<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 June 30, 2001
                                       or

    [ ] Transition report pursuant to Section 13 or 15(d) of the Securities
                             Exchange Act of 1934

                 For the transition period from __________ to

                         Commission File Number: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                      44,114,727
-------------------------------------       ----------------------------------
              (Class)                         (Outstanding at July 31, 2001)
<PAGE>

                         TARGETED GENETICS CORPORATION

                         Quarterly Report on Form 10-Q
                      For the quarter ended June 30, 2001

                               TABLE OF CONTENTS

<TABLE>
<CAPTION>
                                                                                  Page No.
                                                                                  --------
<S>                                                                               <C>
PART I     FINANCIAL INFORMATION

Item 1.    Financial Statements

    a)     Condensed Consolidated Balance Sheets at June 30, 2001
            and December 31, 2000                                                        3
    b)     Condensed Consolidated Statements of Operations for the three
            and six months ended June 30, 2001 and 2000                                  4
    c)     Condensed Consolidated Statements of Cash Flows for the six
            months ended June 30, 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.    Qualitative and Quantitative 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                          18
Item 5.    Other Information                                                             *
Item 6.    Exhibits and Reports on Form 8-K                                             18

SIGNATURES                                                                              19
</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>

                                                                  June 30,      December 31,
                                                                    2001           2000
                                                                ------------   --------------
ASSETS                                                           (Unaudited)
------
<S>                                                            <C>             <C>
Current assets:
         Cash and cash equivalents                             $  26,581,827   $  38,630,216
         Accounts receivable                                       2,312,424       3,086,534
         Receivable from joint venture                               240,299         177,088
         Prepaid expenses and other                                1,030,239         291,435
                                                               -------------   -------------
                  Total current assets                            30,164,789      42,185,273

Property, plant and equipment, net                                 8,635,463       6,206,276
Goodwill and other purchased intangibles, net                     34,786,364      37,821,059
Other assets                                                       1,513,634       1,761,434
                                                               -------------   -------------

                                                               $  75,100,250   $  87,974,042
                                                               =============   =============

LIABILITIES AND SHAREHOLDERS' EQUITY
------------------------------------
Current liabilities:
         Accounts payable                                      $   1,765,752   $   4,000,084
         Payable to joint venture                                    359,965         261,743
         Accrued payroll and other liabilities                     1,016,423         679,739
         Deferred revenue                                          6,752,363       6,906,174
         Current portion of long-term obligations                    970,174         838,245
                                                               -------------   -------------
                  Total current liabilities                       10,864,677      12,685,985

Long-term obligations                                              2,344,538         947,508
Long-term note payable                                             1,512,766       1,498,566
Deferred revenue                                                   6,206,758       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 June 30, 2001 and at
             December 31, 2000                                    13,736,932      13,275,778
         Common stock, $.01 par value, 80,000,000 shares
          authorized, 44,108,727 and 42,608,943 shares
          issued and outstanding at June 30, 2001 and
          December 31, 2000, respectively                        203,354,853     200,968,429
         Accumulated deficit                                    (162,920,274)   (150,812,610)
                                                               -------------   -------------
                          Total shareholders' equity              54,171,511      63,431,597
                                                               -------------   -------------

                                                               $  75,100,250   $  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            Six months ended
                                                       June 30,                     June 30,
                                              --------------------------  ----------------------------
                                                  2001         2000           2001           2000
                                              -----------   -----------   ------------   ------------
<S>                                           <C>           <C>           <C>            <C>
Revenue:                                                    (restated)                    (restated)
  Collaborative agreements                    $ 3,609,210   $ 1,835,697   $  6,737,229   $  4,123,322
  Collaborative agreements with affiliates        729,346       441,799      1,406,700        854,060
                                              -----------   -----------   ------------   ------------
     Total revenue                              4,338,556     2,277,496      8,143,929      4,977,382

Operating expenses:
     Research and development                   6,637,568     4,538,044     13,030,924      8,255,800
     Amortization of acquisition-related
      intangibles                               1,517,346             -      3,034,695              -
     General and administrative                 1,441,681     1,091,622      3,468,559      2,198,573
                                              -----------   -----------   ------------   ------------

     Total expenses                             9,596,595     5,629,666     19,534,178     10,454,373
                                              -----------   -----------   ------------   ------------

Loss from operations                           (5,258,039)   (3,352,170)   (11,390,249)    (5,476,991)

