current portion
    
    
    (1,290,000
    )
    
    
    (1,298,000
    )$
    11,227,000
    
    
    $
    20,494,000
 Future aggregate principal payments related to long-term obligations are
$1,290,000 in 2004, $1,074,000 in 2005, $10,140,000 in 2006 and $13,000 in
2007. During 2003, we converted $9.4 million in outstanding loans and interest
payable to Elan into 5,203,244 shares of restricted and unregistered Targeted
Genetics common stock. As conversion of this debt was completed under the
original terms of our convertible promissory note with Elan, there was no
impact on our results of operations. The promissory note and interest payable
to Elan had a scheduled maturity in July 2005. During 2001, we borrowed $10.0 million from Biogen against an unsecured
loan agreement. Outstanding borrowings under this loan bear interest at the
one-year LIBOR rate plus 1%, which is reset quarterly. At December 31, 2003,
the interest rate was 2.5%. The loan agreement contains financial covenants
establishing limits on our ability to declare or pay cash dividends. The loan
is due in August 2006 and we may repay it at anytime without penalty. Equipment financing obligations relate to secured financing for the
purchase of capital equipment and leasehold improvements. These obligations
bear interest at rates ranging from 7.75% to 14.97% and mature from January
2004 to June 2007. Other long-term obligations include a promissory note payable to Biogen,
which we assumed in September 2000 as part of our acquisition of Genovo. This
promissory note has an outstanding principal amount of $650,000 and bears no
interest. At the time of the acquisition, we discounted the note to reflect
market interest rates, using an imputed interest rate of 5.6%. The note is due
in September 2005. 50




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TARGETED GENETICS CORPORATION NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS - (Continued) 6. Shareholders Equity Series B Convertible Preferred Stock In July 1999, we issued shares of our Series B convertible exchangeable
preferred stock, valued at $12.0 million, to Elan in exchange for our 80.1%
interest in Emerald. The Series B preferred stock is convertible, at Elans
option, into shares of our common stock. Compounding dividends accrue
semi-annually at 7% per year on the $1,000 per share face value of the
preferred stock until July 2005. The Series B preferred stock was exchangeable
for all shares of preferred stock that we hold in Emerald, until the exchange
right expired in July 2003. Series B dividends are not paid in cash, but
rather result in an increase in the number of shares of our common stock to be
issued upon conversion. The Series B preferred stock and accrued dividends were
convertible into 4,765,500 shares of our common stock at December 31, 2003 and
4,448,645 shares at December 31, 2002, and unless converted earlier, will
become convertible into approximately 5.5 million shares of our common stock in
July 2005 when the accrual of dividends ends. The Series B preferred stock
will automatically convert into shares or our common stock in the event of
specified transactions involving a change of control of Targeted Genetics. Elan, as a holder of Series B preferred stock, is not entitled to vote
together with holders of common stock, including with respect to election of
directors, or as a separate class, except as otherwise provided by the
Washington Business Corporation Act. Issuances of Common Stock In June 2003, we issued 7,777,778 shares of our common stock in a public
offering to institutional investors at a price of $2.25 per share and received
net proceeds of approximately $16.1 million to fund our ongoing research and
development activities and general corporate purposes. In August 2003, we issued 2,515,843 shares of our common stock to Biogen
at a price of approximately $1.91 per share and received net proceeds of
approximately $4.8 million to fund our ongoing research and development
activities and general corporate purposes. Stock Purchase Warrants In 1999, in connection with a technology license agreement, we issued to
Alkermes, Inc. a warrant to purchase 1,000,000 shares of our common stock at an
exercise price of $2.50, expiring in June 2007, and a warrant to purchase
1,000,000 shares at an exercise price of $4.16 per share, expiring in June
2009. Both of these warrants were outstanding at December 31, 2003. We have outstanding warrants to purchase a total of 3,826 shares of our
common stock related to a technology license agreement. These warrants have an
exercise price of $4.50 per share and expire March 2004. Shareholder Rights Plan In 1996, our board of directors adopted a shareholder rights plan. Under
our rights plan, each holder of a share of outstanding common stock is also
entitled to one preferred stock purchase right. We adopted the rights plan to
guard against partial tender offers and other abusive tactics that might be
used in an attempt to gain control of Targeted Genetics without paying all
shareholders a fair price for their shares. The rights plan will not prevent a
change of control, but is designed to deter coercive takeover tactics and to
encourage anyone attempting to acquire us to first negotiate with our board.
Generally, if any person or group becomes the beneficial owner of more than 15%
of our outstanding common stock (an acquiring person), then each preferred
stock purchase right not owned by the acquiring person or its affiliates would
entitle its holder to purchase a share of our common stock at a 50% discount,
which would result in a significant dilution of the acquiring persons interest
in Targeted Genetics. If we or 50% or more of our assets or earnings are
thereafter acquired, each right will entitle its holder to purchase a share of
common stock of the acquiring entity for a 50% discount. The shareholder rights plan expires in October 2006. Our board of
directors will generally be entitled to redeem the rights for $0.01 per right
at any time before a person or group acquires more than 15% of our common
stock. In addition, at any time after an acquiring person crosses the 15%
threshold but before it acquires us or 50% of our assets or earnings, the board
may exchange all or part of the rights (other than those held by the acquiring
person) for one share of common stock per right. 51




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TARGETED GENETICS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued) Stock Options We have granted non-qualified and incentive stock options to purchase up
to 6,979,444 shares of our common stock under our 1992 Stock Option Plan, or
the 1992 Plan, our Director Stock Option Plan, our Genovo Stock Option Plan and
our 1999 Stock Option Plan, or the 1999 Plan. The 1992 Plan terminated on
January 21, 2002. Although there are options outstanding under the 1992 Plan,
no additional options may be granted from that plan. Beginning in 1999, we
began granting all options under the 1999 Plan and discontinued granting
options under our other plans. The 1999 Plan, as amended, provides for option grants to our employees,
directors and officers and to consultants, agents, advisors and independent
contractors who provide services to us, or our subsidiaries. The 1999 Plan
authorizes the grant of options to purchase up to 3.5 million shares under the
1999 plan. The exercise price for incentive stock options shall not be less
than the fair market value of the shares on the date of grant. Options granted
under the 1999 Plan expire no later than ten years from the date of grant and
generally vest and become exercisable over a three or four-year period
following the date of grant. In 2003 we granted options to purchase 720,000
shares of our common stock with vesting periods, which range from twelve to
eighteen months. As of December 31, 2003, options to purchase 322,927 shares
of our common stock were available for future grant under the 1999 Plan. In March 2004, our board of directors approved an increase in the number
of shares available for issuance under our 1999 Stock Option Plan. Subject to
shareholder approval at our annual meeting, the number of shares available for
grant under this plan will be increased by 6,000,000 shares to 9,500,000
shares. The following table summarizes activity related to our stock option plans: Weighted Average
    
    OptionsShares
    
    Exercise Price
    
    ExercisableBalance, January 1, 2001
    
    
    3,320,778
    
    
    $
    3.66
    
    
    
    1,782,082Granted
    
    
    1,510,075
    
    
    
    5.27Exercised
    
    
    (672,383
    )
    
    
    1.57Forfeited
    
    
    (274,637
    )
    
    
    5.05Balance, December 31, 2001
    
    
    3,883,833
    
    
    
    4.55
    
    
    
    1,861,093Granted
    
    
    1,347,500
    
    
    
    1.72Exercised
    
    
    (35,053
    )
    
    
    1.06Forfeited
    
    
    (756,873
    )
    
    
    4.12Balance, December 31, 2002
    
    
    4,439,407
    
    
    
    3.80
    
    
    
    2,389,393Granted
    
    
    1,060,250
    
    
    
    0.54Exercised
    
    
    (143,017
    )
    
    
    0.88Expired
    
    
    (4,400
    )
    
    
    0.55Forfeited
    
    
    (1,254,553
    )
    
    
    3.78Balance, December 31, 2003
    
    
    4,097,687
    
    
    
    3.07
    
    
    
    2,706,127
 The following table summarizes information regarding our outstanding and
exercisable options at December 31, 2003: Outstanding
    
    ExercisableWeighted AverageRange of
    
    Number of
    
    Weighted Average
    
    Remaining
    
    Number of
    
    Weighted AverageExercise Prices
    
    Option Shares
    
    Exercise Price
    
    Contractual Life
    
    Option Shares
    
    Exercise Price$0.29  $0.43
    
    
    757,452
    
    
    $
    0.36
    
    
    
    9.18
    
    
    
    373,535
    
    
    $
    0.360.68  1.56
    
    
    796,335
    
    
    
    1.03
    
    
    
    7.56
    
    
    
    380,126
    
    
    
    1.231.59  2.25
    
    
    783,980
    
    
    
    2.03
    
    
    
    5.62
    
    
    
    657,087
    
    
    
    2.032.50  4.86
    
    
    707,361
    
    
    
    3.21
    
    
    
    6.31
    
    
    
    442,648
    
    
    
    3.495.00  6.66
    
    
    734,505
    
    
    
    6.14
    
    
    
    5.90
    
    
    
    559,839
    
    
    
    6.078.56  21.38
    
    
    318,054
    
    
    
    9.73
    
    
    
    6.29
    
    
    
    292,892
    
    
    
    9.664,097,687
    
    
    
    3.07
    
    
    
    6.88
    
    
    
    2,706,127
    
    
    
    3.59
 52




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TARGETED GENETICS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued) We estimated the fair value of each option on the date of grant using the
Black-Scholes pricing model with the following weighted average assumptions: 2003
    
    2002
    
    2001Expected dividend rate
    
    Nil
    
    Nil
    
    NilExpected stock price volatility
    
    
    1.481
    
    
    
    1.480
    
    
    
    1.590Risk-free interest rate
    
    
    2.91
    %
    
    
    4.03
    %
    
    
    4.79
    %Expected life of options
    
    4 years
    
    4 years
    
    4 yearsWeighted average fair value (per share) of options granted
    
    $
    0.49
    
    
    $
    1.58
    
    
    $
    4.94
 Reserved Shares As of December 31, 2003, we had reserved shares of our common stock for
future issuance as follows: Stock options granted
    
