<PAGE>

================================================================================

                                 UNITED STATES
                      SECURITIES AND EXCHANGE COMMISSION
                            Washington, D.C. 20549

                               -----------------

                                   FORM 10-K

<TABLE>
         <S> <C>
         [X]   ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
                         SECURITIES EXCHANGE ACT OF 1934
                   For the fiscal year ended December 31, 2001
                                        OR
         [_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
                         SECURITIES EXCHANGE ACT OF 1934
                    For the transition period from          to
</TABLE>

                      Commission File Number No. 0-23930

                               -----------------

                         TARGETED GENETICS CORPORATION
            (Exact name of Registrant as specified in its charter)

                     Washington                91-1549568
              (State of Incorporation)        (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)

                               -----------------

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

                                     None

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

                         Common Stock, $.01 Par Value

                               -----------------

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

   Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to
the best of 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. [X]

   Indicate the aggregate market value of voting stock held by nonaffiliates of
the Registrant as of March 5, 2002: $88,958,861

   Indicate the number of shares outstanding of each of the Registrant's
classes of common stock as of March 5, 2002:

                    Title of Class               Number of shares
            Common Stock, $0.01 par value           44,140,145

================================================================================

<PAGE>

                      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 9, 2002. The
definitive proxy statement will be filed with the Securities and Exchange
Commission within 120 days after December 31, 2001, the end of the fiscal year
to which this report relates.

<PAGE>

                         TARGETED GENETICS CORPORATION
                          ANNUAL REPORT ON FORM 10-K

                               TABLE OF CONTENTS

<TABLE>
<CAPTION>
                                                                                     Page
                                                                                     No.
                                                                                     ----
<C>       <S>                                                                        <C>

                                         PART I

Item 1.   Business..................................................................   1

Item 2.   Properties................................................................  21

Item 3.   Legal Proceedings.........................................................  21

Item 4.   Submission of Matters to a Vote of Security Holders.......................  21

                                         PART II

Item 5.   Market for Registrant's Equity and Related Shareholder Matters............  22

Item 6.   Selected Financial Data...................................................  23

Item 7.   Management's Discussion and Analysis of Financial Condition and Results of
          Operations................................................................  24

Item 7A.  Quantitative and Qualitative Disclosures About Market Risk................  41

Item 8.   Financial Statements and Supplementary Data...............................  42

Item 9.   Changes in and Disagreements with Accountants on Accounting and Financial
          Disclosure................................................................  64

                                        PART III

Item 10.  Directors and Executive Officers of the Registrant........................  65

Item 11.  Executive Compensation....................................................  65

Item 12.  Security Ownership of Certain Beneficial Owners and Management............  65

Item 13.  Certain Relationships and Related Transactions............................  65

                                         PART IV

Item 14.  Exhibits, Financial Statement Schedules, and Reports on Form 8-K..........  66

SIGNATURES..........................................................................  70
</TABLE>

<PAGE>

                                    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
"believes," "expects," "anticipates," "intends" and other words of similar
meaning 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.

Overview

   Targeted Genetics Corporation was incorporated in the State of Washington in
1989 and 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 inserting genes 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 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 insert genetic material into target cells. Our proprietary vector
technologies include both viral vector technologies and synthetic vector
technologies. 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 using lipids, which are
fatty, water-insoluble organic substances that can be absorbed 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. We believe that
using both viral and synthetic approaches provides advantages in our corporate
partnering efforts and increases the probability of our potential products
reaching the market.

   We have two lead product candidates under development, one for treating
cystic fibrosis and another for treating cancer. We also have a pipeline of
product candidates focused on treating hemophilia, arthritis and cancer, as
well as lysosomal storage disorders, which are a class of genetic diseases in
which missing enzymes

                                      1

<PAGE>

cause a buildup of metabolic byproducts in tissue. We are also developing a
vaccine candidate for the prevention of AIDS. We have entered into six
partnering relationships with pharmaceutical and biotechnology companies and a
public health organization to develop these product candidates. In each of our
partnerships, we have retained a substantial financial interest in the sales of
any commercial products that result from our work. Through our partnership
activities and other internally funded efforts, we have successfully advanced
our product candidates into clinical development, including Phase II clinical
trials for our lead cystic fibrosis and cancer product candidates. In addition,
we have developed processes to manufacture our potential products at a scale
amenable to clinical development and expandable to large-scale production for
commercialization, pending successful completion of clinical trials and
regulatory approval. We believe that these successes in assembling a broad
platform of proprietary intellectual property for developing and manufacturing
potential products and in establishing collaborative relationships and
advancing our potential products to clinical evaluation serve to demonstrate
the value of our intellectual property and our potential to develop gene
therapy product candidates to treat a range of diseases.

   Our business strategy reflects the following five key elements:

   Develop multiple gene delivery systems to maximize product
opportunities.  We believe 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. Accordingly, we are
developing both viral and synthetic vector technologies. 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 long-term expression profile of AAV
vectors may support the development of vaccines capable of conferring long-term
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 we are the only company that has advanced product
candidates using both viral and synthetic vectors into Phase II clinical
trials. We believe that using both types of vectors gives us one of the
broadest 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 for two other viruses, retroviruses and
adenoviruses, that can be used to deliver genes into cells.

   Build a strong product development infrastructure.  Although a great deal of
research has been focused on gene discovery, much less research has been
focused on gene delivery techniques and on creating the product development
infrastructure that is necessary to convert gene discovery into products that
can be evaluated in clinical trials and applied to patient care. We have
therefore focused significant efforts on establishing product development
expertise in the areas of preclinical research and biology, manufacturing
process development and scale-up, quality control, quality assurance,
regulatory affairs and clinical trials. We believe that our product development
focus provides advantages in our corporate partnering efforts and increases our
probability of reaching the market with products having a higher likelihood of
becoming commercially successful.

   Demonstrate clinical proof of concept.  We believe that by providing strong
evidence of the clinical benefit of our products, we can significantly enhance
shareholder value. We have two lead product candidates that we believe could
potentially demonstrate clinical proof of concept in the near term: tgAAVCF for
treating cystic fibrosis and tgDCC-E1A for treating cancer. Both of these
products entered Phase II clinical trials in late 2000 and we expect to have
data available to us in 2002. We believe that clinical proof of concept data in
our cystic fibrosis and cancer programs would demonstrate both the value of
these two lead product candidates and the broader value of our AAV and
synthetic gene delivery technologies.

                                      2

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   Build a strong pipeline of product candidates with significant market
potential.  We believe that there is significant long-term potential for using
our gene delivery systems to treat additional diseases. The infrastructure we
have built to support the development of our tgAAVCF and tgDCC-E1A product
candidates is available to support the development of new products based on our
viral and synthetic gene delivery systems. We believe that we may derive
significant future value by applying this infrastructure and the knowledge and
expertise we gain in developing our two initial product candidates to our
additional product candidates under development. Currently, we have ongoing
preclinical product development activities in the areas of cancer, arthritis,
hemophilia, lysosomal storage disorders and AIDS prophylaxis.

   Establish product development partnerships that allow for long-term value
retention.   We believe that our products under development have significant
long-term potential. We now have collaborative programs underway with six large
pharmaceutical and biotechnology companies and a public health organization. In
all of these partnerships, we have retained a substantial financial interest in
the sales of any commercial products that may result from our work. For
products based on our AAV delivery system, we have retained manufacturing
rights to any product candidates we develop. We have retained worldwide
commercial rights to our tgDCC-E1A product candidate and plan to develop the
product internally or through a collaborative relationship that will allow us
to achieve substantial long-term participation in tgDCC-E1A's potential
downstream commercial revenue.

   The following table summarizes our product development programs:

<TABLE>
<CAPTION>
    Program/Product      Research Preclinical Phase I Phase II Phase III       Collaborator
    ---------------      -------- ----------- ------- -------- --------- ------------------------
<S>                      <C>      <C>         <C>     <C>      <C>       <C>
AAV Vectors:
Cystic Fibrosis.........    --        --        --       --              Celltech Group
Arthritis...............    --        --                                 --
Hemophilia A............    --        --                                 Wyeth/Genetics Institute
Lysosomal Storage
 Disorders..............    --        --                                 Genzyme
AIDS Prophylaxis........    --        --                                 IAVI
Hyperlipidemia..........    --                                           --

Synthetic Vectors:
Head and Neck Cancer....    --        --        --       --              --
Ovarian Cancer..........    --        --        --                       --
Metastatic Cancer.......    --        --                                 --

Adenoviral Vectors:
Glioma..................    --        --        --                       Biogen
</TABLE>

Clinical Product Development Programs

  tgAAVCF for Cystic Fibrosis

   Cystic fibrosis is one of the most common single-gene deficiencies 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, loss of lung function and early death. Current treatments
for cystic fibrosis relieve only the symptoms of the disease, and cannot cure
the disease or stop its progression.

   Our cystic fibrosis product candidate, designated tgAAVCF, is comprised of a
complete functional CFTR human gene delivered in an AAV vector. The objective
of this gene therapy is to deliver a functional copy of the CFTR gene that 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-based approaches for

                                      3

<PAGE>

treating cystic fibrosis, because the drug appears to have a good safety
profile and an ability to deliver the CFTR gene to the appropriate cells in the
lung and support production of the missing protein over an extended period. In
preclinical studies, we have observed delivery of the CFTR gene in up to 50% of
the targeted airway cells and expression of the CFTR gene in the lung for
periods of up to six months with no side effects.

   Our early clinical trials involved the administration of tgAAVCF to the
lung, nose or sinus of over 60 patients. The results of the trials indicated
that the product was safe and well-tolerated with no significant inflammatory
response or other side effects, even after repeat delivery. Additionally, in a
clinical trial involving administration of the product to the maxillary sinus,
we observed:

  .  dose-dependent gene transfer;

  .  persistence of the gene for up to 70 days after treatment;

  .  improvements in lung function measurements of chloride transport in
     biopsied cells after treatment; and

  .  reduction of sinus inflammation, as assessed by changes in levels of
     certain cytokines and immunoregulatory substances secreted by cells of the
     immune system.

   In 1998, we entered into a license and collaboration agreement related to
tgAAVCF with Medeva Pharmaceuticals, Inc., now a wholly owned subsidiary of
Celltech Group plc. Under these agreements, Celltech owns exclusive worldwide
marketing rights to tgAAVCF and provides significant funding to us. The section
below entitled "Research and Development Collaborations" provides a detailed
description of this relationship.

   In 2000, we completed a Phase I clinical trial to test the safety of aerosol
delivery of tgAAVCF to the lungs of cystic fibrosis patients. We treated 12
cystic fibrosis patients with a single dose of tgAAVCF in a dose escalation
study. Data from this trial suggest that tgAAVCF delivered via a nebulizer was
well tolerated and had a good safety profile at all doses evaluated.
Additionally, we observed delivery of the CFTR gene to target cells in all
patients at the highest dose and indications that tgAAVCF was well distributed
throughout the upper airways of the patients. We also observed vector gene
transfer in some patients 90 days after the single administration of
aerosolized tgAAVCF. tgAAVCF has been granted orphan drug status by the United
States Food and Drug Administration, or FDA, which provides for seven years of
market exclusivity.

   In November 2000, we began a Phase II clinical trial to explore the safety
and clinical impact of repeated doses of aerosolized tgAAVCF delivered to the
lungs of adult and adolescent cystic fibrosis patients. This double-blind,
placebo-controlled trial will also evaluate the impact of tgAAVCF on lung
function, lung inflammatory proteins and lung bacteria in patients with cystic
fibrosis. We are conducting this trial in connection with the Cystic Fibrosis
Foundation, the largest cystic fibrosis patient advocacy organization in the
world. During 2001, an independent data and safety monitoring board that
periodically reviews the safety profile of tgAAVCF for this trial allowed us to
reduce the entry age criteria for patients that may be enrolled into this trial
from 18 years of age to 15 years of age, and then subsequently reduce the entry
age to 12 years of age. Because cystic fibrosis is a progressive disease,
reducing the age criteria for patients in this trial will allow us to treat
patients at an earlier stage of the disease, which we believe may better enable
us to halt or significantly slow the development of lung damage. We plan to
complete enrollment of patients into this trial and evaluate the trial results
during 2002.

  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.

                                      4

<PAGE>

   In 1996, we acquired the rights to the E1A gene, which is derived from a
common virus. E1A regulates the expression of viral and cellular genes within
cells infected by the virus. 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. To deliver the E1A gene into human cells, we have combined E1A with
two of our proprietary lipid-based vectors, DCC-Cholesterol and LPD (lipids,
which are fats, polycations, which are compounds with multiple positive charges
and DNA) to create two potential delivery systems for the E1A gene. We believe
these delivery systems may have the necessary characteristics for repeated and
efficient delivery of the E1A gene into rapidly dividing cells, such as tumor
cells.

   Our product candidate for treating cancer is based on the E1A gene. We have
exclusive worldwide rights to issued patents covering the use of the E1A gene
in cancer therapy. 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.
Research also indicates that E1A has anti-tumor effects unrelated to the
inhibition of HER-2/neu expression. For example, our preclinical studies of our
tgDCC-E1A product candidate in mice with tumors indicate that tgDCC-E1A
inhibits expression of the HER-2/neu oncogene, inhibits growth and metastasis
of the tumor cells and increases significantly the long-term survival of the
mice. 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 these trials 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 are
treating advanced-stage ovarian cancer patients with a combination of tgDCC-E1A
and two chemotherapy products, Taxol(R) and Cisplatin, at increasing dosage
levels. tgDCC-E1A and Cisplatin are administered directly to the peritoneal
cavity and Taxol(R) is administered intravenously. This trial is designed to
evaluate drug safety and to assess maximum tolerable dose levels, as well as
measure the biologic activity of E1A. We anticipate presenting preliminary data
from this clinical trial in mid-2002.

   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. We are treating patients with twice-weekly
injections of tgDCC-E1A throughout six to seven weeks of radiation therapy.
Primary endpoints of this trial include 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 include
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. We plan to
perform an interim data analysis for this trial upon completing treatment of
several patients in this trial.

   For a description of research and development expenses related to our
clinical development programs, see the section entitled "Management's
Discussion and Analysis of Financial Condition and Results of Operations--
Results of Operations" in Part II, Item 7 of this annual report.

                                      5

<PAGE>

Preclinical Product Development Programs

  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. Direct and indirect costs
associated with RA cost the U.S. economy nearly $65 billion per year. 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 TNF(a) plays a pivotal role in this disease process and have
validated anti-TNF(a) therapies as a valuable strategy to treat RA. RA is
currently treated with protein therapies such as Immunex Corporation's
Enbrel(R), a variety of systemic treatments, including steroid and nonsteroid
anti-inflammatory drugs, and other drugs such as methotrexate, cyclosporine,
and other monoclonal antibody therapies such as Remicade(R).

   We believe that local administration of DNA sequence encoding anti-TNF(a)
proteins may be a potentially useful alternative to systemic administration of
anti-TNF(a) proteins for treating RA and other inflammatory diseases. The
characteristics of AAV vectors make them well suited for delivery of genes to
joints and other local environments. We are developing an AAV-based product as
a potential alternative or supplement to systemic protein therapy in patients
with RA symptoms limited to one or several joints, or in situations where
systemic delivery of the protein therapy may not be possible.

   We have administered AAV-ratTNFR:Fc, a vector carrying the DNA sequence that
expresses a soluble form of protein that binds TNF(a), to the muscle or the
joint of rats with experimentally induced RA. Data from these studies show that
a single administration of AAV-ratTNFR:Fc to one ankle joint suppressed joint
inflammation, pannus formation (inflammatory cells) and cartilage and bone
damage in the treated ankle.

  Hemophilia A

   Hemophilia A is a hereditary disorder caused by the absence or severe
deficiency of Factor VIII, a blood protein that is essential for proper
coagulation. According to the National Hemophilia Foundation, approximately
14,000 people in the United States suffer from hemophilia A. Hemophilia A
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
Factor VIII protein. If slow, chronic bleeding is not treated, progressive,
irreparable physical damage may result. Because both manufactured and
naturally-derived Factor VIII proteins are expensive, protein therapy is
generally limited to treating 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 is strong rationale for developing a gene therapy
product that could be administered prophylactically to hemophilia A patients to
prevent spontaneous bleeding incidents, for the following reasons:

  .  hemophilia A results 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 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 Factor VIII protein could effectively prevent chronic bleeding
     incidents in hemophilia A patients;

  .  the high cost of protein therapy generally limits its use to treating
     bleeding incidents, which may provide a significant market opportunity for
     gene-based prophylactic products that address the underlying disease; and

  .  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.

                                      6

<PAGE>

   We also believe that AAV vectors represent a promising means of delivering a
gene to trigger production of the Factor VIII protein for treating hemophilia
A. The characteristics of AAV vectors, including their good safety profile and
ability to persist in cells and express genes for extended periods of time,
should provide important advantages compared to other gene delivery methods. We
have invested in significant infrastructure to support the development of
tgAAVCF, our AAV-based product candidate for treating cystic fibrosis, and we
believe this infrastructure can be efficiently adapted to developing an
AAV-based gene therapy product for treating hemophilia A.

   In November 2000, we entered into a collaboration with Wyeth/Genetics
Institute, a unit of Wyeth Pharmaceuticals, to develop gene therapy products
for treating hemophilia. Under the terms of the collaboration agreement
Wyeth/Genetics Institute provides us with significant funding and owns
exclusive worldwide marketing rights to any products resulting from the
collaboration. The section below entitled "Research and Development
Collaborations" provides a detailed description of this relationship.

  Lysosomal Storage Disorders

   Lysosomal storage disorders are a family of diseases caused by the absence
of enzymes that are essential for removing certain metabolic byproducts from
cellular tissues. The buildup, or storage, of these substances causes a loss of
function in many crucial areas of the body, which may result in mental and
physical disability and, in most cases, shortened lifespan. While each of these
diseases typically affects fewer than 5,000 to 20,000 people worldwide,
according to the National Tay Sachs & Allied Diseases Association, there are
more than 40 different lysosomal storage disorders, including Tay Sachs, Pompe,
Gaucher, Fabry and Batten disease.

   We began collaborating with Genzyme Corporation in the area of lysosomal
storage disorders after completing our acquisition of Genovo, Inc. in September
2000. Genzyme and Genovo had initiated a research and development collaboration
in this area in 1999. In November 2000, following our acquisition of Genovo, we
amended the research and development agreement previously entered into between
Genovo and Genzyme to define the scope and level of work that we would perform
for Genzyme in developing products for treating lysosomal storage disorders.
Under the terms of the amended agreement, we will work with Genzyme to develop
potential gene therapies for lysosomal storage disorders and Genzyme will be
responsible for clinical development and commercialization of any products
resulting from the collaboration. The section below entitled "Research and
Development Collaborations" provides a detailed description of this
relationship.

  HIV Vaccine

   According to the International AIDS Vaccine Initiative, or IAVI, more than
40 million people worldwide suffer from AIDS or are infected with HIV, the
virus that causes AIDS. An additional 14,000 men, women and children worldwide
are infected daily. 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 prophylactic vaccine to protect against infection by HIV could
have significant market potential. To date, no company has applied for
regulatory approval of a prophylactic AIDS vaccine, although several vaccines
are under development.

   We are collaborating with IAVI and Children's Research Institute, or CRI, on
the campus of Children's Hospital in Columbus, Ohio to develop a vaccine to
protect against HIV infection. The vaccine will utilize our AAV vectors to
deliver HIV genes that express viral proteins that can be detected by the
immune system to elicit a protective immune response against HIV. We believe
that a single dose of an AAV-based vaccine containing HIV genes could allow for
a sustained and high level of gene expression of HIV proteins in vivo, thereby
eliciting a robust and sustained immune response without exposing the patient
to HIV. Data from studies in nonhuman primates suggest that AAV vector vaccines
may hold significant promise. Monkeys immunized with AAV vectors carrying SIV
genes, the primate equivalent of HIV, develop immune responses that are very
similar to those induced by the human form of HIV. These data provide the basis
for moving

                                      7

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forward with further preclinical development that we believe will support Phase
I clinical trials in humans. Under the terms of the public-private
collaboration, IAVI will fund work at Targeted Genetics and at CRI focused on
development and preclinical and Phase I studies 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 option to
manufacture the vaccine for nonindustrialized nations. The section below
entitled "Research and Development Collaborations" provides a detailed
description of this collaboration.

  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 are
therefore developing new formulations of E1A, which we believe have the
potential to target cancer cells when administered systemically.

   One of these formulations, tgLPD-E1A is based on a non-viral gene delivery
vehicle called LPD, which contains lipids, polycations and DNA, and results in
the formation of small, stable DNA particles encapsulated in a lipid shell. 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 studies of tgLPD-E1A 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 was comparable to the
impact observed when administrating Taxol(R), a chemotherapeutic drug.
Additionally, administering both Taxol(R) and tgLPD-E1A inhibited tumor growth
in mice significantly better than administering either agent alone.
Furthermore, additional studies at Targeted Genetics and Emerald Gene Systems,
our joint venture with Elan Corporation, suggest that the LPD platform could be
modified to provide an enhanced efficacy and safety profile. Consequently, we
plan to perform evaluations of these alternate formulations before deciding
which formulation, if any, will advance into a clinical development phase.

