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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
 WASHINGTON, D.C. 20549
 
 FORM 10-Q
 
 (Mark One)
 þ
    
    QUARTERLY REPORT PURSUANT TO SECTION 13 OR
15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 For the quarterly period ended June 30, 2005
 OR
 o
    
    TRANSITION REPORT PURSUANT TO SECTION 13 OR
15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 For the transition period from  to
 Commission File Number No. 0-23930
 
 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)
 
 þ  ̈
 þ  ̈
  Common Stock, $0.01 par value
    
    85,628,244(Class)
    
    (Outstanding at July 20, 2005)




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TARGETED GENETICS CORPORATION
 
   
 Page No.PART I FINANCIAL INFORMATIONItem 1. Financial Statementsa) Condensed Consolidated Balance Sheets at June 30, 2005 and December 31, 2004
    
    
    1b) Condensed Consolidated Statements of Operations for the three and six months ended
June 30, 2005 and 2004
    
    
    2c) Condensed Consolidated Statements of Cash Flows for the three and six months ended
June 30, 2005 and 2004
    
    
    3d) Notes to Condensed Consolidated Financial Statements
    
    
    4Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
    
    
    7Item 3. Quantitative and Qualitative Disclosures About Market Risk
    
    
    21Item 4. Controls and Procedures
    
    
    21PART II OTHER INFORMATIONItem 1. Legal Proceedings
    
    
    22Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
    
    
    22Item 3. Defaults Upon Senior Securities
    
    
    22Item 4. Submission of Matters to a Vote of Security Holders
    
    
    22Item 5. Other Information
    
    
    22Item 6. Exhibits
    
    
    22SIGNATURES
    
    
    23EXHIBIT INDEX
    
    
    24EXHIBIT 31.1EXHIBIT 31.2EXHIBIT 32.1EXHIBIT 32.2
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PART I FINANCIAL INFORMATION
 
 Item 1. Financial Statements
 TARGETED GENETICS CORPORATION
 
 CONDENSED CONSOLIDATED BALANCE SHEETS
(Unaudited)
 June 30,
    
    December 31,2005
    
    2004ASSETSCurrent assets:Cash and cash equivalents
    
    $
    25,609,000
    
    
    $
    34,096,000Accounts receivable
    
    
    124,000
    
    
    
    404,000Prepaid expenses and other
    
    
    637,000
    
    
    
    653,000Total current assets
    
    
    26,370,000
    
    
    
    35,153,000Property and equipment, net
    
    
    2,150,000
    
    
    
    2,495,000Goodwill, net
    
    
    31,649,000
    
    
    
    31,649,000Other assets
    
    
    201,000
    
    
    
    668,000Total assets
    
    $
    60,370,000
    
    
    $
    69,965,000LIABILITIES AND SHAREHOLDERS EQUITYCurrent liabilities:Accounts payable and accrued expenses
    
    $
    2,464,000
    
    
    $
    1,436,000Accrued employee expenses
    
    
    579,000
    
    
    
    1,030,000Accrued restructure charges
    
    
    517,000
    
    
    
    407,000Deferred revenue
    
    
    143,000
    
    
    
    Current portion of long-term obligations
    
    
    873,000
    
    
    
    1,122,000Total current liabilities
    
    
    4,576,000
    
    
    
    3,995,000Accrued restructure charges and deferred rent
    
    
    5,921,000
    
    
    
    6,026,000Long-term obligations
    
    
    10,071,000
    
    
    
    10,182,000CommitmentsShareholders equity:Preferred stock, $0.01 par value, 6,000,000 shares
authorized:Series A preferred stock, 800,000 shares designated,
none issued and outstanding
    
    
    
    
    
    
    Common stock, $0.01 par value, 180,000,000 shares authorized,
85,628,244 shares issued and outstanding at June 30, 2005 and
85,626,326 shares issued and outstanding at December 31, 2004
    
    
    856,000
    
    
    
    856,000Additional paid-in capital
    
    
    279,751,000
    
    
    
    279,745,000Accumulated deficit
    
    
    (240,805,000
    )
    
    
    (230,839,000
    )Total shareholders equity
    
    
    39,802,000
    
    
    