Equity in loss of joint venture                (1,018,721)     (607,537)    (1,866,939)    (1,171,531)
Investment income                                 477,352       463,503      1,279,257        679,257
Interest expense                                  (65,536)      (64,344)      (129,733)      (128,465)
                                              -----------   -----------   ------------   ------------

Loss before cumulative effect of change
  in accounting principle                      (5,864,944)   (3,560,548)   (12,107,664)    (6,097,730)
Cumulative effect of change in
  accounting principle                                  -             -              -     (3,681,687)
                                              -----------   -----------   ------------   ------------

Net loss                                       (5,864,944)   (3,560,548)   (12,107,664)    (9,779,417)

Accretion of dividend on preferred stock         (232,548)     (216,025)      (461,154)      (432,553)
                                              -----------   -----------   ------------   ------------

Net loss applicable to common shareholders    $(6,097,492)  $(3,776,573)  $(12,568,818)  $(10,211,970)
                                              ===========   ===========   ============   ============

Basic and diluted net loss per share:
Loss before cumulative effect of change
  in accounting principle                     $     (0.14)  $     (0.10)  $      (0.29)  $      (0.19)
Cumulative effect of change in
  accounting principle                                  -             -              -          (0.10)
                                              -----------   -----------   ------------   ------------

Net loss applicable to common shareholders    $     (0.14)  $     (0.10)  $      (0.29)  $      (0.29)
                                              ===========   ===========   ============   ============

Shares used in computation of
  basic and diluted net loss per share         43,977,218    36,415,401     43,748,479     35,619,386
                                              ===========   ===========   ============   ============
</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>
                                                                                     Six months ended
                                                                                         June 30,
                                                                          -------------------------------------
                                                                              2001                     2000
                                                                          ------------             ------------
Operating activities:                                                                               (restated)
---------------------
<S>                                                                       <C>                      <C>
Net loss                                                                  $(12,107,664)            $($9,779,417)
Adjustments to reconcile net loss to net cash
 used in operating activities:
  Cumulative effect adjustment of change in accounting principle                     -                3,681,687
  Amortization of intangibles                                                3,034,695                        -
  Depreciation and amortization                                              1,883,585                  730,501
  Equity in loss of unconsolidated joint venture                             1,866,939                1,171,531
  Noncash equity issuances                                                      80,466                        -
  Changes in operating assets and liabilities:
     Decrease in deferred revenue                                           (3,357,439)                (664,856)
     Increase (decrease) in accounts payable and accrued liabilities        (1,947,648)                  67,345
     Decrease in accounts receivable                                         1,014,409                  192,226
     Increase in other assets                                                 (766,103)                (262,017)
     Decrease (increase) in accounts receivable from joint venture             (63,211)                 289,958
     Increase in accrued interest on securities available for sale                   -                   12,691
                                                                          ------------             ------------

  Net cash used in operating activities                                    (10,361,971)              (4,560,351)

Investing activities:
---------------------
Purchases of property, plant and equipment                                  (4,112,052)                (388,867)
Investment in unconsolidated joint venture                                  (1,768,717)              (1,535,074)
Maturities and sales of securities available for sale                                -                1,520,112
                                                                          ------------             ------------

  Net cash used in investing activities                                     (5,880,769)                (403,829)

Financing activities:
---------------------
Net proceeds from sale of capital stock                                      2,767,112               28,772,407
Proceeds from leasehold improvement and equipment financing                  1,938,516                  671,594
Payments under capital leases and installment loans                           (511,277)                (640,095)
                                                                          ------------             ------------

  Net cash provided by financing activities                                  4,194,351               28,803,906
                                                                          ------------             ------------

Net increase (decrease) in cash and cash equivalents                       (12,048,389)              23,839,726

Cash and cash equivalents, beginning of period                              38,630,216                4,100,798
                                                                          ------------             ------------

Cash and cash equivalents, end of period                                  $ 26,581,827             $ 27,940,524
                                                                          ============             ============

Supplemental disclosure of noncash investing and financing activities:
  Preferred stock dividend                                                $    461,154             $    432,553
  Equipment financed through capital lease                                     101,720                   82,241
  Interest paid on capital lease and installment loans                          76,993                   89,088
</TABLE>

        The accompanying notes are an integral part of this statement.