    
    4,097,687Available for future grants
    
    
    322,927Stock purchase warrants
    
    
    2,003,826Conversion of Series B preferred stock
    
    
    4,765,500Total reserved shares
    
    
    11,189,940
 7. Collaborative and Other Agreements We have entered into various relationships with pharmaceutical and
biotechnology companies and a non-profit organization to develop our product
candidates. Under these partnerships, we typically receive reimbursement for
research and development activities performed by us under the collaboration as
well as milestone and upfront payments. The aggregate revenue we earned under
all of our collaborative research and development collaborations was $14.1
million in 2003, $19.3 million in 2002 and $18.9 million in 2001. International AIDS Vaccine Initiative Agreement In February 2000, we entered into a development collaboration with IAVI
and CRI to develop a vaccine to protect against the progression of HIV
infection to AIDS. Effective December 2003, this collaboration was extended
through December 2006. Under the terms of the collaboration, IAVI provides us
funding to support development, preclinical studies and manufacturing of
product for clinical trials. In addition IAVI provides CRI funding for
development and preclinical studies and is also funding the costs of Phase I
vaccine candidate clinical trials. The collaborative agreement provides for
IAVI to reimburse us for research and development and manufacturing costs on a
cost reimbursable basis. Under the terms of the IAVI agreement, we have rights to manufacture any
vaccines developed under the collaboration and will retain worldwide exclusive
commercialization rights, in developed countries, to any product that results
from the collaboration. If we decline or are unable to produce the vaccine for
developing countries in reasonable quantity and at a reasonable price, IAVI has
the right to contract with other manufacturers to make the vaccine for use in
those countries. We have recognized $4.4 million in revenue from IAVI in 2003,
$5.7 million in revenue in 2002 and $1.9 million of revenue in 2001. Cystic Fibrosis Foundation Agreement In July 2003, we established a collaboration with the CF Foundation
related to our current Phase II clinical trial for our product candidate for
treating cystic fibrosis called tgAAVCF. Under this collaboration, the CF
Foundation is providing funding of up to $1.7 million directly to the sites
conducting the study to cover their direct trial costs. If tgAAVCF is
commercialized, the CF Foundation is entitled to a return on its investment in
this clinical trial to be paid out over five years from the date of product
commercialization. Biogen Agreement In September 2000, we established a three-year multiple-product
development and commercialization collaboration with Biogen. Upon initiation of
the collaboration in 2000, Biogen paid us $8.0 million, which included an
up-front technology license of $5.0 million and up-front prepaid research and
development funding of $3.0 million. Under this agreement, Biogen agreed to 53




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TARGETED GENETICS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued) provide a minimum of $3.0 million of additional research and development
funding, paid at a rate of a minimum of $1.0 million per year. We amortized the
$8.0 million up-front fee paid by Biogen over the initial research and
development collaboration period which ended on September 30, 2003. We
recognized revenue on the $1.0 million minimum annual project funding as we
performed specified research and development. We recognized revenue of $5.1
million in 2003, $2.9 million in 2002 and $2.6 million in 2001 related to the
Biogen collaboration. At the conclusion of the collaboration, we recognized
$2.6 million in revenue to recognize previously deferred payments received from
Biogen. As part of this collaboration, Biogen also agreed to provide us with loans
of up to $10.0 million and committed to purchase, at our discretion, up to
$10.0 million of our common stock. In 2001, we borrowed $10.0 million under the
loan commitment. In September 2002, we issued 5,804,673 shares of our common
stock to Biogen at a price of approximately $0.69 per share and received
proceeds of $4.0 million and in August 2003, we issued 2,515,843 shares of our
common stock to Biogen at a price of $1.91 per share and received proceeds of
$4.8 million. As of December 31, 2003, Biogen owned 12,127,178 shares of our
common stock or approximately 18% of our total shares outstanding. Wyeth Agreement In November 2000, we entered into a collaboration to develop gene therapy
products for treating hemophilia with Wyeth. Under the terms of a research and
development funding agreement, Wyeth paid us up-front payments of $5.6 million
and was to pay us up to $15.0 million to develop a product candidate for
hemophilia A over a three-year research and development collaboration period
scheduled to end in November 2003. In November 2002, Wyeth elected to terminate
this hemophilia collaboration and related agreements. Under the terms of our
agreements with Wyeth, all rights that we granted or otherwise extended to
Wyeth related to the hemophilia technology have returned to us. In February
2003, we entered into a termination agreement with Wyeth that provided for a
$3.2 million cash payment from Wyeth, in payment of an account receivable of
$637,000 recorded in 2002 for services performed prior to Wyeths termination
and as a termination settlement of approximately $2.6 million to be recognized
as revenue. In addition, we recognized $1.3 million in previously received cash
payments as revenue upon termination of the Wyeth agreement. As part of this
settlement agreement we extended the time frame until July 31, 2004 in which we
may exercise an option to access certain technology and rights of Wyeth, which
may be useful in the development of a hemophilia gene therapy. We recognized revenue of $3.9 million in 2003, $7.5 million in 2002 and
$6.5 million in 2001 under this collaboration. These amounts include
amortization in each period of the $5.6 million of up-front payments and
collaborative research funding earned during the period. Alkermes License In June 1999, we entered into an agreement with Alkermes, Inc. to acquire
the exclusive rights to a patent and other pending patent applications for
manufacturing AAV vectors. The license to this technology, first developed by
Childrens Hospital in Columbus, Ohio, covers the use of cell lines for the
manufacture of AAV vectors. The Alkermes license agreement requires us to
satisfy specified development requirements in order to maintain the exclusivity
of the license. We are obligated to make clinical and regulatory development
milestone payments for any product candidates using this technology, to pay
royalties upon the sale of any products using the licensed technology and to
make payments to Alkermes if we sublicense the technology covered by the
license agreement. 8. Emerald Gene Systems Joint Venture In July 1999, we formed Emerald, our joint venture with Elan, to develop
product candidates based on our expertise in gene delivery and Elans expertise
in drug delivery. The initial three-year development period for Emerald ended
during 2002 and there are no ongoing operating activities. We own 80.1% of Emeralds common stock and 80.1% of Emeralds preferred
stock and Elan owns the remaining 19.9% of Emeralds common and preferred
stock. The common stock of Emerald held by Elan is similar in all respects to
the common stock held by us, except that those shares held by Elan do not have
voting rights. The common shares held by Elan may be converted into voting
common shares at Elans election. Although we currently own 100% of the voting
stock, Elan and its subsidiaries retained significant minority investor rights
that are considered participating rights under the FASBs Emerging Issues Task
Force Bulletin 96-16, Investors Accounting for an Investee When the Investor
Has a Majority of the Voting Interest but the Minority Shareholder Has Certain
Approval or Veto Rights. Because Elans participating rights prevented us from
exercising control over Emerald, we have not consolidated the financial
statements of Emerald, but instead have accounted for our investment in Emerald under the equity method of accounting. We
recorded our share of Emeralds net loss from 54




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TARGETED GENETICS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued) operations as equity in net loss
of unconsolidated, majority owned research and development joint venture in the
accompanying statements of operations. In January 2003, the FASB issued FIN No. 46, Consolidation of Variable
Interest Entities.This interpretation of Accounting Research Bulleting No.
51, Consolidated Financial Statementsaddresses consolidation of business
enterprises of variable interest entities in which: (1) the equity investment
at risk is not sufficient to permit the entity to finance its activities
without additional subordinated financial support from other parties, which is
provided through other interests that will absorb some or all of the expected
losses of the entity and (2) the equity investors lack one or more of certain
essential characteristics of a controlling interest. FIN No. 46 applies
immediately to variable interest entities created after January 31, 2003, and
to variable interest entities in which an enterprise obtains an interest after
that date. In December 2003, the FASB revised FIN No. 46 to modify the
effective date for applying this interpretation, which made it effective for us
on January 1, 2004. We will adopt the provisions of FIN No. 46 in the first
quarter of 2004 and do not expect the provisions of FIN No. 46 to have a
significant effect on our financial position or operating results. We are
currently evaluating additional disclosures, if any, that may be required for
Emerald. The preferred shares of Emerald are entitled to a liquidation preference
equal to the amount paid by Elan and us for the preferred stock. However, we do
not expect to realize any proceeds in connection with these rights or otherwise
on the dissolution of Emerald. Both the common stock and preferred stock of
Emerald are subject to certain transfer restrictions, other than to an
affiliate. We acquired our 80.1% interest and Elan acquired its 19.9% interest in
Emerald in exchange for capital contributions receivable of $12.0 million and
$3.0 million, respectively. Both Elan and we licensed intellectual property to
Emerald. Emerald valued the technology licensed by Elan to Emerald at $15.0
million, which represented the consideration to be paid under the License
Agreement. Simultaneous with the formation of the joint venture, we issued to
Elan shares of our Series B convertible exchangeable preferred stock valued at
$12.0 million. These shares were issued in exchange for Elans assumption of
our capital contribution to Emerald. We and Elan funded the expenses of Emerald in proportion to our respective
ownership interests. Since formation we provided Emerald cash funding totaling
$7.5 million consisting of zero in 2003, $1.9 million in 2002, $2.8 million in
2001 and $2.8 million of cash funding prior to 2001. We and Elan conducted
research and development for Emerald and Emerald reimbursed each company for
the costs of research and development and related expenses plus a profit
percentage. We recorded reimbursements that we received from Emerald as revenue
from collaborative agreement with unconsolidated, majority-owned joint venture
in the Consolidated Statements of Operations and we recorded the related
expenses in research and development expense. Under a convertible note facility
provided to us from Elan, we had the option to borrow up to $12.0 million from
Elan to fund our share of Emeralds expenses. We borrowed a total of $8.0
million against this facility consisting of $6.0 million in 2002 and $2.0
million in 2001. During 2003, we converted these loans and $1.4 million of
accrued interest payable to Elan into 5,203,244 shares of restricted and
unregistered Targeted Genetics common stock. The loans and interest payable to
Elan had a scheduled maturity in July 2005. 9. Commitments We
lease our research and office facilities in Seattle, Washington under two
non-cancelable operating leases. The lease on our primary laboratory,
manufacturing and office space expires in March 2009 and has one option to
renew for a five-year period. The lease on our administrative office space
expires in March 2009, includes two options to extend the lease for a total of
five additional years and includes an option to cancel at any time between
April 2006 and March 2009 with certain early termination penalties. We lease a
facility in Bothell, Washington under a non-cancelable operating lease that
expires in September 2015, which was intended to accommodate future
manufacturing of our product candidates. We also lease research and office
facilities in Sharon Hill, Pennsylvania, under a non-cancelable operating lease
that expires in November 2005. 55




