<PAGE>

                      SECURITIES AND EXCHANGE COMMISSION
                             Washington, DC 20549

                                   FORM 10-Q


(Mark One)
[x]  Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange
     Act of 1934

                 For the quarterly period ended March 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
                                                       -----------

                         Commission File Number:0-23930
                                                -------


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


              Washington                               91-1549568
  -----------------------------------   --------------------------------------
    (State or other jurisdiction of      (I.R.S. Employer Identification No.)
     incorporation or organization)

             1100 Olive Way, Suite 100, Seattle, Washington 98101
             ----------------------------------------------------
             (Address of principal executive offices)   (Zip code)

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

     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 the number of shares outstanding of each of the issuer's classes
of common stock, as of the latest practicable date.

        Common Stock, $.01 par value                43,887,161
      --------------------------------     ----------------------------
                 (Class)                   (Outstanding at May 1, 2001)
<PAGE>

                         TARGETED GENETICS CORPORATION

                         Quarterly Report on Form 10-Q
                     For the quarter ended March 31, 2001

                               TABLE OF CONTENTS
<TABLE>
<CAPTION>
                                                                                           Page No.
                                                                                           --------
PART I     FINANCIAL INFORMATION
<S>       <C>                                                                                <C>
Item 1.    Financial Statements

      a)   Condensed Consolidated Balance Sheets - March 31, 2001 and December 31, 2000        3
      b)   Condensed Consolidated Statements of Operations for the three months
           ended March 31, 2001 and 2000                                                       4
      c)   Condensed Consolidated Statements of Cash Flows for the three months
           March 31, 2001 and 2000                                                             5
      d)   Notes to Condensed Consolidated Financial Statements                                6

Item 2.    Management's Discussion and Analysis of Financial Condition and Results
           of Operations                                                                       7
Item 3.    Quantitative and Qualitative Disclosure About Market Risk                          17

PART II    OTHER INFORMATION

Item 1.    Legal Proceedings                                                                   *
Item 2.    Changes in Securities                                                               *
Item 3.    Defaults Upon Senior Securities                                                     *
Item 4.    Submission of Matters to a Vote of Security Holders                                 *
Item 5.    Other Information                                                                   *
Item 6.    Exhibits and Reports on Form 8-K                                                   17

SIGNATURES                                                                                    17
</TABLE>

*   No information is provided due to inapplicability of the item.

                                       2
<PAGE>

PART I  FINANCIAL INFORMATION

Item 1. Financial Statements

                         TARGETED GENETICS CORPORATION
                     CONDENSED CONSOLIDATED BALANCE SHEETS

<TABLE>
<CAPTION>
                                                                 March 31,           December 31,
                                                                   2001                 2000
                                                               -------------        -------------
ASSETS                                                                               (Unaudited)
------
<S>                                                            <C>                  <C>
Current assets:
       Cash and cash equivalents                               $  34,034,268        $  38,630,216
       Accounts receivable                                         2,788,363            3,086,534
       Receivable from joint venture                                 854,442              177,088
       Prepaid expenses and other                                    529,685              291,435
                                                               -------------        -------------
             Total current assets                                 38,206,758           42,185,273

Property, plant and equipment, net                                 7,321,107            6,206,276
Goodwill and other purchased intangibles, net                     36,303,710           37,821,059
Other assets                                                       1,479,034            1,761,434
                                                               -------------        -------------
                                                               $  83,310,609        $  87,974,042
                                                               =============        =============
LIABILITIES AND SHAREHOLDERS' EQUITY
------------------------------------
Current liabilities:
       Accounts payable                                        $   3,877,789        $   4,000,084
       Payable to joint venture                                    1,098,747              261,743
       Accrued payroll and other liabilities                         815,738              679,739
       Deferred revenue                                            7,578,281            6,906,174
       Current portion of long-term obligations                      812,661              838,245
                                                               -------------        -------------
             Total current liabilities                            14,183,216           12,685,985

Long-term obligations, less current portion                          819,736              947,508
Long-term note payable                                             1,505,616            1,498,566
Deferred revenue                                                   7,314,758            9,410,386