    49,762,000Total liabilities and shareholders equity
    
    $
    60,370,000
    
    
    $
    69,965,000
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TARGETED GENETICS CORPORATION
 
 CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
 Three months ended
    
    Six months endedJune 30,
    
    June 30,2005
    
    2004
    
    2005
    
    2004Revenue under
collaborative
agreements
    
    $
    1,462,000
    
    
    $
    2,761,000
    
    
    $
    3,462,000
    
    
    $
    4,081,000Operating expenses:Research and
development
    
    
    4,808,000
    
    
    
    4,828,000
    
    
    
    9,347,000
    
    
    
    9,065,000General and
administrative
    
    
    1,660,000
    
    
    
    2,066,000
    
    
    
    3,545,000
    
    
    
    3,816,000Restructure
charges
    
    
    119,000
    
    
    
    221,000
    
    
    
    338,000
    
    
    
    416,000Total
operating
expenses
    
    
    6,587,000
    
    
    
    7,115,000
    
    
    
    13,230,000
    
    
    
    13,297,000Loss from
operations
    
    
    (5,125,000
    )
    
    
    (4,354,000
    )
    
    
    (9,768,000
    )
    
    
    (9,216,000
    )Investment income
(loss)
    
    
    (33,000
    )
    
    
    21,000
    
    
    
    67,000
    
    
    
    145,000Interest expense
    
    
    (136,000
    )
    
    
    (117,000
    )
    
    
    (265,000
    )
    
    
    (237,000
    )Net loss
    
    $
    (5,294,000
    )
    
    $
    (4,450,000
    )
    
    $
    (9,966,000
    )
    
    $
    (9,308,000
    )Net loss per common
share (basic and
diluted)
    
    $
    (0.06
    )
    
    $
    (0.05
    )
    
    $
    (0.12
    )
    
    $
    (0.12
    )Shares used in
computation of
basic and diluted
net loss per common
share
    
    
    85,628,000
    
    
    
    81,604,000
    
    
    
    85,628,000
    
    
    
    77,239,000
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TARGETED GENETICS CORPORATION
 
 CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
 Six months endedJune 30,2005
    
    2004Operating activities:Net loss
    
    $
    (9,966,000
    )
    
    $
    (9,308,000
    )Adjustments to reconcile net loss to net cash
used in operating activities:Depreciation and amortization
    
    
    647,000
    
    
    
    669,000Loss on investments
    
    
    278,000
    
    
    
    Changes in assets and liabilities:Decrease in accounts receivable
    
    
    280,000
    
    
    
    166,000Increase in prepaid expenses and other
    
    
    (291,000
    )
    
    
    (145,000
    )Decrease in other assets
    
    
    467,000
    
    
    
    155,000Increase in current liabilities
    
    
    595,000
    
    
    
    205,000Increase in deferred revenue
    
    
    143,000
    
    
    
    1,587,000Increase (decrease) in accrued restructure
expenses and deferred rent
    
    
    5,000
    
    
    
    (193,000
    )Net cash used in operating activities
    
    
    (7,842,000
    )
    
    
    (6,864,000
    )Investing activities:Proceeds from sale of investments
    
    
    29,000
    
    
    
    Purchases of property and equipment
    
    
    (302,000
    )
    
    
    (137,000
    )Net cash used in investing activities
    
    
    (273,000
    )
    
    
    (137,000
    )Financing activities:Net proceeds from sales of common stock
    
    
    6,000
    
    
    
    23,793,000Payments under leasehold improvements and
equipment financing arrangements
    
    
    (378,000
    )
    
    
    (468,000
    )Net cash provided by (used in) financing activities
    
    
    (372,000
    )
    
    
    23,325,000Net increase (decrease) in cash and cash equivalents
    
    
    (8,487,000
    )
    
    
    16,324,000Cash and cash equivalents, beginning of period
    
    
    34,096,000
    
    
    
    21,507,000Cash and cash equivalents, end of period
    
    $
    25,609,000
    
    
    $
    37,381,000
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TARGETED GENETICS CORPORATION
 
 NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 (Unaudited)
 1. Basis of Presentation
 .
   2. Long-Term Obligations
  June 30,
    