                                       5
<PAGE>

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


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").  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.  In the
opinion of our management, the financial statements reflect 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 and six months ended June 30,
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
     ------------------------------

  In the fourth quarter of 2000, we adopted the Securities and Exchange
Commission's Staff Accounting Bulletin No. 101, 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 has been recorded as deferred revenue that will be
recognized as revenue over the remaining term of the research and development
collaboration agreements.  The results for the three-month period and the six-
month period ended June 30, 2000 were restated to reflect the effects of the
accounting change.  For the three-month period ended June 30, 2000, as a result
of the change in accounting principle, net loss decreased by $525,000, or $0.01
per share, reflecting the related deferred revenue that was recognized as
revenue during the period.  For the six-month period ended June 30, 2000, as a
result of the change in accounting principle, net loss increased by $2.6
million, or $0.07 per share, reflecting the $3.7 million, or $0.10 per share,
cumulative effect of the change, net of $1.1 million, or $0.03 per share, of the
related deferred revenue that was recognized as revenue during the six-month
period ended June 30, 2000.  We recognized $1.6 million, or $0.04 per share, of
deferred revenue for the three-month period ended June 30, 2001 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.  We
recognized $3.2 million, or $0.07 per share of deferred revenue for the six-
month period ended June 30, 2001, including $2.1 million

                                       6
<PAGE>

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 $1.1
million of revenue related to the cumulative effect adjustment.

3.   Earnings Per Share
     ------------------

Basic net loss per share is computed based upon the weighted average number of
common shares outstanding during the period.  Targeted Genetics' diluted net
loss per share is the same as its basic net loss per share because all stock
options, warrants and other potentially dilutive securities are antidilutive and
are therefore excluded from the calculation of diluted net loss per share.

4.   New Accounting Pronouncements
     -----------------------------

     In July 2001, the Financial Accounting Standards Board (FASB) issued
Statement of Financial Accounting Standards No. 141 (SFAS 141), Business
Combinations.  SFAS 141 requires the purchase method of accounting for business
combinations initiated after June 30, 2001 and eliminates the pooling-of-
interests method.  We do not believe that the adoption of SFAS 141 will have an
impact on our financial statements.

     In July 2001, the FASB issued Statement of Financial Accounting Standards
No. 142 (SFAS 142), Goodwill and Other Intangible Assets, which is effective
January 1, 2002.  SFAS 142 requires, among other things, the discontinuance of
goodwill amortization.  In addition, the standard includes provisions for the
reclassification of certain existing recognized intangibles as goodwill,
reassessment of the useful lives of existing recognized intangibles,
reclassification of certain intangibles out of previously reported goodwill and
the identification of reporting units for purposes of assessing potential future
impairments of goodwill.  SFAS 142 also requires us to complete a transitional
goodwill impairment test six months from the date of adoption.  We are currently
assessing but have not yet determined the impact of SFAS 142 on our financial
position and results of operations.

5.   Matters Associated With Genovo Acquisition
     ------------------------------------------

     In connection with our acquisition of Genovo, we established an escrow of
550,872 shares of Targeted Genetics common stock held for the benefit of former
Genovo stockholders, subject to the fulfillment of specified representations and
warranties in the merger agreement. Included in these representations and
warranties is our collection of a receivable of $2.0 million for pre-acquisition
contractual matters related to Genovo. During the quarter ended June 30, 2001
the party associated with this receivable communicated its intent to dispute
payment. Because we have not yet reviewed the facts connected to the matter nor
determined our course of action, we cannot yet assess to what extent this
receivable will be collectible. According to the terms of the merger agreement,
in the event that we are unable to collect this receivable, we would reduce the
share balance in the escrow account and reflect that change as a reduction in
the Genovo purchase price.

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

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

     This quarterly report on Form 10-Q contains forward-looking statements,
which involve current expectations, forecasts of future events and other
statements that are not historical facts.  Inaccurate assumptions and known and
unknown risks and uncertainties can affect the accuracy of forward-looking
statements.   Our actual results could differ materially from our expectations
for a number of reasons, including the risks described in the section below
entitled "Factors Affecting Our Operating Results, Our Business and Our Stock."
You should not unduly rely on these forward-looking statements, which speak only
as of the date of this report.  We undertake no duty to update any forward-
looking statements to reflect new information, circumstances or events after the
date of this report.