Shareholders' equity:
       Preferred stock, 6,000,000 shares authorized
         Series A preferred stock, $.01 par value; 400,000
           shares authorized, none outstanding                            -                    -
         Series B convertible exchangeable preferred stock,
           $.001 par value; 12,015 shares authorized, issued
           and outstanding at March 31, 2001 and at
           December 31, 2000                                      13,504,384           13,275,778
       Common stock $.01 par value, 80,000,000 shares
         authorized, 43,761,050 and 42,608,943 shares
         issued and outstanding at March 31, 2001 and
         December 31, 2000, respectively                         203,038,229          200,968,429
       Accumulated deficit                                      (157,055,330)        (150,812,610)
                                                               -------------        -------------
             Total shareholders' equity                           59,487,283           63,431,597
                                                               -------------        -------------
                                                               $  83,310,609        $  87,974,042
                                                               =============        =============
</TABLE>

        The accompanying notes are an integral part of this statement.

                                       3
<PAGE>

                         TARGETED GENETICS CORPORATION
                CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
                                  (Unaudited)

<TABLE>
<CAPTION>
                                                                          Three months ended
                                                                                March 31,
                                                                     ------------------------------
                                                                         2001               2000
                                                                     -----------        -----------
Revenue:                                                                                (restated)
<S>                                                                   <C>               <C>
     Collaborative agreements                                         $ 3,128,019        $ 2,287,625
     Collaborative agreements with affiliates                             677,354            412,261
                                                                      -----------        -----------
           Total revenue                                                3,805,373          2,699,886

Operating expenses:
     Research and development                                           6,393,356          3,717,756
     Amortization of acquisition-related intangibles                    1,517,346                  -
     General and administrative                                         2,026,881          1,106,951
                                                                      -----------        -----------
           Total operating expenses                                     9,937,583          4,824,707
                                                                      -----------        -----------

Loss from operations                                                   (6,132,210)        (2,124,821)

Equity in loss of joint venture                                          (848,218)          (563,994)
Investment income                                                         801,905            215,754
Interest expense                                                          (64,197)           (64,121)
                                                                      -----------        -----------

Loss before cumulative effect of change in accounting principle        (6,242,720)        (2,537,182)

Cumulative effect of change in accounting principle                             -         (3,681,687)
                                                                      -----------        -----------

Net loss                                                               (6,242,720)        (6,218,869)

Dividend on preferred stock                                              (228,606)          (216,528)
                                                                      -----------        -----------

Net loss applicable to common shareholders                            $(6,471,326)       $(6,435,397)
                                                                      ===========        ===========

Basic and diluted net loss per share:
Loss before cumulative effect of change in accounting principle            $(0.15)       $     (0.08)

Cumulative effect of change in accounting principle                   $         -        $     (0.10)
                                                                      -----------        -----------

Net loss applicable to common shareholders                                 $(0.15)       $     (0.18)
                                                                      ===========        ===========

Shares used in computation of basic and
  diluted net loss per share                                           43,517,198         34,823,371
                                                                      ===========        ===========

</TABLE>

   The accompanying notes are an integral part of this statement.

                                       4
<PAGE>

                         TARGETED GENETICS CORPORATION
                CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
                                  (Unaudited)

<TABLE>
<CAPTION>
                                                                               Three months ended
                                                                                     March 31,
                                                                          ----------------------------
                                                                              2001              2000
                                                                          -----------       -----------
Operating activities:                                                                        (restated)
---------------------
<S>                                                                       <C>               <C>
Net loss                                                                   $ (6,242,720)     $ (6,218,869)
Adjustments to reconcile net loss to net cash
 used in operating activities:
    Cumulative effect adjustment of change in accounting principle                    -         3,681,687
    Equity in loss of joint venture                                             848,218           563,994
    Depreciation and amortization                                               693,605           352,875
    Amortization of intangibles                                               1,517,349                 -
    Noncash equity variances                                                     80,466                 -
    Decrease in deferred revenue                                             (1,423,521)         (198,334)
    Decrease (increase) in accounts receivable from joint venture              (677,354)          294,124
    Decrease (increase) in accounts receivable                                  298,171          (431,966)
    Increase (decrease) in current liabilities                                  142,281          (122,705)
    Decrease in prepaid expenses and other                                       61,750            38,475
    Decrease in accounts payable and accrued liabilities                       (172,295)         (653,991)
    Decrease (increase) in other assets                                         (35,000)           13,438
                                                                           ------------      ------------
    Net cash used in operating activities                                    (4,909,050)       (2,681,272)

