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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 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, 2004 OR o
    
    TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
 For the transition period from  to
 Commission File Number No. 0-23930   TARGETED GENETICS CORPORATION (Exact name of Registrant as specified in its charter)
   Washington
(State of Incorporation)
    
    91-1549568
(IRS Employer Identification No.)
 1100 Olive Way, Suite 100
Seattle, WA 98101
(Address of principal executive offices, including zip code) (206) 623-7612
(Registrants telephone number, including area code)   Indicate by check mark whether the registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes x No o Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act). Yes x No o Indicate the number of shares outstanding of each of the issuers classes
of common stock, as of the latest practicable date. Common Stock, $0.01 par value
    
    81,624,102(Class)
    
    (Outstanding at July 26, 2004)




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TARGETED GENETICS CORPORATION
Quarterly Report on Form 10-Q
For the quarter ended June 30, 2004 TABLE OF CONTENTS Page No.PART I
    
    
    
    FINANCIAL INFORMATIONItem 1.
    
    
    
    Financial Statementsa)
    
    Condensed Consolidated Balance Sheets at June 30, 2004 and December 31, 2003
    
    
    1b)
    
    Condensed Consolidated Statements of Operations for the three and six months ended June 30, 2004 and 2003
    
    
    2c)
    
    Condensed Consolidated Statements of Cash Flows for the six months ended June 30, 2004 and 2003
    
    
    3d)
    
    Notes to Condensed Consolidated Financial Statements
    
    
    4Item 2.
    
    
    
    Managements Discussion and Analysis of Financial Condition and Results of Operations
    
    
    9Item 3.
    
    
    
    Quantitative and Qualitative Disclosures About Market Risk
    
    
    22Item 4.
    
    
    
    Controls and Procedures
    
    
    22PART II
    
    
    
    OTHER INFORMATIONItem 1.
    
    
    
    Legal Proceedings
    
    
    23Item 2.
    
    
    
    Changes in Securities, Use of Proceeds and Issuer Purchases of Equity Securities
    
    
    23Item 3.
    
    
    
    Defaults Upon Senior Securities
    
    
    23Item 4.
    
    
    
    Submission of Matters to a Vote of Security Holders
    
    
    23Item 5.
    
    
    
    Other Information
    
    
    23Item 6.
    
    
    
    Exhibits and Reports on Form 8-K
    
    
    23SIGNATURES
    
    
    24EXHIBIT INDEX
    
    
    25EXHIBIT 10.2EXHIBIT 31.1EXHIBIT 31.2EXHIBIT 32.1EXHIBIT 32.2
  i




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PART I FINANCIAL INFORMATION 
 Item 1.Financial Statements TARGETED GENETICS CORPORATION 
 CONDENSED CONSOLIDATED BALANCE SHEETS June 30,
    
    December 31,2004
    
    2003(unaudited)ASSETSCurrent assets:Cash and cash equivalents
    
    $
    37,381,000
    
    
    $
    21,057,000Accounts receivable
    
    
    
    
    
    
    166,000Prepaid expenses and other
    
    
    554,000
    
    
    
    409,000Total current assets
    
    
    37,935,000
    
    
    
    21,632,000Property and equipment, net
    
    
    2,876,000
    
    
    
    3,423,000Goodwill, net
    
    
    31,649,000
    
    
    
    31,649,000Other assets
    
    
    813,000
    
    
    
    968,000Total assets
    
    $
    73,273,000
    
    
    $
    57,672,000LIABILITIES AND SHAREHOLDERS EQUITYCurrent liabilities:Accounts payable and accrued expenses
    
    $
    1,988,000
    
    
    $
    1,271,000Accrued employee expenses
    
    
    702,000
    
    
    
    1,564,000Accrued restructure charges
    
    
    1,360,000
    
    
    
    1,404,000Deferred revenue
    
    
    2,767,000
    
    
    
    1,180,000Current portion of long-term obligations
    
    
    1,511,000
    
    
    
    1,290,000Total current liabilities
    
    
    8,328,000
    
    
    
    6,709,000Accrued restructure charges and deferred rent
    
    
    5,358,000
    
    
    
    5,507,000Long-term obligations
    
    
    10,873,000
    
    
    
    11,227,000CommitmentsMinority interest in preferred stock of subsidiary
    
    
    
    
    
    
    750,000Shareholders equity:Preferred stock, $0.01 par value, 6,000,000 shares authorized:Series A preferred stock, 800,000 shares designated, none
issued and outstanding
    
    
    
    
    
    
    Series B preferred stock, none issued and outstanding at
June 30, 2004 and 12,015 shares issued and outstanding at
December 31, 2003
    
    
    
    
    
    
    Common stock, $0.01 par value, 120,000,000 shares authorized,
81,611,999 shares issued and outstanding at June 30, 2004 and
66,206,230 shares issued and outstanding at December 31, 2003
    
    
    816,000
    
    
    
    662,000Additional paid-in capital
    
    
    273,788,000
    
    
    
    249,399,000Accumulated deficit
    
    
    (225,890,000
    )
    
    
    (216,582,000
    )Total shareholders equity
    
    
    48,714,000
    
    
    
    33,479,000Total liabilities and shareholders equity
    
    $
    73,273,000
    
    
    $
    57,672,000
 See accompanying notes to condensed consolidated financial statements 1




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TARGETED GENETICS CORPORATION 
 CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited) Three months ended
    
    Six months endedJune 30,
    
    June 30,2004
    
    2003
    
    2004
    
    2003Revenue under
collaborative
agreements
    
    $
    2,761,000
    
    
    $
    2,053,000
    
    
    $
    4,081,000
    
    
    $
    7,692,000Operating expenses:Research and
development
    
    
    4,828,000
    
    
    
    4,327,000
    
    
    
    9,065,000
    
    
    
    8,869,000General and
administrative
    
    
    2,066,000
    
    
    
    1,438,000
    
    
    
    3,816,000
    
    
    
    2,774,000Restructure
charges
    
    
    221,000
    
    
    
    2,899,000
    
    
    
    416,000
    
    
    
    3,180,000Total
operating
expenses
    
    
    7,115,000
    
    
    
    8,664,000
    
    
    
    13,297,000
    
    
    
    14,823,000Loss from
operations
    
    
    (4,354,000
    )
    
    
    (6,611,000
    )
    
    
    (9,216,000
    )
    
    
    (7,131,000
    )Investment income
    
    
    21,000
    
    
    
    56,000
    
    
    
    145,000
    
    
    
    108,000Interest expense
    
    
    (117,000
    )
    
    
    (360,000
    )
    
    
    (237,000
    )
    
    
    (722,000
    )Net loss
    
    $
    (4,450,000
    )
    
    $
    (6,915,000
    )
    
    $
    (9,308,000
    )
    
    $
    (7,745,000
    )Net loss per common
share (basic and
diluted)
    
    $
    (0.05
    )
    
    $
    (0.13
    )
    
    $
    (0.12
    )
    
    $
    (0.15
    )Shares used in
computation of
basic and diluted
net loss per common
share
    
    
    81,604,000
    
    
    
    51,694,000
    
    
    
    77,239,000
    
    
    
    51,133,000
 See accompanying notes to condensed consolidated financial statements 2




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TARGETED GENETICS CORPORATION 
 CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited) Six months endedJune 30,2004
    
    2003Operating activities:Net loss
    
    $
    (9,308,000
    )
    
    $
    (7,745,000
    )Adjustments to reconcile net loss to net cash
used in operating activities:Depreciation and amortization
    
    
    669,000
    
    
    
    1,545,000Non-cash interest expense
    
    
    148,000
    
    
    
    611,000Changes in assets and liabilities:Decrease in accounts receivable
    
    
    166,000
    
    
    
    1,163,000Increase in prepaid expenses and other
    
    
    (145,000
    )
    
    
    (121,000
    )Decrease in other assets
    
    
    155,000
    
    
    
    76,000Increase (decrease) in current liabilities
    
    
    57,000
    
    
    
    (183,000
    )Increase (decrease) in deferred revenue
    
    
    1,587,000
    
    
    
    (804,000
    )Increase (decrease) in accrued
restructure expenses and deferred rent
    
    
    (193,000
    )
    
    
    2,157,000Net cash used in operating activities
    
    
    (6,864,000
    )
    

    
    (3,301,000
    )Investing activities:Purchases of property and equipment
    
    
    (137,000
    )
    
    
    (118,000
    )Net cash used in investing activities
    
    
    (137,000
    )
    
    
    (118,000
    )Financing activities:Net proceeds from sales of common stock
    
    
    23,793,000
    
    
    
    16,166,000Payments under leasehold improvements and
equipment financing arrangements
    
    
    (468,000
    )
    
    
    (601,000
    )Net cash provided by financing activities
    
    
    23,325,000
    
    
    
    15,565,000Net increase in cash and cash equivalents
    
    
    16,324,000
    
    
    
    12,146,000Cash and cash equivalents, beginning of period
    
    
    21,507,000
    
    
    
    12,606,000Cash and cash equivalents, end of period
    
    $
    37,381,000
    
    
    $
    24,752,000Supplemental information:Cash paid for interest
    
    $
    90,000
    
    
    $
    111,000
 See accompanying notes to condensed consolidated financial statements 3