  Glioma

   Glioma is a type of brain cancer that affects 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. Our
collaboration with Biogen expanded upon a collaboration that Biogen had with
Genovo prior to the acquisition. As part of this collaboration, 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. We are entitled to receive a royalty
on any future sales resulting from this product candidate.

  Hyperlipidemia

   We are exploring gene therapies for cardiovascular disease by applying our
AAV vector technology to treating hyperlipidemia, the elevation of lipids
(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 death from heart attack or stroke. As part of our acquisition of
Genovo, we acquired a product development program aimed at assessing the
delivery of genes to treat dyslipidemia, a condition of increased levels of
vLDL-type cholesterol. We are conducting further research studies to assess the
potential clinical utility of our AAV-VLDLR product candidate

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for treating hyperlipidemia. We have exclusive rights to certain intellectual
property related to the use of AAV-based gene therapy for treating
hypercholesterolemia.

   For a description of research and development expenses related to our
clinical development programs, see the section entitled "Management's
Discussion and Analysis of Financial Condition and Results of
Operations--Results of Operations" in Part II, Item 7 of this annual report.

Core Technology Platform

   We have assembled a broad base of core proprietary technologies that we
believe will allow us to address a number of different diseases. We believe
that different disease targets will require different methods of gene delivery.
The best gene delivery method for a particular disease will depend on the
targeted gene, the type of cell to be modified, the duration of effect desired
and the need for in vivo or ex vivo delivery. Accordingly, our strategy has
been to develop multiple gene delivery systems based on both AAV vector and
synthetic vector technologies. We also have capabilities and intellectual
property in two other types of viral vectors, adenoviruses and retroviruses. In
addition, through our Emerald Gene Systems joint venture, we are working to
create enhanced lipid-based delivery systems that would further extend the
applicability of our technology base. We believe that our broad base of
proprietary gene-delivery technologies will give us the flexibility to develop
gene therapies for a wider range of diseases than we could develop using any
single gene delivery system.

  Gene Therapy

   Overview.  Gene therapy is an approach to treating or preventing genetic and
acquired diseases that involves inserting 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 produce, 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 function or an absence of specific genes causes
proteins to be overproduced, underproduced, or produced incorrectly, any of
which can cause disease. These diseases include cystic fibrosis, in which a
defective protein is produced, and hemophilia, in which a protein is
underproduced. Deficient or absent genes can also cause cells to incorrectly
regulate gene expression which can cause diseases such as certain types of
cancer. 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 to date 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 inserted into 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

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virus to reproduce. 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 long
duration. We and others are using a variety of viral vectors, including AAV and
retroviral vectors, 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 contain no viral genes that could produce unwanted
     cellular immune responses leading to side effects or reduced efficacy;

  .  AAV vectors can introduce genes into nondividing 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 exclusive 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.

   In addition to our tgAAVCF clinical development program for treating cystic
fibrosis, we are conducting preclinical experiments to assess the potential for
using AAV vectors to deliver genes to other target cells for treating other
diseases. Currently, we are evaluating the use of AAV vectors to deliver genes
to joints, muscles, the lung, the liver and the cardiovascular system (heart
and blood vessels). Upon receiving additional financial and scientific
resources, we intend to examine, both internally and through collaborators, the
use of AAV vectors in additional cell types.

   Our 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 vivo gene delivery
approaches include:

  .  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;

  .  injecting pure plasmid, or "naked," DNA in an aqueous solution; and

  .  directing DNA to receptors on target cells by combining the gene with
     molecules (ligands) that bind to the receptors.

   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

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  .  ability to target to specific cell receptors.

   We are working to expand our synthetic vector capabilities by developing
enhancements to cationic lipid-based systems that will expand the potential
uses of synthetic vectors. In one enhancement, which we call LPD, DNA is
condensed and then combined with cationic lipids and polycations to generate
stable particles of defined size that have significantly enhanced gene transfer
efficiency and stability in the bloodstream. We believe that LPD-based
formulations may be useful for delivering genes by intravenous administration.

   Our Enhanced Vector Systems.  Emerald Gene Systems, our joint venture with
Elan, was formed to develop enhanced gene delivery systems that combine our AAV
and synthetic gene delivery technologies with Elan's drug delivery
technologies. Elan's licensed technologies include targeting ligands and
polymers. We plan to develop enhanced gene delivery systems that can be
systemically or orally administered to target the desired cells within the body.

  Cell Therapy

   In November 2000, we established CellExSys, Inc., a majority-owned
subsidiary, to further develop our ex vivo cell 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. Through our ownership of CellExSys, we own or have
rights to over 75 issued patents and patent applications in the area of cell
therapy and other applications of T-cell technology.

   Cell therapy involves transplanting 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. Key to this technology is a
proprietary rapid expansion method, or REM. We have exclusive rights to a
patent on REM that was issued to the Fred Hutchinson Cancer Research Center in
October 1998. Using the REM process, CellExSys can grow billions 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.

   The applications of the REM technology, an ex vivo therapeutic approach, are
quite distinct from our in vivo gene delivery technologies and product
development programs. As a result, we transferred our interests in our cell
therapy and ex vivo therapy-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
well-positioned to identify and take advantage of desirable product,
partnership and financial opportunities that fall outside the field of in vivo
gene therapy. CellExSys intends to fund further development of these cell
therapy technologies by selling its equity securities to third party investors.
Upon completion of these funding activities, we expect that we would no longer
be the majority equity owner of CellExSys.

Research and Development Collaborations

  Medeva Pharmaceuticals, Inc./Celltech Group plc

   In 1998, we entered into a collaboration with Medeva Pharmaceuticals, Inc.,
now a wholly owned subsidiary of Celltech Group plc, to develop and
commercialize tgAAVCF, our gene therapy product candidate for treating cystic
fibrosis. Medeva committed to provide annual funding of up to $5 million for up
to three years, to support our tgAAVCF research and development activities,
including:

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  .  scale-up and validation of manufacturing processes;

  .  development and validation of analytical methods;

  .  conduct of Phase I clinical trials; and

  .  other activities in support of product testing and commercialization.

   In addition, Medeva agreed to pay the costs of Phase II and subsequent
clinical trials of our tgAAVCF product candidate. Although we are currently
managing a Phase II clinical trial in the United States, the agreements provide
that Medeva will conduct all other trials and assume responsibility for
securing worldwide registration of tgAAVCF.

   Under the terms of the Medeva/Celltech collaboration, we granted
Medeva/Celltech an exclusive worldwide license to sell any tgAAVCF products
resulting from the collaboration but retained rights for manufacturing and
supplying bulk tgAAVCF product to support clinical trials and product
commercialization. Our supply rights survive for the term of the patents
covering tgAAVCF. Medeva loaned us $2 million to partially fund the
construction of a pilot-scale tgAAVCF manufacturing facility and agreed to loan
us, under specified conditions, up to an additional $10 million toward building
a Good Manufacturing Practices compliant manufacturing facility for
higher-volume production of tgAAVCF. To date, we have received approximately
$28 million in funding from Celltech out of a potential $54 million in license
fees, development funding, milestone payments, loans and equity investments
connected with the Medeva/Celltech agreements. Assuming successful
commercialization, we will also receive proceeds from sales of tgAAVCF
products, based on a pricing formula intended to provide us with a significant
percentage of Celltech's net revenue from tgAAVCF product sales.

   In November 2000, we initiated a Phase II, double-blind, placebo-controlled
clinical trial to evaluate our tgAAVCF product candidate. In the fourth quarter
of 2001, we completed the initial three-year term of our tgAAVCF product
research and development efforts with Medeva. Depending on the results of the
current Phase II clinical trial, we will either:

  .  work with Celltech toward supporting the design and execution of one or
     more pivotal clinical trials required for product registration and
     approval;

  .  work with Celltech to design and execute additional clinical trials to
     further evaluate the therapeutic potential of tgAAVCF; or

  .  discontinue our work with Celltech and evaluate our strategic options for
     continuing the development of a gene therapy-based cystic fibrosis product.

   Celltech may terminate the collaboration at will with 180 days' notice. If
Celltech exercises its termination right, all rights related to tgAAVCF that we
have granted or otherwise extended to Celltech would return to us.

  Emerald Gene Systems, Ltd.

   In July 1999, we formed Emerald Gene Systems, Ltd., our joint venture with
Elan International Services, Ltd., a wholly owned subsidiary of Elan
Corporation plc. Emerald was formed 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 could potentially be
systemically or orally administered to deliver genes targeting the desired
cells within the body.

   We own 80.1% of Emerald's common and preferred stock and Elan owns the
remaining 19.9% of Emerald's common and preferred stock. Although we own 100%
of Emerald's voting stock, Elan and its subsidiaries have retained significant
minority investor rights that prevent us from exercising control over Emerald.
Accordingly, we do not consolidate Emerald's financial statements but instead
account for our investment in Emerald under the equity method of accounting.


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   We and Elan fund the expenses of Emerald in proportion to our respective
ownership interests. A joint operating committee determines the nature and
scope of activities to be performed by the joint venture on a periodic basis
and at least annually. To date, we and Elan have jointly conducted Emerald's
research and development activities. Emerald reimburses each company for the
costs of research and development and related expenses, plus a profit
percentage.

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

  .  Elan purchased $5 million of our common stock in 1999 at the closing of
     the joint venture agreements and an additional $5 million of our common
     stock in 2000.

  .  In September 2001, we drew $2 million under a $12 million convertible note
     commitment by Elan to fund a portion of our investment in Emerald; and

  .  Elan purchased $12 million of our Series B convertible exchangeable
     preferred stock at the closing of the joint venture agreements, in
     exchange for our initial investment in Emerald.

   At Elan's option, its Series B convertible exchangeable preferred stock can
be converted 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. Alternatively,
Elan can exchange its Series B preferred stock for the preferred shares we hold
in Emerald, which would bring Elan's ownership in Emerald to 50%. If Elan
elects to exchange its Series B preferred stock for our Emerald preferred
stock, Elan must pay us an amount equal to 30.1% of the total funding that we
have provided to Emerald after its formation.

   Elan, as a 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.

   We may borrow up to $12 million from Elan in the form of a convertible note,
to fund our ongoing investment in Emerald. We can draw on this note on a
quarterly basis until July 21, 2002 or through the end of the initial
development period, which is September 30, 2002. Total draws cannot exceed our
cumulative investment in Emerald. Borrowings under the loan facility are
subject to the following terms:

  .  the outstanding principal balance bears interest at 12% per year,
     compounded semi-annually;

  .  interest is payable semi-annually in cash or can be capitalized and added
     to the principal amount outstanding; and

  .  principal and interest outstanding under the loan facility is due July 21,
     2005, payable in cash or shares of our common stock.

   As of December 31, 2001, we had borrowed $2 million against this facility.

   Elan has the option to convert principal and interest outstanding under the
loan facility, on a per-draw basis, into shares of our common stock. If Elan
elects to convert outstanding amounts into our common stock, the conversion
price will be 150% of the average closing price of our common stock for a
specified period of time before the date of each applicable draw under the loan
facility.

   We have the option to prepay the principal and interest outstanding under
the loan facility, in whole or on a per-draw basis, in either cash or shares of
our common stock. If we elect to prepay amounts outstanding with our common
stock, the conversion price will be the lower of 150% of the average closing
price of our common stock for a specified period of time before the date of the
applicable draw and the average closing price of our common stock for a
specified period of time before the date of prepayment. If we elect to prepay
outstanding amounts in cash, we will pay an amount equal to the higher of the
amount of principal and interest outstanding under the applicable draw and the
fair market value of our common stock into which the outstanding amount is
convertible, based on a price per share equal to the average closing price of
our common stock for a specified period of time before the date of prepayment.

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   As of December 31, 2001, we had provided $6.2 million of funding to the
Emerald joint venture, $4.2 million of which remain under the loan facility.

  Biogen, Inc.

   In September 2000, in connection with our acquisition of Genovo, we
established a three-year, multiple-product development and commercialization
collaboration with Biogen, Inc. Under the terms of a development agreement,
Biogen has the option to collaborate with us to develop up to four new gene
therapy product candidates. The specific genes to be delivered will be
determined by Biogen and us over the initial three-year development period. Two
of these genes have been identified, one for treating an infectious disease and
the other for treating a genetic disorder. We are responsible for manufacturing
and supplying bulk vector supplies to Biogen to support product development,
clinical trials and product commercialization.

   Upon initiation of the collaboration Biogen paid us $8 million in research
funding and milestone payments. Under a related funding agreement, Biogen will
provide us with a minimum of $1 million per year in research and development
funding over the initial three-year development period. Minimum annual funding
could be increased by mutual agreement between Biogen and us.  Biogen also
agreed to provide us with loans of up to $10 million and to purchase up to $10
million of our common stock, each at our discretion. During 2001, we borrowed
$10 million from Biogen under this commitment. The loan is due in September
2006 and bears interest at market rates. We can elect to have Biogen purchase
the common stock in one or more tranches through September 2003. The price per
share for any share purchase will equal the average of the daily closing prices
of a share of our common stock for a specified period of time before and after
the applicable exercise date.

   Assuming successful commercialization of products under the Biogen
collaboration, we could receive an aggregate of up to $125 million in license
fees, development funding, milestone payments, loans and equity investments
connected to the Biogen agreements. We granted Biogen an exclusive worldwide
license to sell any products developed in the collaboration. We will either
receive royalties on sales of any products developed under the collaboration,
or alternatively, we will sell products developed under the collaboration to
Biogen at transfer prices that include sales-based and cost-based components,
under a pricing formula specified in the developing and marketing agreement.
The product manufacturing and supply provisions of the agreements are effective
for the term of the patents covering our technology used to develop the
product. Although Biogen may terminate the development and marketing agreement
at any time after September 2001, its obligation under the related funding
agreement to pay $1 million in annual research funding payments continues
through September 2003.

  Wyeth/Genetics Institute

   In November 2000, we entered into a collaboration with Wyeth/Genetics
Institute, a unit of Wyeth Pharmaceuticals, to develop AAV vector-based gene
therapy products for treating hemophilia A and, potentially, hemophilia B.

   Under the terms of the collaboration agreements, Wyeth/Genetics Institute
agreed to pay us $5.6 million in up-front payments and up to $15 million over
the initial three-year development period for developing a hemophilia A product
candidate. We also granted Wyeth/Genetics Institute an option to collaborate on
the development of a hemophilia B product candidate, which if exercised, could
provide us with additional development and milestone payments. Assuming
successful commercialization of both products under this collaboration, we
could receive an aggregate of up to approximately $80 million in license fees,
development funding and milestone payments. Wyeth/Genetics Institute will
manage and fund the costs of clinical trials and related regulatory filings
required for product approval and marketing and will have global marketing
rights for any products resulting from the collaboration.

   Wyeth/Genetics Institute also has agreed to loan us up to $10 million to
finance manufacturing facility expansions if specified conditions are met. In
addition, Wyeth/Genetics Institute has agreed to pay us to manufacture product
for clinical trials and, upon approval, for commercial use, according to a
sales-based formula.

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   The research and development funding agreement is effective until October
2003, with an option to extend the term if both parties agree. The supply
agreement is effective for the term of the initial product development period
and can be extended should regulatory agencies approve a product for commercial
use. Wyeth/Genetics Institute has the right to terminate both agreements at
will, with 180 days' notice. If Wyeth/Genetics Institute exercises this right
to terminate, all rights related to the hemophilia technology that we have
granted or otherwise extended to Wyeth/Genetics Institute will return to us. If
Wyeth/Genetics Institute exercises their right to terminate both agreements at
will or if we exercise our right to terminate for cause, we would have an
option to acquire a right and license to certain hemophilia patent rights
controlled by Wyeth/Genetics Institute.

  Genzyme Corporation

   In 1999, Genovo entered into a research and development collaboration with
Genzyme Corporation to develop potential products for treating lysosomal
storage disorders. Under the terms of the development agreement, Genovo was
committed to perform, for up to three years and at its own cost, up to $2.9
million per year of research and development activities. A related option
agreement gave Genzyme the option to purchase up to $11.4 million of Genovo
equity during the three-year research and development period, of which $3.4
million had been purchased before our acquisition of Genovo in 2000. We assumed
the Genzyme agreements when we acquired Genovo.

   In 2000, we amended the 1999 development agreement to expand its
technological scope and financial terms and establish a development plan for
the second year of the three-year collaboration. Under the amended agreement,
Genzyme will be required to pay milestone payments upon our achievement of
specified regulatory milestones and to pay royalties on sales of any products
developed under the collaboration. The development program under our agreement
with Genzyme is effective through August 2002 and includes an option to extend
the term if both parties agree. Genzyme has the right to terminate the
development program at will, with 90 days' notice. If Genzyme exercises this
right to terminate the development program, or upon its expiration, all rights
that we have granted or otherwise extended to Genzyme will return to us, except
that Genzyme will retain an exclusive license to certain Genovo-related
manufacturing technology for use in the field of lysosomal storage disorders.

   After executing the amended agreement, Genzyme exercised its option to
purchase 311,295 shares of our common stock (as successor company to Genovo) at
a purchase price of $12.8495 per share, resulting in proceeds to us of $4
million. Genzyme has not exercised a second option to acquire up to an
additional 311,295 shares of our common stock also at a price of $12.8495 per
share. We are in negotiations with Genzyme to define the scope of ongoing
development activities and the parameters around which Genzyme would make a
further investment in us. If Genzyme elects not to make an additional
investment or to provide less than the $4 million we would receive if Genzyme
exercised the second stock purchase option, the former Genovo shareholders and
option holders will receive up to 155,648 additional shares of our common stock.

  International AIDS Vaccine Initiative

   In February 2000, we entered into a three-year collaboration with the
International AIDS Vaccine Initiative and Children's Research Institute to
develop a vaccine to prevent AIDS. The vaccine, which will utilize our AAV
vectors to deliver selected HIV genes as a vaccine, is designed to elicit a
protective immune response against HIV. Under this collaboration, vaccine
candidates will be constructed based on subtypes of the virus most prevalent in
Southern and Eastern Africa, and are expected to be evaluated in those regions.
Under the terms of this public-private collaboration, IAVI will fund
development, preclinical studies and Phase I clinical trials performed by us
and by CRI. IAVI has also agreed to invest up to $6 million in research funding
during the initial three years of the collaboration.

   Assuming successful development, we expect to manufacture the vaccine and
will retain exclusive worldwide commercialization rights to any product that
may stem from the collaboration. Under the terms of the collaboration, IAVI has
retained rights to ensure that any successful vaccine will be distributed in
developing

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countries at a reasonable price to be determined by IAVI. If we decline to
produce the vaccine for developing countries in reasonable quantities and at a
reasonable price, IAVI will have rights to obtain licenses from us that will
allow IAVI to contract with other manufacturers to make the vaccine available
at a reasonable price in those countries. In any event, however, we will retain
exclusive rights to commercialize in industrialized countries any vaccine
resulting from the collaboration.

   The initial development periods of our collaborations with Genzyme and Elan
will conclude in 2002 and the initial development periods of our other
collaborations will conclude in 2003, unless we and our collaborators agree to
extend the agreements. Substantially all of our revenue, and substantially all
of our expected revenue for the next several years, is derived from our product
development collaborations. If we were to lose the product development and
other funding that our collaborative partners provide and are unable to obtain
alternative funding, we may be unable to commercialize the product candidate
covered by the affected collaborations. For a more detailed description of the
risk, see the section entitled "Factors Affecting Our Operating Results, Our
Business and Our Stock Price--If we lose significant collaborative funding or
we are unable to raise additional capital when needed, we may be unable to
develop our potential products and conduct our operations" in Part II, Item 7
of this annual report.

  Alkermes, Inc.

   In June 1999, we entered into a license agreement with Alkermes, Inc. in
which we received exclusive rights to an issued patent and other pending patent
applications related to AAV vector manufacturing. The issued patent broadly
covers a manufacturing method that we believe is key to making AAV-based
products in a commercially viable, cost-effective manner. The license to this
technology, first developed by Children's Hospital in Columbus, Ohio, covers
the use of cell lines for manufacturing AAV vectors and expands a limited field
license to these rights that we previously acquired. Under the terms of the
license agreement, we issued to Alkermes 500,000 shares of common stock and two
warrants, each to purchase 1,000,000 additional shares of common stock. The
warrants expire in June 2007 and June 2009 and have an exercise price of $2.50
and $4.16 per share, respectively. 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 Immunex Corporation

   Targeted Genetics was formed in 1989 as a subsidiary of Immunex, 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 common stock, in
exchange for Immunex granting us 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.

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 United States Patent and Trademark Office, or
USPTO, as well as 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 by the USPTO and foreign counterparts. 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

                                      16

<PAGE>

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 since 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 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 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 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 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--Intellectual property
disputes regarding third-party technology that we license may prevent or impair
our ability to develop and commercialize our product candidates" 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, however, 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

                                      17

<PAGE>

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. We also compete with others to acquire products or technology from
research institutions or universities.