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TARGETED GENETICS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Future minimum payments under non-cancelable operating leases at December
31, 2003 were as follows: Year ending December 31,2004
    
    $
    2,526,0002005
    
    
    2,436,0002006
    
    
    2,318,0002007
    
    
    2,345,0002008
    
    
    2,373,000Thereafter
    
    
    10,817,000Total minimum lease payments
    
    $
    22,815,000
 Rent expense under operating leases was $1.7 million in 2003 and $2.9
million in 2002 and 2001. In December 2002 we began implementing a
restructuring plan intended to consolidate our operations and to reduce our
occupancy and other costs. In connection with this restructuring plan, we
vacated our facility in Sharon Hill in February 2003 and began to pursue
sublease tenants or otherwise terminate the leases for our Sharon Hill and
Bothell facilities. Ongoing lease payments of the Sharon Hill and Bothell
facilities reduce the amount of the accrued restructure charges and are not
reflected as rent expense under SFAS No. 146 (See Note 4 to the Consolidated
Financial Statements). 10. Employee Retirement Plan We sponsor an employee retirement plan under Section 401(k) of the
Internal Revenue Code. All of our employees and those of our subsidiaries who
meet the minimum eligibility requirements are eligible to participate in the
plan. Our matching contributions to the 401(k) plan are made at the discretion
of our board of directors and were zero in 2003, $181,000 in 2002 and $192,000
in 2001. Our board of directors suspended matching contributions from January
1, 2003 through December 31, 2003, and reinstated the matching contribution
effective January 1, 2004. 11. Income Taxes At December 31, 2003, we had net operating loss carry-forwards of
approximately $143.0 million and research and tax credit carry-forwards of $6.1
million. The carry-forwards, will begin to expire in 2009 if not utilized. We have provided a
valuation allowance to offset the excess of deferred tax assets over the
deferred tax liabilities, due to the uncertainty of realizing the benefits of
the net deferred tax asset. Significant components of our deferred tax assets and liabilities were as
follows: December 31,2003
    
    2002Deferred tax assetsNet operating loss carry-forwards
    
    $
    48,560,000
    
    
    $
    45,150,000Research and experimental and
orphan drug credit carry-forwards
    
    
    6,130,000
    
    
    
    5,420,000Depreciation and amortization
    
    
    530,000
    
    
    
    1,710,000Deferred revenue
    
    
    
    
    
    
    50,000Other
    
    
    2,350,000
    
    
    
    230,000Gross deferred tax assets
    
    
    57,570,000
    
    
    
    52,560,000Valuation allowance for deferred tax assets
    
    
    (57,570,000
    )
    
    
    (52,560,000
    )Net deferred tax asset
    
    $
    
    
    
    $
    
 The
change in the valuation allowance was $5.0 million for 2003 and $7.0
million for 2002. Our past sales and issuances of stock have likely resulted in
ownership changes as defined by Section 382 of the Internal Revenue Code of
1986, as amended. As a result, the utilization of our net operating losses and
tax credits will be limited and a portion of the carry-forwards may expire
unused. 56




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TARGETED GENETICS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued) 12. Condensed Quarterly Financial Information (unaudited) The following tables present our unaudited quarterly results for 2003 and
2002. The loss in the first quarter of 2003 reflect a $2.6 million termination
settlement payment from Wyeth as discussed in Note 7 to the Consolidated
Financial Statements. The losses in the third quarter of 2003 reflect $2.6
million of revenue from previously deferred payments received from Biogen as
discussed in Note 7 to the Consolidated Financial Statements. We believe that
the following information reflects all normal recurring adjustments for a fair
presentation of the information for the periods presented. The operating
results for any quarter are not necessarily indicative of results for any
future period. Quarter EndedMarch 31,
    
    June 30,
    
    September 30,
    
    December 31,2003
    
    2003
    
    2003
    
    2003Revenue
    
    $
    5,639,000
    
    
    $
    2,053,000
    
    
    $
    5,002,000
    
    
    $
    1,379,000Restructure charges
    
    
    281,000
    
    
    
    2,899,000
    
    
    
    374,000
    
    
    
    1,636,000Loss from operations
    
    
    (520,000
    )
    
    
    (6,611,000
    )
    
    
    (452,000
    )
    
    
    (6,221,000
    )Net loss
    
    
    (830,000
    )
    
    
    (6,915,000
    )
    
    
    (780,000
    )
    
    
    (6,308,000
    )Basic and diluted net loss per common share
    
    
    (0.02
    )
    
    
    (0.13
    )
    
    
    (0.01
    )
    
    
    (0.10
    )Quarter EndedMarch 31,
    
    June 30,
    
    September 30,
    
    December 31,2002
    
    2002
    
    2002
    
    2002Revenue
    
    $
    5,370,000
    
    
    $
    4,593,000
    
    
    $
    4,822,000
    
    
    $
    4,548,000Restructure charges
    
    
    
    
    
    
    
    
    
    
    441,000
    
    
    
    1,886,000Loss from operations
    
    
    (6,226,000
    )
    
    
    (6,271,000
    )
    
    
    (4,511,000
    )
    
    
    (5,733,000
    )Net loss
    
    
    (6,406,000
    )
    
    
    (6,437,000
    )
    
    
    (4,834,000
    )
    
    
    (6,090,000
    )Basic and diluted net loss per common share
    
    
    (0.15
    )
    
    
    (0.15
    )
    
    
    (0.11
    )
    
    
    (0.12
    )
 13. Subsequent Events On February 5, 2004, we issued 10,854,257 shares of our common stock in a
public offering at a price of $2.35 per share and received net proceeds of
approximately $23.8 million. On
February 13, 2004, we sold 158,764 shares of our common stock to Itochu
valued at $375,000 and Itochu returned its interest in CellExSys to us. 57




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Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure. None. 
 Item 9A. Controls and Procedures. Evaluation of disclosure controls and procedures.H. Stewart Parker,
our Chief Executive Officer, and Todd E. Simpson, our Chief Financial Officer,
after evaluating the effectiveness of our disclosure controls and procedures
(as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act
of 1934, as amended) as of the end of the period covered by this annual report,
have concluded that, as of that date, our disclosure controls and procedures
were effective in ensuring that information required to be disclosed by us in
this annual report is accumulated and communicated by our management, to allow
timely decisions regarding required disclosure. 58




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PART III 
 Item 10. Directors and Executive Officers of Registrant. The information required by this Item is incorporated by reference to the
sections captioned Proposal One  Election of Directors, Executive
Officers, and Section 16(a) Beneficial Ownership Reporting Compliance in the
proxy statement for our annual meeting of shareholders to be held on May 20,
2004. Code of Ethics We have a Code of Conduct, which applies to all employees, officers and
directors of Targeted Genetics. Our Code of Conduct meets the requirements of
a code of ethics as defined by Item 406 of Regulation S-K, and applies to our
Chief Executive Officer, Chief Financial Officer (who is both our principal
financial and principal accounting officer), as well as all other employees.
Our Code of Conduct also meets the requirements of a code of conduct under
Marketplace Rule 4350(n) of the National Association of Securities Dealers,
Inc. Our Code of Conduct is posted on our website at
http://www.targetedgenetics.com/investor/corp-info.php under the heading
Corporate Governance. 
 Item 11. Executive Compensation. The information required by this Item with respect to executive
compensation is incorporated by reference to the section captioned Executive
Compensation in the proxy statement for our annual meeting of shareholders to
be held on May 20, 2004. 
 Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Shareholder Matters. The information required by this Item with respect to beneficial ownership
is incorporated by reference to the section captioned Principal Shareholders
and Securities Authorized for Issuance Under Equity Compensation Plans in the
proxy statement for our annual meeting of shareholders to be held on May 20,
2004. 
 Item 13. Certain Relationships and Related Transactions. The information required by this Item with respect to certain
relationships and related-party transactions is incorporated by reference to
the sections captioned Executive CompensationChange of Control Arrangements
and Executive CompensationArrangements with Management in the proxy
statement for our annual meeting of shareholders to be held on May 20, 2004. 
 Item 14. Principal Accountant Fees and Services. The information required by this Item with respect to principal accountant
fees and services is incorporated by reference to the section captioned
Proposal Three  Ratification of Independent Auditors in the proxy statement
for our annual meeting of shareholders to be held on May 20, 2004. 59




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##### Table of Contents






PART IV




Item 15. Exhibits, Financial Statement Schedules and Reports on Form 8-K.



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

The following consolidated financial statements are submitted in Part II,
Item 8 of this annual report:

|                                                                                                                         |  |      |    | 
|------------------------------------------------------------------------------------------------------------------------ |  | ---- | -- | 
|                                                                                                                         |  | Page
|                                                                                                                         |  |     
|Report of Ernst & Young LLP, Independent Auditors                                                                        |  |      | 40 | 
|Consolidated Balance Sheets as of December 31, 2003 and 2002                                                             |  |      | 41 | 
|Consolidated Statements of Operations for the years ended December
31, 2003, 2002 and 2001                               |  |      | 42 | 
|Consolidated Statements of Preferred Stock and Shareholders Equity
for the years ended December 31, 2003, 2002 and 2001 |  |      | 43 | 
|Consolidated Statements of Cash Flows for the years ended December
31, 2003, 2002 and 2001                               |  |      | 44 | 
|Notes to Consolidated Financial Statements                                                                               |  |      | 45 | 



| | 2. |  | Financial Statement Schedules
| | -- |  | -----------------------------

All financial statement schedules have been omitted because the required
information is either included in the consolidated financial statements or the
notes thereto or is not applicable.