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TARGETED GENETICS CORPORATION 
 NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) 1. Basis of Presentation The unaudited condensed consolidated financial statements included in this
quarterly report have been prepared by Targeted Genetics Corporation, or
Targeted Genetics, without audit, according to the rules and regulations of the
Securities and Exchange Commission, or SEC. Our condensed consolidated
financial statements include the accounts of Targeted Genetics, our wholly
owned subsidiaries Genovo, Inc. (inactive) and TGCF Manufacturing Corporation
(inactive), and our majority-owned subsidiary, CellExSys, Inc., or CellExSys.
CellExSys was merged into Chromos Molecular Systems, Inc., or Chromos, on July
27, 2004. The condensed consolidated balance sheet as of December 31, 2003,
and our results of operations for the three and six months ended June 30, 2003,
do not include the accounts of Emerald Gene Systems, Ltd., or Emerald, our
majority-owned research and development joint venture with Elan International
Services Ltd., or Elan, because we did not have operating control of Emerald
during those periods. In connection with a termination agreement with Elan
effective March 31, 2004, we acquired all of Elans equity interest in Emerald.
As a result, Emerald became a wholly-owned subsidiary as of March 31, 2004,
and is consolidated into our financial statements as of that date. The
operations of Emerald terminated during 2002; therefore, the impact of
consolidating the accounts of Emerald into our financial results is not
significant. We are in the process of dissolving Emerald. All significant
inter-company transactions have been eliminated in consolidation. Certain
information and footnote disclosures normally included in financial statements
prepared in accordance with generally accepted accounting principles have been
omitted in accordance with the SECs 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 our
financial position and results of operations as of and for the periods
indicated. Certain reclassifications have been made to conform prior period
results to the current period presentation. We do not believe that our results of operations for the three and six
months ended June 30, 2004 are necessarily indicative of the results to be
expected for the full year. The unaudited condensed consolidated financial statements included in this
quarterly report should be read in conjunction with our audited consolidated
financial statements and related footnotes included in our annual report on
Form 10-K for the year ended December 31, 2003. 4




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TARGETED GENETICS CORPORATION NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS-(Continued) (Unaudited) 2. Long-Term Obligations Long-term obligations consisted of the following: June 30,
    
    December 31,2004
    
    2003Loan payable to Biogen, due August 2006
    
    $
    10,000,000
    
    
    $
    10,000,000Equipment financing obligations
    
    
    1,032,000
    
    
    
    1,501,000Loan payable to Biogen, due September 2005
    
    
    650,000
    
    
    
    650,000Chromos advances
    
    
    502,000
    
    
    
    300,000Other obligations
    
    
    200,000
    
    
    
    66,000Total obligations
    
    
    12,384,000
    
    
    
    12,517,000Less current portion
    
    
    (1,511,000
    )
    
    
    (1,290,000
    )Total long-term obligations
    
    $
    10,873,000
    
    
    $
    11,227,000
 Future aggregate principal payments related to long-term obligations are
$1,139,000 for the remainder of 2004, $1,092,000 in 2005, $10,140,000 in 2006
and $13,000 in 2007. 3. Accrued Restructure Charges We record accrued restructure charges as they relate to the leases on our
facilities in Bothell, Washington and Sharon Hill, Pennsylvania. In December
2002, we began to pursue options to sublease or terminate our lease on the
Bothell facility and in February 2003, we closed our Sharon Hill facility.
Accrued restructure charges represent our best estimate of the fair value of
the liability as determined under Statement of Financial Accounting Standards,
or SFAS, No. 146, Accounting for Costs Associated with Exit or Disposal
Activities,and is computed as the fair value of the difference between the
remaining lease payments due on these leases and the estimated sub-lease market
rates. These assumptions are periodically reviewed and updated as appropriate
and adjustment is made to the accrued restructure charge. Accretion expense is
also recorded on an ongoing basis and results from the difference between the
fair value of payments in the estimate of accrued restructure liability
compared to actual payments made during the quarter. Accretion expense is
reflected as a restructure charge on the consolidated statements of operations.
To the extent that a portion of our facilities are not being offered for
sublease, the cost of the assumed sublease income is recognized ratably as
research and development expense over the remaining term of the lease. If we proceed with further development or commercialization of any of our
product candidates, we may need to resume use of the Bothell facility to
fulfill our manufacturing requirements. If we decide to resume use of this
facility, any remaining accrued restructure charges related to the
manufacturing facility will be reversed and recorded as a one-time credit to
restructure charges, reflected in the period in which use is resumed. Any
decision to resume use of the facility will be based on a number of factors,
including the progress of our product candidates in clinical development, the
estimated duration of facility design and construction, the estimated timing of
product manufacturing requirements, the ability of our current manufacturing
capabilities to meet demand, and the availability of resources. However, unless
we resume use of the Bothell facility, we will continue to account for the
lease in accordance with SFAS No. 146 and will periodically evaluate the
assumptions and record additional restructure charges if necessary. Because we
compute restructure charges using estimates and assumptions regarding the
timing and amounts of future events, further significant adjustments to the
accrual may be necessary based on the actual outcome of events and as we become
aware of new facts and circumstances. 5




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TARGETED GENETICS CORPORATION NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS-(Continued) (Unaudited) The tables below present our total estimated restructure charges and a
reconciliation of the associated liability: Incurred in
    
    Incurred in
    
    Incurred in
    
    Estimated
    
    Total expected toRestructure charges
    
    2002
    
    2003
    
    2004
    
    future charges
    
    be incurredEmployee termination benefits
    
    $
    725,000
    
    
    $
    5,000
    
    
    $
    
    
    
    $
    
    
    
    $
    730,000Contract termination costs
    
    
    1,601,000
    
    
    
    5,153,000
    
    
    
    416,000
    
    
    
    2,507,000
    
    
    
    9,677,000Other associated costs
    
    
    
    
    
    
    32,000
    
    
    
    
    
    
    
    
    
    
    
    32,000Total
    
    $
    2,326,000
    
    
    $
    5,190,000
    
    
    $
    416,000
    
    
    $
    2,507,000
    
    
    $
    10,439,000
 December 31,
    
    
    
    
    
    
    
    
    
    
    
    
    
    June 30,2003
    
    Incurred in
    
    Paid in
    
    
    
    
    
    2004Reconciliation
    
    liability
    
    2004
    
    2004
    
    Adjustments
    
    liabilityEmployee termination benefits
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    Contract termination costs
    
    
    6,870,000
    
    
    
    416,000
    
    
    
    (631,000
    )
    
    
    
    
    
    
    6,655,000Other associated costs
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Total
    
    $
    6,870,000
    
    
    $
    416,000
    
    
    $
    (631,000
    )
    
    $
    
    
    
    $
    6,655,000
 The charges in 2004 represent accretion expense on the accrued restructure
charges of $270,000 and an additional charge of $146,000 due to a change in
estimate related to the Sharon Hill facility to reflect our belief that we can
not secure a sublease tenant prior to the expiration of the lease. Estimated
future charges represent our estimate of the accretion expense throughout the
remainder of the lease term. 4. Shareholders Equity Stock Option Increase and Conversion of Series B Preferred Stock In May 2004, our shareholders approved an increase in the number of shares
of common stock issuable under our 1999 Stock Option Plan by 6,000,000, from
3,500,000 to 9,500,000 shares. Effective March 31, 2004, Elan converted the
Series B preferred stock it held into 4,330,000 shares of our common stock.
Shares reserved for future issuance are as follows: June 30,
    
    December 31,2004

    
    2003Issued and outstanding stock options
    
    
    6,277,840
    
    
    
    4,097,687Shares available for future stock
option grants
    
    
    4,072,360
    
    
    
    322,927Stock purchase warrants
    
    
    2,000,000
    
    
    
    2,003,826Conversion of Series B preferred stock
    
    
    
    
    
    
    4,765,500Total reserved shares
    
    
    12,350,200
    
    
    
    11,189,940
 Stock Compensation As permitted by the provisions of SFAS No. 123, Accounting for
Stock-Based Compensation, we have elected to follow Accounting Principles
Board Opinion No. 25, Accounting for Stock Issued to Employees,and related
interpretations in accounting for employee stock option grants. In addition, we
follow the disclosure requirements of SFAS No. 148, Accounting for Stock-Based
Compensation  Transition and Disclosure  an amendment of SFAS No. 123,which
require prominent disclosures in both annual and interim financial statements
about the method of accounting for stock-based employee compensation and the
effect of the method used on reported results. We do not recognize any
compensation expense for options granted to employees because we grant all
options at fair market value on the date of grant. Options and warrants to
purchase common stock granted to non-employees or directors are recorded as an
expense over their service period based on their fair value, which is
determined using the Black-Scholes method. 6




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TARGETED GENETICS CORPORATION NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS-(Continued) (Unaudited) As allowed by SFAS No. 123, we do not recognize compensation expense on
stock options or warrants granted to employees and directors. If we had elected
to recognize compensation expense based on the fair market value at the grant
dates for stock options granted, the pro forma net loss and net loss per common
share would have been as follows: Three months ended
    
    Six months endedJune 30,
    
    June 30,2004
    
    2003
    
    2004
    
    2003Net loss:As reported
    
    $
    (4,450,000
    )
    
    $
    (6,915,000
    )
    
    $
    (9,308,000
    )
    
    $
    (7,745,000
    )Proforma stock-based
compensation expense
    
    
    (339,000
    )
    
    
    (346,000
    )
    
    
    (574,000

    )
    
    
    (200,000
    )Pro forma
    
    $
    (4,789,000
    )
    
    $
    (7,261,000
    )
    
    $
    (9,882,000
    )
    
    $
    (7,945,000
    )Basic net loss per share:As reported
    
    $
    (0.05
    )
    
    $
    (0.13
    )
    
    $
    (0.12
    )
    
    $
    (0.15
    )Pro forma
    
    
    (0.06
    )
    
    
    (0.14
    )
    
    
    (0.13
    )
    