   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 product 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 premarket approval procedures administered by
the Food and Drug Administration, or 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 in humans. The FDA reviews all product candidates
for safety and efficacy at each stage of clinical testing. Both

                                      18

<PAGE>

safety and efficacy standards must be met before the FDA permits clinical
testing to proceed to the next stage or 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
frequently 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 Institution Review Board 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 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 NIH-funded clinical trial can begin, the Institutional Biosafety
Committee must perform a review of the proposed clinical trial and ensure there
are no safety issues associated with the trial.

   Clinical trials are typically conducted in three phases. 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

                                      19

<PAGE>

other companies in our industry have made progress in the field of gene
therapy, we cannot predict what the FDA or the RAC 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, as well as the approval of several other governmental and
nongovernmental agencies, before we can market the product in the United
States. 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

   At December 31, 2001, we had 173 full-time-equivalent employees, of which
151 are directly involved in research and development, or support our research
and development efforts. 31 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

                                      20

<PAGE>

workforce and scientific advisors or in attracting additional qualified
employees and advisors, our business will not succeed. None of our employees
are covered by a collective bargaining agreement.

Item 2.  Properties

   We currently occupy an aggregate of approximately 90,000 square feet of
laboratory and office space in Seattle, Washington and Sharon Hill,
Pennsylvania. The leases on our Seattle laboratory and office facilities expire
in March 2004 and contain options for us to extend the terms for two additional
five-year periods. The average annual rent payment during the current terms of
the Seattle leases total approximately $1.4 million, including amounts related
to landlord financing of leasehold improvement costs. The lease on our
laboratory and office facilities in Sharon Hill expires in November 2005 and
contains options for us to extend its term for two additional five-year
periods. The annual rent payment during the current term of the Sharon Hill
lease is approximately $353,000. 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 contains an option for us to extend its term for one additional
five-year period. The average annual rent payment during the current term of
the Bothell lease is approximately $1.3 million. We believe that our current
facilities in Seattle and Sharon Hill, together with additional expansion space
available in our Bothell facility and the office complex adjoining our main
Seattle building, will be adequate to meet our projected needs for the next
several years. Within that time frame, however, we could be required to locate
alternative facilities, depending on the extent of our growth and development.

Item 3.  Legal Proceedings

   We are not a party to any material legal proceedings, although from time to
time we may become involved in disputes in connection with the operation of our
business.

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 2001.

                                      21

<PAGE>

                                    PART II

Item 5.  Market for the Registrant's Equity and Related Shareholder Matters

   Our common stock trades on the Nasdaq National Market under the symbol TGEN.
As of March 5, 2002, we had approximately 263 shareholders of record and
approximately 19,700 beneficial holders of our common stock.

   We have never paid cash dividends and do not anticipate paying them in the
foreseeable future. In addition, our loan agreements with Biogen, Inc. and
Celltech Group plc restricts the amount of cash dividends we can pay.

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

<TABLE>
<CAPTION>
                                                            High   Low
                                                           ------ -----
         <S>                                               <C>    <C>
         2001:
            4th Quarter................................... $ 3.50 $1.71
            3rd Quarter...................................   5.87  1.45
            2nd Quarter...................................   6.60  3.00
            1st Quarter...................................   9.25  2.38

         2000:
            4th Quarter...................................  12.81  6.38
            3rd Quarter...................................  17.00  9.00
            2nd Quarter...................................  15.00  5.31
            1st Quarter...................................  28.00  3.63
</TABLE>

   In connection with a private placement of common stock in 1998, we issued
warrants to purchase a total of 4,333,333 shares of common stock at an exercise
price of $2.00 per share. On January 18, 2001, The Equitable Life Assurance
Company exercised warrants to purchase 1,000,000 shares of common stock. The
transaction was exempt from registration under Section 4(2) of the Securities
Act, on the basis that the transaction did not involve a public offering.


                                      22

<PAGE>

Item 6.  Selected Financial Data

<TABLE>
<CAPTION>
                                                            Year Ended December 31,
                                     --------------------------------------------------------------------
                                         2001          2000          1999          1998          1997
                                     ------------  ------------  ------------  ------------  ------------
<S>                                  <C>           <C>           <C>           <C>           <C>
Statement of Operations Data
   Revenue.......................... $ 18,880,000  $ 11,403,000  $  6,848,000  $  7,510,000  $  1,328,000
   Operating expenses...............   47,484,000    57,208,000    33,694,000    16,373,000    15,828,000
   Loss from operations.............  (28,604,000)  (45,805,000)  (26,846,000)   (8,863,000)  (14,501,000)
   Loss before cumulative effect
     of change in accounting
     principle......................  (27,170,000)  (43,973,000)  (26,655,000)   (8,687,000)  (14,188,000)
   Cumulative effect of change
     in accounting principle........           --    (3,682,000)           --            --            --
   Net loss.........................  (27,170,000)  (47,655,000)  (26,655,000)   (8,687,000)  (14,188,000)
   Basic and diluted net loss per
     share:
       Loss before cumulative
         effect of change in
         accounting principle....... $      (0.64) $      (1.19) $      (0.84) $      (0.33) $      (0.70)
       Cumulative effect of
         change in accounting
         principle..................           --         (0.10)           --            --            --
          Net loss per basic
            and diluted
            common share (1)........        (0.64)        (1.29)        (0.84)        (0.33)        (0.70)
   Shares used in computing
     basic and diluted net loss
     per common share...............   43,927,822    37,752,164    32,173,756    26,637,823    20,196,325
   Proforma amounts assuming
     the accounting change is
     applied retroactively:
     Net loss.......................                              (24,555,000)  (14,468,000)
     Net loss per common
       share........................                             $      (0.77) $      (0.54)

                                                                 December 31,
                                     --------------------------------------------------------------------
                                         2001          2000          1999          1998          1997
                                     ------------  ------------  ------------  ------------  ------------
Balance Sheet Data
   Cash and cash equivalents........ $ 25,186,000  $ 38,630,000  $  7,153,000  $ 11,957,000  $  5,038,000
   Total assets.....................   71,038,000    87,974,000    13,692,000    16,204,000     9,767,000
   Long-term obligations............   16,403,000     2,447,000     2,088,000       900,000     1,517,000
   Total shareholders' equity.......   37,401,000    63,432,000     6,966,000    11,982,000     5,592,000
</TABLE>
--------
(1) Effective January 1, 2000, we changed our method of accounting for
    nonrefundable up-front license fees. See Note 1 to the consolidated
    financial statements.

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<PAGE>

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

Overview

   We develop gene therapy products and technologies to treat acquired and
inherited diseases on our own and through various research and development
collaborations with others. We have historically funded our product development
efforts primarily through the sale of equity securities and through funding
received from our product development partners. We have six major
collaborations that provide ongoing funding for our research and development
programs:

  .  a cystic fibrosis product development collaboration with Medeva
     Pharmaceuticals, Inc., now a wholly owned subsidiary of Celltech Group plc;

  .  an AAV-based AIDS vaccine development collaboration with the International
     Aids Vaccine Initiative;

  .  a multiple-product gene therapy product development collaboration with
     Biogen, Inc.;

  .  a lysosomal storage disorder product development collaboration with
     Genzyme Corporation;

  .  an AAV-based hemophilia product development collaboration with
     Wyeth/Genetics Institute, a unit of Wyeth Pharmaceuticals; and

  .  Emerald Gene Systems, Ltd., our joint venture with Elan International
     Services, Ltd., a wholly owned subsidiary of Elan Corporation plc, for the
     development of enhanced gene delivery technology.

   Our development collaborations with other entities typically provide us with
funding, including one or more purchases of our equity securities, loans,
payments for reimbursement of research and development costs and milestone fees
and payments. We and our partner will typically agree on a development plan for
the product candidate, which often extends for multiple years. The product
candidate's progress is periodically reviewed with the partner. Our development
partners often coordinate clinical evaluation of product candidates and
marketing rights for product candidates that are successfully developed. We
generally maintain manufacturing and royalty-based interests in successfully
developed product candidates.

   We have two lead product candidates in clinical trials, tgAAVCF for treating
cystic fibrosis and tgDCC-E1A for treating cancer. tgAAVCF is currently in a
Phase II clinical trial. tgDCC-E1A is currently in a Phase I clinical trial for
treating ovarian cancer and a Phase II clinical trial for treating head and
neck cancer. We are pursuing tgDCC-E1A initially as a company-funded program
but anticipate entering into a strategic collaboration later in the development
process. Our product candidates for treating hemophilia and lysosomal storage
disorders, our potential vaccine to prevent HIV infection and the products we
are developing with Elan and Biogen are all in preclinical development.
Developing 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 of this Item 7 entitled "Factors Affecting Our
Operating Results, Our Business and Our Stock Price--Risks Related to Product
Development and Regulatory Approval" and elsewhere in this annual report. As a
result, we are unable to predict whether we will be able to successfully
develop any of our product candidates or the time or cost successful
development will require.

   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, milestone payments and licensing fees from current and potential
future corporate collaborators. The timing and amount of our future revenue,
will be subject to significant fluctuations,

                                      24

<PAGE>

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 may 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 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 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, 2001, our accumulated deficit totaled $178.0 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 our staffing levels, outside costs for supplies and materials and clinical
trial activities. We increased our staffing, outside costs and clinical trial
activities in 2001 and 2000 as a result of the greater number, complexity and
advancing development stages of our collaborations. We anticipate 2002 staffing
and outside costs for supplies, materials and clinical trial activities will
continue at levels similar to those in 2001. As described in the section of
this Item 7 entitled "Liquidity and Capital Resources," the initial development
periods of three of our collaborations conclude in 2002 and 2003. If we and the
collaborators do not agree to extend these collaborations, they will terminate.
Absent new collaborative partnerships or extensions to our existing
collaborative partnerships, we anticipate that both our research and
development costs and our revenue will decrease in 2003. We will need to scale
our research and development activities to match the levels of funding provided
by our collaborators and other sources of capital available to us, which may be
subject to fluctuation in the future.

   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 and on acceptable terms,
obtain and maintain corporate partnerships or complete acquisition transactions
necessary or desirable to complete the development of our product candidates.

   In September 2000, we acquired Genovo, Inc., a privately held biotechnology
company focused on developing therapeutic products based on AAV vectors. The
purchase price totalled $66.4 million, which consisted of 5,250,805 shares of
our common stock, valued at $58.4 million, assumed Genovo options valued at
$7.7 million and transaction costs of $600,000 less $300,000 allocated to the
intrinsic value of unvested stock options that we assumed. In connection with
the acquisition of Genovo, we recorded acquired in-process research and
development, or IPR&D, expenses of $28.0 million and acquisition-related
intangibles of $39.5 million, consisting of AAV vector know-how of $12.7
million, workforce in place of $1.6 million and goodwill of $25.2 million.

Significant Accounting Policies

   There are several accounting policies that we believe are critical to the
presentation of our consolidated financial statements. Note 1 to our
consolidated financial statements "Description of Business and Summary of
Significant Accounting Policies" summarizes each of our significant accounting
policies. The most critical accounting policies include those related to
revenue recognition, specifically as these policies relate to our

                                      25

<PAGE>

collaborative development relationships with other companies, the accounting
and presentation for our unconsolidated joint venture interest in Emerald, the
application of assumptions and estimates in accounting for acquired IPR&D costs
and the valuation of our intangible assets.

   We generate revenue from technology licenses, collaborative research
arrangements and cost reimbursement agreements. Revenue under technology
licenses and collaborative agreements typically consist 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 ratably over 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.

   We own 80.1% of Emerald's common and preferred stock and 100% of its voting
shares and Elan owns the remaining 19.9% of Emerald's common and preferred
stock. Although we own a controlling interest in Emerald, Elan and its
subsidiaries have 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 prevent us from
exercising control over Emerald, we do not consolidate Emerald's financial
statements but instead account for our investment in Emerald under the equity
method of accounting.

   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 IPR&D 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.

   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

   Revenue in 2001 totaled $18.9 million, compared to $11.4 million in 2000.
This increase primarily resulted from our hemophilia product development
collaboration with Wyeth/Genetics Institute and our multiple-product
development collaboration with Biogen, both of which were established in late
2000. The increase also reflects growth in revenue earned from the Emerald
joint venture and revenue earned under our AIDS vaccine collaboration with
IAVI. The increase in revenue for 2001 was partially offset by a decrease in
revenue earned under our development program with Celltech for a cystic
fibrosis product candidate, under which we earned a $2 million milestone
payment in 2000. Revenue increased to $11.4 million in 2000 from $6.8 million
in 1999, reflecting amounts generated under our collaboration agreement with
Celltech, a full year of providing research and development services to Emerald
and, to a lesser degree, revenue generated from a partial year of product
development efforts in our collaborations with Wyeth/Genetics Institute, Biogen
and IAVI.

   We generated $2.8 million in revenue in 2001, $1.9 million in revenue in
2000 and $446,000 in revenue in 1999 from research and development activities
performed for Emerald.

                                      26

<PAGE>

  Operating Expenses

   Research and Development.  We incurred research and development expenses of
$31.5 million in 2001, compared to $19.3 million in 2000. This increase
resulted from increased research and development efforts in our hemophilia and
AIDS vaccine product development collaborations, design costs associated with
our large-scale manufacturing facility expansion and the addition of Genovo's
research and development operations. The increase also reflects increased
research and development activities to support our collaborations with Elan, as
well as additional clinical and regulatory activities associated with the
development for our cancer programs. Research and development expenses
increased to $19.3 million in 2000 from $14.3 million in 1999, reflecting
increased expenses related to our acquisition of Genovo's research and
development operations, additional activities related to our collaborations
with Wyeth/Genetics Institute and IAVI and, to a lesser extent, costs incurred
to support the Emerald joint venture. The increase in total expenses in 2001
was partially offset by decreases in our tgDCC-E1A development expenses as
tgDCC-E1A moved into clinical development.

   Our research and development expenses for the years ended December 31, 2001,
2000 and 1999 were as follows:

<TABLE>
<CAPTION>
                                                Year Ended December 31,
                                          -----------------------------------
                                             2001        2000        1999
                                          ----------- ----------- -----------
   <S>                                    <C>         <C>         <C>
   Preclinical programs.................. $18,693,000 $ 6,321,000 $ 1,440,000
   Clinical programs:
      Cystic fibrosis....................   2,521,000   3,959,000   5,440,000
      Cancer products....................   2,630,000   2,251,000     770,000
      Indirect costs.....................   7,702,000   6,781,000   6,641,000
                                          ----------- ----------- -----------
          Total..........................  12,853,000  12,991,000  12,851,000
                                          ----------- ----------- -----------
   Total research and development expense $31,546,000 $19,312,000 $14,291,000
                                          =========== =========== ===========
</TABLE>

   Indirect costs include facility and occupancy costs, intellectual
property-related expenses, including patent prosecution and maintenance, and
license and royalty payments. Direct costs include specifically identifiable
costs of salaries, benefits, clinical trial sites, outside services, materials
and supplies.

   Costs associated with our preclinical program activities increased each
year, reflecting the addition of the AIDS vaccine collaboration with IAVI in
early 2000, the hemophilia collaboration with Wyeth/Genetics Institute and the
lysosomal storge disorder collaboration with Genzyme in late 2000 and increased
activity in our self-funded RA and gene delivery technology development
programs. Costs associated with our clinical program activities were relatively
stable as increases in costs attributable to our cancer research and
development programs were offset by decreases in costs attributable to our
cystic fibrosis research and development costs.

   Equity in Loss of Unconsolidated, Majority-Owned Research and Development
Joint Venture.  Our equity in the net loss of the Emerald joint venture
increased to $3.7 million in 2001 from $2.5 million in 2000. Losses in both
years reflect our 80.1% equity share in the loss generated by Emerald's
research and development and licensing activities performed by Elan and us. In
1999, our equity in the net loss of Emerald was $12.6 million, which included
our 80.1% share of a $15.0 million charge for an exclusive license to Elan's
drug delivery technology and our 80.1% share of Emerald's 1999 collaboration
costs.

   In-Process Research and Development.  In 2000, we recorded $28.0 million in
IPR&D expenses, which reflects the portion of the purchase price paid to
acquire Genovo that was allocated to acquired IPR&D. In 1999, we incurred an
expense of $3.2 million to acquire from Alkermes, Inc. an exclusive sublicense
to a patent and patent applications related to the manufacture of AAV vectors.
We acquired this license in exchange for shares of our common stock and
warrants to purchase shares of our common stock.

                                      27

<PAGE>

   We acquired ongoing IPR&D projects from Genovo in the fields of AAV
manufacturing platforms, lysosomal storage disorders, glioma, hemophilia and
hyperlipidemia. The amount recorded as IPR&D expense for the Genovo acquisition
represents the present value of the estimated after-tax cash flows that we
believe may be generated by the purchased technology that, as of the
acquisition date, had not yet reached technological feasibility. We based the
cash flow projections for revenue on estimates of growth rates and the
aggregate size of the markets for each product, the probability of technical
success given the stage of development at the time of acquisition, royalty
rates based on prior licensing agreements, product sales cycles and the
estimated life of the product's underlying technology. We deducted our
estimated operating expenses and income taxes from our estimated revenue
projections to arrive at our estimated after-tax cash flows. The rate that we
used to discount projected cash flows for in-process technologies ranged from
30% to 45%, depending on the relative risk of each in-process technology, and
were based primarily on internal rates of return, cost of capital, rates of
return for research and development and our weighted average cost of capital at
the time of acquisition. The acquired IPR&D projects consisted of the following:

  .  AAV manufacturing platform projects related to hyperlipidemia, hemophilia,
     lysosomal storage disorders, and glioma, which pursue manufacture of AAV
     as a stable gene therapy vector capable of delivering genes to a variety
     of dividing and nondividing cells. Genovo estimated that the additional
     research and development costs to complete the AAV manufacturing platform
     projects in 2007 would be approximately $23.8 million. Since the
     acquisition of Genovo, we have continued to perform preclinical
     development of the AAV manufacturing platform program we acquired from
     Genovo.

  .  Technology in the area of lysosomal storage disorders, which is a family
     of approximately 40 genetic diseases, are normally single-gene defects
     that prevent the production of one or more lysosomal enzymes, which leads
     to abnormal deposits of substrates within lysosomal vacuoles. Genovo
     estimated the additional costs to complete these technologies at
     approximately $9.0 million, with a targeted completion date in 2007. Since
     the acquisition of Genovo, we have been developing with Genzyme
     Corporation a product candidate for treating Fabry disease, which is
     currently in preclinical development.

  .  Glioma technology, intended to treat brain tumors in adults. These tumors,
     which are highly malignant, are nearly always fatal and currently have no
     known curative treatment. Genovo had been developing a gene therapy
     product to treat glioma with Biogen. Genovo estimated that the additional
     costs to complete its glioma technology at approximately $750,000, with a
     targeted completion date in 2006. Since our acquisition of Genovo, Biogen
     has begun a Phase I clinical trial of its gene therapy product candidate
     to treat glioma.

  .  Technologies for treating hemophilia, which is a genetic disorder that
     results in prolonged external and/or internal bleeding. Genovo estimated
     the additional costs to complete its hemophilia technologies at
     approximately $12.0 million, with a targeted completion date in 2009. We
     are working with Wyeth/Genetics Institute to develop a gene therapy
     product candidate to treat hemophilia A, which is currently in preclinical
     development.

  .  Technologies for treating hyperlipidemia, which is an elevation of lipids
     in the bloodstream that are transported as part of large molecules called
     lipoproteins. Genovo estimated that its hyperlipidemia technology would be
     completed in 2007, at an additional cost of approximately $16.0 million.
     We currently have limited preclinical development activities focused on
     hyperlipidemia.

   Genovo based all of these estimates and projections on assumptions believed
to be reasonable at the time of the acquisition, but that are inherently
uncertain and unpredictable. If we do not successfully develop these projects,
our business, operating results and financial condition may be adversely
affected. As of the date of the acquisition, we concluded that Genovo's
technologies under development, once completed, can be economically used only
for their specifically intended purposes and that these in-process technologies
have no alternative future use after taking into consideration the overall
objectives of the project, progress toward the objectives and uniqueness of
developments to these objectives. Given the uncertainties involved in
developing these product candidates, we are unable to predict whether we will
be able to successfully develop any of these product

                                      28

<PAGE>

candidates or the time or costs involved in doing so. The risk of untimely
completion includes the risk that competitors will develop alternative products.

   General and Administrative.  We incurred general and administrative expenses
of $6.2 million in 2001 as compared to $5.7 million in 2000. This increase is
attributable to higher business development and legal costs, including expenses
related to the spin-out of our majority-owned cell therapy subsidiary,
CellExSys, Inc., and increased administrative support for our growing number of
collaborative partnerships. General and administrative expenses increased to
$5.7 million in 2000 from $3.6 million in 1999. This increase reflected the
addition of Genovo administrative costs, costs associated with integrating
Genovo's operations into our own and greater business-development and legal
costs related to establishing new development collaborations.