Investing activities:
---------------------
Purchases of property, plant and equipment                                   (1,689,248)         (362,825)
Investment in joint venture                                                     (11,214)         (563,994)
Maturities and sales of securities available for sale                                 -            10,920
                                                                           ------------      ------------
    Net cash used in investing activities                                    (1,700,462)         (915,889)

Financing activities:
---------------------
Net proceeds from sale of capital stock                                       2,217,940        28,681,742
Payments under capital leases and installment loans                            (204,376)         (305,712)
Proceeds from leasehold improvement and equipment financing                           -           456,182
                                                                           ------------      ------------
    Net cash provided by financing activities                                 2,013,564        28,832,212
                                                                           ------------      ------------

Net increase (decrease) in cash and cash equivalents                         (4,595,948)       25,235,041
Cash and cash equivalents, beginning of period                               38,630,216         4,100,798
                                                                           ------------      ------------

Cash and cash equivalents, end of period                                   $ 34,034,268      $ 29,335,839
                                                                           ============      ============

Supplemental disclosure of noncash investing and financing activities:
    Preferred stock dividend                                               $    228,606      $    216,528
    Equipment financed through capital lease                                     51,020            45,599
    Interest paid on capital lease and installment loans                         36,377            44,543

</TABLE>

        The accompanying notes are an integral part of this statement.

                                       5
<PAGE>

                         TARGETED GENETICS CORPORATION
             NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
                                  (Unaudited)


Note 1.  Basis of Presentation
------------------------------

  The condensed consolidated financial statements included in this quarterly
report have been prepared by Targeted Genetics Corporation without audit,
according to the rules and regulations of the Securities and Exchange Commission
("SEC"). The consolidated financial statements include the accounts of Targeted
Genetics and its wholly-owned subsidiaries Genovo, Inc., TGCF Manufacturing
Corporation and CellExSys, Inc. Certain information and footnote disclosures
normally included in financial statements prepared in accordance with generally
accepted accounting principles have been omitted pursuant to such rules and
regulations. The financial statements reflect, in the opinion of management, all
adjustments (which consist solely of normal recurring adjustments) necessary to
present fairly the financial position and results of operations as of and for
the periods indicated.

  The results of operations for the three months ended March 31, 2001, are not
necessarily indicative of the results to be expected for the full year. The
unaudited consolidated financial statements included in this quarterly report
should be read in conjunction with the audited consolidated financial statements
and related footnotes for the year ended December 31, 2000, included in Targeted
Genetics'annual report on Form 10-K for the year ended December 31, 2000.

2.  Change in Accounting Principle
    ------------------------------

We adopted the Securities and Exchange Commission's Staff Accounting Bulletin
No. 101., in the fourth quarter of 2000, effective January 1, 2000, and recorded
a $3.7 million charge as a cumulative effect of the change in accounting
principle. 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. The cumulative
effect was initially recorded as deferred revenue that will be recognized as
revenue over the remaining term of the research and development collaboration
agreements, as appropriate. The results for the first quarter of 2000 were
restated to reflect the effects of the accounting change. For the quarter ended
March 31, 2000, the impact of the change in accounting principle was to increase
net loss by $3.2 million, or $0.09 per share, comprised of the $3.7 million
cumulative effect of the change ($0.10 per share), net of $0.5 million of the
related deferred revenue that was recognized as revenue during the quarter ended
March 31, 2000 ($0.01 per share). For the quarter ended March 31, 2001, we
recognized $1.6 million of deferred revenue including $1.1 million of revenue
related to up-front payments received in the second half of 2000 when we
initiated collaborations with Biogen, Inc. and Genetics Institute and $525,000
of revenue related to the cumulative effect adjustment.

                                       6
<PAGE>

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

Forward-Looking Statements
--------------------------

  This quarterly report contains forward-looking statements, which involve
current expectations or forecasts of future events and other statements that are
not historical facts. Inaccurate assumptions and known or unknown risks and
uncertainties can affect the accuracy of forward-looking statements. Our actual
results could differ materially from those expressed in the forward-looking
statements for a number of reasons, including the factors described in the
section below entitled "Factors Affecting Our Operating Results, Our Business
and Our Stock Price". You should not unduly rely on these forward-looking
statements which speak only as of the date of this report. We undertake no
obligation to update any forward-looking statements to reflect new information,
circumstances or events after the future date of this report.