    
    (0.16
    )
 5. Merger Agreement Between CellExSys, Inc. and Chromos Molecular Systems,
Inc. On July 27, 2004, Chromos acquired all of the outstanding shares of
CellExSys through a merger between CellExSys and Chromos Inc., a wholly owned
subsidiary of Chromos. Under the terms of the merger agreement, Chromos has
issued to CellExSys shareholders 1,500,000 shares of Chromos common stock and a
secured convertible debenture totaling approximately $2.5 million. The
debenture bears annual interest of 2% and is payable in two annual installments
on the first and second anniversary of the closing. Each shareholder of CellExSys will receive a pro rata distribution of
Chromos common stock and principal and interest payments received on the
debenture, based on the shareholders equity interest in CellExSys as of July
27, 2004, the date of closing. We owned approximately 79% of CellExSys at the
time of the merger. The debenture is repayable by Chromos at its option in
either cash or by the issuance of shares of Chromos common stock, assuming
certain limited conditions are met by Chromos. In combination with the shares
of Chromos common stock issued at closing, if the debenture is fully paid in
shares of Chromos common stock, the shareholders of CellExSys would receive up
to 3.5 million shares, which represents approximately 17.2 percent of Chromos,
based on issued and outstanding shares of Chromos as of the date of closing.
The value of these 3.5 million shares as of the date of closing was
approximately $1.4 million. Chromos has funded certain of CellExSys
operational costs through the closing of the merger. This funding totaled
$502,000 and is reflected as current portion of long-term obligations in the
condensed consolidated balance sheets. As a result of the merger, we will
record a gain during the quarter ended September 30, 2004 equal to the
combination of 1) the net liabilities assumed by Chromos, 2) the deposits
received from Chromos to fund pre-closing operating costs and 3) our pro-rata
share of the fair value of the merger consideration. Subsequent to the merger,
we have agreed to provide certain transition services and assistance to
CellExSys for a limited period of time, which CellExSys will pay on a monthly
basis. 7




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TARGETED GENETICS CORPORATION NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS-(Continued) (Unaudited) Condensed financial information for CellExSys is as follows: June 30,
    
    December 31,2004
    
    2003Current assets
    
    $
    160,000
    
    
    $
    2,000Non-current assets
    
    
    60,000
    
    
    
    60,000Total assets
    
    $
    220,000
    
    
    $
    62,000Current liabilities
    
    $
    749,000
    
    
    $
    574,000Net capital deficiency
    
    
    (529,000
    )
    
    
    (512,000
    )Total liabilities and net capital deficiency
    
    $
    220,000
    
    
    $
    62,000
 Three months ended
    
    Six months endedJune 30,
    
    June 30,2004
    
    2003
    
    2004
    
    2003Revenue
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    Operating expenses:Research and
development
    
    
    420,000
    
    
    
    468,000
    
    
    
    834,000
    
    
    
    1,072,000General and
administrative
    
    
    107,000
    
    
    
    139,000
    
    
    
    236,000
    
    
    
    298,000Total
operating
expenses
    
    
    527,000
    
    
    
    607,000
    
    
    
    1,070,000
    
    
    
    1,370,000Net loss
    
    $
    (527,000
    )
    
    $
    (607,000
    )
    
    $
    (1,070,000
    )
    
    $
    (1,370,000
    )
 Research and development expenses include an allocation of facilities and
other fixed costs based on resource utilization as follows: $107,000 for the
three months ended June 30, 2004, compared to $120,000 for the same period in
2003 and $214,000 for the six months ended June 30, 2004, compared to $236,000
for the same period in 2003. 8




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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
that involve risks and uncertainties. Forward-looking statements include
statements about our product development and commercialization goals and
expectations, potential market opportunities, our plans for and anticipated
results of our clinical development activities and the potential advantage of
our product candidates, and other statements that are not historical facts.
Words such as may, will, believes, estimates, expects, anticipates,
plans and intends, or statements concerning potential or opportunity
and other words of similar meaning or the negative thereof, may identify
forward-looking statements, but the absence of these words does not mean that
the statement is not forward-looking. In making these statements, we rely on a
number of assumptions and make predictions about the future. Our actual results
could differ materially from those stated in, or implied by, forward-looking
statements for a number of reasons, including the risks described in the
section entitled Factors Affecting Our Operating Results, Our Business and Our
Stock Price in Part I, Item 2 of this quarterly report. You should not unduly rely on these forward-looking statements, which
speak only as of the date of this quarterly report. We undertake no obligation
to publicly revise any forward-looking statement after the date of this
quarterly report to reflect circumstances or events occurring after the date of
this quarterly report or to conform the statement to actual results or changes
in our expectations. You should, however, review the factors, risks and other
information we provide in the reports we file from time to time with the SEC. Business Overview Targeted Genetics Corporation develops gene therapy products and
technologies for treating both acquired and inherited diseases. Our gene
therapy product candidates are designed to treat disease by regulating cellular
function at a genetic level. This involves introducing genetic material into
target cells and activating it in a manner that provides the desired effect. We
have assembled a broad base of proprietary intellectual property that we
believe gives us the potential to address the significant diseases that are the
primary focus of our business. Our proprietary intellectual property includes
genes, methods of transferring genes into cells, processes to manufacture our
lead gene delivery product candidates and other proprietary technologies and
processes. In addition, we have established expertise and development
capabilities focused in the areas of preclinical research and biology,
manufacturing and manufacturing process scale-up, quality control, quality
assurance, regulatory affairs and clinical trial design and implementation. We
believe that our focus and expertise will enable us to develop products based
on our proprietary intellectual property. Gene therapy products involve the use of delivery vehicles, called
vectors, to place genetic material into target cells. Our proprietary vector
technologies include both viral and synthetic vectors. Our viral vector
development activities, which use modified viruses to deliver genes into cells,
focus primarily on adeno-associated virus, or AAV, a common virus that has not
been associated with any human disease or illness. We believe that AAV provides
a number of safety and gene delivery advantages over other viruses for several
of our potential gene therapy products. Our synthetic vectors deliver genes
into cells using lipids, which are fatty, water-insoluble organic substances
that can promote gene uptake through cell membranes. We believe that synthetic
vectors may provide a number of gene delivery advantages for repeated,
efficient delivery of therapeutic genes into rapidly dividing cells, such as
certain types of tumor cells. Although our current product development
candidates utilize AAV as the delivery vector, we believe that possessing
capabilities in both viral and synthetic approaches provides advantages in our
corporate partnering efforts and increases the range of our potential products
that may reach the market. We have an AAV-based product candidate under development for treating
cystic fibrosis that is being evaluated in a second Phase II clinical trial
initiated in July 2003. We designed this trial to enroll up to 100 patients and
are conducting it in collaboration with the Cystic Fibrosis Foundation, or CF
Foundation. In June 2004, we announced that an independent data monitoring
committee, or DMC, met for a scheduled interim analysis of this Phase II
clinical trial. Based upon its review, the DMC recommended continuation of the
study as planned. The DMC provided its recommendation based upon an analysis of
whether or not there was a chance that, upon full patient enrollment, the study
could show a statistically significant positive impact on lung function
measurements in patients treated with tgAAVCF compared to placebo. We expect
to complete patient accrual and dosing by the end of 2004. This second Phase II
trial follows an initial repeat dosing trial for which we announced final data
in June 2003. Data from this trial showed a good safety profile and indicated a
statistically significant improvement in lung function at day 30 and a decrease
in levels of an inflammatory cytokine at day 14 in patients treated with
tgAAVCF when compared to placebo. We are developing an AAV-based vaccine product candidate for high-risk
populations in developing nations to protect against the progression of Human
Immunodeficiency Virus, or HIV, infection to Acquired Immune Deficiency
Syndrome, or AIDS, in partnership with the International AIDS Vaccine
Initiative, or IAVI, a non-profit organization, and The Columbus Childrens 9




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Research Institute at Childrens Hospital in Columbus, Ohio, or CCRI. In
December 2003, we initiated a Phase I initial dose escalation safety trial in
humans for our AIDS vaccine product candidate in Europe. This dose-escalation
safety trial is designed to enroll up to 50 volunteers who are uninfected with
HIV and in good health. Each participant in this trial will receive a single
injection of the vaccine candidate or placebo and will be monitored for safety
and immune response. We expect to complete the dose-escalation phase of this
trial by the end of 2004. We are also developing an AAV-based product candidate for the treatment of
rheumatoid arthritis. In March 2004, we initiated a Phase I clinical trial for
this product candidate for treating rheumatoid arthritis. This dose-escalation
safety trial is designed to enroll up to 32 patients with rheumatoid arthritis
and will be conducted at multiple sites in the United States and Canada.
Patients will be monitored for safety and secondarily for improvements in
arthritis signs and symptoms. We expect to complete patient accrual and dosing
in this trial by the first quarter of 2005. We have additional product
candidates focused on treating cancer and hemophilia; however, we have
suspended further development of these programs until we can find other sources
of funding for the programs. We have developed processes to manufacture our potential products using
methods and at a scale amenable to clinical development and expandable to
large-scale production for advancing our potential products to clinical
evaluation and commercialization. These methods are similar to the methods used
to manufacture other biologics. As a result, we evaluated and continue to
evaluate opportunities to utilize excess capacity to manufacture biologics for
other companies. In March 2003, we entered into a manufacturing services
agreement with GenVec, Inc., or GenVec, to manufacture clinical supply of
GenVecs cancer product candidate, TNFerade, an adeno-viral-based gene therapy
product. In January 2004, we completed our manufacturing work for GenVec. We believe that a wide range of diseases may potentially be treated, or
prevented, with gene-based products, including cancer, genetic diseases and
infectious diseases. We believe that there is also a significant opportunity to
treat diseases that are currently treated using proteins and monoclonal
antibodies, or small molecule drugs. These diseases may be more effectively
treated by gene-based therapies due to their ability to provide a long-term or
a localized method of treatment. Our business strategy is to develop multiple
gene delivery systems, which we believe will maximize our product
opportunities. Using AAV gene delivery systems, we are developing product
candidates across multiple diseases with the belief that gene-based therapies
may provide a means to treat diseases not fully treatable with current biologic
and pharmaceutical drugs. We believe that, if successful, we can establish
significant market potential for our product candidates. There currently are no
commercially available gene therapy products in the United States. We intend to
pursue product development programs to enable us to demonstrate proof of
concept and eventually commercialize gene-based therapeutics to address
currently unmet medical needs in treating disease. The development of pharmaceutical products involves extensive preclinical
development followed by human clinical trials that take several years or more
to complete. The length of time required to completely develop any product
candidate varies substantially according to the type, complexity and novelty of
the product candidate, the degree of involvement by a development partner, and
the intended use of the product candidate. Our commencement and rate of
completion of clinical trials may vary or be delayed for many reasons,
including those discussed in the section entitled Factors Affecting Our
Operating Results, Our Business and Our Stock Price in Part I, Item 2 of this
quarterly report. Results of Operations Revenue Revenue. Revenue increased to $2.8 million for the three months ended
June 30, 2004 from $2.1 million for the same period in 2003. This increase in
revenue reflects higher research and development activities under our AIDS
vaccine collaboration with IAVI and revenue from completing our contract
manufacturing agreement with GenVec, partially offset by no corresponding
revenue for Biogen, Inc., or Biogen, in 2004. Revenue decreased to $4.1
million for the six months ended June 30, 2004 from $7.7 million for the same
period in 2003. Revenue for the six months ended June 30, 2003 includes $3.9
million of revenue related to the termination of our collaboration with Wyeth
Pharmaceuticals, or Wyeth, in February 2003 and $1.7 million of previously
deferred payments received from Biogen under a collaboration that ended in
September 2003. We expect that our revenue for the remainder of 2004 will consist of
research and development revenue from our collaboration with IAVI, which we
expect will increase through the remainder of 2004 as planned program
activities increase. As a result of the conclusion of our former collaborations
with Biogen and Wyeth in 2003, we expect total revenue in 2004 to be less than
2003. Our revenue for the next several years will depend on the continuation
of the current collaboration with IAVI and our success with entering into and
performing under potential new collaborations. 10