   Amortization of Acquisition-Related Intangibles.  We recorded amortization
expenses of $6.1 million in 2001, compared to $1.7 million in 2000, for
goodwill, noncompetition agreements and assembled workforce that we acquired
when we purchased Genovo. We recorded no expenses related to amortization of
acquired intangibles in 1999. In July 2001, the Financial Accounting Standards
Board, or FASB, issued Statement of Financial Accounting Standards, or SFAS,
No. 142, "Goodwill and Other Intangible Assets," which requires use of a
nonamortization approach to account for purchased goodwill and certain
intangibles, effective January 1, 2002. Under this nonamortization approach,
goodwill and certain intangibles will not be amortized into operating results,
but instead will be reviewed for impairment and written down and charged to
operating results only in the periods in which the carrying value of goodwill
and certain intangibles is more than its fair value. Assembled workforce will
be reclassified into goodwill in accordance with SFAS No. 142 and will be
evaluated accordingly. We will continue to amortize noncompetition agreements
over each agreement's estimated remaining useful life. We expect adoption of
SFAS No. 142 to substantially reduce our amortization of goodwill and
intangibles commencing January 1, 2002.

  Other Income and Expense

   Investment Income.  Our investment income from marketable securities, all of
which are cash equivalents, was $1.9 million in 2001, compared to $2.1 million
in 2000 and $426,000 in 1999. These fluctuations result from fluctuations in
the level of our cash and investments during the periods and, to a lesser
degree, from fluctuations in interest rates. Most of our cash is invested in a
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 increased to $452,000 in 2001 from $265,000 in 2000 and
$235,000 in 1999. The increase in 2001 is primarily due to higher average
outstanding principal balances during the second half of the year, when we drew
$13.0 million on available loans and notes. We expect our interest expense to
increase in 2002, to reflect our increased level of borrowings during 2001.

  Accounting Change

   In the fourth quarter of 2000, we adopted the provisions of the SEC's Staff
Accounting Bulletin No. 101, or SAB 101, "Revenue Recognition in Financial
Statements." SAB 101 generally provides that nonrefundable up-front fees for
licenses and rights to product candidates must be deferred and recognized as
revenue over the product development period in which we are providing
continuing services related to product development. Previously, we recognized
revenue from nonrefundable up-front license fees when the technology was
transferred and we had fulfilled all of our significant contractual obligations
relating to the fees. The cumulative effect on prior years of implementing SAB
101 resulted in a noncash charge of $3.7 million and a corresponding increase
in deferred revenue. This cumulative effect adjustment was calculated as of
January 1, 2000 and included in our financial results for 2000. We recognized
$1.6 million of revenue in 2001 and $2.1 million in 2000 related to this change
in accounting.

                                      29

<PAGE>

Liquidity and Capital Resources

   In the last three years, we have financed our operations primarily through
proceeds from public and private sales of our equity securities, which have
totaled approximately $47.5 million and through cash payments received from our
development partners to fund the development of our product candidates, which
totaled approximately $60.2 million. To a lesser degree, we have also financed
our operations through grant funding, interest earned on cash, cash equivalents
and short-term investments and funding under equipment leasing agreements.
These financing sources have historically allowed us to maintain adequate
levels of cash and investments.

   Our combined cash and cash equivalents totaled $25.2 million at December 31,
2001 compared with $38.6 million at December 31, 2000. During 2001, we used
$23.5 million to fund our operations, $4.4 million to purchase capital
equipment, $2.8 million to fund our share of the operations of the Emerald
joint venture and $1.1 million to repay scheduled debt payments. The primary
financing sources of our cash and cash equivalents in 2001 were $13.0 million
borrowed under debt financing commitments from our corporate partners,
$3.1 million in proceeds from the sale of common stock and $2.4 million
received under equipment financing agreements.

   Our future cash requirements will depend on many factors, including the rate
and extent of scientific progress in our research and development programs, the
scope and results of clinical trials, the time and costs involved in obtaining
regulatory approvals, the costs of our success in filing, prosecuting and
enforcing patents, competing technological and market developments and the cost
and success of product commercialization. We do not expect to generate positive
cash flow from our operations for at least the next several years, because all
of our product candidates are in pre-clinical and clinical development and we
expect to continue incurring significant expense in advancing our research and
development programs and commercializing our product candidates. Assuming our
research efforts for existing collaborations are continued for the full
research term, as of December 31, 2001 we have total committed funding of
approximately $65 million. This amount consists of i) $25 million of cash on
hand, ii) $17 million expected to be received in 2002 under loan and equity
commitments from our strategic partners, of which approximately $4 million must
be spent on the project sponsored by the partner providing the commitment, and
iii) $23 million in collaborative funding that we expect to receive from our
development partners primarily in 2002 and 2003 to help fund costs associated
with the development programs that they sponsor. In general, the obligation of
our corporate collaborators to provide research funding can be terminated by
our partners with notice. In the case of such an event, the collaboration
agreements specify the rights, if any, that each party will retain. We also
have warrants outstanding to purchase 3.3 million shares of our common stock at
$2.00 per share, which expire in April 2003. These warrants, if exercised would
provide us with proceeds of up to $6.7 million. The holder of these warrants,
however, may not elect to exercise the warrant to purchase shares of our common
stock.

   Because internally generated cash flow will not be sufficient to fund
development and commercialization of our product candidates, grow our business
and expand research and development of our product candidates for treating
additional diseases, we will require substantial additional financial
resources. We may be unable to obtain funding when needed on acceptable terms,
if at all. A significant portion of our operating expenses are funded through
our collaborative development agreements with third parties. The initial
development periods of our collaborations with Genzyme and Elan will conclude
in 2002 and the initial development periods of our other collaborations will
conclude in 2003. These development collaborations typically provide for
extension options to continue development of product candidates. Absent new
collaborative partnerships or extensions to our existing collaborative
partnerships, our research and development revenue and funding will decrease in
2003. We may also need to scale a large portion of our future research and
development activities to match the levels of funding provided by our
collaborators or from other funding that may be available to us. Assuming that
we conduct our currently planned operating activities and receive the funding
anticipated from our collaborative partners, and that we are able to scale our
operations to reflect any lesser amount of funding, we expect that our
available cash, anticipated interest income and collaborative funding will be
sufficient to finance our operations to 2004. We may require additional capital
before that time, however, as a result of unanticipated loss of funding

                                      30

<PAGE>

from collaborative partners, the implementation of additional research and
development programs or other factors discussed in the section of this Item 7
entitled "Factors Affecting Our Operating Results, Our Business and Our Stock
Price." We may be unable to obtain financing when needed on acceptable terms,
if at all.

   We intend to take advantage of additional funding opportunities as they
arise. If we fail to receive substantial amounts of our currently anticipated
collaborative funding or fail to secure additional collaborative agreements, or
if we fail to obtain alternative financing when needed, we will need to
substantially reduce the scope and size of our operations. We may also need to
reduce or terminate business development or other operating activities, or
delay, curtail or terminate research and development of one or more of our
product candidates.

   The following are our contractual commitments associated with our debt and
lease obligations:

<TABLE>
<CAPTION>
                                          Payments Due by Period
                        ----------------------------------------------------------
Contractual Obligations    Total       2002     2003-2005   2006-2007  After 2007
----------------------- ----------- ---------- ----------- ----------- -----------
<S>                     <C>         <C>        <C>         <C>         <C>
 Lease commitments..... $23,853,000 $2,903,000 $ 6,300,000 $ 2,725,000 $11,925,000
 Long term obligations.  17,711,000  1,308,000   5,876,000  10,527,000          --
                        ----------- ---------- ----------- ----------- -----------
    Total.............. $41,564,000 $4,211,000 $12,176,000 $13,252,000 $11,925,000
                        =========== ========== =========== =========== ===========
</TABLE>

Impact of New Accounting Pronouncements

   In June 2001, the FASB issued SFAS No. 141, "Business Combinations" and SFAS
No. 142, "Goodwill and Other Intangibles." SFAS No. 141 requires that business
combinations be accounted for using the purchase method of accounting,
effective July 1, 2001. SFAS No. 142 requires the use of a nonamortization
approach to account for goodwill and certain intangibles, effective January 1,
2002. Under this nonamortization approach, goodwill and certain intangibles
will not be amortized into results of operations, but instead will be reviewed
for impairment and written down through a charge to operations only in the
periods in which the carrying value of goodwill and certain intangibles is more
than its fair value. As of January 1, 2002, of the $31.8 million of net
goodwill and other purchased intangibles, $31.4 million will be classified as
goodwill and will no longer be amortized. The remaining $0.4 million will be
classified apart from goodwill and will continue to be amortized over its
estimated remaining useful life. We expect adoption of this accounting standard
to substantially reduce our amortization of purchased goodwill and intangibles
commencing January 1, 2002. The amount of goodwill amortization that would have
been recorded in 2002 is approximately $5.6 million. Since future impairment
reviews will be based on events and estimations in the future, we are currently
unable to estimate the effect that such review may have on our consolidated
financial statements.

   The FASB also recently issued SFAS No. 144, "Accounting for the Impairment
or Disposal of Long-Lived Assets," which is applicable to financial statements
issued for fiscal years beginning after December 15, 2001. SFAS No. 144
supersedes SFAS No. 121, "Accounting for the Impairment of Long-Lived Assets
and for Long-Lived Assets to Be Disposed Of," and portions of Accounting
Principles Bulletin Opinion No. 30, "Reporting the Results of Operations." SFAS
No. 144 provides a single accounting model for disposal of long-lived assets
and significantly changes the criteria for classification of an asset as
held-for-sale. If assets are classified as held-for-sale, they are not
depreciated and are stated at the lower of fair value and carrying amount. SFAS
No. 144 also requires us to display expected future operating losses from
discontinued operations in the period or periods in which the losses are
incurred, rather than as of the measurement date, as presently required. We do
not expect the provisions of SFAS No. 144 to have a significant effect on our
financial position or operating results as we currently do not hold any of our
assets as held-for sale and we have no indication that an impairment of any of
our long-lived assets exists.

                                      31

<PAGE>

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 Product Development and Regulatory Approval

  If we are unable to successfully complete preclinical and clinical
  development of our product candidates, we will be unable to generate
  sufficient capital to maintain our business.

   All of our potential products are either in research and development or in
early-stage clinical trials. Our ability to apply for and obtain regulatory
approval of our potential products depends upon successful completion of
additional research and development and testing, in both preclinical and
clinical trials. A product candidate that appears promising at an early stage
of research or development may not result in a commercially successful product.
Our trials may fail to demonstrate the safety and efficacy of a prospective
product, for example, or we may encounter unacceptable side effects or other
problems during or after clinical trials. Should this occur, we may have to
delay or discontinue development of the potential product, and corporate
partners that support development of that product candidate may terminate their
support. If we are unable to successfully complete preclinical and clinical
development of some or all of our product candidates, we may be unable to
generate sufficient product revenue to maintain our business.

   Completion of clinical trials may take several years or more. The number and
cost of clinical trials and the length of time necessary to complete trials
generally varies substantially according to the type, complexity, novelty and
intended use of the product candidate. The commencement, cost and rate of
completion of our clinical trials may vary or be delayed for many reasons,
including the risks discussed under the subheading below entitled "Risks
Related to Our Industry and Clinical Trials" and elsewhere in this "Factors
Affecting Our Operating Results, Our Business and Our Stock Price" section.

  Failure to timely obtain regulatory approval for our product candidates could
  prevent or impair our ability to commercialize our products.

   Even if our clinical trials are successful, commercializing any product in
the United States or abroad requires regulatory approval from the Food and Drug
Administration, or FDA, and applicable state and foreign regulators. Moreover,
the FDA and other applicable regulatory bodies must conclude at each stage of
clinical testing that our clinical data suggest acceptable levels of safety and
efficacy in order for us to proceed to the next stage of clinical trials. In
addition, gene therapy clinical trials that receive funding 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 an NIH-funded clinical trial can
begin, the NIH's Institution Biosafety Committee must review the proposed
clinical trial to ensure that there are no safety issues associated with the
trial. The regulatory process in the gene therapy industry is costly, time
consuming and subject to unpredictable delays, and regulatory requirements
governing gene and cell therapy products frequently change. In addition, 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 among trials and potential products. 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. To our knowledge, no gene therapy products have received regulatory
approval in the United States or in other countries. Because our product
candidates involve new and unproven technologies, we believe that regulatory
approval may proceed more slowly than clinical trials involving traditional
drugs. We do not expect any of our product candidates to be approved for
commercial sale for at least several years. Some or all of our product
candidates may never receive regulatory approval or may not receive approval
for all of the clinical applications for which we seek approval. 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 product sales or royalty revenue.

                                      32

<PAGE>

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

   Our manufacturing operations are subject to the current Good Manufacturing
Practices requirements of the FDA, as well as to other federal, state and local
regulations such as the Occupational Health and Safety Act and the
Environmental Protection Act. While we currently anticipate that we will be
able to manufacture products that meet applicable regulatory requirements, we
may be unable to attain or maintain compliance with current or future
regulations. If we discover previously unknown manufacturing, contamination,
product side effect or other problems after we receive regulatory approval for
a potential product or fail to comply with applicable requirements, we may
suffer restrictions on our ability to market the product or be required to
withdraw the product from the market. Either of these, or an unexpected
increase in the cost of compliance, could make it more difficult to maintain or
improve our financial condition.

Risks Related to Our Business Operations

  If we lose significant collaborative funding or we are unable to raise
  additional capital when needed, we may be unable to develop our potential
  products and conduct our operations.

   Because internally generated cash flow will not fund development and
commercialization of our products, we will require substantial additional
financial resources to develop and commercialize our potential products. A
significant portion of our operating expenses are funded through our
collaborative development agreements with third parties. If a current or future
collaborator were to terminate its financial or scientific support of a
potential product, we may be unable to complete development and
commercialization of that product candidate. We currently have collaborations
with five pharmaceutical and biotechnology companies and a public health
organization that provide expertise and funding to develop our product
candidates. The initial development periods of three of these
collaborations--Emerald Gene Systems for enhanced gene delivery systems,
Genzyme Corporation for lysosomal storage disorders and IAVI for AIDS
vaccines--will conclude in 2002 or early 2003. Each of these agreements will
terminate unless we and the collaborator agree to extend the agreement.
Substantially all of our revenue and substantially all of our expected revenue
for the next several years, are derived from our collaborations to develop
product candidates. If we were to lose this revenue, or other sources of
funding that our corporate partners provide, we may be unable to continue our
research and development program for the potential product covered by the
collaboration and our business would suffer. Assuming that we conduct our
currently planned operating activities and receive the funding anticipated from
existing corporate partners, and that we are able to scale our operations to
reflect any lesser amount of funding, we expect that our available cash,
anticipated interest income and collaborative funding will be sufficient to
finance our operations to 2004. We may require additional capital before that
time, however, as a result of unanticipated loss of funding from collaborative
partners, the implementation of additional research and development programs or
other factors discussed in this "Factors Affecting Our Operating Results, Our
Business and Our Stock Price" section or elsewhere in this annual report. We
may be unable to obtain financing when needed on acceptable terms, if at all.

   We intend to take advantage of additional funding opportunities as they
arise. Sources of additional funding could include one or more of the following:

  .  product development and funding collaborations;

  .  technology sales;

  .  technology licenses;

  .  issuing debt; or

  .  issuing equity.

   If we lose significant amounts of collaborative funding or we are unable to
obtain additional financing when needed, we will be forced to make substantial
reductions in the scope and size of our operations. We may be

                                      33

<PAGE>

forced to delay or terminate one or more research and development programs,
curtail capital expenditures or reduce or terminate business development and
other operating activities.

  We have a history of losses and may never become profitable, which could
  result in a decline in the value of our common stock and a loss of your
  investment.

   We have generated small amounts of revenue and incurred significant net
losses since inception. As of December 31, 2001, we had an accumulated deficit
of $178.0 million. We expect to continue to incur substantial additional losses
in the future, primarily due to the following factors:

  .  we will not generate any product revenue for at least several years
     because all of our product candidates are in preclinical and clinical
     development and have not received regulatory approval for commercial sale;
     and

  .  we will continue to incur significant expense for the foreseeable future
     to develop our research and development programs, conduct preclinical and
     clinical trials, seek regulatory approval for our product candidates and
     provide general and administrative support for these activities.

   We may never generate profits and, if we do become profitable, we may be
unable to sustain or increase profitability.

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

   We have entered into various license agreements, both exclusive and
nonexclusive, 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 and those of our partners. If
we are unable to maintain our current licenses or obtain additional licenses on
acceptable terms for technology used in our potential products, we and our
corporate partners may be required to expend significant time and resources to
develop or in-license replacement technology. If we are unable to do so, we may
be unable to develop or commercialize some or all of our potential products. In
addition, the license agreements for technology for which we hold exclusive
licenses typically contain provisions requiring us to meet minimum development
milestones in order to maintain the license on an exclusive basis. If we do not
meet these requirements, our licensors may convert the license to a
nonexclusive license or terminate the license.

  We may be unable to develop and commercialize some of our potential products
  if our relationships with scientific consultants and corporate collaborators
  are not successful.

   Our success depends on the continued availability of outside scientific
consultants and corporate collaborators to perform research and to provide or
develop technology and processes to advance and augment our internal efforts.
Competition for scientific consultants and corporate collaborators in gene
therapy is intense. If we are unsuccessful in establishing additional and
maintaining existing relationships with individual and corporate collaborators,
we could experience delays in our research and development or loss of access to
important enabling technology. We may be unable to enter into additional
collaborations on acceptable terms, if at all. Even if we maintain our current
scientific collaborations or establish new relationships, they may never result
in the successful development of product candidates.

   The development and commercialization of many of our potential products, and
therefore, the success of our business, substantially depends on the
performance of these scientific consultants and corporate collaborators.
Because they are not our employees, we have limited control over their
activities and the amount of time they devote to our business. If our
scientific consultants do not dedicate sufficient time, or if our corporate
partners do not commit sufficient financial and technical resources, to our
research and development programs or the

                                      34

<PAGE>

commercialization of our potential products, the preclinical or clinical
development related to the collaboration could be delayed or terminated. Even
if substantial time and resources are dedicated to developing our product
candidates, we may be unable to successfully complete development and
commercialization of our product candidates. Our current or future
collaborators may provide scientific expertise, technology or funding for, or
develop or market, competing products or alternative technologies.

   Any rights in inventions or processes discovered by a scientific consultant
may be contractually subject to the rights of his or her research institution
in that work. Some consultants may have obligations to other entities under
consulting or other agreements that may potentially conflict with their
obligations to us. Disputes, and potentially litigation, may arise with respect
to ownership of technology invented or discovered by a scientific consultant or
with respect to a product candidate developed under corporate collaborations.
We may be unable to secure our rights with respect to these technology or
product candidates.

Risks Related to Our Industry and Clinical Trials

  Adverse events in the field of gene therapy could damage public perception of
  our prospective 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 November 1999, a patient
with a rare metabolic disorder died in a gene therapy trial using an adenoviral
vector to deliver a therapeutic gene. Genovo, a company we later acquired, was
providing partial funding for this investigator-sponsored trial conducted at
the University of Pennsylvania. Other patient deaths, though unrelated to gene
therapy, have occurred in other clinical trials. These deaths 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. For example, there has been
concern in the past regarding the potential safety and efficacy of gene therapy
products derived from pathogenic viruses like adenoviruses. While our product
candidates use AAV vectors, which are nonpathogenic, and nonviral vectors, the
public and the medical community nonetheless may conclude that our technology
is unsafe. Moreover, to the extent that unfavorable publicity or negative
public perception arising from other biotechnology-related fields such as human
cloning and stem-cell research are linked in the public mind to gene therapy,
our industry will be harmed.

   Future adverse events in or negative public perception regarding gene
therapy or the biotechnology industry could also result in greater governmental
regulation, 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.

  The success of our early clinical trials are based on small numbers of
  patients over the short term and may not be indicative of results in a large
  number of patients or long-term efficacy.

   Results in early-stage clinical testing are based on limited numbers of
patients. Our reported progress and results from our early phases of clinical
testing 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 will have a lasting effect. If a larger
group of patients does not experience positive results, or any favorable
results do not demonstrate a lasting effect, the product candidate may not
receive approval from the FDA for further studies or commercialization. In
addition, 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.

                                      35

<PAGE>

  Failure to recruit patients could delay or prevent clinical trials of our
  potential products, which could cause a delay or inability to develop those
  potential products.

   Identifying and qualifying patients to participate in testing our potential
products is critical to our near-term success. The timing of our clinical
trials depends on the speed at which we can recruit patients to participate in
testing our products. We have experienced delays in our previous and current
clinical trials, and we may experience similar delays in the future. If
negative publicity as a result of adverse events in the biotechnology industry
affects the willingness of patients to participate in our gene therapy trials,
the timeline for recruiting patients, conducting trials and obtaining
regulatory approval of potential products will be delayed. Delays in recruiting
or enrolling patients to test our products result in increased costs, delays in
advancing our product development and delays in proving the effectiveness of
our technology, and could result in termination of the clinical trials
altogether. Any of these events could delay or prevent the development of our
product candidates.

  The success of our technology in animal models does not guarantee that the
  same results will be replicated in humans.

   Because animals are different from humans, the successful results of our
technology in animal models may not be predictive of the results that we will
see in our clinical trials with humans. If successful results for a potential
product in animal models are not replicated in human clinical trials, we may
have to expend greater resources to pass the clinical trial stage and obtain
regulatory approval of the product candidate or abandon its development.

Risks Related to Our Intellectual Property

  We may be unable to adequately protect our proprietary rights, which may
  limit our ability to successfully market any products.