Results of Operations
---------------------

    Revenue.  Revenue for the quarter ended March 31, 2001 increased to $3.8
million from $2.7 million for the first quarter of 2000, primarily due to
increased revenue associated with the initiation in the second half of 2000 of a
multiple product development collaboration with Biogen, Inc. and a hemophilia
product development collaboration with Genetics Institute. The increase in
revenue from the addition of the hemophilia research and development activities
to our business base, was offset by a decrease in revenue from our Celltech
Group plc cystic fibrosis product development collaboration in the first quarter
2001 compared to the same period last year, which resulted primarily from vector
manufacturing revenue recognized last year as we were preparing for the current
Phase II cystic fibrosis clinical trial.

     Research and Development Expenses.  Research and development expenses for
the quarter ended March 31, 2001 increased to $6.4 million from $3.7 million for
the first quarter of 2000. This increase reflects expenses related to the
research and development operations assumed from the acquisition of Genovo,
hiring additional research scientists to support our Genetics Institute and
International AIDS Vaccine Initiative (IAVI) product development collaborations
and Emerald Gene Systems joint venture, and hiring additional clinical and
regulatory personnel to design and administer our cystic fibrosis and cancer
clinical trials. Current quarter expenses also reflect increased activity within
our majority-owned CellExSys, Inc. cell therapy business subsidiary and
increased research and development efforts in our cancer and arthritis programs.
We expect to see continued increases in quarterly costs associated with
developing our gene therapy product candidates for cancer and hemophilia and
providing research and development services to Emerald. This trend of quarter to
quarter research and development cost increases should be partially offset in
the second half of 2001 by the anticipated spin-off of CellExSys. Our costs will
vary depending on the level of clinical trial activity occurring in each
quarter.

                                       7
<PAGE>

    Amortization of Acquisition-Related Intangibles.  Amortization of
acquisition-related intangibles for the quarter ended March 31, 2001 reflects
amortization expense for goodwill, noncompetition agreements and work force
know-how that we acquired when we purchased Genovo. We had no expenses related
to amortization of acquired intangibles in the first quarter of 2000.

    General and Administrative Expenses.  General and administrative expenses
for the quarter ended March 31, 2001 increased to $2.0 million from $1.1 million
for the first quarter of 2000. The increase reflects the addition of Genovo
operating costs, greater investments in business development, costs associated
with spinning off our CellExSys cell therapy subsidiary and increased
administrative support for our growing number of collaborative partnerships.

    Equity in Loss of Joint Venture.  We recognized a $848,000 loss in the first
quarter of 2001 for our 80.1% equity share in the losses of Emerald Gene
Systems. Our equity losses in Emerald were $564,000 in the first quarter of
2000.

    Investment Income.  Investment income for the first quarter ended March 31,
2001 increased to $802,000 from $216,000 for the first quarter of 2000. The
increase resulted from higher average cash balances in 2001 and an increase in
the value per share of our short-term bond mutual fund.

    Interest Expense.  Interest expense for the quarter ended March 31, 2001
remained unchanged at $64,000 in comparison to the first quarter of 2000. Lower
average principal balances in 2001 and an addition of amortization for a
discount note, offset each other to keep interest expense the same as compared
to the first quarter of 2000.

    Accounting Change.  In accordance with SEC Staff Accounting Bulletin No.
101, Revenue Recognition in Financial Statements, effective January 1, 2000 we
changed our method of accounting for nonrefundable up-front license fees to
recognize these fees on a straight-line basis over the term of the related
research and development collaboration arrangements. As of January 1, 2000, we
recognized a $3.7 million noncash cumulative effect adjustment to reflect this
change in accounting principle. We recorded the cumulative effect adjustment as
deferred revenue that will be recognized as revenue over the remaining term of
the research and development collaboration agreements. We recognized $1.6
million of amortized deferred revenue related to this accounting principle in
the first quarter of 2001 and $525,000 of amortized deferred revenue in the
first quarter of 2000. Amortized deferred revenue in 2001 included $1.1 million
of revenue related to up-front payments received in the second half of 2000 when
we initiated collaborations with Biogen, Inc. and Genetics Institute and
$525,000 of revenue related to the cumulative effect adjustment. Amortized
deferred revenue in 2000 consisted entirely of revenue related to the cumulative
effect adjustment.