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##### Table of Contents



3. Exhibits

|      |  |                                                                                                                                                                                                           |  |    
|----- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ---
|3.1   |  | Amended and Restated Articles of Incorporation (Exhibit 3.1)                                                                                                                                              |  | (S)
|      |  |                                                                                                                                                                                                           |  |    
|3.2   |  | Amended and Restated Bylaws (Exhibit 3.2)                                                                                                                                                                 |  | (D)
|      |  |                                                                                                                                                                                                           |  |    
|4.1   |  | Rights Agreement, dated as of October 17, 1996, between
Targeted Genetics and ChaseMellon Shareholder Services
(Exhibit 2.1)                                                                              |  | (C)
|      |  |                                                                                                                                                                                                           |  |    
|4.2   |  | First Amendment of Rights Agreement, dated July 21, 1999,
between Targeted Genetics and ChaseMellon Shareholder
Services (Exhibit 1.9)                                                                    |  | (J)
|      |  |                                                                                                                                                                                                           |  |    
|4.3   |  | Second Amendment to Rights Agreement, dated September 25,
2002, between Targeted Genetics and Mellon Investor
Services LLC (formerly known as ChaseMellon Investor
Services L.L.C.) (Exhibit 10.1)        |  | (T)
|      |  |                                                                                                                                                                                                           |  |    
|4.4   |  | Third Amendment to Rights Agreement, dated January 23,
2003, between Targeted Genetics and Mellon Investor
Services LLC (Exhibit 4.4)                                                                     |  | (V)
|      |  |                                                                                                                                                                                                           |  |    
|4.5   |  | Fourth Amendment to Rights Agreement, dated as of September
2, 2003, between Targeted Genetics and Mellon Investor
Services LLC (Exhibit 4.1)                                                             |  | (Y)
|      |  |                                                                                                                                                                                                           |  |    
|10.1  |  | Form of Indemnification Agreement between Targeted Genetics
and its officers and directors (Exhibit 10.1)                                                                                                 |  | (K)
|      |  |                                                                                                                                                                                                           |  |    
|10.2  |  | Form of Senior Management Employment Agreement between the
registrant and its executive officers (Exhibit 10.2)                                                                                           |  | (D)
|      |  |                                                                                                                                                                                                           |  |    
|10.3  |  | Gene Transfer Technology License Agreement, dated as of
February 18, 1992, between Immunex Corporation and Targeted
Genetics* (Exhibit 10.3)                                                              |  | (K)
|      |  |                                                                                                                                                                                                           |  |    
|10.4  |  | PHS Patent License AgreementNon-Exclusive, dated as of
July 13, 1993, between National Institutes of Health
Centers for Disease Control and Targeted Genetics* (Exhibit
10.4)                            |  | (K)
|      |  |                                                                                                                                                                                                           |  |    
|10.5  |  | Patent License Agreement, dated as of December 25, 1993,
between The University of Florida Research Foundation, Inc.
and Targeted Genetics* (Exhibit 10.5)                                                |  | (K)
|      |  |                                                                                                                                                                                                           |  |    
|10.6  |  | PHS Patent License AgreementExclusive, dated as of March
10, 1994, between National Institutes of Health Centers for
Disease Control and Targeted Genetics* (Exhibit 10.10)                              |  | (E)
|      |  |                                                                                                                                                                                                           |  |    
|10.7  |  | License Agreement, dated as of March 28, 1994, between
Targeted Genetics and the University of Michigan* (Exhibit
10.13)                                                                                  |  | (E)
|      |  |                                                                                                                                                                                                           |  |    
|10.8  |  | Patent and Technology License Agreement, effective as of
March 1, 1994, between the Board of Regents of the
University of Texas M.D. Anderson Cancer Center and RGene
Therapeutics, Inc.* (Exhibit 10.29) |  | (A)
|      |  |                                                                                                                                                                                                           |  |    
|10.9  |  | First Amended and Restated License Agreement, effective as
of October 12, 1995, between The University of Tennessee
Research Corporation and RGene Therapeutics, Inc.* (Exhibit
10.30)                    |  | (A)
|      |  |                                                                                                                                                                                                           |  |    
|10.10 |  | Amendment to First Amended and Restated License Agreement,
dated as of June 19, 1996, between The University of
Tennessee Research Corporation and RGene Therapeutics,
Inc.* (Exhibit 10.1)               |  | (B)
|      |  |                                                                                                                                                                                                           |  |    
|10.11 |  | Second Amendment to First Amended and Restated License
Agreement, dated as of April 17, 1998, between The
University of Tennessee Research Corporation and RGene
Therapeutics, Inc.* (Exhibit 10.16)      |  | (G)
|      |  |                                                                                                                                                                                                           |  |    
|10.12 |  | License Agreement, dated as of March 15, 1997, between the
Burnham Institute and Targeted Genetics* (Exhibit 10.23)                                                                                       |  | (E)
|      |  |                                                                                                                                                                                                           |  |    
|10.13 |  | Exclusive Sublicense Agreement, dated June 9, 1999, between
Targeted Genetics and Alkermes, Inc.* (Exhibit 10.36)                                                                                         |  | (I)
|      |  |                                                                                                                                                                                                           |  |    
|10.14 |  | Amendment No. 2 to Exclusive Sublicense Agreement, dated as
of May 29, 2003, between Targeted Genetics and Alkermes,
Inc.* (Exhibit 10.1)                                                                 |  | (X)
|      |  |                                                                                                                                                                                                           |  |    
|10.15 |  | Master Agreement, dated as of November 23, 1998, between
Targeted Genetics and Medeva Pharmaceuticals, Inc.*
(Exhibit 1.1)                                                                                |  | (H)
|      |  |                                                                                                                                                                                                           |  |    
|10.16 |  | License and Collaboration Agreement, dated as of November
23, 1998, between Targeted Genetics and Medeva
Pharmaceuticals, Inc.* (Exhibit 1.2)                                                             |  | (H)

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|      |  |                                                                                                                                                                                                                           |  |     
|----- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ----
|10.17 |  | Supply Agreement, dated as of November 23, 1998, between Targeted Genetics and
Medeva Pharmaceuticals, Inc.* (Exhibit 1.3)                                                                                                |  | (H) 
|      |  |                                                                                                                                                                                                                           |  |     
|10.18 |  | Credit Agreement, dated as of November 23, 1998, between Targeted Genetics and
Medeva PLC (Exhibit 1.5)                                                                                                                   |  | (H) 
|      |  |                                                                                                                                                                                                                           |  |     
|10.19 |  | Funding Agreement, dated as of July 21, 1999, among Targeted Genetics, Elan
International Services, Ltd., and Elan Corporation, plc (Exhibit 1.3)                                                                         |  | (J) 
|      |  |                                                                                                                                                                                                                           |  |     
|10.20 |  | Subscription, Joint Development and Operating Agreement, dated as of July 21,
1999, among Elan Corporation, plc, Elan International Services, Ltd., Targeted
Genetics and Targeted Genetics Newco, Ltd. * (Exhibit 1.4)   |  | (J) 
|      |  |                                                                                                                                                                                                                           |  |     
|10.21 |  | Convertible Promissory Note, dated July 21, 1999, issued by Targeted Genetics
to Elan International Services, Ltd. (Exhibit 1.5)                                                                                          |  | (J) 
|      |  |                                                                                                                                                                                                                           |  |     
|10.22 |  | License Agreement dated July 21, 1999, between Targeted Genetics Newco, Ltd.
and Targeted Genetics * (Exhibit 1.6)                                                                                                        |  | (J) 
|      |  |                                                                                                                                                                                                                           |  |     
|10.23 |  | License Agreement, dated July 21, 1999, between Targeted Genetics Newco, Ltd.
and Elan Pharmaceutical Technologies, a division of Elan Corporation, plc *
(Exhibit 1.7)                                                   |  | (J) 
|      |  |                                                                                                                                                                                                                           |  |     
|10.24 |  | Office Lease, dated as of October 7, 1996, between Benaroya Capital Company,
LLC and Targeted Genetics (Exhibit 10.26)                                                                                                    |  | (D) 
|      |  |                                                                                                                                                                                                                           |  |     
|10.25 |  | First Lease Amendment, dated May 12, 1997, between Targeted Genetics and
Benaroya Capital Company, LLC (Exhibit 10.1)                                                                                                     |  | (R) 
|      |  |                                                                                                                                                                                                                           |  |     
|10.26 |  | Second Lease Amendment, dated February 25, 2000, between Targeted Genetics and
Benaroya Capital Company, LLC (Exhibit 10.2)                                                                                               |  | (R) 
|      |  |                                                                                                                                                                                                                           |  |     
|10.27 |  | Third Lease Amendment, dated April 19, 2000, between Targeted Genetics and
Benaroya Capital Company, LLC (Exhibit 10.3)                                                                                                   |  | (R) 
|      |  |                                                                                                                                                                                                                           |  |     
|10.28 |  | Fourth Lease Amendment, dated March 28, 2001, between Targeted Genetics and
Benaroya Capital Company, LLC (Exhibit 10.4)                                                                                                  |  | (R) 
|      |  |                                                                                                                                                                                                                           |  |     
|10.29 |  | Fifth Lease Amendment, dated January 2, 2004, between Targeted Genetics and
Benaroya Capital Company, LLC* (Exhibit 10.3)                                                                                                 |  | (AA)
|      |  |                                                                                                                                                                                                                           |  |     
|10.30 |  | Canyon Park Building Lease, dated as of June 30, 2000, between Targeted
Genetics and CarrAmerica Corporation (Exhibit 10.1)                                                                                               |  | (L) 
|      |  |                                                                                                                                                                                                                           |  |     
|10.31 |  | Olive Way Building Lease, dated as of November 20, 1993, as amended, between
Targeted Genetics and Ironwood Apartments, Inc. (successor in interest to
Metropolitan Federal Savings and Loan Association) (Exhibit 10.29) |  | (K) 
|      |  |                                                                                                                                                                                                                           |  |     
|10.32 |  | Fifth Amendment to Lease Agreement, dated as of June 20, 2003, between
Targeted Genetics and Ironwood Apartments, Inc. (Exhibit 10.2)                                                                                     |  | (X) 
|      |  |                                                                                                                                                                                                                           |  |     
|10.33 |  | Sixth Amendment to Lease Agreement, dated as of November 1, 2003, between
Targeted Genetics and Ironwood Apartments, Inc.* (Exhibit 10.1)                                                                                 |  | (AA)
|      |  |                                                                                                                                                                                                                           |  |     
|10.34 |  | 1992 Restated Stock Option Plan (Exhibit 99.1)                                                                                                                                                                            |  | (F) 
|      |  |                                                                                                                                                                                                                           |  |     
|10.35 |  | Stock Option Plan for Nonemployee Directors (Exhibit 10.34)                                                                                                                                                               |  | (E) 
|      |  |                                                                                                                                                                                                                           |  |     
|10.36 |  | 1999 Restated Stock Option Plan, as restated on January 23, 2001 (Exhibit 10.2)                                                                                                                                           |  | (Q) 
|      |  |                                                                                                                                                                                                                           |  |     
|10.37 |  | 2000 Genovo Inc. Roll-Over Stock Option Plan (Exhibit 99.1)                                                                                                                                                               |  | (O) 
|      |  |                                                                                                                                                                                                                           |  |     
|10.38 |  | Agreement and Plan of Merger dated as of August 8, 2000, among Targeted
Genetics, Inc., Genovo, Inc., TGC Acquisition Corporation and Biogen, Inc.*
(Exhibit 2.1)                                                         |  | (M) 
|      |  |                                                                                                                                                                                                                           |  |     
|10.39 |  | Development and Marketing Agreement, dated as of August 8, 2000, between
Targeted Genetics, Genovo,                                                                                                                       |  | (N) 