   Our success substantially depends 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 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 could suffer a reduction in sales or be forced out of
the market.

  Intellectual property disputes regarding third-party technology that we
  license may prevent or impair our ability to develop and commercialize our
  product candidates.

   We have licensed technology underlying several issued and pending patents,
and have acquired rights to the gene delivered in our product candidate for
cystic fibrosis. 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

                                      36

<PAGE>

intellectual property or our competitors could market competing products using
the intellectual property. Licensing of intellectual property critical to our
business 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 scientific
     collaborators; 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. For example, in 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 CFTR gene and related vector. Our tgAAVCF
product candidate for treating cystic fibrosis uses our proprietary AAV
delivery technology to deliver a normal copy of the CFTR gene. Interference
proceedings before the USPTO are confidential, involving the opposing parties
only, and can take several years to complete. Although we are not a party to
the interference proceeding, its outcome could affect our license to the CFTR
gene and related vector. The USPTO could rule that our licensor has priority of
invention on both the CFTR gene and vector that we license, that our licensor
has priority of invention on neither the gene nor the vector, or that our
licensor has priority of invention on only the gene or only the vector. If the
USPTO or 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 rights to the CFTR gene and the vector,
and we cannot maintain 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.

  Intellectual property claims and litigation could strain our resources and
  subject us to significant liability for damages and invalidation of our
  proprietary rights.

   As the biotechnology industry expands, the risk increases that other
companies may claim that our processes and potential products infringe on their
patents. 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 a litigation or
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.

                                      37

<PAGE>

Risks Related to the Capital Markets and Dilution

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

   In recent years, 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. Our common stock has experienced, and is likely to continue
to experience, price fluctuations that cause the market price of our common
stock to decline. 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. Market
fluctuations in the price of our common stock could adversely affect our
collaborative opportunities and our future ability to sell equity securities at
a price we deem appropriate, and 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 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.
Furthermore, we may enter into financing transactions at prices that represent
a substantial discount to market price. Raising funds through the issuance of
equity securities will dilute the ownership of our existing shareholders. 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.

Additional Risks Related to Our Industry

  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. Although we believe that our safety procedures for handling, storing
and disposing of these materials comply with applicable laws and regulations,
we cannot eliminate the risk of accidental contamination or injury from
hazardous materials. If a hazardous material accident occurred, we could be
held liable for any resulting damages. This liability could exceed our
financial resources. These hazardous materials are subject to federal, state
and local regulations. We may be required to incur significant costs to comply
with future environmental or other laws. 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. If our
access to these materials is limited, we could experience 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 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, drugs and
other pharmaceutical products. 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
resources and larger

                                      38

<PAGE>

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 we are able to market or result in our
products failing to achieve market acceptance.

   Gene therapy is a new and rapidly evolving field and is expected to continue
to undergo significant and rapid technological change and competition. Our
competitors may develop new technologies and products that are available for
sale before our potential products or that may be more effective than our
potential products. 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 could impair our ability to successfully
  commercialize our potential products and become profitable.

   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 these proposals 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.

  Our ability to successfully commercialize our product candidates will
  substantially depend on the willingness of third-party payors to provide
  adequate reimbursement for the cost of our products.

   Sales of medical products and treatments substantially depend, both
domestically and abroad, on the availability of reimbursement to the consumer
from third-party payors. Considerable pressure to reduce healthcare costs may
cause reimbursement to become more restricted in the future. 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.

                                      39

<PAGE>

Additional Risks Related to Our Business Operations

  Our business will not succeed if our product candidates fail to achieve
  market acceptance.

   Even if our potential products succeed in clinical trials and are approved
for marketing, these products may never achieve market acceptance. If marketing
our products is unsuccessful 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 in this section or elsewhere in this annual report, we will be unable
to generate sufficient product revenues to maintain our business.

  Our limited manufacturing capability may limit our ability to successfully
  introduce our potential products.

   We currently do not have the capacity to manufacture large-scale commercial
quantities of our potential products. To do so, we will need to expand our
current facilities and staff or supplement them through the use of contract
providers. Our current manufacturing facility, which is designed for
manufacturing our AAV vectors for clinical and development purposes, is subject
to initial and ongoing regulation by the FDA and other government agencies, and
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. If we are unable to obtain and maintain the necessary
manufacturing capabilities, either alone or through third parties, we will be
unable to manufacture sufficient product to sustain our business. In addition,
we are unlikely to become profitable if we or our contract providers are unable
to manufacture our products in a cost-effective manner.

  If we do not attract and retain qualified personnel, we will be unable to
  successfully develop our potential products.

   Our future success depends in large part on our ability to attract and
retain key technical and management employees and scientific advisors. We have
programs in place to retain personnel, including competitive compensation
packages and programs to create a positive work environment. Because other
companies, research and academic institutions and other organizations in our
field compete intensely for employees, however, we may be unable to retain our
existing personnel or attract additional qualified employees and advisors. If
we experience excessive turnover or difficulties in recruiting new personnel,
our research and development could be delayed and we could experience
difficulties in generating sufficient revenue to maintain our business.

  If we do not develop adequate 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 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 corporate partners to utilize their
mature marketing and distribution capabilities. However, we may be unable to
enter into marketing and distribution agreements on favorable terms, if at all.
While we believe that our corporate partners will be motivated to market and
distribute our potential products, our current and potential future partners
may not commit sufficient resources to commercializing our products and
technology on a timely basis. If our corporate partners do not adequately
market and distribute our products 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.

  Product liability and other claims and product recalls could exceed our
  insurance coverage and damage our reputation, which could significantly harm
  our financial condition.

   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. Potential known and unknown

                                      40

<PAGE>

side effects of gene therapy may be serious and potentially life-threatening.
Product liability claims may be made by clinical trial participants, consumers,
health care providers or other sellers or users of our products. We may also
face product recalls and adverse publicity resulting from a product recall or a
liability claim against us or a collaborative partner. 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, 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.

Item 7A.  Quantitative and Qualitative Disclosures About Market Risk

   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 neither employ any derivative or other financial instruments or
derivative commodity instruments to hedge any market risks nor plan to employ
these instruments in the future. At December 31, 2001, we held $25.2 million in
cash and cash equivalents, which are primarily invested in a short-term bond
fund invested in securities that, on the average, mature in less than 12
months. An analysis of the impact on these instruments of a hypothetical 10%
change in short-term interest rates compared to interest rates at December 31,
2001, indicates that such change would not have a significant impact on
expected fiscal year 2002 earnings.

                                      41

<PAGE>

Item 8.  Financial Statements and Supplementary Data

<TABLE>
<CAPTION>
                                                                                            Page
                                                                                            ----
<S>                                                                                         <C>
Report of Ernst & Young LLP, Independent Auditors..........................................  43
Consolidated Balance Sheets as of December 31, 2001 and 2000...............................  44
Consolidated Statements of Operations for the years ended December 31, 2001, 2000 and 1999.  45
Consolidated Statements of Shareholders' Equity for the period from January 1, 1999 through
  December 31, 2001........................................................................  46
Consolidated Statements of Cash Flows for the years ended December 31, 2001, 2000 and 1999.  47
Notes to Consolidated Financial Statements.................................................  48
</TABLE>


                                      42

<PAGE>

               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, 2001 and 2000, and the related
consolidated statements of operations, shareholders' equity, and cash flows for
each of the three years in the period ended December 31, 2001. 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, 2001 and 2000, and the consolidated
results of its operations and its cash flows for each of the three years in the
period ended December 31, 2001 in conformity with accounting principles
generally accepted in the United States.

   As discussed in Note 1 to the consolidated financial statements, in 2000 the
Company changed its method of accounting for revenue recognition.

                                                              ERNST & YOUNG LLP

Seattle, Washington
February 14, 2002

                                      43

<PAGE>

                         TARGETED GENETICS CORPORATION

                          CONSOLIDATED BALANCE SHEETS

<TABLE>
<CAPTION>
                                                                                         December 31,
                                                                                 ----------------------------
                                                                                     2001           2000
                                                                                 -------------  -------------
<S>                                                                              <C>            <C>
                                  ASSETS
Current assets:
   Cash and cash equivalents.................................................... $  25,186,000  $  38,630,000
   Accounts receivable..........................................................     2,475,000      3,087,000
   Receivable from unconsolidated, majority-owned research and
     development joint venture..................................................       893,000        177,000
   Prepaid expenses and other...................................................       935,000        292,000
                                                                                 -------------  -------------
          Total current assets..................................................    29,489,000     42,186,000
Property and equipment, net.....................................................     8,308,000      6,206,000
Goodwill and other purchased intangibles, net...................................    31,752,000     37,821,000
Other assets....................................................................     1,489,000      1,761,000
                                                                                 -------------  -------------
                                                                                 $  71,038,000  $  87,974,000
                                                                                 =============  =============
                   LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
   Accounts payable and accrued expenses........................................ $   3,452,000  $   3,579,000
   Payable to unconsolidated, majority-owned research and development
     joint venture..............................................................     1,123,000        262,000
   Accrued employee expenses....................................................     1,114,000        696,000
   Deferred revenue.............................................................     4,631,000      6,906,000
   Current portion of long-term obligations.....................................     1,308,000        838,000
                                                                                 -------------  -------------
          Total current liabilities.............................................    11,628,000     12,281,000
Deferred rent...................................................................       640,000        404,000
Long-term obligations...........................................................    16,403,000      2,447,000
Deferred revenue................................................................     4,966,000      9,410,000

Commitments

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 convertible exchangeable preferred stock, 12,015 shares
         designated, issued and outstanding at December 31, 2001 and
         2000, liquidation preference of $12,015,000............................            --             --
   Common stock, $0.01 par value, 80,000,000 shares authorized,
     44,125,677 shares issued and outstanding at December 31, 2001 and
     42,608,943 shares at December 31, 2000.....................................       441,000        426,000
   Additional paid-in capital...................................................   214,942,000    213,818,000
   Accumulated deficit..........................................................  (177,982,000)  (150,812,000)
                                                                                 -------------  -------------
          Total shareholders' equity............................................    37,401,000     63,432,000
                                                                                 -------------  -------------
                                                                                 $  71,038,000  $  87,974,000
                                                                                 =============  =============
</TABLE>

       See accompanying notes to the consolidated financial statements.

                                      44

<PAGE>

                         TARGETED GENETICS CORPORATION

                     CONSOLIDATED STATEMENTS OF OPERATIONS

<TABLE>
<CAPTION>
                                                                         Year Ended December 31,
                                                                ----------------------------------------
                                                                    2001          2000          1999
                                                                ------------  ------------  ------------
<S>                                                             <C>           <C>           <C>
Revenue:
   Collaborative agreements.................................... $ 16,117,000  $  9,553,000  $  6,402,000
   Collaborative agreement with unconsolidated, majority-
     owned research and development joint venture..............    2,763,000     1,850,000       446,000
                                                                ------------  ------------  ------------
       Total revenue...........................................   18,880,000    11,403,000     6,848,000
                                                                ------------  ------------  ------------
Operating expenses:
   Research and development....................................   31,546,000    19,312,000    14,291,000
   Equity in net loss of unconsolidated, majority-owned
     research and development joint venture....................    3,666,000     2,474,000    12,610,000
   Acquired in-process research and development................           --    28,029,000     3,200,000
   Amortization of acquisition-related intangibles.............    6,069,000     1,686,000            --
   General and administrative..................................    6,203,000     5,707,000     3,593,000
                                                                ------------  ------------  ------------
       Total operating expenses................................   47,484,000    57,208,000    33,694,000
                                                                ------------  ------------  ------------
Loss from operations...........................................  (28,604,000)  (45,805,000)  (26,846,000)

Investment income..............................................    1,886,000     2,097,000       426,000
Interest expense...............................................     (452,000)     (265,000)     (235,000)
                                                                ------------  ------------  ------------
Loss before cumulative effect of change in accounting principle  (27,170,000)  (43,973,000)  (26,655,000)
Cumulative effect of change in accounting principle............           --    (3,682,000)           --
                                                                ------------  ------------  ------------
Net loss....................................................... $(27,170,000) $(47,655,000) $(26,655,000)
                                                                ============  ============  ============
Net loss applicable to common shareholders:
   Net loss.................................................... $(27,170,000) $(47,655,000) $(26,655,000)
   Accretion of dividend on preferred stock....................     (945,000)     (885,000)     (376,000)
                                                                ------------  ------------  ------------
Net loss applicable to common shareholders..................... $(28,115,000) $(48,540,000) $(27,031,000)
                                                                ============  ============  ============
Computation of net loss per common share:
   Loss before cumulative effect of change in accounting
     principle................................................. $      (0.64) $      (1.19) $      (0.84)
   Cumulative effect of change in accounting principle.........           --         (0.10)           --
                                                                ------------  ------------  ------------
   Net loss per common share (basic and diluted)............... $      (0.64) $      (1.29) $      (0.84)
                                                                ============  ============  ============
Shares used in computation of net loss per common share........   43,927,822    37,752,164    32,173,756
                                                                ============  ============  ============
</TABLE>

       See accompanying notes to the consolidated financial statements.

                                      45

<PAGE>

                         TARGETED GENETICS CORPORATION

                CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY

<TABLE>
<CAPTION>
                                                                                                          Accumulated
                                      Preferred Stock     Common Stock       Additional                      Other
                                      --------------- --------------------    Paid-In      Accumulated   Comprehensive
                                      Shares   Amount   Shares     Amount     Capital        Deficit        Income
                                      ------   ------ ----------  --------  ------------  -------------  -------------
<S>                                   <C>      <C>    <C>         <C>       <C>           <C>            <C>
Balance at January 1, 1999...........     --   $  --  30,652,375  $307,000  $ 88,149,000  $ (76,502,000)   $ 28,000
   Net loss--1999....................     --      --          --                            (26,655,000)
   Unrealized gains on securities
    available for sale...............     --      --          --                                     --     (44,000)

   Comprehensive loss................
   Issuance of Series B convertible
    exchangeable preferred stock
    for interest in unconsolidated,
    majority-owned research and
    development joint venture........ 12,015      --          --        --    12,015,000             --          --
   Sale of common stock to
    Celltech for cash, net of
    issuance costs of $14,000........     --      --     677,392     7,000     1,480,000             --          --
   Sale of common stock to Elan,
    net of issuance costs of
    $57,000..........................     --      --   2,148,899    21,000     4,921,000             --          --
   Issuance of common stock and
    warrants to Alkermes for
    technology rights, net of
    issuance costs of $18,000........     --      --     500,000     5,000     3,177,000             --          --
   Exercise of stock options.........     --      --      40,509        --        56,000             --          --
                                      ------   -----  ----------  --------  ------------  -------------    --------
Balance at December 31, 1999......... 12,015      --  34,019,175   340,000   109,798,000   (103,157,000)    (16,000)
   Net loss--2000....................     --      --          --                            (47,655,000)
   Unrealized losses on securities
    available for sale...............     --      --          --                                     --      16,000

   Comprehensive loss................
   Sale of common stock for cash,
    net of issuance costs of
    $2,181,000.......................     --      --   2,164,285    22,000    28,097,000             --          --
   Issuance of common stock to
    Elan for cash, net of issuance
    costs of $4,000..................     --      --     382,739     4,000     4,992,000             --          --
   Issuance of common stock in
    Genovo acquisition...............     --      --   5,250,805    53,000    66,077,000             --          --
   Exercise of stock options.........     --      --     730,765     7,000     4,600,000             --          --
   Exercise of warrants..............     --      --      61,174        --       254,000             --          --
                                      ------   -----  ----------  --------  ------------  -------------    --------
Balance at December 31, 2000......... 12,015      --  42,608,943   426,000   213,818,000   (150,812,000)         --
   Net loss and comprehensive
    loss--2001.......................     --      --          --        --            --    (27,170,000)         --
   Cancellation of shares held in
    escrow related to Genovo
    acquisition......................     --      --    (155,649)   (2,000)   (1,998,000)            --          --
   Exercise of stock options.........     --      --     672,383     7,000     1,052,000             --          --
   Exercise of warrants..............     --      --   1,000,000    10,000     1,990,000             --          --
   Stock based compensation..........     --      --          --        --        80,000             --          --
                                      ------   -----  ----------  --------  ------------  -------------    --------
Balance at December 31, 2001......... 12,015   $  --  44,125,677  $441,000  $214,942,000  $(177,982,000)   $     --
                                      ======   =====  ==========  ========  ============  =============    ========
</TABLE>
<TABLE>
<CAPTION>

                                          Total
                                      Shareholders'
                                         Equity
                                      -------------
<S>                                   <C>
Balance at January 1, 1999........... $ 11,982,000
   Net loss--1999....................  (26,655,000)
   Unrealized gains on securities
    available for sale...............      (44,000)
                                      ------------
   Comprehensive loss................  (26,699,000)
   Issuance of Series B convertible
    exchangeable preferred stock
    for interest in unconsolidated,
    majority-owned research and
    development joint venture........   12,015,000
   Sale of common stock to
    Celltech for cash, net of
    issuance costs of $14,000........    1,487,000
   Sale of common stock to Elan,
    net of issuance costs of
    $57,000..........................    4,942,000
   Issuance of common stock and
    warrants to Alkermes for
    technology rights, net of
    issuance costs of $18,000........    3,182,000
   Exercise of stock options.........       56,000
                                      ------------
Balance at December 31, 1999.........    6,965,000
   Net loss--2000....................  (47,655,000)
   Unrealized losses on securities
    available for sale...............       16,000
                                      ------------
   Comprehensive loss................  (47,639,000)
   Sale of common stock for cash,
    net of issuance costs of
    $2,181,000.......................   28,119,000
   Issuance of common stock to
    Elan for cash, net of issuance
    costs of $4,000..................    4,996,000
   Issuance of common stock in
    Genovo acquisition...............   66,130,000
   Exercise of stock options.........    4,607,000
   Exercise of warrants..............      254,000
                                      ------------
Balance at December 31, 2000.........   63,432,000
   Net loss and comprehensive
    loss--2001.......................  (27,170,000)
   Cancellation of shares held in
    escrow related to Genovo
    acquisition......................   (2,000,000)
   Exercise of stock options.........    1,059,000
   Exercise of warrants..............    2,000,000
   Stock based compensation..........       80,000
                                      ------------
Balance at December 31, 2001......... $ 37,401,000
                                      ============
</TABLE>

       See accompanying notes to the consolidated financial statements.

                                      46

<PAGE>

                         TARGETED GENETICS CORPORATION

                     CONSOLIDATED STATEMENTS OF CASH FLOWS

<TABLE>
<CAPTION>
                                                                             Year Ended December 31,
                                                                    ----------------------------------------
                                                                        2001          2000          1999
                                                                    ------------  ------------  ------------
<S>                                                                 <C>           <C>           <C>
Operating activities:
   Net loss........................................................ $(27,170,000) $(47,655,000) $(26,655,000)
   Adjustments to reconcile net loss to net cash used in
     operating activities:
       Cumulative effect of change in accounting principle
         adjustment................................................           --     3,682,000            --
       Equity in net loss of unconsolidated, majority-owned
         research and development joint venture....................    3,666,000     2,474,000    12,610,000
       Acquired in-process research and development................           --    28,029,000     3,200,000
       Depreciation and amortization...............................    2,623,000     1,473,000     1,614,000
       Amortization of acquisition-related intangibles.............    6,069,000     1,686,000            --
       Stock-based compensation expense............................       80,000       301,000            --
       Changes in assets and liabilities:
          Increase (decrease) in deferred revenue..................   (6,719,000)   12,635,000            --
          Increase in accounts receivable..........................   (1,388,000)   (1,695,000)   (1,289,000)
          Decrease (increase) in accounts receivable from
            unconsolidated, majority-owned research and
            development joint venture..............................     (716,000)      269,000      (446,000)
          Decrease (increase) in prepaid expenses and other........     (643,000)     (396,000)       62,000
          Increase (decrease) in current liabilities...............      241,000      (972,000)    1,221,000
          Increase in deferred rent................................      236,000       364,000        40,000
          Increase (decrease) in other assets......................      178,000      (800,000)           --
                                                                    ------------  ------------  ------------
Net cash used in operating activities..............................  (23,543,000)     (605,000)   (9,643,000)
                                                                    ------------  ------------  ------------
Investing activities:
   Purchases of property and equipment.............................   (4,411,000)   (2,797,000)   (1,856,000)
   Investment in unconsolidated, majority-owned research and
     development joint venture.....................................   (2,805,000)   (2,807,000)     (595,000)
   Maturities and sales of securities available for sale...........           --     3,024,000     7,393,000
   Purchases of securities available for sale......................           --            --      (483,000)
   Net cash acquired in acquisition................................           --       359,000            --
                                                                    ------------  ------------  ------------
   Net cash provided by (used in) investing activities.............   (7,216,000)   (2,221,000)    4,459,000
                                                                    ------------  ------------  ------------
Financing activities:
   Loan proceeds from collaborative partners.......................   13,000,000            --     1,000,000
   Net proceeds from sales of capital stock........................    3,059,000    37,976,000     6,468,000
   Proceeds from leasehold improvements and equipment
     financing arrangements........................................    2,401,000       671,000     1,294,000
   Payments under leasehold improvements and equipment
     financing arrangements........................................   (1,145,000)   (1,292,000)   (1,348,000)
                                                                    ------------  ------------  ------------
   Net cash provided by financing activities.......................   17,315,000    37,355,000     7,414,000
                                                                    ------------  ------------  ------------
Net increase (decrease) in cash and cash equivalents...............  (13,444,000)   34,529,000     2,230,000
Cash and cash equivalents, beginning of year.......................   38,630,000     4,101,000     1,871,000
                                                                    ------------  ------------  ------------
Cash and cash equivalents, end of year............................. $ 25,186,000  $ 38,630,000  $  4,101,000
                                                                    ============  ============  ============
Supplemental information:
   Cash paid for interest.......................................... $    269,000  $    245,000  $    203,000
   Acquisition-related common stock issued (recovered).............   (2,000,000)   66,130,000            --
   Preferred stock dividend........................................      945,000       885,000       376,000
   Preferred stock issuance in exchange for interest in
     unconsolidated, majority-owned research and
     development joint venture.....................................           --            --    12,015,000
</TABLE>

        See accompanying notes to the consolidated financial statements

                                      47

<PAGE>

                         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 acquired and inherited
diseases.