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Operating Expenses Research and Development Expenses. Research and development expenses
increased to $4.8 million for the three months ended June 30, 2004 from $4.3
million for the same period in 2003, and increased to $9.1 million for the six
months ended June 30, 2004 from $8.9 million for the same period in 2003.
These increases reflect higher costs in our AIDS vaccine and rheumatoid
arthritis programs, which moved out of preclinical development and into
clinical testing in late 2003 and early 2004. As a result, the costs
associated with these programs are included in the costs of programs in
clinical development, which increased in 2004 compared to 2003. The following is an allocation of our total research and development costs
between our programs in clinical development and those that are in research or
preclinical stages of development: Three months ended
    
    Six months endedJune 30,
    
    June 30,2004
    
    2003
    
    2004
    
    2003Programs in clinical development:Cystic fibrosis
    
    $
    316,000
    
    
    $
    99,000
    
    
    $
    452,000
    
    
    $
    218,000AIDS vaccine
    
    
    1,041,000
    
    
    
    
    
    
    
    1,570,000
    
    
    
    Rheumatoid arthritis
    
    
    825,000
    
    
    
    
    
    
    
    906,000
    
    
    
    Indirect costs
    
    
    1,684,000
    
    
    
    190,000
    
    
    
    2,568,000
    
    
    
    320,000Total clinical development program expense
    
    
    3,866,000
    
    
    
    289,000
    
    
    
    5,496,000
    
    
    
    538,000Research and preclinical development
program expense
    
    
    962,000
    
    
    
    4,038,000
    
    
    
    3,569,000
    
    
    
    8,331,000Total research and development expense
    
    $
    4,828,000
    
    
    $
    4,327,000
    
    
    $
    9,065,000
    
    
    $
    8,869,000
 Research and development costs attributable to programs in clinical
development include the applicable costs of salaries, benefits, clinical
trials, outside services, materials and supplies incurred to support the
programs, and any preclinical activities conducted in support of the clinical
program. Indirect costs allocated to clinical programs include facility and
occupancy costs, research and development administrative costs, and license and
royalty payments. Our development partners separately fund the clinical trial
costs of our cystic fibrosis and AIDS vaccine programs. As a result, we do not
include those costs in our research and development expenses. Costs attributed to research and preclinical programs represent our
earlier stage development activities, including costs incurred on programs
prior to their transition into clinical trials, as well as costs that are not
allocable to a clinical development program, such as unallocated manufacturing
infrastructure costs. Because we conduct multiple research projects and
utilize resources across several programs, our research and preclinical
development costs are not directly assigned to individual programs. For purposes of reimbursement from our collaboration partners, we capture
the level of effort expended on a program through our project management
system, which is based primarily on human resource time allocated to each
program, supplemented by an allocation of indirect costs and other specifically
identifiable costs, if any. As a result, the costs allocated to a program do
not necessarily reflect the actual costs of the program. We initiated clinical testing of our AIDS vaccine product candidate in
December 2003 and our rheumatoid arthritis product candidate in March 2004. As
a result, all related development activities associated with our cystic
fibrosis, rheumatoid arthritis and AIDS vaccine programs are reflected as costs
associated with programs in clinical development as of the date of initiation
of clinical testing. Therefore, during 2004, we expect our research and
development expenses associated with programs under clinical development to
increase, reflecting the transition of these programs into clinical testing. General and Administrative Expenses. General and administrative
expenses increased to $2.1 million for the three months ended June 30, 2004,
from $1.4 million for the same period in 2003, and increased to $3.8 million
for the six months ended June 30, 2004 from $2.8 million for the same period in
2003. This increase primarily reflects higher professional service costs
related to patent issuances and regulatory compliance, and higher personnel
costs. Restructure Charges.Restructure charges decreased to $221,000 for the
three months ended June 30, 2004, from $2.9 million for the same period in
2003, and decreased to $416,000 for the six months ended June 30, 2004, from
$3.2 million for the same period in 2003. The charge for the six months ended
June 30, 2004 represents accretion expense of $270,000 due to the passage of
time and results from the difference between the fair value of payments in the
estimate of the accrued restructure liability compared to the actual rent
payments made during the quarter and an additional charge of $146,000 due to
updates to our assumptions as to rental income that may be achieved under a
sublease arrangement of our Sharon Hill facility. The charges for 11




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the three and six months ended June 30, 2003, primarily represent changes
in the restructure accrual due to significant changes in our expectations
regarding market conditions and sublease assumptions. Other Income and Expense Investment Income. Investment income decreased to $21,000 for the three
months ended June 30, 2004, from $56,000 for the same period in 2003. This
decrease resulted from a decrease in the net yield of our cash equivalents.
Investment income increased to $145,000 for the six months ended June 30, 2004,
from $108,000 for the same period in 2003. This increase resulted from higher
average cash balances in 2004 as a result of our financing completed in
February 2004, partially offset by lower yields. Interest Expense. Interest expense relates to interest on outstanding
loans from our collaborative partners, notes and obligations under equipment
financing arrangements and installment loans we use to finance purchases of
laboratory and computer equipment, furniture and leasehold improvements.
Interest expense decreased to $117,000 for the three months ended June 30,
2004, from $360,000 for the same period in 2003 and decreased to $237,000 for
the six months ended June 30, 2004, from $722,000 for the same period in 2003.
These decreases reflects lower average principal balances as the result of our
conversion of approximately $9.4 million of debt owed to Elan into shares of
our common stock in September 2003. Liquidity and Capital Resources Our combined cash and cash equivalents increased to $37.4 million at June
30, 2004, compared to $21.1 million at December 31, 2003. For the six months
ended June 30, 2004, the principal sources of cash were $23.8 million in net
proceeds from the issuance of approximately 10.9 million shares of our common
stock in February 2004 and collaborative funding received from partners. Our
principal use of cash was $6.9 million to fund our operations during the
period. Our shareholders equity increased to $48.7 million at June 30, 2004,
compared to $33.5 million at December 31, 2003. This increase includes net
proceeds of $23.8 million from the February 2004 sale of our common stock and
the February 2004 acquisition of the minority interest in CellExSys of
$750,000, reduced by the net loss during the period of $9.3 million. We have financed our product development activities and general corporate
functions primarily through proceeds from public and private sales of our
equity securities, through cash payments received from our collaborative
partners and proceeds from the issuance of debt. To a lesser degree, we have
also financed our operations through interest earned on cash and cash
equivalents, loan funding under equipment leasing agreements and research
grants. These financing sources have historically allowed us to maintain
adequate levels of cash and investments. Our cystic fibrosis product candidate is in a second Phase II clinical
trial, our AIDS vaccine candidate is in a Phase I clinical trial and we
initiated a Phase I clinical trial for our rheumatoid arthritis product
candidate in March 2004. We expect to continue incurring significant expense in
advancing our product candidates toward commercialization. As a result, we do
not expect to generate sustained positive cash flow from our operations for at
least the next several years and only then if we can successfully develop and
commercialize our product candidates. We will require substantial additional
financial resources to fund the development and commercialization of our
product candidates and expand research and development of our product
candidates for treating additional diseases. We expect to maintain our focus on our key development programs in cystic
fibrosis, AIDS and rheumatoid arthritis in 2004. We believe that our cash
needs will increase by approximately 20% during 2004 compared to 2003 to
support the advancement of these clinical development programs. We expect to
continue to receive financial support for specific programs to offset some of
the costs of development. We have an ongoing collaboration with IAVI and CCRI to develop an AIDS
vaccine. The term of this collaboration has been extended through December
2006. Assuming that we complete all of the planned development activities, we
expect to receive up to $10.7 million in funding from IAVI to cover the costs
of this program in 2004. We also have a collaboration with the CF Foundation
related to our second Phase II clinical trial for our product candidate for
treating cystic fibrosis. Under this collaboration, the CF Foundation is
providing funding to the sites conducting this trial to cover their direct
costs of the trial. We expect that our cash and cash equivalents at June 30, 2004, plus the
funding we expected from IAVI to fund 2004 work under our AIDS vaccine
collaboration, will be sufficient to fund our operations until at least the
beginning of 2006. We believe that this will be sufficient time to complete
each of our current clinical trials, evaluate the results, and, assuming
satisfactory results, plan or initiate further clinical testing. In August
2006, our $10 million note payable to Biogen becomes due, which will require
that we raise additional capital to repay the note or seek an alternative
arrangement to repay the note. We also have a $650,000 loan from Biogen that
becomes due in September 2005. Although our development collaboration with
IAVI has been 12