    December 31,2005
    
    2004Loan payable to Biogen, due August 2006
    
    $
    10,000,000
    
    
    $
    10,000,000Loan payable to Biogen, due September 2005
    
    
    642,000
    
    
    
    624,000Equipment financing obligations
    
    
    302,000
    
    
    
    680,000Total obligations
    
    
    10,944,000
    
    
    
    11,304,000Less current portion
    
    
    (873,000
    )
    
    
    (1,122,000
    )Total long-term obligations
    
    $
    10,071,000
    
    
    $
    10,182,000
  3. Accrued Restructure Charges
 Accounting for Costs Associated with Exit or Disposal Activities,
 4




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ContractTerminationCostsDecember 31, 2004 accrued liability
    
    $
    6,348,000Charges incurred
    
    
    100,000Adjustments to the liability
    
    
    238,000Amount paid
    
    
    (349,000
    )June 30, 2005 accrued liability
    
    $
    6,337,000
   4. Stock Compensation
 Accounting for Stock-Based Compensation Accounting for Stock Issued
to Employees,
 Three months ended
    
    Six months endedJune 30,
    
    June 30,2005
    
    2004
    
    2005
    
    2004Net loss:As reported
    
    $
    (5,294,000
    )
    
    $
    (4,450,000
    )
    
    $
    (9,966,000
    )
    
    $
    (9,308,000
    )Proforma stock-based
compensation expense
    
    
    (404,000
    )
    
    
    (339,000
    )
    
    
    (868,000
    )
    
    
    (574,000
    )Pro forma
    
    $
    (5,698,000
    )
    
    $
    (4,789,000
    )
    
    $
    (10,834,000
    )
    
    $
    (9,882,000
    )Basic net loss per share:As reported
    
    $
    (0.06
    )
    
    $
    (0.05
    )
    
    $
    (0.12
    )
    
    $
    (0.12
    )Pro forma
    
    
    (0.07
    )
    
    
    (0.06
    )
    
    
    (0.13
    )
    
    
    (0.13
    )
 5




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Share Based
Payment
  5. Investment in Securities of Chromos Molecular Systems, Inc.
   6




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Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
 Forward-Looking Statements
   Business Overview
    
    
    signs and symptoms of disease as measured by standardized arthritis index scores for tenderness and swelling,
    
    molecular markers of disease, and
 7




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
    
    gene expression in both drug-treated and placebo-treated groups of patients.
      8




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Results of Operations
 Revenue
  Operating Expenses
 Research and Development Expenses
  Three months ended
    
    Six months endedJune 30,
    
    June 30,2005
    
    2004
    
    2005
    
    2004Programs in clinical development:AIDS vaccine
    
    
    864,000
    
    
    
    1,041,000
    
    
    
    1,988,000
    
    
    
    1,570,000Inflammatory arthritis
    
    
    581,000
    
    
    
    825,000
    
    
    
    1,167,000
    
    
    
    906,000Cystic fibrosis
    
    
    85,000
    
    
    
    316,000
    
    
    
    274,000
    
    
    
    452,000Indirect costs
    
    
    1,099,000
    
    
    
    1,684,000
    
    
    
    2,610,000
    
    
    
    2,568,000Total clinical development program expense
    
    
    2,629,000
    
    
    
    3,866,000
    
    
    
    6,039,000
    
    
    
    5,496,000Research and preclinical development
program expense
    
    
    2,179,000
    
    
    
    962,000
    
    
    
    3,308,000
    
    
    
    3,569,000Total research and development expense
    
    $
    4,808,000
    
    
    $
    4,828,000
    
    
    $
    9,347,000
    
    
    $
    9,065,000
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General and Administrative Expenses
 Restructure Charges.
 Other Income and Expense
 Investment Income (Loss)
 Interest Expense
 Liquidity and Capital Resources
    10




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.
 $
  
    
    the rate and extent of scientific progress in our research and development programs;
    
    the timing, costs and scope of, and our success in, clinical trials, obtaining regulatory
approvals and filing, prosecuting and enforcing patents;
    
    competing technological and market developments;
    
    the timing and costs of, and our success in, any product commercialization activities and
facility expansions, if and as required; and
    
    the expense and outcome of any litigation or administrative proceedings involving our
intellectual property, or access to third-party intellectual property through licensing
agreements.
   