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|      |  |                                                                                                                                                                                                                |  |     
|----- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ----
|      |  | Inc. and Biogen, Inc. (Exhibit 10.1)                                                                                                                                                                           |  |     
|      |  |                                                                                                                                                                                                                |  |     
|10.40 |  | Funding Agreement dated as of August 8, 2000, between Targeted Genetics and
Biogen, Inc. (Exhibit 10.2)                                                                                                        |  | (N) 
|      |  |                                                                                                                                                                                                                |  |     
|10.41 |  | Amendment to Funding Agreement, dated as of July 14, 2003, between Targeted
Genetics and Biogen, Inc. (Exhibit 10.3)                                                                                           |  | (X) 
|      |  |                                                                                                                                                                                                                |  |     
|10.42 |  | Product Development Agreement, dated as of November 9, 2000, between Targeted
Genetics and Genetics Institute, Inc. * (Exhibit 10.1)                                                                           |  | (P) 
|      |  |                                                                                                                                                                                                                |  |     
|10.43 |  | Supply Agreement, dated as of November 9, 2000, between Targeted Genetics and
Genetics Institute, Inc.* (Exhibit 10.2)                                                                                         |  | (P) 
|      |  |                                                                                                                                                                                                                |  |     
|10.44 |  | Amendment No. 1 to Product, Development and Supply Agreement, dated February
24, 2003, between Genetics Institute LLC (formerly known as Genetics
Institute, Inc.) and Targeted Genetics* (Exhibit 10.41)      |  | (V) 
|      |  |                                                                                                                                                                                                                |  |     
|10.45 |  | Industrial Collaboration Agreement, dated as of February 1, 2000, between the
International Aids Vaccine Initiative, Inc., Childrens Research Institute and
Targeted Genetics* (Exhibit 10.1)                 |  | (U) 
|      |  |                                                                                                                                                                                                                |  |     
|10.46 |  | Amendment No. 1 to Industrial Collaboration Agreement, dated as of March 14,
2003, among the International Aids Vaccine Initiative, Inc., Childrens
Research Institute and Targeted Genetics* (Exhibit 10.42) |  | (V) 
|      |  |                                                                                                                                                                                                                |  |     
|10.47 |  | Amendment No. 2 to Industrial Collaboration Agreement, dated August 1, 2003,
among Targeted Genetics, International Aids Vaccine Initiative, Inc. and
Childrens Research Institute* (Exhibit 10.2)            |  | (Z) 
|      |  |                                                                                                                                                                                                                |  |     
|10.48 |  | Amendment No. 3 to Industrial Collaboration Agreement, dated December 2, 2003,
among Targeted Genetics, International Aids Vaccine Initiative, Inc. and
Childrens Research Institute* (Exhibit 10.2)          |  | (AA)
|      |  |                                                                                                                                                                                                                |  |     
|10.49 |  | Settlement and Termination Agreement, dated as of December 19, 2002, between
Celltech Pharmaceuticals Inc., Medeva Limited and Targeted Genetics (Exhibit
10.40)                                               |  | (V) 
|      |  |                                                                                                                                                                                                                |  |     
|10.50 |  | Biological Processing Services Agreement, dated as of March 28, 2003, between
GenVec, Inc. and Targeted Genetics* (Exhibit 10.1)                                                                               |  | (W) 
|      |  |                                                                                                                                                                                                                |  |     
|10.51 |  | Study Funding Agreement, dated as of April 23, 2003, between Targeted Genetics
and Cystic Fibrosis Foundation Therapeutics, Inc.* (Exhibit 10.2)                                                               |  | (W) 
|      |  |                                                                                                                                                                                                                |  |     
|10.52 |  | Amendment Agreement to Exclusive Sublicense Agreement, dated as of March 12,
2002, between Targeted Genetics and Alkermes, Inc.*                                                                               |  |     
|      |  |                                                                                                                                                                                                                |  |     
|10.53 |  | Common Stock and Warrants Issuance Agreement, dated June 9, 1999, by and
between Targeted Genetics and Alkermes, Inc. (Exhibit 10.37)                                                                          |  | (I) 
|      |  |                                                                                                                                                                                                                |  |     
|10.54 |  | Warrant Agreements, dated June 9, 1999, by and between Targeted Genetics and
Alkermes, Inc. (Exhibit 10.38)                                                                                                    |  | (I) 
|      |  |                                                                                                                                                                                                                |  |     
|10.55 |  | Registration Rights Agreement, dated as of July 21, 1999, by and
among the Company and EIS.                                                                                                                    |  | (J) 
|      |  |                                                                                                                                                                                                                |  |     
|21.1  |  | Subsidiaries of Targeted Genetics                                                                                                                                                                              |  |     
|      |  |                                                                                                                                                                                                                |  |     
|23.1  |  | Consent of Ernst & Young LLP, Independent Auditors                                                                                                                                                             |  |     
|      |  |                                                                                                                                                                                                                |  |     
|31.1  |  | Section 302 Certification of Chief Executive Officer                                                                                                                                                           |  |     
|      |  |                                                                                                                                                                                                                |  |     
|31.2  |  | Section 302 Certification of Chief Financial Officer                                                                                                                                                           |  |     
|      |  |                                                                                                                                                                                                                |  |     
|32.1  |  | Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350,
as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002                                                              |  |     
|      |  |                                                                                                                                                                                                                |  |     
|32.2  |  | Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350,
as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002                                                              |  |     