Basis of Presentation

   Our consolidated financial statements include the accounts of Targeted
Genetics, our wholly owned subsidiaries Genovo, Inc. and TGCF Manufacturing
Corporation, and our majority owned subsidiary, CellExSys, Inc. The
consolidated financial statements do not include Emerald Gene Systems, Ltd. our
unconsolidated, majority-owned research and development joint venture with Elan
International Services Ltd., a wholly owned subsidiary of Elan Corporation plc,
because we do not have operating control of the joint venture. All significant
inter-company transactions have been eliminated in consolidation.

Cash Equivalents

   We consider to be cash equivalents all 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, recorded at cost, which approximates fair market value, consist
principally of money market accounts and shares of a short-term,
limited-maturity mutual fund.

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

   Our financial statements present property and equipment at cost less
accumulated depreciation, which includes the amortization of assets recorded
under equipment financing leases. 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.

Purchased Intangible Assets

   Purchased intangible assets consist of acquired technology that is core to
our development programs and goodwill. We amortize our purchased intangibles on
the straight-line method over periods ranging from two to seven years.

Long-Lived Assets

   In accordance with Statement of Financial Accounting Standards (SFAS) No.
121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived
Assets to be Disposed Of," we review the carrying value of

                                      48

<PAGE>

                         TARGETED GENETICS CORPORATION

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

intangible assets and other long-lived assets on a regular basis for the
existence of facts or circumstances, both internal and external, that may
indicate impairment. 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. To date, we have no indication
that an impairment of our intangible and other long-lived assets exists.

Stock Compensation

   As permitted by the provisions of Financial Accounting Standards Board
(FASB) Statement No. 123, "Accounting for Stock-Based Compensation," we have
elected to follow Accounting Principles Board (APB) Opinion No. 25, "Accounting
for Stock Issued to Employees," and related interpretations in accounting for
employee stock option grants, and we apply the disclosure-only provisions to
account for our stock option plans. 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.

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 recognized ratably over 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. Payments received in excess of
amounts earned are classified as deferred revenue.

   We previously recognized nonrefundable, up-front license fees as revenue
when the technology was transferred and when all of its significant contractual
obligations relating to the fees had been fulfilled. Effective January 1, 2000,
we changed our method of accounting for nonrefundable up-front license fees to
recognize such fees over the term of the related research and development
collaboration arrangement on a straight-line basis, as this method best matches
the effort provided. We believe that this change in accounting principle is
preferable, based on guidance provided in the SEC's Staff Accounting Bulletin
(SAB) No. 101, "Revenue Recognition in Financial Statements." The $3.7 million
cumulative effect of the change in accounting principle, calculated as of
January 1, 2000, was reported as a charge for the year 2000. The cumulative
effect was recorded as deferred revenue that was recognized as revenue over the
remaining term of the research and development collaboration agreements. $2.1
million ($0.06 per share) of the $3.7 million cumulative effect was amortized
as deferred revenue in 2000 and $1.6 million ($0.04 per share) was amortized in
2001. Had the change in accounting been in effect retroactively to January 1,
1999, net loss for 1999 would have decreased by $2.1 million ($0.07 per share).

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 10% of
our total shares then outstanding. We cannot control or monitor shares of our
stock that these partners may buy or sell in open market transactions. Although
each of our collaborative partners influence the activities specific to their
collaborations with us, our partners do not influence our management or
operating policies generally or otherwise significantly influence our operating
activities.

                                      49

<PAGE>

                         TARGETED GENETICS CORPORATION

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)


Significant Revenue Relationships and Concentration of Risk

   Four companies accounted for 100% of the revenue we recorded from
collaborative agreements in 2001 and 2000. One company accounted for 100% of
our revenue from collaborative agreements in 1999. Emerald Gene Systems, our
80.1% unconsolidated, majority-owned research and development joint venture
with Elan, accounted for all of our revenue from collaborative agreements with
unconsolidated joint ventures. A change in the level of work or funding
received from any one of these collaborative partners could disrupt our
business and adversely affect our cash flow and results of operations.

Research and Development Costs

   Research and development costs are expensed as incurred. Costs and expenses
related to programs conducted under collaborative agreements that result in
collaborative revenue totaled $11.4 million in 2001, $6.6 million in 2000 and
$6.7 million in 1999. See Notes 6 and 7 for more detailed information.

Net Loss Per Common Share

   Net loss per common share is based on net loss after giving effect to
preferred stock dividends, divided by the weighted average number of common
shares outstanding during the period. Preferred stock dividends are not
included in our net loss amount and are reflected only in the computation of
net loss applicable to common shareholders. 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
13,535,778 shares in 2001, 14,028,623 shares in 2000 and 12,632,797 shares in
1999.

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.

Recent Accounting Pronouncements

   In June 2001, the FASB issued SFAS No. 141, "Business Combinations" and SFAS
No. 142, "Goodwill and Other Intangibles." SFAS No. 141 requires that business
combinations be accounted for using the purchase method of accounting,
effective July 1, 2001. SFAS No. 142 requires the use of a nonamortization
approach to account for goodwill and certain intangibles, effective January 1,
2002. Under this nonamortization approach, goodwill and certain intangibles
will not be amortized into results of operations, but instead will be reviewed
for impairment and written down through a charge to operations only in the
periods in which the carrying value of goodwill and certain intangibles is more
than its fair value. As of January 1, 2002, of the $31.8 million of net
goodwill and other purchased intangibles, $31.4 million will be classified as
goodwill and will no longer be amortized. The remaining $0.4 million will be
classified apart from goodwill and will continue to be amortized over its
estimated remaining useful life. We expect adoption of this accounting standard
to substantially reduce our amortization of purchased goodwill and intangibles
commencing January 1, 2002. The amount of goodwill amortization that would have
been recorded in 2002 is approximately $5.6 million. Since future impairment
reviews will be based on events and estimations in the future, we are currently
unable to estimate the effect that such review may have on our consolidated
financial statements.

   The FASB also recently issued SFAS No. 144, "Accounting for the Impairment
or Disposal of Long-Lived Assets," which is applicable to financial statements
issued for fiscal years beginning after December 15, 2001. SFAS No. 144
supersedes SFAS No. 121, "Accounting for the Impairment of Long-Lived Assets
and for Long-Lived Assets to Be Disposed Of," and portions of APB Opinion No.
30, "Reporting the Results of Operations."

                                      50

<PAGE>

                         TARGETED GENETICS CORPORATION

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

SFAS No. 144 provides a single accounting model for disposal of long-lived
assets and significantly changes the criteria for classification of an asset as
held-for-sale. If assets are classified as held-for-sale, they are not
depreciated and are stated at the lower of fair value and carrying amount. SFAS
No. 144 also requires us to display expected future operating losses from
discontinued operations in the period or periods in which the losses are
incurred, rather than as of the measurement date, as presently required. We do
not expect the provisions of SFAS No. 144 to have a significant effect on our
financial position or operating results as we currently do not hold any of our
assets as held-for sale and we have no indication that an impairment of any of
our long-lived assets exists.

Reclassifications

   Certain reclassifications have been made to conform prior year results to
the current year presentation.

2.  Long-Lived Assets

   Property and equipment consisted of the following:

<TABLE>
<CAPTION>
                                                         December 31,
                                                  -------------------------
                                                      2001         2000
                                                  ------------  -----------
   <S>                                            <C>           <C>
   Furniture and equipment....................... $  9,848,000  $ 7,288,000
   Leasehold improvements........................    9,433,000    7,389,000
                                                  ------------  -----------
                                                    19,281,000   14,677,000
   Less accumulated depreciation and amortization  (10,973,000)  (8,471,000)
                                                  ------------  -----------
                                                  $  8,308,000  $ 6,206,000
                                                  ============  ===========
</TABLE>

   We finance some 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 $3.7 million at
December 31, 2001 and $2.4 million at December 31, 2000, with related
accumulated depreciation of $1.3 million for each period.

   Goodwill and other purchased intangibles consisted of the following:

<TABLE>
<CAPTION>
                                                         December 31,
                                                   ------------------------
                                                      2001         2000
                                                   -----------  -----------
    <S>                                            <C>          <C>
    Goodwill...................................... $37,892,000  $37,892,000
    Other purchased intangibles...................   1,615,000    1,615,000
                                                   -----------  -----------
                                                    39,507,000   39,507,000
    Less accumulated depreciation and amortization  (7,755,000)  (1,686,000)
                                                   -----------  -----------
                                                   $31,752,000  $37,821,000
                                                   ===========  ===========
</TABLE>

                                      51

<PAGE>

                         TARGETED GENETICS CORPORATION

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)


3.  Long-Term Obligations

   Long-term obligations consisted of the following:

<TABLE>
<CAPTION>
                                                  December 31,
                                            -----------------------
                                               2001         2000
                                            -----------  ----------
           <S>                              <C>          <C>
           Loan payable to Biogen.......... $10,000,000  $       --
           Loan payable to Celltech........   2,000,000   1,000,000
           Convertible loan payable to Elan   2,000,000          --
           Equipment financing obligations.   3,153,000   1,732,000
           Other long-term obligations.....     558,000     553,000
                                            -----------  ----------
                                             17,711,000   3,285,000
           Less current portion............  (1,308,000)   (838,000)
                                            -----------  ----------
                                            $16,403,000  $2,447,000
                                            ===========  ==========
</TABLE>

   Future aggregate principal payments related to long-term obligations are
$1.3 million in 2002, $3.0 million in 2003, $0.7 million in 2004, $2.2 million
in 2005 and $10.5 million in 2006.

   During 2001, we drew $10.0 million against a $10.0 million unsecured loan
agreement from Biogen. Outstanding borrowings under this loan bear interest at
the one-year LIBOR rate plus 100 basis points reset annually. At December 31,
2001, the interest rate was 3.4%. 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.

   Under our agreements with Celltech, we have drawn $2.0 million under a $2.0
million unsecured loan facility to partially fund the cost of establishing our
tgAAVCF manufacturing facilities for clinical trials. This loan is due in
November 2003. Interest accrues at a rate that is 150 basis points over the
one-month LIBOR rate, but neither less than 5% nor more than 7% per year. At
December 31, 2001, the interest rate was 5.0%. This loan agreement limits our
ability to declare or pay cash dividends. We can, at our option and with
Celltech's consent, repay the loan with our common stock at any time during the
loan term, at a conversion price equal to the average closing price of the
common stock over a specified period preceding the repayment date.

   In connection with the formation of Emerald (see Note 7), Elan has committed
to loan us up to $12.0 million, in one or more draws, to support our share of
Emerald's operating costs. Interest on borrowings under this loan facility
accrue at a rate of 12.0% per annum, compounded semi-annually. Principal and
interest outstanding under this loan facility are due in July 2005, payable
either in cash or shares of our common stock. Interest is payable semi-annually
and, if we elect not to pay, the interest is capitalized to principal and
treated as a new borrowing from Elan. As of December 31, 2001, we had borrowed
$2.0 million under this facility.

   Elan has the option to convert principal and interest outstanding under the
loan facility, on a per-draw basis, into shares of our common stock. If Elan
elects to convert outstanding amounts into shares of our common stock, the
conversion price will be 150% of the average closing price of our common stock
for a specified period of time before the date of the applicable draw on the
note. As of December 31, 2001, if Elan had elected to convert the outstanding
principal under the loan facility, it would have received 335,570 shares of our
common stock.

   We have the option to prepay principal and interest outstanding under the
loan facility, in whole or on a per-draw basis, in either cash or shares of our
common stock. If we elect to prepay outstanding amounts with our common stock,
the conversion price will equal 150% of the average closing price of our common
stock for a specified period of time before the date of the applicable draw and
the average closing price of our common

                                      52

<PAGE>

                         TARGETED GENETICS CORPORATION

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

stock for a specified period of time before the date of prepayment. If we elect
to prepay the outstanding amounts in cash, we will pay an amount equal to the
higher of the amount of principal and interest outstanding under the applicable
draw and the fair market value of our common stock into which the outstanding
amount is convertible, based on a price per share equal to the average closing
price of our common stock for a specified period of time before the date of
prepayment.

   If the issuance of shares to Elan upon conversion of amounts outstanding
under the loan facility would result in Elan owning more than 19.9% of our
total shares outstanding and we are unable to obtain shareholder approval of
such issuance, we may be unable to issue shares of our common stock to repay
amounts outstanding under the loan facility.

   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 2002 to
October 2005.

   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.

4.  Shareholders' Equity

Series B Preferred Stock

   In July 1999, Elan purchased $12,015,000 of our Series B preferred stock in
conjunction with the formation of Emerald (see Note 7). The Series B preferred
stock is convertible at the holder's option and bears an annual dividend of 7%,
which accrues semi-annually and is added to the carrying amount of the stock.
The Series B preferred stock had accrued dividends of $2.2 million as of
December 31, 2001 and $1.3 million as of December 31, 2000.

   The Series B preferred stock is convertible until July 2005, at Elan's
option, into shares of our common stock, at a conversion price of $3.32 per
share. As of December 31, 2001, the Series B preferred stock and accrued
dividends were convertible into 4,283,471 shares of our common stock. If Elan
were to elect to convert the Series B preferred stock into our common stock in
July 2005, the expiration of the conversion option, we would issue 5,470,546
shares of our common stock, assuming all dividends were accumulated and unpaid.
In addition, the Series B preferred stock will automatically convert into
common stock in the event of specified transactions involving a change of
control of Targeted Genetics. In the event that the issuance of common stock to
Elan upon the conversion of the Series B preferred stock would result in Elan
owning more than 19.9% of our then-outstanding shares and we were unable to
obtain shareholder approval for such issuance, we have the right, at our
option, to redeem that number of shares that would exceed 19.9% of our
then-outstanding shares.

   Alternatively, Elan has the option to exchange the Series B preferred stock
and accrued dividends for our shares of Emerald preferred stock, which would
bring Elan's ownership in Emerald to 50%. This exchange option is exercisable
anytime through the earlier of April 2003 and six months after the completion
of Emerald's initial research and development program, which is currently
September 30, 2002, but is subject to extension. In the event that Elan elects
to exchange the Series B preferred stock for our Emerald preferred shares, Elan
must pay us an amount equal to 30.1% of the total funding that we have provided
to Emerald after its formation. This exchange right will terminate if the
Series B preferred stock is converted into common stock. If the conversion
occurs as a result of a specified transaction involving a change in control at
Targeted Genetics, the exchange right will survive but, in order to exercise
this exchange right, Elan will be required to tender the consideration it
received upon the automatic conversion of the preferred stock in the
transaction.

                                      53

<PAGE>

                         TARGETED GENETICS CORPORATION

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)


   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.

  Stock Purchase Warrants

   In 1999, in connection with a technology license agreement, we issued to
Alkermes, Inc. warrants to purchase 1,000,000 shares of our common stock at an
exercise price of $2.50, expiring in June 2007, and 1,000,000 shares at an
exercise price of $4.16 per share, expiring in June 2009. All of these warrants
remain outstanding at December 31, 2001.

   In connection with a private placement of common stock in 1998, we issued
warrants to purchase a total of 4,333,333 shares of common stock at an exercise
price of $2.00 per share. In 2001 a warrant holder exercised warrants to
purchase 1,000,000 shares of our common stock, resulting in $2.0 million of
proceeds. The remaining warrants issued in connection with the 1998 private
placement expire in April 2003.

   We have outstanding warrants to purchase a total of 35,141 shares related to
equipment financing and consulting agreements. These warrants have a weighted
average price of $4.80 per share and expire between May 2002 and March 2004.

  Shareholder Rights Plan

   In 1996, our board of directors adopted a shareholder rights plan. Under our
rights plan, each outstanding share of our common stock also represents 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 it 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 right not owned by
the acquiring person or its affiliates would entitle its holder to purchase
shares of our common stock at a 50% discount, which would result in a
significant dilution of the acquiring persons 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 shares of common stock of the acquiring
entity for a 50% discount.

   The 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.

  Stock Options

   We have granted non-qualified and incentive stock options to purchase up to
6,979,444 shares of common stock under our stock option plans. Beginning in
1999, we began granting all options under our 1999 Stock Option Plan (the 1999
Plan), and discontinued granting options under our two other plans. In
connection with our acquisition of Genovo, we established the 2000 Genovo, Inc.
Roll-over Stock Option Plan (the Genovo Plan). In 2001, our shareholders
approved both the Genovo Plan and an increase in the number of shares available
for grant under the 1999 Plan from 1.5 million shares to 3.5 million shares.


                                      54

<PAGE>

                         TARGETED GENETICS CORPORATION

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

   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 exercise price
of 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. As of
December 31, 2001, 1,288,697 shares of our common stock were available for
future grant under the 1999 Plan.

   The Genovo Plan was established to convert Genovo employees' options to
purchase shares of Genovo common stock into options to purchase our common
stock. In 2000, we granted options to purchase 679,444 shares of our common
stock at a weighted average exercise price of $1.30 per share under the Genovo
Plan to the former employees of Genovo. The size of the grant to each former
Genovo employee was based on the number of shares subject to that employee's
Genovo options at the effective time of the acquisition. Options granted under
the Genovo Plan are fully vested and expire ten years from the date that the
underlying Genovo stock options were granted. No additional options will be
granted under the Genovo Plan.

   The following table summarizes activity related to our stock option plans:

<TABLE>
<CAPTION>
                                                 Weighted
                                                 Average
                                                 Exercise   Options
                                       Shares     Price   Exercisable
                                      ---------  -------- -----------
           <S>                        <C>        <C>      <C>
           Balance, January 1, 1999.. 1,860,586   $2.42
              Granted................   835,265    1.94
              Exercised..............   (40,509)   1.39
              Canceled...............  (214,000)   2.51
                                      ---------
           Balance, December 31, 1999 2,441,342    2.26    1,094,420
              Granted................ 1,373,716    5.65
              Exercised..............  (419,470)   1.45
              Canceled...............   (74,810)   6.13
                                      ---------
           Balance, December 31, 2000 3,320,778    3.66    1,782,082
              Granted................ 1,510,075    5.27
              Exercised..............  (672,383)   1.57
              Canceled...............  (274,637)   5.05
                                      ---------
           Balance, December 31, 2001 3,883,833    4.55    1,861,093
                                      =========
</TABLE>

                                      55

<PAGE>

                         TARGETED GENETICS CORPORATION

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)


   The following table summarizes information regarding our outstanding and
exercisable options at December 31, 2001:

<TABLE>
<CAPTION>
                                  Outstanding                            Exercisable
                ----------------------------------------------- ------------------------------
                                               Weighted Average
   Range of       Number of   Weighted Average    Remaining       Number of   Weighted Average
Exercise Prices Option Shares  Exercise Price  Contractual Life Option Shares  Exercise Price
--------------- ------------- ---------------- ---------------- ------------- ----------------
<S>             <C>           <C>              <C>              <C>           <C>
 $0.50-$ 1.22       421,179        $ 1.07            6.05           405,554        $ 1.07
  1.38-  1.99       699,339          1.72            6.93           439,354          1.71
  2.02-  3.00       646,064          2.27            8.09           302,412          2.32
  3.09-  6.50       905,172          5.08            7.27           374,255          4.80
  6.66-  8.56       883,367          7.21            8.77           232,272          7.59
  8.88- 21.38       328,712         10.86            8.53           107,246         11.01
                    -----                                           -----
                  3,883,833          4.55            7.66         1,861,093          3.56
                  =========                                       =========
</TABLE>

   As allowed by SFAS 123, 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:

<TABLE>
<CAPTION>
                                      2001          2000          1999
                                  ------------  ------------  ------------
    <S>                           <C>           <C>           <C>
    Net loss:
       as reported............... $(27,170,000) $(47,655,000) $(26,655,000)
       pro forma.................  (32,278,000)  (53,693,000)  (27,610,000)
    Basic net loss per share:
       as reported............... $      (0.64) $      (1.29) $      (0.84)
       pro forma.................        (0.76)        (1.45)        (0.87)
</TABLE>

   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:

<TABLE>
<CAPTION>
                                                                       2001    2000    1999
                                                                      ------- ------- -------
<S>                                                                   <C>     <C>     <C>
Expected dividend rate............................................... Nil     Nil     Nil
Expected stock price volatility...................................... 1.590   1.661   0.908
Risk-free interest rate.............................................. 4.90%   6.47%   5.05%
Expected life of options............................................. 4 years 4 years 4 years
Weighted (per share) average fair value of options granted........... $5.27   $9.90   $1.94
</TABLE>

   Compensation expense included in the pro forma amounts above may not be
representative of the effects on pro forma earnings for future years.