    
    entering into additional product development and funding collaborations or other strategic
transactions, or extending or expanding our current collaborations;
    
    selling or licensing our technology or product candidates;
    
    borrowing under loan or equipment financing arrangements;
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
    
    issuing equity in the public or private markets; or
    
    issuing debt.
  Factors Affecting Our Operating Results, Our Business and Our Stock Price
  Risks Related to Our Business
 If we are unable to raise additional capital when needed, we will be unable to conduct our
operations and develop our potential products.
  
    
    the rate and extent of scientific progress in our research and development programs;
    
    the timing, costs and scope of, and our success in, conducting clinical trials,
obtaining regulatory approvals and pursuing patent prosecutions;
    
    competing technological and market developments;
    
    the timing and costs of, and our success in, any commercialization activities and
facility expansions, if and as required; and
    
    the existence and/or outcome of any litigation or administrative proceedings involving
intellectual property.
  
    
    extending or expanding our current collaborations;
    
    entering into additional product development collaborations;
    
    selling or licensing our technology or product candidates;
    
    borrowing under loan or equipment financing arrangements;
    
    issuing equity in the public or private markets; or
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
    
    issuing debt.
   We expect to continue to operate at a loss and may never become profitable.
  All of our product candidates are in early-stage clinical trials or preclinical development, and if
we are unable to successfully develop and commercialize our product candidates we will be unable to
generate sufficient capital to maintain our business.
   Failure to recruit patients could delay or prevent clinical trials of our potential products, which
could delay or prevent the development of potential products.
  The regulatory approval process for our product candidates is costly, time-consuming and subject to
unpredictable changes and delays, and our product candidates may never receive regulatory approval.
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If we are unable to obtain or maintain licenses for necessary third-party technology on acceptable
terms or to develop alternative technology, we may be unable to develop and commercialize our
product candidates.
    
    
    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
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licensors and us and our partners; and
    
    the priority of invention of patented technology.
  Litigation involving intellectual property, product liability or other claims and product recalls
could strain our resources, subject us to significant liability, damage our reputation or result in
the invalidation of our proprietary rights.
   If we lose our collaborative partners, we may be unable to develop our potential products.
  If we do not attract and retain qualified personnel, we may be unable to develop and commercialize
some of our potential products.
  If our partners or scientific consultants terminate, reduce or delay our relationships with them,
we may be unable to develop our potential products.
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The success of our clinical trials and preclinical studies may not be indicative of results in a
large number of patients of either safety or efficacy.
  We may be unable to adequately protect our proprietary rights domestically or overseas, which may
limit our ability to successfully market any product candidates.
   If we do not develop adequate development, manufacturing, sales, marketing and distribution
capabilities, either alone or with our business partners, we will be unable to generate sufficient
product revenue to maintain our business.
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Post-approval manufacturing or product problems or failure to satisfy applicable regulatory
requirements could prevent or limit our ability to market our products.
  Risks Related to Our Industry
 Adverse events in the field of gene therapy could damage public perception of our potential
products and negatively affect governmental approval and regulation.
   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.
  17




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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.
  
    
    research and development;
    
    clinical trials;
    
    obtaining FDA and other regulatory approvals;
    
    manufacturing; and
    
    marketing and distribution.
   Healthcare reform measures and the unwillingness of third-party payors to provide adequate
reimbursement for the cost of our products could impair our ability to successfully commercialize
our potential products and become profitable.
   18




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19




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Risks Related to Our Common Stock
 If we are unable to comply with the minimum requirements for quotation on the NASDAQ SmallCap
Market and we may be delisted from the NASDAQ SmallCap Market, the liquidity and market price of
our common stock would decline.
   Concentration of ownership of our common stock may give certain shareholders significant influence
over our business.
  