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extended through the end of 2006, the development plan and budget under
the collaboration is established on an annual basis. While we expect this
program to continue through at least the duration of the current collaboration
term, we have not established the work plan and budget for 2005 and 2006 with
IAVI and have therefore not yet made an assumption as to the level of funding
that we may receive from IAVI in those years. We expect the level of our future operating expenses to be driven by the
needs of our product development programs, offset by the availability of funds
through partner-funded collaborations, equity offerings or other financing
activities. The size, scope and pace of our development activities depend on
the availability of these resources. Our future cash requirements will depend
on many factors, including:  
    
    the rate and extent of scientific progress in our research and
development programs;
    
    the timing, costs and scope of, and our success in, clinical trials,
obtaining regulatory approvals and filing, prosecuting and enforcing
patents;
    
    competing technological and market developments;
    
    the timing and costs of, and our success in, any product
commercialization activities and facility expansions, if and as required;
and
    
    the expense and outcome of any litigation or administrative proceedings
involving our intellectual property, or access to third-party
intellectual property through licensing agreements. IAVI has the right to terminate our collaboration and its obligation to
provide research funding at any time for any reason with 90 days notice. If we
were to lose the collaborative funding expected from IAVI and were unable to
obtain alternative sources of funding for the AIDS vaccine product candidate,
we may be unable to continue our research and development program for that
product candidate. The CF Foundation has the right to terminate our funding
agreement at any time for any reason. We are seeking partners for our hemophilia and cancer programs and
evaluating other opportunities to obtain additional capital to fund our future
operations. Additional sources of financing could involve one or more of the
following:  
    
    entering into additional product development and funding collaborations
or other strategic transactions, or extending or expanding our current
collaborations;
    
    selling or licensing our technology or product candidates;
    
    borrowing under loan or equipment leasing arrangements;
    
    issuing equity in the public or private markets; or
    
    issuing debt. Additional funding may not be available to us on reasonable terms, if at
all. Depending on our ability to successfully access additional funding, we may
be forced to implement significant cost reduction measures. These adjustments
may include scaling back, delaying or terminating one or more research and
development programs, curtailing capital expenditures or reducing other
operating activities. We may also be required to relinquish some rights to our
technology or product candidates or grant licenses on unfavorable terms, either
of which would reduce the ultimate value to us of the technology or product
candidates. 13




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Factors Affecting Our Operating Results, Our Business and Our Stock Price In addition to the other information contained in this quarterly report,
you should carefully read and consider the following risk factors. If any of
these risks actually occur, our business, operating results or financial
condition could be harmed. This could cause the trading price of our stock to
decline, and you could lose all or part of your investment. Risks Related to Our Business We expect to continue to operate at a loss and may never become profitable. Substantially all of our revenue has been derived under collaborative
research and development agreements relating to the development of our
potential product candidates. We have incurred, and will continue to incur for
the foreseeable future, significant expense to develop our research and
development programs, conduct preclinical studies and clinical trials, seek
regulatory approval for our product candidates and provide general and
administrative support for these activities. As a result, we have incurred
significant net losses since inception, and we expect to continue to incur
substantial additional losses in the future. As of June 30, 2004, we had an
accumulated deficit of approximately $226 million. We may never generate
profits and, if we do become profitable, we may be unable to sustain or
increase profitability. All of our product candidates are in early-stage clinical trials or preclinical
development, and if we are unable to successfully develop and commercialize our
product candidates we will be unable to generate sufficient capital to maintain
our business. In July 2003, we initiated a confirmatory Phase II clinical trial for our
cystic fibrosis product candidate in the United States. In December 2003, we
initiated a Phase I trial for our AIDS vaccine product candidate in Europe. In
March 2004, we initiated a Phase I trial for our rheumatoid arthritis product
candidate in the United States and Canada. Our product candidates for cancer
have been evaluated in Phase I and Phase II clinical trials. We will not
generate any product revenue for at least several years and then only if we can
successfully develop and commercialize our product candidates. Commercializing
our potential products depends on successful completion of additional research
and development and testing, in both preclinical development and clinical
trials. Clinical trials may take several years or more to complete. The
commencement, cost and rate of completion of our clinical trials may vary or be
delayed for many reasons, including the risks discussed elsewhere in this
section. If we are unable to successfully complete preclinical and clinical
development of some or all of our product candidates in a timely manner, we may
be unable to generate sufficient product revenue to maintain our business. Even if our potential products succeed in clinical trials and are approved
for marketing, these products may never achieve market acceptance. If we are
unsuccessful in commercializing our product candidates for any reason,
including greater effectiveness or economic feasibility of competing products
or treatments, the failure of the medical community or the public to accept or
use any products based on gene delivery, inadequate marketing and distribution
capabilities or other reasons discussed elsewhere in this section, we will be
unable to generate sufficient product revenue to maintain our business. If we are unable to raise additional capital when needed, we will be unable to
conduct our operations and develop our potential products. Because internally generated cash flow will not fund development and
commercialization of our product candidates, we will require substantial
additional financial resources. Our future capital requirements will depend on
many factors, including:  
    
    the rate and extent of scientific progress in our research and
development programs;
    
    the timing, costs and scope of, and our success in, conducting clinical
trials, obtaining regulatory approvals and pursuing patent prosecutions;
    
    competing technological and market developments;
    
    the timing and costs of, and our success in, any commercialization
activities and facility expansions, if and as required; and
    
    the existence and/or outcome of any litigation or administrative
proceedings involving intellectual property. As of June 30, 2004, we had approximately $37.4 million in cash and cash
equivalents. We expect that our cash resources at June 30, 2004 and the funding
expected from IAVI to fund 2004 work under our AIDS vaccine collaboration will
be sufficient to fund our operations until at least the beginning of 2006. We
are evaluating opportunities to obtain additional capital to fund our
operations beyond that time. Additional sources of financing could involve one
or more of the following: 14




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
    
    extending or expanding our current collaborations;
    
    entering into additional product development collaborations;
    
    selling or licensing our technology or product candidates;
    
    borrowing under loan or equipment leasing arrangements;
    
    issuing equity in the public or private markets; or
    
    issuing debt. Additional funding may not be available to us on reasonable terms, if at
all. The funding that we expect to receive from IAVI depends on continued
scientific progress under the collaboration and IAVIs ability and willingness
to continue or extend the collaboration. If we are unable to successfully
access additional capital, we may need to scale back, delay or terminate one or
more of our key development programs, curtail capital expenditures or reduce
other operating activities. We may also be required to relinquish some rights
to our technology or product candidates or grant or take licenses on
unfavorable terms, either of which would reduce the ultimate value to us of our
technology or product candidates. The regulatory approval process for our product candidates is costly,
time-consuming and subject to unpredictable changes and delays, and our product
candidates may never receive regulatory approval. To our knowledge, no gene therapy products have received regulatory
approval for marketing from the U.S. Food and Drug Administration, or FDA.
Because our product candidates involve new and unproven technologies, we
believe that the regulatory approval process may proceed more slowly compared
to clinical trials involving traditional drugs. The FDA and applicable state
and foreign regulators must conclude at each stage of clinical testing that our
clinical data suggest acceptable levels of safety in order for us to proceed to
the next stage of clinical trials. In addition, gene therapy clinical trials
conducted at institutions that receive funding for recombinant DNA research
from the U.S. National Institutes of Health, or NIH, are subject to review by
the NIHs Office of Biotechnology Activities Recombinant DNA Advisory
Committee, or RAC. Although NIH guidelines do not have regulatory status, the
RAC review process can impede the initiation of the trial, even if the FDA has
reviewed the trial and approved its initiation. Moreover, before a clinical
trial can begin at an NIH-funded institution, that institutions Institutional
Biosafety Committee must review the proposed clinical trial to assess the
safety of the trial. The regulatory process for our product candidates is costly,
time-consuming and subject to unpredictable delays. The clinical trial
requirements of the FDA, NIH and other agencies and the criteria these
regulators use to determine the safety and efficacy of a product candidate vary
substantially according to the type, complexity, novelty and intended use of
the potential products. In addition, regulatory requirements governing gene and
cell therapy products have changed frequently and may change in the future.
Accordingly, we cannot predict how long it will take or how much it will cost
to obtain regulatory approvals for clinical trials or for manufacturing or
marketing our potential products. Some or all of our product candidates may
never receive regulatory approval. A product candidate that appears promising
at an early stage of research or development may not result in a commercially
successful product. Our clinical trials may fail to demonstrate the safety and
efficacy of a product candidate or a product candidate may generate
unacceptable side affects or other problems during or after clinical trials.
Should this occur, we may have to delay or discontinue development of the
product candidate, and the corporate partner that supports development of that
product candidate may terminate its support. Delay or failure to obtain, or
unexpected costs in obtaining, the regulatory approval necessary to bring a
potential product to market could decrease our ability to generate sufficient
product revenue to maintain our business. If we are unable to obtain or maintain licenses for necessary third-party
technology on acceptable terms or to develop alternative technology, we may be
unable to develop and commercialize our product candidates. We have entered into exclusive and nonexclusive license agreements that
give us and our partners rights to use technologies owned or licensed by
commercial and academic organizations in the research, development and
commercialization of our potential products. For example, we have a gene
transfer technology license agreement with Amgen Inc., or Amgen, as the
successor to Immunex Corporation, or Immunex, under which we have license
rights to certain Immunex proprietary technology specifically applicable to
gene therapy applications. In a February 2004 letter, Amgen took the position
that we are not licensed, either exclusively or non-exclusively, to use Immunex
intellectual property covering TNFR:Fc or therapeutic uses for TNFR:Fc. We have
responded with a letter confirming our confidence that the gene transfer
technology license agreement provides us with an exclusive worldwide license to
use the gene construct coding for TNFR:Fc for gene therapy applications. We
have had and expect to have further communications with Amgen regarding our
differences. Notwithstanding our confidence, it is possible that 15