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---

|* |  | Portions of these exhibits have been omitted based on a grant of or
application for confidential treatment from the SEC. The omitted portions
of these exhibits have been filed separately with the SEC.
|- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|     |  |                                                                                                                                                                                                     
|---- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(A)  |  | Incorporated by reference to the designated exhibit included with
Targeted Genetics Registration Statement on Form S-1 (No. 333-03592)
filed on April 16, 1996, as amended.                        
|     |  |                                                                                                                                                                                                     
|(B)  |  | Incorporated by reference to the designated exhibit included with
Targeted Genetics Quarterly Report on Form 10-Q (No. 0-23930) for the
period ended June 30, 1996, filed on August 12, 1996.      
|     |  |                                                                                                                                                                                                     
|(C)  |  | Incorporated by reference to Targeted Genetics Registration Statement on
Form 8-A filed on October 22, 1996.                                                                                       
|     |  |                                                                                                                                                                                                     
|(D)  |  | Incorporated by reference to the designated exhibit included with
Targeted Genetics Annual Report on Form 10-K (No. 0-23930) for the year
ended December 31, 1996, filed on March 17, 1997.        
|     |  |                                                                                                                                                                                                     
|(E)  |  | Incorporated by reference to the designated exhibit included with
Targeted Genetics Annual Report on Form 10-K (No. 0-23930) for the year
ended December 31, 1997, filed on March 31, 1998.        
|     |  |                                                                                                                                                                                                     
|(F)  |  | Incorporated by reference to the designated exhibit included with
Targeted Genetics Registration Statement on Form S-8 (No. 333-58907),
filed on July 10, 1998.                                    
|     |  |                                                                                                                                                                                                     
|(G)  |  | Incorporated by reference to the designated exhibit included with
Targeted Genetics Annual Report on Form 10-K (No. 0-23930) for the year
ended December 31, 1998, filed on March 10, 1999.        
|     |  |                                                                                                                                                                                                     
|(H)  |  | Incorporated by reference to the designated exhibit included with
Targeted Genetics Current Report on Form 8-K (No. 0-23930) filed on
January 6, 1999.                                             
|     |  |                                                                                                                                                                                                     
|(I)  |  | Incorporated by reference to the designated exhibit included with
Targeted Genetics Quarterly Report on Form 10-Q (No. 0-23930) for the
period ended June 30, 1999, filed on August 5, 1999.       
|     |  |                                                                                                                                                                                                     
|(J)  |  | Incorporated by reference to the designated exhibit included with
Targeted Genetics Current Report on Form 8-K (No. 0-23930) filed on
August 4, 1999.                                              
|     |  |                                                                                                                                                                                                     
|(K)  |  | Incorporated by reference to the designated exhibit included with
Targeted Genetics Annual Report on Form 10-K (No. 0-23930) for the year
ended December 31, 1999, filed on March 23, 2000.        
|     |  |                                                                                                                                                                                                     
|(L)  |  | Incorporated by reference to Targeted Genetics Quarterly Report on Form
10-Q (No. 0-23930) for the period ended June 30, 2000, filed on August 11,
2000.                                           
|     |  |                                                                                                                                                                                                     
|(M)  |  | Incorporated by reference to the designated exhibit included with
Targeted Genetics Current Report on Form 8-K (No. 0-23930) filed on
August 23, 2000.                                             
|     |  |                                                                                                                                                                                                     
|(N)  |  | Incorporated by reference to the designated exhibit included with
Targeted Genetics Current Report on Form 8-K (No. 0-23930) filed on
September 13, 2000.                                           
|     |  |                                                                                                                                                                                                     
|(O)  |  | Incorporated by reference to the designated exhibit included with
Targeted Genetics Registration Statement on Form S-8 (No. 333-48220),
filed on October 19, 2000.                                 
|     |  |                                                                                                                                                                                                     
|(P)  |  | Incorporated by reference to the designated exhibit included with
Targeted Genetics Current Report on Form 8-K (No. 0-23930) filed on
February 21, 2001.                                            
|     |  |                                                                                                                                                                                                     
|(Q)  |  | Incorporated by reference to Targeted Genetics Quarterly Report on Form
10-Q (No. 0-23930) for the period ended March 31, 2001, filed on May 11,
2001.                                             
|     |  |                                                                                                                                                                                                     
|(R)  |  | Incorporated by reference to the designated exhibit included with
Targeted Genetics Quarterly Report on Form 10-Q (No. 0-23930) for the
period ended June 30, 2001, filed on August 14, 2001.      
|     |  |                                                                                                                                                                                                     
|(S)  |  | Incorporated by reference to the designated exhibit included with
Targeted Genetics Quarterly Report on Form 10-Q (No. 0-23930) for the
period ended June 30, 2002, filed on August 14, 2002.      
|     |  |                                                                                                                                                                                                     
|(T)  |  | Incorporated by reference to the designated exhibit included with
Targeted Genetics Current Report on Form 8-K (No. 0-23930) filed on
October 11, 2002.                                            
|     |  |                                                                                                                                                                                                     
|(U)  |  | Incorporated by reference to the designated exhibit included with
Targeted Genetics Quarterly Report on Form 10-Q (No. 0-23930) for the
period ended September 30, 2002, filed on October 14, 2002.
|     |  |                                                                                                                                                                                                     
|(V)  |  | Incorporated by reference to the designated exhibit included with
Targeted Genetics Annual Report on Form 10-K (No. 0-23930) for the year
ended December 31, 2002, filed on March 27, 2003.        
|     |  |                                                                                                                                                                                                     
|(W)  |  | Incorporated by reference to the designated exhibit included with
Targeted Genetics Quarterly Report on Form 10-Q (No. 0-23930) for the
period ended March 31, 2003, filed on May 15, 2003.        
|     |  |                                                                                                                                                                                                     
|(X)  |  | Incorporated by reference to the designated exhibit included with
Targeted Genetics Current Report on Form 8-K (No. 0-23930) filed on July
22, 2003.                                               
|     |  |                                                                                                                                                                                                     
|(Y)  |  | Incorporated by reference to the designated exhibit included with
Targeted Genetics Current Report on Form 8-K (No. 0-23930) filed on
October 1, 2003.                                             
|     |  |                                                                                                                                                                                                     
|(Z)  |  | Incorporated by reference to the designated exhibit included with
Targeted Genetics Quarterly Report on Form 10-Q (No. 0-23930) for the
period ended September 30, 2003, filed on October 31, 2003.
|     |  |                                                                                                                                                                                                     
|(AA) |  | Incorporated by reference to the designated exhibit included with
Targeted Genetics Current Report on Form 8-K (No. 0-23930) filed on
January 13, 2004.                                            
|    
|     |  | (b) Reports on Form 8-K                                                                                                                                                                             

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On October 1, 2003, Targeted Genetics filed a Current Report on Form 8-K
to announce the conversion of approximately $9.4 million in outstanding loans
and interest payable to Elan International Services Ltd. into 5,203,244 shares
of our common stock.

On
October 30, 2003, Targeted Genetics furnished a Current Report
on Form 8-K to announce its financial results for the quarter
ended September 30, 2003.

On December 9, 2003, Targeted Genetics filed a Current Report on Form 8-K
to announce the initiation of a clinical trial of
tgAAV09, our AIDS vaccine candidate.

65



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##### Table of Contents






SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) 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 in the city of
Seattle, state of Washington, on March 10, 2004.

| |  |                               |  |                                      
| |  | ----------------------------- |  | -------------------------------------
| |  | TARGETED GENETICS CORPORATION
| |  |                               |  |                                      
| |  | By:                           |  | /s/ H. STEWART PARKER                
| |  |                               |  |                                      
| |  |                               |  | President and Chief Executive Officer

POWER OF ATTORNEY

Each person whose individual signature appears below hereby authorizes and
appoints H. Stewart Parker and Todd E. Simpson, and each of them, with full
power of substitution and resubstitution and full power to act without the
other, as his or her true and lawful attorney-in-fact and agent to act in his
or her name, place and stead and to execute in the name and on behalf of each
person, individually and in each capacity stated below, and to file, any and
all amendments to this report, and to file the same, with all exhibits thereto,
and other documents in connection therewith, with the Securities and Exchange
Commission, granting unto said attorneys-in-fact and agents, and each of them,
full power and authority to do and perform each and every act and thing,
ratifying and confirming all that said attorneys-in-fact and agents or any of
them or their or his or her substitute or substitutes may lawfully do or cause
to be done by virtue thereof.

Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated.

|                                                               |  |                                                                                                                                              |  |               
|-------------------------------------------------------------- |  | -------------------------------------------------------------------------------------------------------------------------------------------- |  | --------------
|Signature                                                      |  | Title                                                                                                                                        |  | Date          
|                                                               |  |                                                                                                                                              |  |               
|/s/ H. STEWART PARKER

H. Stewart Parker                       |  | President, Chief
Executive Officer
and Director
(Principal Executive
Officer)                                                                |  | March 10, 2004
|                                                               |  |                                                                                                                                              |  |               
|/s/ TODD E. SIMPSON

Todd E. Simpson                           |  | Vice President,
Finance and
Administration and
Chief Financial
Officer, Secretary
and Treasurer
(Principal Financial
and Accounting
Officer) |  | March 10, 2004
|                                                               |  |                                                                                                                                              |  |               
|/s/ JEREMY L. CURNOCK COOK

Jeremy L. Curnock Cook             |  | Chairman of the Board                                                                                                                        |  | March 10, 2004
|                                                               |  |                                                                                                                                              |  |               
|/s/ JACK L. BOWMAN

Jack L. Bowman                             |  | Director                                                                                                                                     |  | March 10, 2004
|                                                               |  |                                                                                                                                              |  |               
|/s/ JOSEPH M. DAVIE, PH.D., M.D.

Joseph M. Davie, Ph.D., M.D. |  | Director                                                                                                                                     |  | March 10, 2004
|                                                               |  |                                                                                                                                              |  |               
|/s/ LOUIS P. LACASSE

Louis P. Lacasse                         |  | Director                                                                                                                                     |  | March 10, 2004
|                                                               |  |                                                                                                                                              |  |               
|/s/ NELSON L. LEVY, PH.D., M.D.

Nelson L. Levy, Ph.D., M.D.   |  | Director                                                                                                                                     |  | March 10, 2004
|                                                               |  |                                                                                                                                              |  |               
|/s/ MARK P. RICHMOND, PH.D.

Mark P. Richmond, Ph.D.           |  | Director                                                                                                                                     |  | March 10, 2004