                                       8
<PAGE>

Financial Condition
-------------------

As of March 31, 2001, we had $34.0 million in cash and cash equivalents compared
to $38.6 million in cash and cash equivalents as of December 31, 2000. In
addition, we had $24.0 million in working capital compared to $29.5 million in
working capital as of December 31, 2000. These decreases reflect operating
losses for the first quarter, investments in leasehold improvements and capital
equipment and principal payments on capital lease obligations.

     We have financed our operations through private and public offerings of our
equity securities, research funding under collaborative agreements, license
fees, capital and operating lease transactions, equipment financing arrangements
and investment income. Although we expect our expenses to continue to increase
in 2001, we expect cash generated from our collaborations with Genetics
Institute, Biogen, Emerald and IAVI to increase as well, partially offsetting
our expense increases. We also have contractual commitments for the following
cash resources:

  .  a $10.0 million equity investment by Biogen;
  .  a $10.0 million loan agreement with Biogen;
  .  funds available under a $12.0 million convertible loan with Elan
     Corporation plc, our partner in the Emerald joint venture; and
  .  an additional $1.0 million of proceeds under our loan agreement with
     Celltech.

We also have warrants outstanding for 3.3 million shares of common stock, which
would provide us with proceeds of $6.7 million if exercised. These warrants
expire April 2003. Genzyme Corporation also has an option, exercisable in August
2001, to purchase 311,295 shares of our common stock at an aggregate purchase
price of $4.0 million.

     Gene therapy products are subject to long development timelines and the
risks of failure inherent in the development of products based on innovative
technologies. Although our technology appears promising, we do not know whether
any commercially viable products will result from our research and development
activities. Because we do not anticipate having any product-related revenue for
at least the next several years, we expect to generate substantial additional
losses in the future.

     We currently estimate that, based on our current planned rate of spending,
our existing cash and cash equivalents together with the funding we expect our
existing collaborative partners to provide, will be sufficient to meet our
operating and capital requirements until mid-2003. The assumed levels of revenue
and expense underlying our estimates, however, may not be accurate. Our business
strategy includes entering into additional collaborative relationships with
corporate partners to generate license fees, milestone payments, research and
development funding and, potentially, equity investments, all of which would be
used to fund our ongoing operations. We may be unsuccessful in establishing
additional collaborative relationships or in maintaining our existing ones. Over
the long term, regardless of our partnering success, we expect that we will need
to raise substantial additional funds to continue developing and commercializing
our products.

                                       9
<PAGE>

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

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

If we are unable to secure financing on terms acceptable to us for future
capital needs, we will be unable to fund continuing operations.

     Developing and commercializing our potential products will require
substantial additional financial resources. Because internally generated cash
flow will not fund development and commercialization of our products, we will
look to outside sources for funding. These sources could involve one or more of
the following types of transactions:

  .  product development and funding collaborations;
  .  technology sales;
  .  technology licenses;
  .  issuing debt; or
  .  issuing equity.

     If we cannot obtain additional financing when needed or on acceptable
terms, we will be unable to fund continuing operations.

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 we began business. As of March 31, 2001, we have incurred
cumulative losses of $157.2 million. We expect to continue to incur substantial
additional losses in the future, primarily due to the following factors:

  .  all of our products are in a testing phase and have not received regulatory
     approval; and
  .  we will spend significant amounts on operating expenses.

     We may never generate profits, and if we do become profitable, we may be
unable to sustain or increase profitability on a quarterly or annual basis. As a
result, the trading price of our stock could decline and you could lose all or
part of your investment.

If our preclinical and clinical trials are unsuccessful or we do not receive
regulatory approval for our products, most of which are in the early stage of
product development, we may be unable to generate sufficient revenue to maintain
our business.

     Almost all of our potential products are in research and development or in
early-stage clinical trials. We cannot apply for regulatory approval of our
potential products until we have

                                      10
<PAGE>

performed additional research and development and testing, both in preclinical
and clinical trials. Our trials may not demonstrate the safety and efficacy of
any potential product, and we may encounter unacceptable side effects or other
problems. Should this occur, we may have to delay or discontinue development of
the potential product. After a successful clinical trial, we cannot market any
product in the United States or abroad until we receive regulatory approval from
the Food and Drug Administration (FDA) and applicable state and foreign
regulators. If we are unable to gain regulatory approval of any product after
successful clinical trials, we may be unable to generate sufficient product
revenue to maintain our business.