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a resolution of those differences, through litigation or otherwise, could
cause delay or discontinuation of our development of tgAAC94 or our inability
to commercialize any resulting product. We believe that we will need to obtain additional licenses to use patents
and unpatented technology owned or licensed by others for use, compositions,
methods, processes to manufacture compositions, processes to manufacture and
purify gene delivery product candidates and other technologies and processes
for our present and potential product candidates. If we are unable to maintain
our current licenses for third-party technology or obtain additional licenses
on acceptable terms, we may be required to expend significant time and
resources to develop or license replacement technology. If we are unable to do
so, we may be unable to develop or commercialize the affected product
candidates. In addition, the license agreements for technology for which we
hold exclusive licenses typically contain provisions that require us to meet
minimum development milestones in order to maintain the license on an exclusive
basis for some or all fields of the license. We also have license agreements
for some of our technologies, which may require us to sublicense certain of our
rights. If we do not meet these requirements, our licensor may convert all or a
portion of the license to a nonexclusive license or, in some cases, terminate
the license. In many cases, patent prosecution of our licensed technology is controlled
solely by the licensor. If our licensors fail to obtain and maintain patent or
other protection for the proprietary intellectual property we license from
them, we could lose our rights to the intellectual property or our exclusivity
with respect to those rights, and our competitors could market competing
products using the intellectual property. Licensing of intellectual property is
of critical importance to our business and involves complex legal, business and
scientific issues and is complicated by the rapid pace of scientific discovery
in our industry. Disputes may arise regarding intellectual property subject to
a licensing agreement, including:  
    
    the scope of rights granted under the license agreement and other
interpretation-related issues;
    
    the extent to which our technology and processes infringe on
intellectual property of the licensor that is not subject to the
licensing agreement;
    
    the sublicensing of patent and other rights under our collaborative
development relationships;
    
    the ownership of inventions and know-how resulting from the joint
creation or use of intellectual property by our licensors and us and our
partners; and
    
    the priority of invention of patented technology. If disputes over intellectual property that we have licensed prevent or
impair our ability to maintain our current licensing arrangements on acceptable
terms, we may be unable to successfully develop and commercialize the affected
product candidates. Failure to recruit patients could delay or prevent clinical trials of our
potential products, which could delay or prevent the development of potential
products. Identifying and qualifying patients to participate in clinical trials of
our potential products is critically important to our success. The timing of
our clinical trials depends on the speed at which we can recruit patients to
participate in testing our product candidates. We have experienced delays in
some of our clinical trials, and we may experience similar delays in the
future. If patients are unwilling to participate in our gene therapy trials
because of negative publicity from adverse events in the biotechnology or gene
therapy industries or for other reasons, including competitive clinical trials
for similar patient populations, the timeline for recruiting patients,
conducting trials and obtaining regulatory approval of potential products will
be delayed. These delays could result in increased costs, delays in advancing
our product development, delays in testing the effectiveness of our technology
or termination of the clinical trials altogether. Litigation involving intellectual property, product liability or other claims
and product recalls could strain our resources, subject us to significant
liability, damage our reputation or result in the invalidation of our
proprietary rights. As our product development efforts progress, especially in potentially
significant markets such as AIDS or rheumatoid arthritis therapies, the risk
increases that others may claim that our processes and potential products
infringe on their intellectual property rights. In addition, administrative
proceedings, litigation or both may be necessary to enforce our intellectual
property rights or determine the rights of others. Defending or pursuing these
claims, regardless of their merit, would be costly and would likely divert
managements attention and resources away from our operations. If there were to
be an adverse outcome in litigation or an interference proceeding, we could
face potential liability for significant damages or be required to obtain a
license to the patented process or technology at issue, or both. If we are
unable to obtain a license on acceptable terms, or to develop or obtain
alternative technology or processes, we may be unable to manufacture or market
any product or potential product that uses the affected process or technology. 16




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Clinical trials and the marketing of any potential products may expose us
to liability claims resulting from the testing or use of our products. Gene
therapy treatments are new and unproven, and potential known and unknown side
effects of gene therapy may be serious and potentially life-threatening.
Product liability claims may be made by clinical trial participants, consumers,
healthcare providers or other sellers or users of our products. Although we
currently maintain liability insurance, the costs of product liability and
other claims against us may exceed our insurance coverage. In addition, we may
require increased liability coverage as additional product candidates are used
in clinical trials and commercialized. Liability insurance is expensive and may
not continue to be available on acceptable terms. A product liability or other
claim or product recall not covered by or exceeding our insurance coverage
could significantly harm our financial condition. In addition, adverse
publicity resulting from a product recall or a liability claim against us, one
of our partners or another gene therapy company could significantly harm our
reputation and make it more difficult to obtain the funding and collaborative
partnerships necessary to maintain our business. If we lose IAVI as a partner, we may be unable to develop our AIDS vaccine
product candidate. We have a collaborative development agreement with IAVI, which expires in
December 2006, that we expect to provide us with funding to reimburse research
and development and manufacturing expenses we incur in connection with the
collaboration. In addition, our collaboration with IAVI provides funding for
the Phase I clinical trial for our AIDS vaccine product candidate. A
significant portion of our operating and clinical trial expenses are funded
through our collaborative agreements with IAVI. IAVI has the right to terminate the collaboration or its obligation to
provide funding at any time for any reason with 90 days notice, which would
significantly affect our operating activities. The loss of significant amounts
of collaborative or clinical trial funding could cause the delay, reduction or
termination of the related research and development programs, and a reduction
in capital expenditures and other operating activities necessary to support
general operations. Such a reduction could further impede our ability to
develop our product candidates. If we do not attract and retain qualified personnel, we may be unable to
develop and commercialize some of our potential products. Our future success depends in large part on our ability to attract and
retain key technical and management personnel. All of our employees, including
our executive officers, can terminate their employment with us at any time. We
have programs in place designed to retain personnel, including competitive
compensation packages and programs to create a positive work environment. Other
companies, research and academic institutions and other organizations in our
field compete intensely for employees, however, and we may be unable to retain
our existing personnel or attract additional qualified employees and
consultants. If we experience significant turnover or difficulty in recruiting
new personnel, our research and development of product candidates could be
delayed and we could experience difficulty in generating sufficient revenue to
maintain our business. If our partners or scientific consultants terminate, reduce or delay our
relationships with them, we may be unable to develop our potential products. Our partners provide funding, manage regulatory filings, aid and augment
our internal research and development efforts and provide access to important
intellectual property and know-how. Their activities include, for example,
support in processing the regulatory filings of our product candidates and
funding clinical trials. Our outside scientific consultants and contractors
perform research, develop technology and processes to advance and augment our
internal efforts and provide access to important intellectual property and
know-how. Their activities include, for example, clinical evaluation of our
product candidates, product development activities performed under our research
collaborations, research under sponsored research agreements and contract
manufacturing services. Collaborations with established pharmaceutical and
biotechnology companies and academic, research and public health organizations
often provide a measure of validation of our product development efforts in the
eyes of securities analysts, investors and the medical community. The
development of certain of our potential products, and therefore the success of
our business, depends on the performance of our partners, consultants and
contractors. If they do not dedicate sufficient time, regulatory or other
technical resources to the research and development programs for our product
candidates or if they do not perform their obligations as expected, we may
experience delays in, and may be unable to continue, the preclinical or
clinical development of those product candidates. Each of our collaborations
and scientific consulting relationships concludes at the end of the term
specified in the applicable agreement unless we and our partners agree to
extend the relationship. Any of our partners may decline to extend the
collaboration, or may be willing to extend the collaboration only with a
significantly reduced scope, for a number of scientific or business reasons.
Competition for scientific consultants and partners in gene therapy is intense.
We may be unable to successfully maintain our existing relationships or
establish additional relationships necessary for the development of our product
candidates on acceptable terms, if at all. If we are unable to do so, our
research and development programs may be delayed or we may lose access to
important intellectual property or know-how. 17




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The success of our clinical trials and preclinical studies may not be
indicative of results in a large number of patients of either safety or
efficacy. The successful results of our technology in preclinical studies using
animal models may not be predictive of the results that we will see in our
clinical trials. In addition, results in early-stage clinical trials are based
on limited numbers of patients and generally test for drug safety rather than
efficacy. Our reported progress and results from our early phases of clinical
testing of our product candidates may not be indicative of progress or results
that will be achieved from larger populations, which could be less favorable.
Moreover, we do not know if the favorable results we have achieved in clinical
trials will have a lasting effect. If a larger group of patients does not
experience positive results, or if any favorable results do not demonstrate a
beneficial effect, our product candidate for cystic fibrosis, or any other
potential products that we advance to clinical trials, may not receive approval
from the FDA for further clinical trials or commercialization. We may be unable to adequately protect our proprietary rights domestically or
overseas, which may limit our ability to successfully market any product
candidates. Our success depends substantially on our ability to protect our
proprietary rights and operate without infringing on the proprietary rights of
others. We own or license patents and patent applications, and will need to
license additional patents, for genes, processes, practices and techniques
critical to our present and potential product candidates. If we fail to obtain
and maintain patent or other intellectual property protection for this
technology, our competitors could market competing products using those genes,
processes, practices and techniques. The patent process takes several years and
involves considerable expense. In addition, patent applications and patent
positions in the field of biotechnology are highly uncertain and involve
complex legal, scientific and factual questions. Our patent applications may
not result in issued patents and the scope of any patent may be reduced both
before and after the patent is issued. Even if we secure a patent, the patent
may not provide significant protection and may be circumvented or invalidated. We also rely on unpatented proprietary technology and technology that we
have licensed on a nonexclusive basis. While we take precautions to protect our
proprietary unpatented technology, we may be unable to meaningfully protect
this technology from unauthorized use or misappropriation by a third party. Our
competitors could also obtain rights to our nonexclusively licensed proprietary
technology. In any event, other companies may independently develop equivalent
proprietary information and techniques. If our competitors develop and market
competing products using our unpatented or nonexclusively licensed proprietary
technology or substantially similar technology, our products, if successfully
developed, could suffer a reduction in sales or be forced out of the market. If we do not develop adequate manufacturing, sales, marketing and distribution
capabilities, either alone or with our business partners, we will be unable to
generate sufficient product revenue to maintain our business. We currently do not have the physical capacity to manufacture large-scale
quantities of our potential products. This could limit our ability to conduct
large clinical trials of a product candidate and to commercially launch a
successful product candidate. In order to manufacture product at such scale, we
will need to expand or improve our current facilities and staff or supplement
them through the use of contract providers. If we are unable to obtain and
maintain the necessary manufacturing capabilities, either alone or through
third parties, we will be unable to manufacture our potential products in
quantities sufficient to sustain our business. Moreover, we are unlikely to
become profitable if we, or our contract providers, are unable to manufacture
our potential products in a cost-effective manner. In addition, we have no experience in sales, marketing and distribution.
To successfully commercialize any products that may result from our development
programs, we will need to develop these capabilities, either on our own or with
others. We intend to enter into collaborations with other entities to utilize
their mature marketing and distribution capabilities, but we may be unable to
enter into marketing and distribution agreements on favorable terms, if at all.
If our current or future collaborative partners do not commit sufficient
resources to timely marketing and distributing our future products, if any, and
we are unable to develop the necessary marketing and distribution capabilities
on our own, we will be unable to generate sufficient product revenue to sustain
our business. 18