66



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##### Table of Contents






EXHIBIT INDEX

|      |  |                                                                                                                                                                                                           |  |    
|----- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ---
|3.1   |  | Amended and Restated Articles of Incorporation (Exhibit 3.1)                                                                                                                                              |  | (S)
|      |  |                                                                                                                                                                                                           |  |    
|3.2   |  | Amended and Restated Bylaws (Exhibit 3.2)                                                                                                                                                                 |  | (D)
|      |  |                                                                                                                                                                                                           |  |    
|4.1   |  | Rights Agreement, dated as of October 17, 1996, between Targeted Genetics and ChaseMellon Shareholder Services
(Exhibit 2.1)                                                                              |  | (C)
|      |  |                                                                                                                                                                                                           |  |    
|4.2   |  | First Amendment of Rights Agreement, dated July 21, 1999, between Targeted Genetics and ChaseMellon Shareholder
Services (Exhibit 1.9)                                                                    |  | (J)
|      |  |                                                                                                                                                                                                           |  |    
|4.3   |  | Second Amendment to Rights Agreement, dated September 25, 2002, between Targeted Genetics and Mellon Investor
Services LLC (formerly known as ChaseMellon Investor Services L.L.C.) (Exhibit 10.1)        |  | (T)
|      |  |                                                                                                                                                                                                           |  |    
|4.4   |  | Third Amendment to Rights Agreement, dated January 23, 2003, between Targeted Genetics and Mellon Investor
Services LLC (Exhibit 4.4)                                                                     |  | (V)
|      |  |                                                                                                                                                                                                           |  |    
|4.5   |  | Fourth Amendment to Rights Agreement dated as of September 2, 2003, between Targeted Genetics and Mellon
Investor Services LLC (Exhibit 4.1)                                                              |  | (Y)
|      |  |                                                                                                                                                                                                           |  |    
|10.1  |  | Form of Indemnification Agreement between Targeted Genetics and its officers and directors (Exhibit 10.1)                                                                                                 |  | (K)
|      |  |                                                                                                                                                                                                           |  |    
|10.2  |  | Form of Senior Management Employment Agreement between the registrant and its executive officers (Exhibit 10.2)                                                                                           |  | (D)
|      |  |                                                                                                                                                                                                           |  |    
|10.3  |  | Gene Transfer Technology License Agreement, dated as of February 18, 1992, between Immunex Corporation and
Targeted Genetics* (Exhibit 10.3)                                                              |  | (K)
|      |  |                                                                                                                                                                                                           |  |    
|10.4  |  | PHS Patent License AgreementNon-Exclusive, dated as of July 13, 1993, between National Institutes of Health
Centers for Disease Control and Targeted Genetics* (Exhibit 10.4)                            |  | (K)
|      |  |                                                                                                                                                                                                           |  |    
|10.5  |  | Patent License Agreement, dated as of December 25, 1993, between The University of Florida Research Foundation,
Inc. and Targeted Genetics* (Exhibit 10.5)                                                |  | (K)
|      |  |                                                                                                                                                                                                           |  |    
|10.6  |  | PHS Patent License AgreementExclusive, dated as of March 10, 1994, between National Institutes of Health
Centers for Disease Control and Targeted Genetics* (Exhibit 10.10)                              |  | (E)
|      |  |                                                                                                                                                                                                           |  |    
|10.7  |  | License Agreement, dated as of March 28, 1994, between Targeted Genetics and the University of Michigan*
(Exhibit 10.13)                                                                                  |  | (E)
|      |  |                                                                                                                                                                                                           |  |    
|10.8  |  | Patent and Technology License Agreement, effective as of March 1, 1994, between the Board of Regents of the
University of Texas M.D. Anderson Cancer Center and RGene Therapeutics, Inc.* (Exhibit 10.29) |  | (A)
|      |  |                                                                                                                                                                                                           |  |    
|10.9  |  | First Amended and Restated License Agreement, effective as of October 12, 1995, between The University of
Tennessee Research Corporation and RGene Therapeutics, Inc.* (Exhibit 10.30)                    |  | (A)
|      |  |                                                                                                                                                                                                           |  |    
|10.10 |  | Amendment to First Amended and Restated License Agreement, dated as of June 19, 1996, between The University of
Tennessee Research Corporation and RGene Therapeutics, Inc.* (Exhibit 10.1)               |  | (B)
|      |  |                                                                                                                                                                                                           |  |    
|10.11 |  | Second Amendment to First Amended and Restated License Agreement, dated as of April 17, 1998, between The
University of Tennessee Research Corporation and RGene Therapeutics, Inc.* (Exhibit 10.16)      |  | (G)
|      |  |                                                                                                                                                                                                           |  |    
|10.12 |  | License Agreement, dated as of March 15, 1997, between the Burnham Institute and Targeted Genetics* (Exhibit
10.23)                                                                                       |  | (E)
|      |  |                                                                                                                                                                                                           |  |    
|10.13 |  | Exclusive Sublicense Agreement, dated June 9, 1999, between Targeted Genetics and Alkermes, Inc.* (Exhibit
10.36)                                                                                         |  | (I)
|      |  |                                                                                                                                                                                                           |  |    
|10.14 |  | Amendment No. 2 to Exclusive Sublicense Agreement, dated as of May 29, 2003, between Targeted Genetics and
Alkermes, Inc.* (Exhibit 10.1)                                                                 |  | (X)
|      |  |                                                                                                                                                                                                           |  |    
|10.15 |  | Master Agreement, dated as of November 23, 1998, between Targeted Genetics and Medeva Pharmaceuticals, Inc.*
(Exhibit 1.1)                                                                                |  | (H)
|      |  |                                                                                                                                                                                                           |  |    
|10.16 |  | License and Collaboration Agreement, dated as of
November 23, 1998, between Targeted Genetics and
Medeva Pharmaceuticals, Inc.* (Exhibit 1.2)                                                             |  | (H)
|      |  |                                                                                                                                                                                                           |  |    
|10.17 |  | Supply Agreement, dated as of November 23, 1998,
between Targeted Genetics and Medeva
Pharmaceuticals, Inc.* (Exhibit 1.3)                                                                                |  | (H)

67



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##### Table of Contents



|      |  |                                                                                                                                                                                                                           |  |     
|----- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ----
|10.18 |  | Credit Agreement, dated as of November 23, 1998,
between Targeted Genetics and Medeva PLC (Exhibit
1.5)                                                                                                                   |  | (H) 
|      |  |                                                                                                                                                                                                                           |  |     
|10.19 |  | Funding Agreement, dated as of July 21, 1999, among
Targeted Genetics, Elan International Services,
Ltd., and Elan Corporation, plc (Exhibit 1.3)                                                                         |  | (J) 
|      |  |                                                                                                                                                                                                                           |  |     
|10.20 |  | Subscription, Joint Development and Operating
Agreement, dated as of July 21, 1999, among Elan
Corporation, plc, Elan International Services, Ltd.,
Targeted Genetics and Targeted Genetics Newco, Ltd.
* (Exhibit 1.4)   |  | (J) 
|      |  |                                                                                                                                                                                                                           |  |     
|10.21 |  | Convertible Promissory Note, dated July 21, 1999,
issued by Targeted Genetics to Elan International
Services, Ltd. (Exhibit 1.5)                                                                                          |  | (J) 
|      |  |                                                                                                                                                                                                                           |  |     
|10.22 |  | License Agreement dated July 21, 1999, between Targeted Genetics Newco, Ltd. and Targeted Genetics * (Exhibit 1.6)                                                                                                        |  | (J) 
|      |  |                                                                                                                                                                                                                           |  |     
|10.23 |  | License Agreement, dated July 21, 1999, between Targeted Genetics Newco, Ltd. and Elan Pharmaceutical Technologies, a division of Elan Corporation, plc
* (Exhibit 1.7)                                                   |  | (J) 
|      |  |                                                                                                                                                                                                                           |  |     
|10.24 |  | Office Lease, dated as of October 7, 1996, between Benaroya Capital Company, LLC and Targeted Genetics (Exhibit 10.26)                                                                                                    |  | (D) 
|      |  |                                                                                                                                                                                                                           |  |     
|10.25 |  | First Lease Amendment, dated May 12, 1997, between Targeted Genetics and Benaroya Capital Company, LLC (Exhibit 10.1)                                                                                                     |  | (R) 
|      |  |                                                                                                                                                                                                                           |  |     
|10.26 |  | Second Lease Amendment, dated February 25, 2000, between Targeted Genetics and Benaroya Capital Company, LLC (Exhibit 10.2)                                                                                               |  | (R) 
|      |  |                                                                                                                                                                                                                           |  |     
|10.27 |  | Third Lease Amendment, dated April 19, 2000, between Targeted Genetics and Benaroya Capital Company, LLC (Exhibit 10.3)                                                                                                   |  | (R) 
|      |  |                                                                                                                                                                                                                           |  |     
|10.28 |  | Fourth Lease Amendment, dated March 28, 2001, between Targeted Genetics and Benaroya Capital Company, LLC (Exhibit 10.4)                                                                                                  |  | (R) 
|      |  |                                                                                                                                                                                                                           |  |     
|10.29 |  | Fifth Lease Amendment, dated January 2, 2004, between Targeted Genetics and Benaroya Capital Company, LLC* (Exhibit 10.3)                                                                                                 |  | (AA)
|      |  |                                                                                                                                                                                                                           |  |     
|10.30 |  | Canyon Park Building Lease, dated as of June 30, 2000, between Targeted Genetics and CarrAmerica Corporation (Exhibit 10.1)                                                                                               |  | (L) 
|      |  |                                                                                                                                                                                                                           |  |     
|10.31 |  | Olive Way Building Lease, dated as of November 20, 1993, as amended, between Targeted Genetics and Ironwood Apartments, Inc. (successor in interest to
Metropolitan Federal Savings and Loan Association) (Exhibit 10.29) |  | (K) 
|      |  |                                                                                                                                                                                                                           |  |     
|10.32 |  | Fifth Amendment to Lease Agreement, dated as of June 20, 2003, between Targeted Genetics and Ironwood Apartments, Inc. (Exhibit 10.2)                                                                                     |  | (X) 
|      |  |                                                                                                                                                                                                                           |  |     
|10.33 |  | Sixth Amendment to Lease Agreement, dated as of November 1, 2003, between Targeted Genetics and Ironwood Apartments, Inc.* (Exhibit 10.1)                                                                                 |  | (AA)
|      |  |                                                                                                                                                                                                                           |  |     
|10.34 |  | 1992 Restated Stock Option Plan (Exhibit 99.1)                                                                                                                                                                            |  | (F) 
|      |  |                                                                                                                                                                                                                           |  |     
|10.35 |  | Stock Option Plan for Nonemployee Directors (Exhibit 10.34)                                                                                                                                                               |  | (E) 
|      |  |                                                                                                                                                                                                                           |  |     
|10.36 |  | 1999 Restated Stock Option Plan, as restated on January 23, 2001 (Exhibit 10.2)                                                                                                                                           |  | (Q) 
|      |  |                                                                                                                                                                                                                           |  |     
|10.37 |  | 2000 Genovo Inc. Roll-Over Stock Option Plan (Exhibit 99.1)                                                                                                                                                               |  | (O) 
|      |  |                                                                                                                                                                                                                           |  |     
|10.38 |  | Agreement and Plan of Merger dated as of August 8, 2000, among Targeted Genetics, Inc., Genovo, Inc., TGC Acquisition Corporation and Biogen, Inc.*
(Exhibit 2.1)                                                         |  | (M) 
|      |  |                                                                                                                                                                                                                           |  |     
|10.39 |  | Development and Marketing Agreement, dated as of August 8, 2000, between Targeted Genetics, Genovo, Inc. and Biogen, Inc. (Exhibit 10.1)                                                                                  |  | (N) 
|      |  |                                                                                                                                                                                                                           |  |     
|10.40 |  | Funding Agreement dated as of August 8, 2000, between Targeted Genetics and Biogen, Inc. (Exhibit 10.2)                                                                                                                   |  | (N) 
|      |  |                                                                                                                                                                                                                           |  |     
|10.41 |  | Amendment to Funding Agreement, dated as of July 14, 2003, between Targeted Genetics and Biogen, Inc. (Exhibit 10.3)                                                                                                      |  | (X) 