Delays or unexpected costs in obtaining approval of our potential products or
complying with governmental regulatory requirements could make it more difficult
to maintain or improve our financial condition.

     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
requirements of the FDA, National Institutes of Health (NIH) and other agencies
for clinical trials and the criteria regulators use to determine 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. Delays in bringing a potential product to
market or unexpected costs in obtaining regulatory approval could decrease our
ability to generate product sales revenue. In addition, all manufacturing
operations are subject on an ongoing basis to the current Good Manufacturing
Practices requirements of the FDA, as well as to other federal, state and local
regulations. While we currently anticipate that we will be able to manufacture
products that meet these requirements, we may be unable to attain or maintain
compliance with current or future regulatory requirements. If we discover
previously unknown problems after we receive regulatory approval of a potential
product or fail to comply with applicable requirements, we may suffer
restrictions on our ability to market the product, including mandatory
withdrawal of the product from the market. This, or an unexpected increase in
the cost of compliance, could make it more difficult to maintain or improve our
financial condition.

Failure to recruit patients could delay or prevent clinical trials of our
potential products, which could cause a delay or inability to develop our
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. Delays in recruiting or enrolling patients to test our products
could result in increased costs, delays in advancing our product development,
delays in proving the effectiveness of our technology or termination of the
clinical trials altogether. Any of these could delay or prevent the development
of our product candidates.

Our business will not succeed if our technology and products fail to achieve
market acceptance.

                                       11
<PAGE>

     Even if our potential products or those of our corporate partners succeed
in clinical trials and are approved for marketing, these products may never
achieve market acceptance. Competing gene delivery products or alternative
treatment methods, including more traditional approaches to treating disease,
may be more effective or may be more economically feasible than our products.
Moreover, doctors, patients, the medical community in general or the public may
never accept or use any products based on gene delivery or other technologies
that we or our corporate partners develop.

We may be unable to adequately protect our proprietary rights, which may limit
our ability to compete effectively.

     Our success depends in part on our ability to protect our proprietary
rights. We own or exclusively license patents and patent applications for a
number of genes, processes, practices and techniques critical to our present and
potential products. 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 failure of our licensors to obtain and maintain patent
protection for technology they license to us could similarly harm our business.
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 the
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. In any
event, other companies may independently develop substantially equivalent
proprietary information and techniques.

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

     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, litigation may be necessary to enforce our intellectual
property rights or determine the rights of others. Defending these claims,
regardless of their merit, would be costly and would likely divert management's
attention and resources away from our operations. If we infringe on another
company's patented processes or technology, we may have to pay damages. We may
also be required to obtain a license, or develop or obtain alternative
technology, in order to continue manufacturing or marketing the affected product
or using the affected process. If we are unable to obtain a license on
acceptable terms or obtain or develop alternative technology, we may be unable
to develop or commercialize some or all of our product candidates and our
business could be harmed.

     Our potential tgAAV-CF product uses our proprietary adeno-associated virus
(AAV) delivery technology to deliver a normal copy of a CFTR gene to which we
have rights under a

                                      12
<PAGE>

nonexclusive license. The United States Patent and Trademark Office has declared
an interference proceeding to determine the priority of invention of this gene.
If the eventual outcome does not favor our licensor, we will have to pay
increased license fees to the prevailing party to secure and maintain access to
the CFTR gene to continue with development of tgAAV-CF. The costs of licensing
the CFTR gene could be substantial. If we cannot maintain access to the CFTR
gene, we may be unable to develop or deliver our potential tgAAV-CF product,
which could result in decreased ability to generate revenue and difficulty in
obtaining additional financing to fund our operations.