                                       7
<PAGE>

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

     Revenue. Revenue for the three-month period ended June 30, 2001 increased
to $4.3 million from $2.3 million for the three-month period ended June 30,
2000. Revenue for the six months ended June 30, 2001 increased to $8.1 million
from $5.0 million for the same period in 2000. The increases in revenue for both
the three-month period and the six-month period ended June 30, 2001 were
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.
Increases in revenue from the addition of the hemophilia research and
development activities were offset by decreases in revenue from our cystic
fibrosis product development collaboration with Celltech Group plc for both the
three-month period and the six-month period ended June 30, 2001 compared to the
same periods in 2000, 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 three-month period ended June 30, 2001 increased to $6.6 million from $4.5
million for the three-month period ended June 30, 2000.  Research and
development expenses for the six-month period ended June 30, 2001 increased to
$13.0 million from $8.3 million for the same period in 2000 .  The year-to-year
increases in research and development expenses for both the three-month period
and the six-month period ended June 30 reflect increased 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 our Emerald Gene Systems joint venture; hiring additional clinical and
regulatory personnel to design and administer our cystic fibrosis and cancer
clinical trials; and increased costs associated with expanding our manufacturing
facilities.  Expenses for 2001 also reflect increased activity within our
majority-owned cell therapy business subsidiary, CellExSys, Inc., 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, hemophilia and AIDS and
providing research and development services to Emerald.  This trend of quarterly
increases in research and development costs 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.

     Goodwill Amortization.  Amortization of goodwill for the second quarter of
2001 and six-month period ended June 30, 2001 reflect 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 six-month period ended June 30, 2000.

     General and Administrative Expenses. General and administrative expenses
for the second quarter of 2001 increased to $1.4 million from $1.1 million for
the same period in 2000. General and administrative expenses for the six months
ended June 30, 2001 increased to $3.5 million from $2.2 million for the same
period in 2000. The year-to-year increases in both periods

                                       8
<PAGE>

reflect 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 losses of  $1.0 million for
the second quarter of 2001 and losses of $1.9 million for the six-month period
ended June 30, 2001 for our 80.1% equity share in the losses of Emerald Gene
Systems.  Our equity losses in Emerald were $608,000 for the second quarter of
2000 and $1.2 million for the six-month period ended June 30, 2000.

     Investment Income.  Investment income for the second quarter of 2001 of
$477,000 was approximately equal to that of the same period in 2000, because
increases in average investment balances during the three-month period ended
June 30, 2001 were offset by slightly lower interest rates.  Investment income
for the six months ended June 30, 2001 increased to $1.3 million from $679,000
for the same period in 2000, due primarily to an increase in the value per share
of our short-term bond mutual fund in the first quarter.

     Interest Expense. Interest expense for the second quarter of 2001 increased
to $66,000 from $64,000 for the same period in 2000. Interest expense for the
six-month period ended June 30, 2001 increased to $130,000 from $128,000 for the
same period in 2000. The year-to-year increases in both periods were primarily
due to higher average outstanding principal balances in the second quarter of
2001 and added amortization for a discount note, partially offset by lower
average principal balances in the first quarter of 2001.

     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 change in accounting
principle in the second quarter of 2001 and $525,000 of amortized deferred
revenue in the second quarter of 2000.  We recognized $3.2 million of amortized
deferred revenue related to this change in accounting principle in the six-month
period ended June 30, 2001 and $1.1 million of amortized deferred revenue in the
six-month period ended June 30, 2000.  Amortized deferred revenue in second
quarter of 2001 included $1.1 million of deferred revenue related to up-front
payments received in the second half of 2000 when we initiated collaborations
with Biogen and Genetics Institute and $525,000 of deferred revenue related to
the cumulative effect adjustment.  Amortized deferred revenue in the six-month
period ended June 30, 2001 included $2.1 million of deferred revenue related to
up-front payments received in the second half of 2000 when we initiated
collaborations with Biogen, Inc. and Genetics Institute and $1.1 million of
deferred revenue related to the cumulative effect adjustment.  Amortized
deferred revenue in 2000 consisted entirely of deferred revenue related to the
cumulative effect adjustment.

                                       9
<PAGE>

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

As of June 30, 2001, we had $26.6 million in cash and cash equivalents, compared
with $38.6 million in cash and cash equivalents as of December 31, 2000.  In
addition, we had $19.3 million in working capital compared with $29.5 million in
working capital as of December 31, 2000.  These decreases reflect operating
losses for the first half of 2001, investments in leasehold improvements and
capital equipment for the expanded clinical manufacturing facility 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,
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 in April 2003.  Genzyme Corporation also has an option, exercisable in
August 2001, to purchase 311,295 shares of our common stock at a purchase price
of $12.8495 per share for an aggregate purchase price of $4.0 million.