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Post-approval manufacturing or product problems or failure to satisfy
applicable regulatory requirements could prevent or limit our ability to market
our products. Commercialization of any products will require continued compliance with
FDA and other federal, state and local regulations. For example, our current
manufacturing facility, which is designed for manufacturing our AAV vectors for
clinical and development purposes, is subject to the Good Manufacturing
Practices requirements and other regulations of the FDA, as well as to other
federal, state and local regulations such as the Occupational Health and Safety
Act, the Toxic Substances Control Act, the Resource Conservation and Recovery
Act and the Environmental Protection Act. Any future manufacturing facilities
that we may construct for large-scale commercial production will also be
subject to regulation. We may be unable to obtain regulatory approval for or
maintain in operation this or any other manufacturing facility. In addition, we
may be unable to attain or maintain compliance with current or future
regulations relating to manufacture, safety, handling, storage, record keeping
or marketing of potential products. If we fail to comply with applicable
regulatory requirements or discover previously unknown manufacturing,
contamination, product side effects or other problems after we receive
regulatory approval for a potential product, we may suffer restrictions on our
ability to market the product or be required to withdraw the product from the
market. Risks Related to Our Industry Adverse events in the field of gene therapy could damage public perception of
our potential products and negatively affect governmental approval and
regulation. Public perception of our product candidates could be harmed by negative
events in the field of gene therapy. For example, in late 2002, two patients in
a French academic clinical trial being treated for x-linked severe combined
immunodeficiency in a gene therapy trial using a retroviral vector developed
leukemia. Patient deaths, related and unrelated to gene therapy, have occurred
in other clinical trials. These adverse events and the resulting publicity, as
well as any other adverse events in the field of gene therapy that may occur in
the future, could result in a decrease in demand for any products that we may
develop. The commercial success of our product candidates will depend in part
on public acceptance of the use of gene therapy for preventing or treating
human diseases. If public perception is influenced by claims that gene therapy
is unsafe, our product candidates may not be accepted by the general public or
the medical community. The public and the medical community may conclude that
our technology is unsafe. Future adverse events in gene therapy or the biotechnology industry could
also result in greater governmental regulation, unfavorable public perception,
stricter labeling requirements and potential regulatory delays in the testing
or approval of our potential products. Any increased scrutiny could delay or
increase the costs of our product development efforts or clinical trials. Our use of hazardous materials exposes us to liability risks and regulatory
limitations on their use, either of which could reduce our ability to generate
product revenue. Our research and development activities involve the controlled use of
hazardous materials, including chemicals, biological materials and radioactive
compounds. Our safety procedures for handling, storing and disposing of these
materials must comply with federal, state and local laws and regulations,
including, among others, those relating to solid and hazardous waste
management, biohazard material handling, radiation and air pollution control.
We may be required to incur significant costs in the future to comply with
environmental or other applicable laws and regulations. In addition, we cannot
eliminate the risk of accidental contamination or injury from hazardous
materials. If a hazardous material accident were to occur, we could be held
liable for any resulting damages, and this liability could exceed our financial
resources. Accidents unrelated to our operations could cause federal, state or
local regulatory agencies to restrict our access to hazardous materials needed
in our research and development efforts, which could result in delays in our
research and development programs. Paying damages or experiencing delays caused
by restricted access could reduce our ability to generate revenue and make it
more difficult to fund our operations. The intense competition and rapid technological change in our market may result
in pricing pressures and failure of our potential products to achieve market
acceptance. We face increasingly intense competition from a number of commercial
entities and institutions that are developing gene therapy and cell therapy
technologies. Our competitors include early-stage and more established gene
delivery companies, other biotechnology companies, pharmaceutical companies,
universities, research institutions and government agencies developing gene
therapy products or other biotechnology-based therapies designed to treat the
diseases on which we focus. We also face competition from companies using more
traditional approaches to treating human diseases, such as surgery, medical
devices and pharmaceutical products. As our product candidates become
commercial gene therapy products that may affect commercial markets of the
analogous protein or traditional pharmaceutical therapy, disputes including
lawsuits, demands, threats or patent challenges may arise in an effort to slow
our development. In addition, we compete with other companies to acquire
products or technology from research institutions or universities. Many of our
competitors have substantially more financial and 19




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infrastructure resources and larger research and development staffs than
we do. Many of our competitors also have greater experience and capabilities
than we do in:  
    
    research and development;
    
    clinical trials;
    
    obtaining FDA and other regulatory approvals;
    
    manufacturing; and
    
    marketing and distribution. In addition, the competitive positions of other companies, institutions
and organizations, including smaller competitors, may be strengthened through
collaborative relationships. Consequently, our competitors may be able to
develop, obtain patent protection for, obtain regulatory approval for, or
commercialize new products more rapidly than we do, or manufacture and market
competitive products more successfully than we do. This could limit the prices
we could charge for the products that we are able to market or result in our
products failing to achieve market acceptance. Gene therapy is a rapidly evolving field and is expected to continue to
undergo significant and rapid technological change and competition. Rapid
technological development by our competitors, including development of
technologies, products or processes that are more effective or more
economically feasible than those we have developed, could result in our actual
and proposed technologies, products or processes losing market share or
becoming obsolete. Healthcare reform measures and the unwillingness of third-party payors to
provide adequate reimbursement for the cost of our products could impair our
ability to successfully commercialize our potential products and become
profitable. Sales of medical products and treatments depends substantially, both
domestically and abroad, on the availability of reimbursement to the consumer
from third-party payors. Our potential products may not be considered
cost-effective by third-party payors, who may not provide coverage at the price
set for our products, if at all. If purchasers or users of our products are
unable to obtain adequate reimbursement, they may forego or reduce their use of
our products. Even if coverage is provided, the approved reimbursement amount
may not be high enough to allow us to establish or maintain pricing sufficient
to realize a sufficient return on our investment. Increasing efforts by governmental and third-party payors, such as
Medicare, private insurance plans and managed care organizations, to cap or
reduce healthcare costs will affect our ability to commercialize our product
candidates and become profitable. We believe that third-party payors will
attempt to reduce healthcare costs by limiting both coverage and level of
reimbursement for new products approved by the FDA. There have been and will
continue to be a number of federal and state proposals to implement government
controls on pricing, the adoption of which could affect our ability to
successfully commercialize our product candidates. Even if the government does
not adopt any such proposals or reforms, their announcement could impair our
ability to raise capital. Risks Related to Our Common Stock Concentration of ownership of our common stock may give certain shareholders
significant influence over our business. A small number of investors own a significant number of shares of our
common stock. As of June 30, 2004, Biogen and Elan and its affiliates each
held approximately 12.1 million shares of our common stock, or 14.9% of our
current common shares outstanding. This concentration of stock ownership may
allow these shareholders to exercise significant control over our strategic
decisions and block, delay or substantially influence all matters requiring
shareholder approval, such as:  
    
    election of directors;
    
    amendment of our charter documents; or
    
    approval of significant corporate transactions, such as a change of control of Targeted Genetics. 20




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The interests of these shareholders may conflict with the interests of
other holders of our common stock with regard to such matters. Furthermore,
this concentration of ownership of our common stock could allow these
shareholders to delay, deter or prevent a third party from acquiring control of
Targeted Genetics at a premium over the then-current market price of our common
stock, which could result in a decrease in our stock price. Market fluctuations or volatility could cause the market price of our common
stock to decline and limit our ability to raise capital. The stock market in general and the market for biotechnology-related
companies in particular have experienced extreme price and volume fluctuations,
often unrelated to the operating performance of the affected companies. The
market price of the securities of biotechnology companies, particularly
companies such as ours without earnings and product revenue, has been highly
volatile and is likely to remain so in the future. Any report of clinical trial
results that are below the expectations of financial analysts or investors
could result in a decline in our stock price. We believe that in the past,
similar levels of volatility have contributed to the decline in the market
price of our common stock, and may do so again in the future. Trading volumes
of our common stock can increase dramatically, resulting in a volatile market
price for our common stock. In addition, the trading price of our common stock
could decline significantly as a result of sales of a substantial number of
shares of our common stock, or the perception that significant sales could
occur. For example, on March 31, 2004, we and Elan entered into a termination
agreement that permits Elan to sell shares of our common stock, subject to
certain exceptions, under the trading volume limitations of Rule 144(e)(1)
promulgated under the Securities Act of 1933, as amended. The trading volume
limitations on Elan are reduced over time subject to the terms of the
termination agreement. In addition, Elan has registration rights with respect
to its holdings pursuant to a registration rights agreement dated July 21,
1999. Both the termination agreement and the registration rights agreement
permit Elan to sell quantities of stock, which could adversely impact the price
of our common stock. In the past, securities class action litigation has been brought against
companies that experience volatility in the market price of their securities.
Market fluctuations in the price of our common stock could also adversely
affect our collaborative opportunities and our future ability to sell equity
securities at a price we deem appropriate. As a result, you could lose all or
part of your investment. Our future capital-raising activities will likely involve the issuance of
equity securities, which will dilute your investment and could result in a
decline in the trading price of our common stock. Since June 1, 2003, we have issued 18.6 million shares of our common stock
in equity financings that have been priced at a discount to the then-current
market price of our common stock. These financings were completed in order to
fund our research and development programs and for other general corporate
purposes. To meet all or a portion of our future funding requirements, we will
likely sell additional securities in the public or private equity markets if
and when conditions are favorable, even if we do not have an immediate need for
additional capital at that time. Raising funds through the issuance of equity
securities will dilute the ownership of our existing shareholders. Furthermore,
we may enter into financing transactions at prices that represent a substantial
discount to market price. A negative reaction by investors and securities
analysts to any discounted sale of our equity securities could result in a
decline in the trading price of our common stock. 21