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

     Our success depends on the continued availability of outside scientific and
corporate collaborators to perform research and develop processes to advance and
augment our internal efforts and to fund our development programs. Competition
for collaborators in gene therapy is intense. If we are unsuccessful in
recruiting or maintaining our relationships with scientific collaborators and
other corporate partners, we could experience delays in our research and
development or loss of access to important enabling technology. Even if we
maintain our current or establish new scientific collaborations or other
partnerships, however, 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 our collaborators. If our corporate partners do not commit
sufficient financial and technical resources to our research and development
programs or the commercialization of our products, the preclinical or clinical
development related to the collaboration could be delayed or terminated. Our
current or future collaborators may develop, market or provide funding for
competing products or alternative technologies. In addition, disputes may arise
with respect to ownership of technology or product candidates developed under
our collaborations. Moreover, our corporate partners may terminate any existing
partnerships, and we may be unable to enter into additional collaborations on
acceptable terms, or at all.

If we are unable to license necessary technology from third parties, 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. Our
success depends on our ability to obtain and maintain these kinds of licensing
arrangements. Disputes may arise regarding rights to inventions and know-how
resulting from the joint creation or use of intellectual property by our
licensors and us and or scientific collaborators. In addition, many of our in-
licensing agreements contain milestone-based termination provisions. If we or
any of our corporate partners fail to meet agreed milestones, the licensor could
terminate the relevant agreement.

                                       13
<PAGE>

     If we are unable to maintain our current licenses and obtain additional
licenses in the future on acceptable terms, 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 develop alternative technology or
obtain a replacement license on acceptable terms, we may be unable to develop or
commercialize some or all of our potential products and our business may suffer.

If we or our business partners are unable to successfully market and distribute
any potential product, our business will be harmed.

     We have no experience in sales and marketing. To market any products that
may result from our development programs, we will need to develop marketing and
sales capabilities, either on our own or with others. We intend to enter into
collaborations with corporate partners to utilize the mature marketing and
distribution capabilities of our partners. While we believe that these
collaborative 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 technology on a timely basis. If our business
partners do not successfully market and distribute our products and we are
unable to develop sufficient marketing and distribution capabilities on our own,
our business will be harmed.

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 presently face competition from other companies and institutions
developing gene therapy and cell therapy technologies and from companies using
more traditional approaches to treating human diseases. We also compete with
other companies to acquire products or technology from research institutions or
universities. Most of our competitors have substantially more financial and
infrastructure resources and experience than we do in the following areas:

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

     In addition, the competitive positions of other companies may be
strengthened through collaborative relationships. Consequently, our competitors
may be able to commercialize and obtain regulatory approval for new products
more rapidly than we do, or manufacture and market competitive products more
successfully than we do. This could result in pricing pressures or our products
failing to achieve market acceptance. In addition, gene therapy is a new and
rapidly evolving field and is expected to continue to undergo significant and
rapid technological change. Rapid technological development by our competitors,
including development of technologies, products or processes that are more
effective than those we have developed, could result in our actual and proposed
technologies, products or processes losing market share or becoming obsolete.

                                       14
<PAGE>

If we do not attract and retain qualified personnel, we will be unable to
successfully and timely 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 competition
for employees in our field is intense, 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.

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 clinical
or 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. We have recently leased a building for the purpose of
developing a facility to manufacture AAV vectors for Phase III and early
commercial purposes. This manufacturing facility, if successfully developed, as
well as any future manufacturing facilities that we may construct, will be
subject to initial and ongoing regulation by the FDA and other governmental
agencies. 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 introduce sufficient product to sustain our
business.

Our use of hazardous materials to develop our potential products exposes us to
liability risks and the risk of regulatory limitation of our use of these
materials, either of which could reduce our ability to generate revenue and make
it more difficult to fund our operations.

     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 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 would be liable for any
resulting damages. This liability could exceed our financial resources.
Additionally, hazardous materials are subject to regulatory oversight. 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.

                                       15
<PAGE>

The costs of product liability and other claims and product recalls could exceed
the amount of our insurance, which could significantly harm our financial
condition or our reputation.

     Our business activities expose us to the risk of liability claims or
product recalls and any adverse publicity that might result from a liability
claim against us. We currently have only limited amounts of liability insurance,
and the amounts of claims against us may exceed our insurance coverage.
Liability insurance is expensive and may not continue to be available on
acceptable terms. A product liability or other claim not covered by insurance or
in excess of our insurance or a product recall could significantly harm our
financial condition or our reputation. In addition, a liability claim against
one of our corporate partners or another gene therapy company could also harm
our reputation.

Our recent acquisition of Genovo and any future acquisitions could be costly,
difficult to integrate and disruptive to our business.