                                      56

<PAGE>

                         TARGETED GENETICS CORPORATION

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)


Reserved Shares

   As of December 31, 2001, we had reserved shares of our common stock for
future issuance as follows:

<TABLE>
     <S>                                                         <C>
     Stock options granted......................................  3,883,833
     Available for future grant.................................  1,288,697
     Stock purchase warrants....................................  5,368,474
     Conversion of Series B preferred stock and note............  4,619,041
                                                                 ----------
        Total................................................... 15,160,045
                                                                 ==========
</TABLE>

5.  Acquisition of Genovo, Inc.

   The purchase price for our acquisition of Genovo, Inc. was approximately
$66.4 million, which consisted of the following:

<TABLE>
<S>                                                                <C>
Issuance of 5,250,805 shares of common stock...................... $58,461,000
Fair value of options to purchase 1,302,034 shares of common stock   7,668,000
Transaction costs.................................................     584,000
                                                                   -----------
Total consideration...............................................  66,713,000
Less: intrinsic value of unvested stock options...................    (301,000)
                                                                   -----------
Purchase price.................................................... $66,412,000
                                                                   ===========
</TABLE>

   Of the $66.4 million purchase price, $28.0 million consisted of acquired
in-process research and development (IPR&D) expenses, $39.5 million consisted
of intangibles, consisting of AAV vector know-how of $12.7 million, assembled
workforce of $1.6 million, goodwill of $25.2 million, $1.9 million of tangible
assets and $3.0 of liabilities assumed.

   We evaluated acquired IPR&D connected with our acquisition of Genovo by
utilizing the present value of the estimated after-tax cash flows expected to
be generated by the purchased technology, which had not reached technological
feasibility at the effective time of the acquisition. We based the cash flow
projections for revenue on estimates of growth rates and the aggregate size of
the markets for each product or technology; the probability of technical
success given the stage of development at the time of acquisition; royalty
rates, based on prior licensing agreements; product sales cycles; and the
estimated life of the product's underlying technology. We deducted estimated
operating expenses and income taxes from estimated revenue projections to
arrive at estimated after-tax cash flows. We utilized discount rates of 30% to
45% to discount projected cash flows for in-process technologies, depending on
the relative risk of each in-process technology. We computed these rates based
primarily on our internal rates of return, cost of capital, rates of return for
research and development and the weighted average cost of capital at the time
of acquisition. Projected operating expenses include general and administrative
expenses and research and development costs.

   We based all of the foregoing estimates and projections regarding the Genovo
acquisition on assumptions that we believed to be reasonable at the time of the
acquisition but that are inherently uncertain and unpredictable. If we do not
successfully develop the projects and technologies considered in these
estimates, its business, operating results and financial condition may be
adversely affected. As of the date of the acquisition, we concluded that the
technologies under development, once completed, could be economically used only
for their specifically intended purposes and that the in-process technology had
no alternative future use after taking into consideration the overall
objectives of the project, progress toward the objectives and uniqueness of
developments to these objectives. If we fail in these development efforts, no
alternative economic value will

                                      57

<PAGE>

                         TARGETED GENETICS CORPORATION

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

result from these technologies and the economic contribution that we projected
from the IPR&D will not materialize. The risk of unsuccessful or untimely
completion includes the risk that our competitors will develop alternative gene
delivery technologies or will develop more effective or economically feasible
technologies using more traditional approaches to treating human diseases.

   In connection with our acquisition of Genovo, we established an escrow of
550,872 shares of our common stock held for the benefit of former Genovo
stockholders, pending resolution of specified pre-acquisition contingencies
related to Genovo. During 2001, a party associated with a pre-acquisition
contractual matter notified us that it would dispute reimbursing us for a $2.0
million settlement payment we made. Based on our review of the facts, we
determined that the $2.0 million receivable we had recorded in anticipation of
reimbursement was not collectable. As a result, and in accordance with the
terms of the Genovo merger agreement, we cancelled 155,649 shares held in
escrow, valued at $2.0 million. We reflected the $2.0 million as a reduction of
equity during 2001 and retired the shares.

   Under the following circumstances, we may issue additional shares of our
common stock as merger consideration, as follows:

  .  Because specified Genovo licensing arrangements were unresolved at the
     time of the merger, we established an escrow of 700,000 shares of our
     common stock potentially issuable as additional merger consideration.
     Pending completion of negotiations, we may issue a portion of these shares
     in exchange for additional license rights. The escrow period ends in March
     2002, but may be extended.

  .  In connection with the Genovo merger and a collaborative research
     agreement previously entered into between Genzyme Corporation and Genovo,
     we assumed two outstanding options for Genzyme to purchase Genovo capital
     stock. After the merger, Genzyme exercised the first option to purchase
     311,295 shares of our common stock (as successor company to Genovo) at a
     price of $12.8495 per share. Genzyme has not exercised the second option
     to acquire up to an additional 311,295 shares of our common stock, also at
     a price of $12.8495 per share. We are in negotiations with Genzyme to
     define the scope of ongoing development activities and the parameters
     around which Genzyme would make a further investment in us. Should Genzyme
     elect not to make an additional investment, or to provide us with less
     than $4.0 million through exercise of the option agreement, the former
     Genovo shareholders and option holders could receive up to 155,648
     additional shares of our common stock.

   In each of these circumstances, the fair value of the shares issued to the
former Genovo stockholders, if any, will be determined on the date the
additional shares may be issued and will be reflected as additional purchase
price. No amounts related to these contingencies have been included in the
purchase price for the acquisition to date.

6.  Collaborative and Other Agreements

Celltech Group Agreement

   In October 1998, we entered into a series of agreements with Medeva
Pharmaceuticals, Inc. to collaborate on the development of our tgAAVCF gene
therapy product for treating cystic fibrosis. In January 2000, Medeva merged
with Celltech/Chiroscience to become part of Celltech Group plc and Celltech
assumed Medeva's rights and responsibilities under these agreements. Under a
research and development funding agreement, we granted Medeva an exclusive
worldwide license to sell tgAAVCF, but retained rights for supplying bulk
tgAAVCF product to support clinical trials and commercialization. In 1998, we
received a license and technology access fee of $5.0 million from Medeva at the
time of signing and milestone payments of $1.0 million at the initiation of
Phase I clinical trials of the tgAAVCF product. In 2000, we received $2.0
million at the initiation of Phase II clinical trials of the tgAAVCF product.
We received no milestone payments from Celltech in 2001. In addition, Celltech
agreed to pay up to $5.0 million per year from October 1998 through October
2001 to support research

                                      58

<PAGE>

                         TARGETED GENETICS CORPORATION

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

and development activities for tgAAVCF and to reimburse us for certain clinical
trial expenses. Celltech also agreed to fund the costs of the Phase II clinical
trial, which was initiated in November 2000. Assuming successful development
and regulatory approval, Celltech will have the exclusive right to market the
product on a worldwide basis. Under a long-term supply agreement, we will
manufacture and supply bulk product to Celltech under a specific pricing
formula. Celltech has the option to terminate the agreements with 180 days'
notice. Should Celltech exercise this right to terminate, all rights related to
tgAAVCF technology we have granted or otherwise extended to Celltech would
return to us.

   We recognized revenue of $5.0 million in 2001, $8.6 million in 2000 and $6.4
million in 1999 under the Celltech collaboration and we have recognized total
revenue of $23.4 million since the inception of the collaboration. Revenue
recognized since inception include $6.0 million of deferred revenue
amortization resulting from our adoption of SAB 101, as follows: $1.6 million
in 2001, $2.1 million in 2000 and 1999 and $200,000 in 1998. Under related
agreements, Celltech purchased 1,427,392 shares of our common stock for
$2.8 million and loaned us $2.0 million.

Biogen Agreement

   In September 2000, we established a multiple-product development and
commercialization collaboration with Biogen, Inc. Under the terms of the
collaborative agreement, we granted Biogen an exclusive worldwide license to
sell any products developed in the collaboration and assumed responsibility for
manufacturing and supplying any developed products to Biogen to support product
development, clinical trials and product commercialization. We will receive
royalties on sales of any products that result from the collaborative product
development efforts or, alternatively, we will sell product to Biogen at
specified transfer prices. Upon initiation of the collaboration, 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 a
related three-year research and development funding agreement, Biogen agreed to
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. Although Biogen
may terminate the development and marketing agreement at any time, its
obligation under the related funding agreement to pay the minimum annual
project funding would continue through September 2003.

   We are amortizing the $8.0 million up-front fee paid by Biogen over the
initial three-year research and development period. We will recognize revenue
on the $1.0 million minimum annual project funding as we perform specified
research and development efforts. We recognized revenue of $2.6 million in 2001
and $429,000 in 2000 related to the Biogen collaboration. These amounts include
amortization of up-front payments and research funding earned during each
period.

   Under the related funding agreement, Biogen also agreed to provide us with
loans of up to $10.0 million, which amount we borrowed in 2001, and to purchase
up to $10.0 million of our common stock, none of which has been purchased, each
at our discretion. Until September 2003, we can elect to have Biogen purchase
the $10.0 million of our common stock, subject to limitations on Biogen's
percentage ownership of our stock, in one or more pieces, at a price per share
equal to the average of the daily closing prices of a share of our common stock
for a specified period of time before and after the applicable exercise date.

Wyeth/Genetics Institute Agreement

   In November 2000, we entered into a collaboration to develop gene therapy
products for treating hemophilia with Wyeth/Genetics Institute, a unit of Wyeth
Pharmaceuticals. Under the terms of a research and development funding
agreement, Wyeth/Genetics Institute paid us up-front payments of $5.6 million
and will pay us up to $15.0 million to develop a product candidate for
hemophilia A over a three-year research and development collaboration period
ending in November 2003. We granted Wyeth/Genetics Institute an option to
collaborate on

                                      59

<PAGE>

                         TARGETED GENETICS CORPORATION

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

the development of a hemophilia B product candidate under similar terms. Under
a related supply agreement, Wyeth/Genetics Institute agreed to pay us to
manufacture product for clinical trials and for commercial supply according to
a sales-based formula assuming regulatory approval of products successfully
developed. In addition, Wyeth/Genetics Institute agreed to manage and fund the
costs of clinical trials and related regulatory filings required for product
approval and marketing. Wyeth/Genetics Institute will retain global marketing
rights for any products resulting from the collaboration.

   Wyeth/Genetics Institute has also agreed, upon the occurrence of specified
future events, to loan us up to $10 million to finance manufacturing facility
expansions if certain conditions are met. No amounts have been borrowed under
this commitment.

   Wyeth/Genetics Institute has the right to terminate both agreements at will,
with 180 days' notice. Should Wyeth/Genetics Institute terminate the
collaboration, all rights that were granted or otherwise extended to
Wyeth/Genetics Institute related to the hemophilia technology that we have
granted or otherwise extended to Wyeth/Genetics Institute would return to us.
If Wyeth/Genetics Institute exercises their right to terminate both agreements
at will or if we exercise our right to terminate for cause, we would have an
option to acquire a right and license to certain hemophilia patent rights
controlled by Wyeth/Genetics Institute.

   We recognized revenue of $6.5 million in 2001 and $454,000 in 2000 under
this collaboration. These revenue amounts include amortization in each period
of the $5.6 million of up-front payments and the collaborative research funding
earned during the period.

Genzyme Agreement

   In connection with the acquisition of Genovo in September 2000, we assumed a
three-year development and license agreement with Genzyme Corporation that
Genovo had entered into in August 1999. Under that agreement Genovo was
committed to perform up to $2.9 million per year of research and development
activities related to product candidates for treating lysosomal storage
disorders. In November 2000, we amended the development agreement to expand the
collaboration's technological scope and modify financial terms. Under the terms
of the amended agreement, should we achieve specified regulatory milestones,
Genzyme would be required to make milestone payments and pay royalties to us on
sales of any products developed under the agreement.

   The development program under our agreement with Genzyme is effective
through August 2002 and includes an option to extend the term if both parties
agree. Genzyme has the right to terminate the development program at will, with
90 days' notice. Should Genzyme exercise this right to terminate the
development program, or upon its expiration, all rights that we granted or
otherwise extended to Genzyme would return to us, except that Genzyme will
retain an exclusive license to certain Genovo-related manufacturing technology
for use in the field of lysosomal storage disorders. We do not recognize
revenue on the research that we perform in connection with this collaboration
because to date we have funded this project through the proceeds received from
the sale of equity securities to Genzyme.

   In connection with our acquisition of Genovo, we also assumed a separate
agreement that granted Genzyme an option to purchase up to $11.4 million of
Genovo equity, of which $3.4 million had been purchased as of the Genovo
acquisition date. After the execution of the amended agreement, Genzyme
exercised its option to purchase 311,295 shares of our common stock for a total
of $4.0 million. Genzyme has not exercised the second option to acquire up to
an additional 311,295 shares of our common stock also at a price of $12.8495
per share. We are in negotiations with Genzyme to define the terms by which
Genzyme would exercise its option or other means by which Genzyme would make an
additional investment in us. Should Genzyme elect not to make an

                                      60

<PAGE>

                         TARGETED GENETICS CORPORATION

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

additional investment, or to provide less than the $4.0 million through
exercise of the option agreement, the former Genovo shareholders and option
holders could receive up to 155,648 additional shares of our common stock.

International AIDS Vaccine Initiative Agreement

   In February 2000, we entered into a three-year development collaboration
with the International AIDS Vaccine Initiative (IAVI) and Children's Research
Institute on the campus of Children's Hospital in Columbus, Ohio, to develop a
vaccine to prevent AIDS. Under the terms of the collaboration, IAVI provides
funding to support development, preclinical studies and manufacturing of
product for clinical trial studies. The collaboration provides for up to $6.0
million in cost reimbursable research funding from IAVI.

   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 to produce the vaccine for developing
countries in reasonable quantity and at a reasonable price, IAVI will have
rights to obtain the necessary licenses from us that will allow IAVI to
contract with other manufacturers to make the vaccine for use in those
countries. We recognized $1.9 million in revenue from IAVI in 2001 and $23,000
of revenue in 2000, which is based on the research and development costs
incurred during those periods.

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 and expands a previously acquired limited field
license to these rights. In exchange for this technology license, we issued
500,000 shares of our common stock, a warrant to purchase 1.0 million shares of
our common stock at an exercise price of $2.50 per share, which expires in June
2007, and a warrant to purchase another 1.0 million shares of our common stock
at an exercise price of $4.16 per share, which expires in June 2009. Both
warrants were outstanding at December 31, 2001. During 1999, we recorded a $3.2
million non-cash charge based on the fair value of the warrants and shares of
common stock issued to Alkermes. The charge was recorded because the underlying
technology is not complete and we will have to invest significant resources to
develop and improve its commercial feasibility.

   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.

7.  Emerald Gene Systems Joint Venture

   In July 1999, we formed Emerald Gene Systems, Ltd. our joint venture with
Elan Corporation plc, a wholly owned subsidiary of Elan International Services,
Ltd. Emerald was formed to develop product candidates based on our expertise in
gene delivery and Elan's expertise in drug delivery. Both we and Elan licensed
intellectual property to Emerald. Emerald recorded a $15.0 million charge to
expense related to the intellectual property rights it acquired from Elan. We
assigned no value and recorded no revenue associated with the license of our
technology to the joint venture.

   In connection with the formation of Emerald, we issued to Elan shares of our
Series B convertible exchangeable preferred stock valued at $12.0 million. We
used the proceeds from the sale of the Series B

                                      61

<PAGE>

                         TARGETED GENETICS CORPORATION

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

preferred stock to acquire our 80.1% interest in Emerald. The Series B
preferred stock is convertible, at Elan's option, into shares our common stock,
at a conversion price of $3.32 per share. In addition, the Series B preferred
stock will automatically convert into common stock in the event of specified
transactions involving a change of control of Targeted Genetics. Alternatively,
Elan has the option to exchange the Series B preferred stock for the preferred
shares we hold in Emerald, which would increase Elan's ownership in Emerald to
50%. This exchange option is exercisable at any time through the earlier of
April 2003 and six months after the completion of Emerald's initial research
and development program, which is currently September 30, 2002, but is subject
to extension. In the event that Elan elects to exchange the Series B preferred
stock for our Emerald preferred stock, Elan must pay us an amount equal to
30.1% of the total funding that we have provided to Emerald after its
formation. We provided $3.5 million of funding to Emerald in 2001, $2.5 million
of funding in 2000 and no funding in 1999.

   We and Elan fund the expenses of Emerald in proportion to our respective
ownership interests. A joint operating committee determines the nature and
scope of activities to be performed by the joint venture on a periodic basis
and at least annually. We and Elan conduct Emerald's research and development
and Emerald reimburses each company for the costs of research and development
and related expenses plus a profit percentage. Our share of anticipated funding
for 2002 is $3.1 million. Reimbursement that we receive from Emerald is
reflected as revenue from collaborative agreement with unconsolidated,
majority-owned joint venture in the accompanying statements of operations and
related expenses are included in research and development expense. Under a loan
facility provided to us from Elan, we have the option to borrow up to $12.0
million from Elan to fund our share of Emerald's expenses. In September 2001,
we borrowed $2.0 million against this loan facility.

   We currently own 80.1% of Emerald's common and preferred stock and 100% of
the voting shares and Elan owns the remaining 19.9% of Emerald's common and
preferred stock. Although we own 100% of the voting stock, Elan and its
subsidiaries have retained significant minority investor rights that prevent us
from exercising control over Emerald. Accordingly, we do not consolidate the
financial statements of Emerald but instead account for our investment in
Emerald under the equity method of accounting. We record our share of Emerald's
net loss from operations as equity in net loss of unconsolidated,
majority-owned research and development joint venture in the accompanying
statements of operations.

   The condensed financial statements of Emerald are as follows:

<TABLE>
<CAPTION>
                                                       December 31,
                                                  ----------------------
                                                     2001        2000
                                                  -----------  ---------
       <S>                                        <C>          <C>
       Total assets, current..................... $     6,000  $   6,000
                                                  ===========  =========
       Current liabilities.......................   1,393,000    331,000
       Total shareholders' equity................  (1,387,000)  (325,000)
                                                  -----------  ---------
       Total liabilities and shareholders' equity $     6,000  $   6,000
                                                  ===========  =========
</TABLE>

<TABLE>
<CAPTION>

                                    Year Ended December 31,  July 21, 1999
                                   ------------------------  (Inception) to
                                      2001         2000      Dec. 31, 1999
                                   -----------  -----------  --------------
    <S>                            <C>          <C>          <C>
    Revenue                        $        --  $        --   $         --
    Expenses:
       Research and development...   4,563,000    3,073,000        723,000
       Technology access fee......          --           --     15,000,000
       General and administrative.      14,000       14,000         19,000
                                   -----------  -----------   ------------
           Net loss............... $(4,577,000) $(3,087,000)  $(15,742,000)
                                   ===========  ===========   ============
</TABLE>

                                      62

<PAGE>

                         TARGETED GENETICS CORPORATION

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)


8.  Commitments

   We lease our research and office facilities in Seattle, Washington under two
non-cancelable operating leases that expire in March 2004. We lease a facility
in Bothell, Washington under a non-cancelable operating lease that expires on
October 2015, which facility is intended to accommodate future manufacturing of
our product candidates. The research and office facility leases may be extended
under two additional five-year renewal options. The manufacturing facility
lease may be extended for an additional five-year period. We also lease
research and office facilities in Sharon Hill, Pennsylvania, under a
non-cancelable operating lease that expires in November 2005. This lease may be
extended for two additional five-year periods.

   Future minimum payments under non-cancelable operating leases at December
31, 2001 were as follows:

<TABLE>
              <S>                                      <C>
              Year ending December 31,
                 2002................................. $ 2,903,000
                 2003.................................   2,920,000
                 2004.................................   1,842,000
                 2005.................................   1,538,000
                 2006.................................   1,362,000
                 Thereafter...........................  13,288,000
                                                       -----------
                     Total minimum lease payments..... $23,853,000
                                                       ===========
</TABLE>

   Rent expense under operating leases was $2.9 million for 2001, $1.1 million
for 2000 and $587,000 for 1999.

9.  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 are 21
years old or older are eligible to participate in the plan. Our contributions
to the 401(k) plan are made at the discretion of the board of directors and
were $192,000 in 2001, $144,000 in 2000 and $90,000 in 1999.