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Item 3. Quantitative and Qualitative Disclosures About Market Risk Cash and cash equivalents.Because of the short-term nature of our
investments, we believe that our exposure to market rate fluctuations on those
investments is minimal. Currently, we do not use any derivative or other
financial instruments or derivative commodity instruments to hedge any market
risks and do not plan to employ these instruments in the future. At June 30,
2004, we held $37.4 million in cash and cash equivalents, which are primarily
invested in a money market fund that invests in securities that, on the
average, mature in less than 60 days and a short-term bond fund that invests in
securities that, on the average, mature in less than 12 months. An analysis of
the impact on these securities of a hypothetical 10% change in short-term
interest rates from those in effect at June 30, 2004, indicates that such a
change in interest rates would not have a significant impact on our financial
position or on our expected results of operations in 2004. Notes payable.Our results of operations are affected by changes in
short-term interest rates as a result of a loan from Biogen that contains a
variable interest rate. Interest payments on this loan are determined by the
LIBOR plus a margin of 1%. The carrying amounts of the notes payable and
equipment financing arrangements approximate fair value because the interest
rates on these instruments change with, or approximate, market rates. The
following table provides information as of June 30, 2004, about our obligations
that are sensitive to changes in interest rate fluctuations: Expected Maturity Date2004
    
    2005
    
    2006
    
    2007
    
    TotalMaturities of long-term obligations:Variable rate note
    
    $
    196,000
    
    
    $
    
    
    
    $
    10,000,000
    
    
    $
    
    
    
    $
    10,196,000Fixed rate notes
    
    
    
    
    
    
    608,000
    
    
    
    
    
    
    
    
    
    
    
    608,000Fixed rate equipment financing
    
    
    394,000
    
    
    
    484,000
    
    
    
    140,000
    
    
    
    13,000
    
    
    
    1,031,000Other
    
    
    549,000
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    549,000Total
    
    $
    1,139,000
    
    
    $
    1,092,000
    
    
    $
    10,140,000
    
    
    $
    13,000
    
    
    $
    12,384,000
 
 Item 4. Controls and Procedures Evaluation of disclosure controls and procedures.H. Stewart Parker, our
Chief Executive Officer, and Todd E. Simpson, our Chief Financial Officer,
after evaluating the effectiveness of our disclosure controls and procedures
(as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act
of 1934, as amended) as of the end of the period covered by this quarterly
report, have concluded that, as of that date, our disclosure controls and
procedures were effective in ensuring that information required to be disclosed
by us in this quarterly report is accumulated and communicated by our
management, to allow timely decisions regarding required disclosure. 22




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PART II OTHER INFORMATION 
 Item 1. Legal Proceedings None. 
 Item 2. Changes in Securities, Use of Proceeds and Issuer Purchases of
Equity Securities Certain of our loan agreements contain financial covenants establishing
limits on our ability to declare or pay cash dividends. 
 Item 3. Defaults Upon Senior Securities None. 
 Item 4. Submission of Matters to a Vote of Security Holders We held an annual meeting of our shareholders on May 20, 2004. Of the
77,244,183 shares outstanding as of the record date for the annual meeting,
72,293,669 shares, or 93.59% of the total shares eligible to vote at the annual
meeting, were represented in person or by proxy.  1)
    
    At the annual meeting, Jack L. Bowman and Jeremy L. Curnock Cook
were each elected to serve as Class 1 members of our board of
directors, each to hold office for a three-year term or until his
successor is elected and qualified. Each of the incumbent Class 1
directors who stood for reelection was elected with the following
voting results: Nominee
    
    Votes For
    
    Votes WithheldJack L. Bowman
    
    
    71,545,248
    
    
    
    748,421Jeremy L. Curnock Cook
    
    
    71,543,267
    
    
    
    750,402
  2)
    
    A proposal to amend the 1999 Stock Option Plan passed with the
following results: Votes For
    
    Votes Against
    
    Abstain
    
    Broker Non Votes30,377,643
    
    
    
    2,702,902
    
    
    
    318,384
    
    
    
    38,894,740
  3)
    
    A proposal to approve the ratification of Ernst &Young LLP as
independent auditors passed with the following results: Votes For
    
    Votes Against
    
    Abstain72,006,050
    
    
    
    161,706
    
    
    
    125,913
 
 Item 5. Other Information None. 
 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 April 6, 2004, we filed a current report on Form 8-K announcing a
Termination Agreement with Elan Corporation plc that formally concludes
the collaboration between the companies through the joint venture
Emerald Gene Systems, Ltd.On April 28, 2004, we filed a current report on Form 8-K to furnish the
press release announcing our financial results for the quarterly period
ended March 31, 2004.On June 24, 2004, we filed a current report on Form 8-K announcing (1)
the interim results of our Phase II trial for the treatment of cystic
fibrosis and (2) the proposed sale of CellExSys, Inc., our
majority-owned subsidiary, to Chromos Molecular Systems, Inc. 23




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SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, as
amended, the registrant has duly caused this report to be signed on its behalf
by the undersigned thereunto duly authorized. TARGETED GENETICS CORPORATIONDate: July 30, 2004
    
    By:
    
    /s/   H. STEWART PARKERH. Stewart Parker,President, Chief Executive Officer and Director(Principal Executive Officer)Date: July 30, 2004
    
    By:
    
    /s/   TODD E. SIMPSONTodd E. Simpson, Vice President,Finance and Administration,Chief Financial Officer,Secretary and Treasurer(Principal Financial and Accounting Officer)
 24




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TARGETED GENETICS CORPORATION 
 INDEX TO EXHIBITS Exhibit No.
    
    Description
    
    Note3.1
    
    Restated Articles of Incorporation (Exhibit 3.1)
    
    (A)3.2
    
    Amended and Restated Bylaws (Exhibit 3.2)
    
    (B)4.1
    
    Rights Agreement, dated as of October 17, 1996,
between Targeted Genetics and ChaseMellon Shareholder Services, L.L.C. (Exhibit 2.1)
    
    (C)4.2
    
    First Amendment to Rights Agreement, dated July 21,
1999, between Targeted Genetics and ChaseMellon
 Shareholder Services, L.L.C. (Exhibit 1.9)
    
    (D)4.3
    
    Second Amendment to Rights Agreement, dated
September 25, 2002, between Targeted Genetics and
 Mellon Investor Services L.L.C. (Exhibit 10.1)
    
    (E)4.4
    
    Third Amendment to Rights Agreement, dated January
23, 2003, between Targeted Genetics and Mellon
 Investor Services L.L.C. (Exhibit 4.4)
    
    (F)4.5
    
    Fourth Amendment to Rights Agreement, dated
September 2, 2003, between Targeted Genetics and
 Mellon Investor Services L.L.C. (Exhibit 4.1)
    
    (G)10.1
    
    Termination Agreement, dated March 31, 2004, among
Targeted Genetics, Elan Corporation plc, Elan Pharma
International Limited, Elan International Services,
 Ltd. and Emerald Gene Systems, Ltd.* (Exhibit 99.2)
    
    (H)10.2
    
    Agreement and Plan of Merger, dated June 21, 2004,
by and among, Chromos Molecular Systems Inc.,
 Chromos, Inc., CellExSys, Inc. and Targeted Genetics31.1
    
    Certification of Chief Executive Officer pursuant to
Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended31.2
    
    Certification of Chief Financial Officer pursuant to
Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended32.1
    
    Certification of Chief Executive Officer pursuant to
18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 200232.2
    
    Certification of Chief Financial Officer pursuant to
18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
   *
    
    Portions of this exhibit have been omitted based on an application
for confidential treatment filed with the SEC. The omitted portions of the
exhibit have been filed separately with the SEC.(A)
    
    Incorporated by reference to the designated exhibit included with
Targeted Genetics Quarterly Report on Form 10-Q (No. 0-23930) for the
period ended June 30, 2002.(B)
    
    Incorporated by reference to the designated exhibit included with
Targeted Genetics Annual Report on Form 10-K (No. 0-23930) for the year
ended December 31, 1996.(C)
    
    Incorporated by reference to the designated exhibit included with
Targeted Genetics Registration Statement on Form 8-A (No. 0-23930) filed
on October 22, 1996. 25




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##### Table of Contents



(D)
    
    Incorporated by reference to the designated exhibit included with
Targeted Genetics Current Report on Form 8-K (No. 0-23930) filed on
August 4, 1999.(E)
    
    Incorporated by reference to the designated exhibit included with
Targeted Genetics Current Report on Form 8-K (No. 0-23930) filed on
October 11, 2002.(F)
    
    Incorporated by reference to the designated exhibit included with
Targeted Genetics Annual Report on Form 10-K (No. 0-23930) for the year
ended December 31, 2002.(G)
    
    Incorporated by reference to the designated exhibit included with
Targeted Genetics Current Report on Form 8-K (No. 0-23930) filed on
October 1, 2003.(H)
    
    Incorporated by reference to the designated exhibit included with
Targeted Genetics Current Report on Form 8-K (No. 0-23930) filed on April
6, 2004. 26