68



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|      |  |                                                                                                                                                                                                                |  |     
|----- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ----
|10.42 |  | Product Development Agreement, dated as of November 9, 2000, between Targeted Genetics and Genetics Institute, Inc. * (Exhibit 10.1)                                                                           |  | (P) 
|      |  |                                                                                                                                                                                                                |  |     
|10.43 |  | Supply Agreement, dated as of November 9, 2000, between Targeted Genetics and Genetics Institute, Inc.* (Exhibit 10.2)                                                                                         |  | (P) 
|10.44 |  | Amendment No. 1 to Product, Development and Supply Agreement, dated February 24, 2003, between Genetics Institute LLC (formerly known as Genetics
Institute, Inc.) and Targeted Genetics* (Exhibit 10.41)      |  | (V) 
|      |  |                                                                                                                                                                                                                |  |     
|10.45 |  | Industrial Collaboration Agreement, dated as of February 1, 2000, between the International Aids Vaccine Initiative, Inc., Childrens Research Institute
and Targeted Genetics* (Exhibit 10.1)                 |  | (U) 
|      |  |                                                                                                                                                                                                                |  |     
|10.46 |  | Amendment No. 1 to Industrial Collaboration Agreement, dated as of March 14, 2003, among the International Aids Vaccine Initiative, Inc., Childrens
Research Institute and Targeted Genetics* (Exhibit 10.42) |  | (V) 
|      |  |                                                                                                                                                                                                                |  |     
|10.47 |  | Amendment No. 2 to Industrial Collaboration Agreement, dated August 1, 2003, among Targeted Genetics, International Aids Vaccine Initiative, Inc. and
Childrens Research Institute* (Exhibit 10.2)            |  | (Z) 
|      |  |                                                                                                                                                                                                                |  |     
|10.48 |  | Amendment No. 3 to Industrial Collaboration Agreement, dated December 2, 203, among Targeted Genetics, International Aids Vaccine Initiative, Inc. and
Childrens Research Institute* (Exhibit 10.2)           |  | (AA)
|      |  |                                                                                                                                                                                                                |  |     
|10.49 |  | Settlement and Termination Agreement, dated as of December 19, 2002, between Celltech Pharmaceuticals Inc., Medeva Limited and Targeted Genetics
(Exhibit 10.40)                                               |  | (V) 
|      |  |                                                                                                                                                                                                                |  |     
|10.50 |  | Biological Processing Services Agreement, dated as of March 28, 2003, between GenVec, Inc. and Targeted Genetics* (Exhibit 10.1)                                                                               |  | (W) 
|      |  |                                                                                                                                                                                                                |  |     
|10.51 |  | Study Funding Agreement, dated as of April 23, 2003 between Targeted Genetics and Cystic Fibrosis Foundation Therapeutics, Inc.* (Exhibit 10.2)                                                                |  | (W) 
|      |  |                                                                                                                                                                                                                |  |     
|10.52 |  | Amendment Agreement to Exclusive Sublicense Agreement, dated as of March 12, 2002, between Targeted Genetics and Alkermes, Inc.*                                                                               |  |     
|      |  |                                                                                                                                                                                                                |  |     
|10.53 |  | Common Stock and Warrants Issuance Agreement, dated June 9, 1999, by and between Targeted Genetics and Alkermes, Inc. (Exhibit 10.37)                                                                          |  | (I) 
|      |  |                                                                                                                                                                                                                |  |     
|10.54 |  | Warrant Agreements, dated June 9, 1999, by and between Targeted Genetics and Alkermes, Inc. (Exhibit 10.38)                                                                                                    |  | (I) 
|      |  |                                                                                                                                                                                                                |  |     
|10.55 |  | Registration Rights Agreement, dated as of July 21, 1999, by and
among the Company and EIS.                                                                                                                    |  | (J) 
|      |  |                                                                                                                                                                                                                |  |     
|21.1  |  | Subsidiaries of Targeted Genetics                                                                                                                                                                              |  |     
|      |  |                                                                                                                                                                                                                |  |     
|23.1  |  | Consent of Ernst & Young LLP, Independent Auditors                                                                                                                                                             |  |     
|      |  |                                                                                                                                                                                                                |  |     
|31.1  |  | Section 302 Certification of Chief Executive Officer                                                                                                                                                           |  |     
|      |  |                                                                                                                                                                                                                |  |     
|31.2  |  | Section 302 Certification of Chief Financial Officer                                                                                                                                                           |  |     
|      |  |                                                                                                                                                                                                                |  |     
|32.1  |  | Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002                                                              |  |     
|      |  |                                                                                                                                                                                                                |  |     
|32.2  |  | Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002                                                              |  |     



---

|*   |  | Portions of these exhibits have been omitted based on a grant of or
application for confidential treatment from the SEC. The omitted portions
of these exhibits have been filed separately with the SEC.
|--- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|   
|(A) |  | Incorporated by reference to the designated exhibit included with
Targeted Genetics Registration Statement on Form S-1 (No. 333-03592)
filed on April 16, 1996, as amended.                            
|   
|(B) |  | Incorporated by reference to the designated exhibit included with
Targeted Genetics Quarterly Report on Form 10-Q (No. 0-23930) for the
period ended June 30, 1996, filed on August 12, 1996.          
|   
|(C) |  | Incorporated by reference to Targeted Genetics Registration Statement on
Form 8-A filed on October 22, 1996.                                                                                           
|   
|(D) |  | Incorporated by reference to the designated exhibit included with
Targeted Genetics Annual Report on Form 10-K (No. 0-23930) for the year
ended December 31, 1996, filed on March 17, 1997.            
|   
|(E) |  | Incorporated by reference to the designated exhibit included with
Targeted Genetics Annual Report on Form 10-K (No. 0-23930) for the year
ended December 31, 1997, filed on March 31, 1998.            
|   
|(F) |  | Incorporated by reference to the designated exhibit included with
Targeted Genetics Registration Statement on Form S-8 (No. 333-58907),
filed on July 10, 1998.                                        
|   
|(G) |  | Incorporated by reference to the designated exhibit included with
Targeted Genetics Annual Report on Form 10-K (No. 0-23930) for the year
ended December 31, 1998, filed on March 10, 1999.            

69



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##### Table of Contents



|(H)  |  | Incorporated by reference to the designated exhibit included with
Targeted Genetics Current Report on Form 8-K (No. 0-23930) filed on
January 6, 1999.                                             
|---- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|    
|(I)  |  | Incorporated by reference to the designated exhibit included with
Targeted Genetics Quarterly Report on Form 10-Q (No. 0-23930) for the
period ended June 30, 1999, filed on August 5, 1999.       
|    
|(J)  |  | Incorporated by reference to the designated exhibit included with
Targeted Genetics Current Report on Form 8-K (No. 0-23930) filed on
August 4, 1999.                                              
|    
|(K)  |  | Incorporated by reference to the designated exhibit included with
Targeted Genetics Annual Report on Form 10-K (No. 0-23930) for the year
ended December 31, 1999, filed on March 23, 2000.        
|    
|(L)  |  | Incorporated by reference to Targeted Genetics Quarterly Report on Form
10-Q (No. 0-23930) for the period ended June 30, 2000, filed on August 11,
2000.                                           
|    
|(M)  |  | Incorporated by reference to the designated exhibit included with
Targeted Genetics Current Report on Form 8-K (No. 0-23930) filed on
August 23, 2000.                                             
|    
|(N)  |  | Incorporated by reference to the designated exhibit included with
Targeted Genetics Current Report on Form 8-K (No. 0-23930) filed on
September 13, 2000.                                           
|    
|(O)  |  | Incorporated by reference to the designated exhibit included with
Targeted Genetics Registration Statement on Form S-8 (No. 333-48220),
filed on October 19, 2000.                                 
|    
|(P)  |  | Incorporated by reference to the designated exhibit included with
Targeted Genetics Current Report on Form 8-K (No. 0-23930) filed on
February 21, 2001.                                            
|    
|(Q)  |  | Incorporated by reference to Targeted Genetics Quarterly Report on Form
10-Q (No. 0-23930) for the period ended March 31, 2001, filed on May 11,
2001.                                             
|    
|(R)  |  | Incorporated by reference to the designated exhibit included with
Targeted Genetics Quarterly Report on Form 10-Q (No. 0-23930) for the
period ended June 30, 2001, filed on August 14, 2001.      
|    
|(S)  |  | Incorporated by reference to the designated exhibit included with
Targeted Genetics Quarterly Report on Form 10-Q (No. 0-23930) for the
period ended June 30, 2002, filed on August 14, 2002.      
|    
|(T)  |  | Incorporated by reference to the designated exhibit included with
Targeted Genetics Current Report on Form 8-K (No. 0-23930) filed on
October 11, 2002.                                            
|    
|(U)  |  | Incorporated by reference to the designated exhibit included with
Targeted Genetics Quarterly Report on Form 10-Q (No. 0-23930) for the
period ended September 30, 2002, filed on October 14, 2002.
|    
|(V)  |  | Incorporated by reference to the designated exhibit included with
Targeted Genetics Annual Report on Form 10-K (No. 0-23930) for the year
ended December 31, 2002, filed on March 27, 2003.        
|    
|(W)  |  | Incorporated by reference to the designated exhibit included with
Targeted Genetics Quarterly Report on Form 10-Q (No. 0-23930) for the
period ended March 31, 2003, filed on May 15, 2003.        
|    
|(X)  |  | Incorporated by reference to the designated exhibit included with
Targeted Genetics Current Report on Form 8-K (No. 0-23930) filed on July
22, 2003.                                               
|    
|(Y)  |  | Incorporated by reference to the designated exhibit included with
Targeted Genetics Current Report on Form 8-K (No. 0-23930) filed on
October 1, 2003.                                             
|    
|(Z)  |  | Incorporated by reference to the designated exhibit included with
Targeted Genetics Quarterly Report on Form 10-Q (No. 0-23930) for the
period ended September 30, 2003, filed on October 31, 2003.
|    
|(AA) |  | Incorporated by reference to the designated exhibit included with
Targeted Genetics Current Report on Form 8-K (No. 0-23930) filed on
January 13, 2004.                                            

70