     In September 2000, we acquired Genovo, a privately held biotechnology
company specializing in viral gene delivery. In the future, we may acquire
additional complementary companies, products or technologies. Managing the
Genovo acquisition and any future acquisition may entail numerous operational
and financial risks and strains, including:

  .  difficulties in assimilating the operations, technologies, products or
     potential products and personnel of the acquired company;
  .  loss of key employees of the acquired company;
  .  disruption of our business;
  .  diversion of management's attention from our core business;
  .  assumption of known and unknown liabilities;
  .  higher-than-expected acquisition and integration costs and charges against
     earnings; and
  .  potentially dilutive issuances of equity securities.

     We may be unable to successfully integrate Genovo or any future
acquisitions with our existing operations or successfully develop any acquired
product candidates or technologies. We may not gain any substantial benefit from
the Genovo acquisition or any products, technologies or businesses that we
acquire in the future, notwithstanding the expenditure of a significant amount
of time and financial, personnel and other resources.

Market fluctuations or volatility could cause the market price of our common
stock to decline.

     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, these fluctuations in price, regardless of our performance. These
fluctuations could cause the market price of our common stock to decline.

                                       16
<PAGE>

Item 3.  Qualitative and Quantitative Disclosure 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 nominal. At
present, we do not employ any derivative or other financial instruments or
derivative commodity instruments to hedge any market risks and we do not
currently plan to employ them in the future. At March 31, 2001, we held $34.0
million in cash and cash equivalents, primarily invested in a short-term bond
fund owning securities that, on the average, mature in less than one year.

PART II   OTHER INFORMATION

Item 6.  Exhibits and Reports on Form 8-K

(a)  See the Index to Exhibits included in this quarterly report.

(b)  Reports on Form 8-K.

     On February 21, 2001, we filed a current report on Form 8-K reporting our
     November 9, 2000 agreement with Genetics Institute, Inc., the biotechnology
     research division of Wyeth-Ayerst, a division of American Home Products
     Corporation to collaborate on the development of gene therapy products for
     the treatment of hemophilia.

                                  SIGNATURES

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

                         TARGETED GENETICS CORPORATION
                         -----------------------------
                                 (Registrant)

                  Signature                           Date
                  ---------                           ----

       /s/ H. Stewart Parker                       May 11, 2001
       ---------------------                       ------------
       H. Stewart Parker
       President and Chief Executive Officer

       (Principal Executive Officer)

       /s/ David J. Poston                         May 11, 2001
       -------------------                         ------------
       David J. Poston
       Senior Director, Finance; Assistant
       Secretary (Interim Principal Financial and
       Accounting Officer)

                                       17
<PAGE>

                         Targeted Genetics Corporation


                               INDEX TO EXHIBITS

<TABLE>
<C>        <S>                                                                                 <C>
 Exhibit
   No.      Description                                                                          Note
   3.1      Restated Articles of Incorporation                                                    (A)
   3.2      Amended and Restated Bylaws (Exhibit 3.2)                                             (C)
   4.1      Rights Agreement, dated as of October 17, 1996, between Targeted Genetics and         (B)
            ChaseMellon Shareholder Services, L.L.C. (Exhibit 2.1)
   4.2      First Amendment to Rights Agreement, dated July 21, 1999, between Targeted            (D)
            Genetics and ChaseMellon Shareholder Services , L.L.C. (Exhibit 1.9)
  10.1      2000 Genovo Inc. Roll-Over Stock Option Plan (Exhibit 99.1)                           (E)
  10.2      1999 Restated Stock Option Plan, as Amended January 23, 2001
</TABLE>
       ____________


 (A)  Incorporated by reference to Targeted Genetics' Quarterly Report on Form
 10-Q for the quarter ended June 30, 2000, filed August 11, 2000.

 (B)   Incorporated by reference to the designated exhibit included with
 Targeted Genetics' Registration Statement on Form 8-A, filed October 22, 1996.

 (C)  Incorporated by reference to the designated exhibit included with Targeted
 Genetics'  Annual Report on Form 10-K for the year ended December 31, 1996,
 filed on March 12, 1997.

 (D) Incorporated by reference to the designated exhibit included with Targeted
 Genetics' Current Report on Form 8-K, filed on August 4, 1999.

 (E) 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.

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