     In connection with our acquisition of Genovo, we established an escrow of
550,872 shares of Targeted Genetics common stock held for the benefit of former
Genovo stockholders, subject to the fulfillment of specified representations and
warranties in the merger agreement. Included in these representations and
warranties is our collection of a receivable of $2.0 million under a contractual
obligation with a third party for pre-acquisition Genovo matters. Recently, we
were advised that the third party disputes payment of this receivable. Failure
to collect this receivable would reduce our working capital.

     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

                                       10
<PAGE>

expect that we will need to raise substantial additional funds to continue
developing and commercializing our products.

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 June 30, 2001, we have incurred cumulative
losses of $163.3 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.

                                       11
<PAGE>

     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 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, we will be unable to generate
product revenue and may be unable 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.

                                       12
<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 rights 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 nonexclusive license. The United States Patent and Trademark
Office has declared an

                                       13
<PAGE>

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.

     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

                                       14
<PAGE>

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.

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

                                       15
<PAGE>

     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.

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

                                       16
<PAGE>

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 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.

     We were recently advised that a third party disputes payment of a $2.0
million contractual receivable related to fulfillment of representations and
warranties connected with our acquisition of Genovo. If we are unable to collect
this receivable, our operating capital will be reduced.

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.

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 June 30, 2001, we held $26.6
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.

                                       17
<PAGE>

PART II   OTHER INFORMATION

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

     We held an annual meeting of our shareholders on May 8, 2001.  Of the
43,757,050 shares outstanding as of the record date for the annual meeting,
36,580,187 shares, or 84% of the total shares eligible to vote at the annual
meeting, were represented in person or by proxy.

     The following matters were approved by our shareholders at the annual
meeting:

          1) The election of Jack L. Bowman and Jeremy L. Curnock Cook to serve
             as Class I members of our board of directors, with terms expiring
             in 2004 and the election of Joseph M. Davie to serve as a class II
             member of our board of directors, with a term expiring in 2002 .
             Our shareholders cast greater than 97% of the votes cast in favor
             of each nominee.
          2) The amendment of the Targeted Genetics Corporation 1999 Stock
             Option Plan to increase the number of shares of common stock
             issuable under the Plan from 1,500,000 to 3,500,000 shares. Our
             shareholders cast 20,413,458 votes in favor of the proposal and
             6,044,896 votes against. In addition, there were 37,142 abstentions
             and 10,084,691 broker non-votes.
          3) The adoption of the Targeted Genetics Corporation 2000 Genovo
             Rollover Stock Option Plan. Our shareholders cast 21,650,444 votes
             in favor of this proposal, and 4,806,385 votes against. In
             addition, there were 38,667 abstentions and 10,084,691 broker non-
             votes.

Item 6. Exhibits and Reports on Form 8-K

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

(b)  We did not file any current reports on Form 8-K during the quarter ended
     June 30, 2001.

                                       18
<PAGE>

                                  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)


Date:    August 14, 2001                /s/ H. Stewart Parker
      ----------------------            -------------------------------------
                                        H. Stewart Parker, President and
                                        Chief Executive Officer
                                        (Principal Executive Officer)


Date:    August 14, 2001                /s/ David J. Poston
      ----------------------            -------------------------------------
                                        David J. Poston, Senior Director,
                                        Finance, Assistant Secretary
                                        (Interim Principal Financial and
                                        Accounting Officer)

                                       19
<PAGE>

                         Targeted Genetics Corporation

                               INDEX TO EXHIBITS

<TABLE>
<CAPTION>
Exhibit
  No.     Description                                                                     Note
<S>                                                                                       <C>
  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     First Lease Amendment, dated May 12, 1997, between Targeted Genetics and
          Benaroya Capital Company, LLC
 10.2     Second Lease Amendment, dated February 25, 2000, between Targeted Genetics and
          Benaroya Capital Company, LLC
 10.3     Third Lease Amendment, dated April 19, 2000, between Targeted Genetics and
          Benaroya Capital Company, LLC
 10.4     Fourth Lease Amendment, dated March 28, 2001, between Targeted Genetics and
          Benaroya Capital Company, LLC
</TABLE>
    _______

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

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

                                       20