10.  Income Taxes

   At December 31, 2001, we had net operating loss carryforwards of $103.0
million and research and tax credit carryforwards of $4.3 million. The
carryforwards, which are available to offset future federal income taxes, begin
to expire in 2008 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:

<TABLE>
<CAPTION>
                                                           December 31,
                                                    --------------------------
                                                        2001          2000
                                                    ------------  ------------
 <S>                                                <C>           <C>
 Deferred tax assets:..............................
    Net operating loss carryforwards............... $ 39,150,000  $ 33,210,000
    Deferred revenue...............................      400,000       640,000
    Research and experimental credit carryforwards.    4,300,000     3,430,000
    Depreciation and amortization..................    1,340,000     1,060,000
    Other..........................................      420,000       260,000
                                                    ------------  ------------
 Gross deferred tax assets.........................   45,610,000    38,600,000
 Valuation allowance for deferred tax assets.......  (45,610,000)  (38,600,000)
                                                    ------------  ------------
 Net deferred tax asset............................ $         --  $         --
                                                    ============  ============
</TABLE>

                                      63

<PAGE>

                         TARGETED GENETICS CORPORATION

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)


   Our utilization of federal income tax carryforwards is subject to limitation
under Section 382 of the Internal Revenue Code. Our past sales and issuances of
common stock have resulted in "ownership changes," as defined under Section
382, and may result in limitations on our future use of some portion of the net
operating loss carryforwards.

11.  Condensed Quarterly Financial Information (unaudited)

   The following tables present our unaudited quarterly results for 2001 and
2000. 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.

<TABLE>
<CAPTION>
                                                               Quarter Ended
                                            ---------------------------------------------------
                                             March 31,    June 30,    September 30, December 31,
                                               2001         2001          2001          2001
                                            -----------  -----------  ------------- ------------
<S>                                         <C>          <C>          <C>           <C>
Revenue.................................... $ 3,805,000  $ 4,339,000   $ 5,538,000  $ 5,198,000
Net loss...................................  (6,132,000)  (5,258,000)   (6,347,000)  (8,053,000)
Net loss attributable to common shares.....  (6,471,000)  (6,098,000)   (7,233,000)  (8,313,000)
Basic and diluted net loss per common share       (0.15)       (0.14)        (0.16)       (0.19)
</TABLE>

<TABLE>
<CAPTION>
                                                               Quarter Ended
                                            ---------------------------------------------------
                                             March 31,    June 30,    September 30, December 31,
                                               2000         2000          2000          2000
                                            -----------  -----------  ------------- ------------
<S>                                         <C>          <C>          <C>           <C>
Revenue.................................... $ 2,700,000  $ 2,277,000  $  1,914,000  $ 4,512,000
Operating loss.............................  (2,125,000)  (3,352,000)  (31,891,000)  (6,644,000)
Loss before cumulative effect of change in
  accounting principle.....................  (2,537,000)  (3,561,000)  (32,005,000)  (5,871,000)
Cumulative effect of change in accounting
  principle................................  (3,682,000)          --            --           --
Net loss...................................  (6,219,000)  (3,561,000)  (32,005,000)  (5,871,000)
Net loss attributable to common shares.....  (6,435,000)  (3,777,000)  (32,229,000)  (6,100,000)
Basic and diluted net loss per common share       (0.18)       (0.10)        (0.86)       (0.14)
</TABLE>

Item 9.  Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure

   None.

                                      64

<PAGE>

                                   PART III

Item 10.  Directors and Executive Officers of Registrant

   The information required by this Item with respect to our directors is
incorporated by reference to the section captioned "Election of Directors" in
the proxy statement for our annual meeting of shareholders to be held on May 9,
2002.

   The information required by this Item with respect to our executive officers
is incorporated by reference to the section captioned "Executive Officers" in
the proxy statement for our annual meeting of shareholders to be held on May 9,
2002.

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
9, 2002.

Item 12.  Security Ownership of Certain Beneficial Owners and Management

   The information required by this Item with respect to beneficial ownership
is incorporated by reference from the section captioned "Principal
Shareholders" in the proxy statement for our annual meeting of shareholders to
be held on May 9, 2002.

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 9, 2002.

                                      65

<PAGE>

                                    PART IV

Item 14.  Exhibits, Financial Statement Schedules and Reports on Form 8-K

   (a) 1.  Financial Statements

   The following consolidated financial statements are submitted in Item 8 of
this report:

<TABLE>
<CAPTION>
                                                                                            Page(s) in
                                                                                               10-K
                                                                                            ----------
<S>                                                                                         <C>
Report of Ernst & Young LLP, Independent Auditors..........................................     43

Consolidated Balance Sheets at December 31, 2001 and 2000..................................     44

Consolidated Statements of Operations for the years ended December 31, 2001, 2000 and 1999.     45

Consolidated Statements of Shareholders' Equity for the period from January 1, 1999 through
  December 31, 2001........................................................................     46

Consolidated Statements of Cash Flows for the years ended December 31, 2001, 2000 and 1999.     47

Notes to Consolidated Financial Statements.................................................     48
</TABLE>

                                      66

<PAGE>

   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.

   3.  Exhibits

<TABLE>
<C>   <S>                                                                                          <C>
  3.1 Restated Articles of Incorporation (Exhibit 3.1)                                             (L)

  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    (C)
        Shareholder Services (Exhibit 2.1)

  4.2 First Amendment of Rights Agreement, dated July 21, 1999, between Targeted Genetics and      (J)
        ChaseMellon Shareholder Services (Exhibit 1.9)

 10.1 Form of Indemnification Agreement between Targeted Genetics and its officers and directors   (K)
        (Exhibit 10.1)

 10.2 Form of Senior Management Employment Agreement between the registrant and its executive      (D)
        officers (Exhibit 10.2)

 10.3 Gene Transfer Technology License Agreement, dated as of February 18, 1992, between           (K)
        Immunex Corporation and Targeted Genetics* (Exhibit 10.3)

 10.4 PHS Patent License Agreement--Non-Exclusive, dated as of July 13, 1993, between National     (K)
        Institutes of Health Centers for Disease Control and Targeted Genetics* (Exhibit 10.4)

 10.5 Patent License Agreement, dated as of December 25, 1993, between The University of Florida   (K)
        Research Foundation, Inc. and Targeted Genetics* (Exhibit 10.5)

 10.6 PHS Patent License Agreement--Exclusive, dated as of March 10, 1994, between National        (E)
        Institutes of Health Centers for Disease Control and Targeted Genetics* (Exhibit 10.10)

 10.7 License Agreement, dated as of March 28, 1994, between Targeted Genetics and the University  (E)
        of Michigan* (Exhibit 10.13)

 10.8 Patent and Technology License Agreement, effective as of March 1, 1994, between the Board of (A)
        Regents of the University of Texas M.D. Anderson Cancer Center and RGene Therapeutics,
        Inc.* (Exhibit 10.29)

 10.9 First Amended and Restated License Agreement, effective as of October 12, 1995, between The  (A)
        University of Tennessee Research Corporation and RGene Therapeutics, Inc.* (Exhibit 10.30)

10.10 Amendment to First Amended and Restated License Agreement, dated as of June 19, 1996,        (B)
        between The University of Tennessee Research Corporation and RGene Therapeutics, Inc.*
        (Exhibit 10.1)

10.11 Second Amendment to First Amended and Restated License Agreement, dated as of April 17,      (G)
        1998, between The University of Tennessee Research Corporation and RGene Therapeutics,
        Inc.* (Exhibit 10.16)

10.12 License Agreement, dated as of March 15, 1997, between the Burnham Institute and Targeted    (E)
        Genetics* (Exhibit 10.23)

10.13 Exclusive Sublicense Agreement, dated June 9, 1999, between Targeted Genetics and Alkermes,  (I)
        Inc. (Exhibit 10.36)

10.14 Master Agreement, dated as of November 23, 1998, between Targeted Genetics and Medeva        (H)
        Pharmaceuticals, Inc.* (Exhibit 1.1)

10.15 License and Collaboration Agreement, dated as of November 23, 1998, between Targeted         (H)
        Genetics and Medeva Pharmaceuticals, Inc.* (Exhibit 1.2)
</TABLE>

                                      67

<PAGE>

<TABLE>
<C>   <S>                                                                                        <C>

10.16 Supply Agreement, dated as of November 23, 1998, between Targeted Genetics and Medeva      (H)
        Pharmaceuticals, Inc.* (Exhibit 1.3)

10.17 Credit Agreement, dated as of November 23, 1998, between Targeted Genetics, Medeva         (H)
        Pharmaceuticals, Inc. and Medeva PLC* (Exhibit 1.5)

10.18 Funding Agreement, dated as of July 21, 1999, among Targeted Genetics, Elan International  (J)
        Services, Ltd., and Elan Corporation, plc (Exhibit 1.3)

10.19 Subscription, Joint Development and Operating Agreement, dated as of July 21, 1999, among  (J)
        Elan Corporation, plc, Elan International Services, Ltd., Targeted Genetics and Targeted
        Genetics Newco, Ltd. * (Exhibit 1.4)

10.20 Convertible Promissory Note, dated July 21, 1999, issued by Targeted Genetics to Elan      (J)
        International Services, Ltd. (Exhibit 1.5)

10.21 License Agreement dated July 21, 1999, between Targeted Genetics Newco, Ltd. and Targeted  (J)
        Genetics * (Exhibit 1.6)

10.22 License Agreement, dated July 21, 1999, between Targeted Genetics Newco, Ltd. and Elan     (J)
        Pharmaceutical Technologies, a division of Elan Corporation, plc * (Exhibit 1.7)

10.23 Office Lease, dated as of October 7, 1996, between Benaroya Capital Company, LLC and       (D)
        Targeted Genetics (Exhibit 10.26)

10.24 Canyon Park Building Lease, dated as of June 30, 2000, between Targeted Genetics and       (L)
        CarrAmerica Corporation (Exhibit 10.1)

10.25 Olive Way Building Lease, dated as of November 20, 1993, as amended, between Targeted      (K)
        Genetics and Ironwood Apartments, Inc. (successor in interest to Metropolitan Federal
        Savings and Loan Association) (Exhibit 10.29)

10.26 First Lease Amendment, dated May 12, 1997, between Targeted Genetics and Benaroya Capital  (Q)
        Company, LLC (Exhibit 10.1)

10.27 Second Lease Amendment, dated February 25, 2000, between Targeted Genetics and Benaroya    (Q)
        Capital Company, LLC (Exhibit 10.2)

10.28 Third Lease Amendment, dated April 19, 2000, between Targeted Genetics and Benaroya        (Q)
        Capital Company, LLC (Exhibit 10.3)

10.29 Fourth Lease Amendment, dated March 28, 2001, between Targeted Genetics and Benaroya       (Q)
        Capital Company, LLC (Exhibit 10.4)

10.30 1992 Restated Stock Option Plan (Exhibit 99.1)                                             (F)

10.31 Stock Option Plan for Nonemployee Directors (Exhibit 10.34)                                (E)

10.32 1999 Restated Stock Option Plan, as amended January 23, 2001 (Exhibit 10.2)                (P)

10.33 2000 Genovo Inc. Roll-Over Stock Option Plan (Exhibit 99.1)                                (N)

10.34 Agreement and Plan of Merger dated as of August 8, 2000, among Targeted Genetics, Inc.,
        TGC Acquisition Corporation and Biogen, Inc.*

10.35 Development and Marketing Agreement, dated as of August 8, 2000, between Targeted          (M)
        Genetics and Biogen, Inc.* (Exhibit 10.1)

10.36 Funding Agreement dated as of August 8, 2000, between Targeted Genetics and Biogen, Inc.   (M)
        (Exhibit 10.2)

10.37 Product Development Agreement, dated as of November 9, 2000, between Targeted Genetics     (O)
        and Genetics Institute, Inc. * (Exhibit 10.1)

10.38 Supply Agreement, dated as of November 9, 2000, between Targeted Genetics and Genetics     (O)
        Institute, Inc.* (Exhibit 10.2)
</TABLE>

                                      68

<PAGE>

<TABLE>
           <C>  <S>

           21.1 Subsidiaries of Targeted Genetics

           23.1 Consent of Ernst & Young LLP, Independent Auditors
</TABLE>
--------
 * Portions of these exhibits have been omitted based on a grant of
   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 12, 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 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 September 13,
    2000.
(N) 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.
(O) 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.
(P) 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.
(Q) Incorporated by reference to Targeted Genetics' Quarterly Report on Form
    10-Q (No. 0-23930) for the period ended June 30, 2001, filed on August 14,
    2001.

   (c) Reports on Form 8-K

   On October 29, 2001, Targeted Genetics filed a Current Report on Form 8-K to
announce the appointment of Todd E. Simpson to the position of Vice President,
Finance and Administration, and Chief Financial Officer.


                                      69

<PAGE>

                                  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 18, 2002.

                                               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     President, Chief Executive    March 18, 2002
-----------------------------   Officer and Director
      H. Stewart Parker         (Principal Executive
                                Officer)

    /S/  TODD E. SIMPSON      Vice President, Finance and   March 18, 2002
-----------------------------   Administration and Chief
       Todd E. Simpson          Financial Officer,
                                Secretary and Treasurer
                                (Principal Financial and
                                Accounting Officer)

 /s/  JEREMY L. CURNOCK COOK  Chairman of the Board         March 18, 2002
-----------------------------
   Jeremy L. Curnock Cook

     /s/  JACK L. BOWMAN      Director                      March 18, 2002
-----------------------------
       Jack L. Bowman

/s/  JOSEPH M. DAVIE, PH.D.,  Director                      March 18, 2002
            M.D.
-----------------------------
Joseph M. Davie, Ph.D., M.D.

     /s/  JAMES D. GRANT      Director                      March 18, 2002
-----------------------------
       James D. Grant

                                      70

<PAGE>

          Signature                       Title                  Date
          ---------                       -----                  ----

    /s/  LOUIS P. LACASSE     Director                      March 18, 2002
-----------------------------
      Louis P. Lacasse

 /s/  NELSON L. LEVY, PH.D.,  Director                      March 18, 2002
            M.D.
-----------------------------
 Nelson L. Levy, Ph.D., M.D.

  /s/  MARK RICHMOND, PH.D.   Director                      March 18, 2002
-----------------------------
    Mark Richmond, Ph.D.

                                      71

<PAGE>

                                 EXHIBIT INDEX

<TABLE>
<C>   <S>                                                                                          <C>
  3.1 Restated Articles of Incorporation (Exhibit 3.1)                                             (L)

  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    (C)
        Shareholder Services (Exhibit 2.1)

  4.2 First Amendment of Rights Agreement, dated July 21, 1999, between Targeted Genetics and      (J)
        ChaseMellon Shareholder Services (Exhibit 1.9)

 10.1 Form of Indemnification Agreement between Targeted Genetics and its officers and directors   (K)
        (Exhibit 10.1)

 10.2 Form of Senior Management Employment Agreement between the registrant and its executive      (D)
        officers (Exhibit 10.2)

 10.3 Gene Transfer Technology License Agreement, dated as of February 18, 1992, between           (K)
        Immunex Corporation and Targeted Genetics* (Exhibit 10.3)

 10.4 PHS Patent License Agreement--Non-Exclusive, dated as of July 13, 1993, between National     (K)
        Institutes of Health Centers for Disease Control and Targeted Genetics* (Exhibit 10.4)

 10.5 Patent License Agreement, dated as of December 25, 1993, between The University of Florida   (K)
        Research Foundation, Inc. and Targeted Genetics* (Exhibit 10.5)

 10.6 PHS Patent License Agreement--Exclusive, dated as of March 10, 1994, between National        (E)
        Institutes of Health Centers for Disease Control and Targeted Genetics* (Exhibit 10.10)

 10.7 License Agreement, dated as of March 28, 1994, between Targeted Genetics and the University  (E)
        of Michigan* (Exhibit 10.13)

 10.8 Patent and Technology License Agreement, effective as of March 1, 1994, between the Board of (A)
        Regents of the University of Texas M.D. Anderson Cancer Center and RGene Therapeutics,
        Inc.* (Exhibit 10.29)

 10.9 First Amended and Restated License Agreement, effective as of October 12, 1995, between The  (A)
        University of Tennessee Research Corporation and RGene Therapeutics, Inc.* (Exhibit 10.30)

10.10 Amendment to First Amended and Restated License Agreement, dated as of June 19, 1996,        (B)
        between The University of Tennessee Research Corporation and RGene Therapeutics, Inc.*
        (Exhibit 10.1)

10.11 Second Amendment to First Amended and Restated License Agreement, dated as of April 17,      (G)
        1998, between The University of Tennessee Research Corporation and RGene Therapeutics,
        Inc.* (Exhibit 10.16)

10.12 License Agreement, dated as of March 15, 1997, between the Burnham Institute and Targeted    (E)
        Genetics* (Exhibit 10.23)

10.13 Exclusive Sublicense Agreement, dated June 9, 1999, between Targeted Genetics and Alkermes,  (I)
        Inc. (Exhibit 10.36)

10.14 Master Agreement, dated as of November 23, 1998, between Targeted Genetics and Medeva        (H)
        Pharmaceuticals, Inc.* (Exhibit 1.1)

10.15 License and Collaboration Agreement, dated as of November 23, 1998, between Targeted         (H)
        Genetics and Medeva Pharmaceuticals, Inc.* (Exhibit 1.2)

10.16 Supply Agreement, dated as of November 23, 1998, between Targeted Genetics and Medeva        (H)
        Pharmaceuticals, Inc.* (Exhibit 1.3)

10.17 Credit Agreement, dated as of November 23, 1998, between Targeted Genetics, Medeva           (H)
        Pharmaceuticals, Inc. and Medeva PLC* (Exhibit 1.5)
</TABLE>

<PAGE>

<TABLE>
<C>   <S>                                                                                        <C>

10.18 Funding Agreement, dated as of July 21, 1999, among Targeted Genetics, Elan International  (J)
        Services, Ltd., and Elan Corporation, plc (Exhibit 1.3)

10.19 Subscription, Joint Development and Operating Agreement, dated as of July 21, 1999, among  (J)
        Elan Corporation, plc, Elan International Services, Ltd., Targeted Genetics and Targeted
        Genetics Newco, Ltd. * (Exhibit 1.4)

10.20 Convertible Promissory Note, dated July 21, 1999, issued by Targeted Genetics to Elan      (J)
        International Services, Ltd. (Exhibit 1.5)

10.21 License Agreement dated July 21, 1999, between Targeted Genetics Newco, Ltd. and Targeted  (J)
        Genetics * (Exhibit 1.6)

10.22 License Agreement, dated July 21, 1999, between Targeted Genetics Newco, Ltd. and Elan     (J)
        Pharmaceutical Technologies, a division of Elan Corporation, plc * (Exhibit 1.7)

10.23 Office Lease, dated as of October 7, 1996, between Benaroya Capital Company, LLC and       (D)
        Targeted Genetics (Exhibit 10.26)

10.24 Canyon Park Building Lease, dated as of June 30, 2000, between Targeted Genetics and       (L)
        CarrAmerica Corporation (Exhibit 10.1)

10.25 Olive Way Building Lease, dated as of November 20, 1993, as amended, between Targeted      (K)
        Genetics and Ironwood Apartments, Inc. (successor in interest to Metropolitan Federal
        Savings and Loan Association) (Exhibit 10.29)

10.26 First Lease Amendment, dated May 12, 1997, between Targeted Genetics and Benaroya Capital  (Q)
        Company, LLC (Exhibit 10.1)

10.27 Second Lease Amendment, dated February 25, 2000, between Targeted Genetics and Benaroya    (Q)
        Capital Company, LLC (Exhibit 10.2)

10.28 Third Lease Amendment, dated April 19, 2000, between Targeted Genetics and Benaroya        (Q)
        Capital Company, LLC (Exhibit 10.3)

10.29 Fourth Lease Amendment, dated March 28, 2001, between Targeted Genetics and Benaroya       (Q)
        Capital Company, LLC (Exhibit 10.4)

10.30 1992 Restated Stock Option Plan (Exhibit 99.1)                                             (F)

10.31 Stock Option Plan for Nonemployee Directors (Exhibit 10.34)                                (E)

10.32 1999 Restated Stock Option Plan, as amended January 23, 2001 (Exhibit 10.2)                (P)

10.33 2000 Genovo Inc. Roll-Over Stock Option Plan (Exhibit 99.1)                                (N)

10.34 Agreement and Plan of Merger dated as of August 8, 2000, among Targeted Genetics, Inc.,
        TGC Acquisition Corporation and Biogen, Inc.*

10.35 Development and Marketing Agreement, dated as of August 8, 2000, between Targeted          (M)
        Genetics and Biogen, Inc.* (Exhibit 10.1)

10.36 Funding Agreement dated as of August 8, 2000, between Targeted Genetics and Biogen, Inc.   (M)
        (Exhibit 10.2)

10.37 Product Development Agreement, dated as of November 9, 2000, between Targeted Genetics     (O)
        and Genetics Institute, Inc. * (Exhibit 10.1)

10.38 Supply Agreement, dated as of November 9, 2000, between Targeted Genetics and Genetics     (O)
        Institute, Inc.* (Exhibit 10.2)

 21.1 Subsidiaries of Targeted Genetics

 23.1 Consent of Ernst & Young LLP, Independent Auditors
</TABLE>

<PAGE>

--------
 * Portions of these exhibits have been omitted based on a grant of
   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 12, 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 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 September 13,
    2000.
(N) 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.
(O) 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.
(P) 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.
(Q) Incorporated by reference to Targeted Genetics' Quarterly Report on Form
    10-Q (No. 0-23930) for the period ended June 30, 2001, filed on August 14,
    2001.