    
    election of directors;
    
    amendment of our charter documents; or
    
    approval of significant corporate transactions, such as a change of control of Targeted Genetics.
   Market fluctuations or volatility could cause the market price of our common stock to decline and
limit our ability to raise capital.
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Item 3. Quantitative and Qualitative Disclosures About Market Risk
 Notes payable:
 Expected Maturity Date2005
    
    2006
    
    2007
    
    2008
    
    2009
    
    TotalMaturities of long-term obligations:Variable rate note
    
    $
    
    
    
    $
    10,000,000
    
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    10,000,000Fixed rate notes
    
    
    642,000
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    642,000Fixed rate equipment financing
    
    
    120,000
    
    
    
    155,000
    
    
    
    26,000
    
    
    
    1,000
    
    
    
    
    
    
    
    302,000Total
    
    $
    762,000
    
    
    $
    10,155,000
    
    
    $
    26,000
    
    
    $
    1,000
    
    
    $
    
    
    
    $

    10,944,000
 
 Item 4. Controls and Procedures
 Evaluation of disclosure controls and procedures.
 Changes in internal control over financial reporting.
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PART II OTHER INFORMATION
 
 Item 1. Legal Proceedings
  
 Item 2. Unregistered Sales of Securities and Use of Proceeds
  
 Item 3. Defaults Upon Senior Securities
  
 Item 4. Submission of Matters to a Vote of Security Holders
  1)
    
    At the annual meeting, Joseph M. Davie and Louis P. Lacasse were each elected to
serve as Class 2 members of our board of directors, each to hold office for a three-year
term or until his successor is elected and qualified. The Board members whose terms in
office continued after the annual meeting were Jeremy L. Curnock Cook (chairman), Jack L.
Bowman, Nelson L. Levy, H. Stewart Parker and Mark H. Richmond. Each of the incumbent
Class 2 directors who stood for reelection was elected with the following voting results:
 Nominee
    
    Votes For
    
    Votes WithheldJoseph M. Davie
    
    
    79,841,183
    
    
    
    563,754Louis P. Lacasse
    
    
    79,822,090
    
    
    
    582,847
 2)
    
    A proposal to amend the Amended and Restated Articles of Incorporation to increase
the authorized common stock from 120,000,000 shares to 180,000,000 shares passed with the
following results:
 Votes For
    
    Votes Against
    
    Abstain67,053,528
    
    1,622,904
    
    11,728,504
 3)
    
    A proposal to approve the ratification of Ernst &Young LLP as independent auditors
passed with the following results:
 Votes For
    
    Votes Against
    
    Abstain79,481,331
    
    853,734
    
    69,873
 
 Item 5. Other Information
  
 Item 6. Exhibits
  22




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SIGNATURES
  Targeted
Genetics CorporationDate:
    
    July 28, 2005
    
    
    
    By:
    
   /s/ H. Stewart ParkerH. Stewart Parker,President, Chief Executive Officer and Director(Principal Executive Officer)Date:
    
    July 28, 2005
    
    
    
    By:
    

/s/
Todd E. SimpsonTodd E. Simpson, Vice President,Finance and Administration,Chief Financial Officer,Secretary and Treasurer(Principal Financial and Accounting Officer)
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TARGETED GENETICS CORPORATION
 
 INDEX TO EXHIBITS
 Exhibit No.
    
    Description
    
    Note3.1
    
    Amended and Restated Articles of Incorporation (Exhibit 3.1)
    
    (A)3.2
    
    Amended and Restated Bylaws (Exhibit 3.2)
    
    (B)31.1
    
    Certification of Chief Executive Officer pursuant to Rules
13a-15(e) and 15d-15(e) under the Securities Exchange Act of
1934, as amended31.2
    
    Certification of Chief Financial Officer pursuant to Rules
13a-15(e) and 15d-15(e) under the Securities Exchange Act of
1934, as amended32.1
    
    Certification of Chief Executive Officer pursuant to 18
U.S.C. Section 1350, as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 200232.2
    
    Certification of Chief Financial Officer pursuant to 18
U.S.C. Section 1350, as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002
 
 (A)
    
    Incorporated by reference to the designated exhibit included with
Targeted Genetics Current Report on Form 8-K (No. 0-23930) filed on June 1, 2005.(B)
    
    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. 24