<PAGE>

                      SECURITIES AND EXCHANGE COMMISSION
                             Washington, DC  20549

                                  FORM 10-Q/A
                                Amendment No. 1


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

               For the quarterly period ended September 30, 2000

                                       or

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

    For the transition period from ____________ to ____________

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


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


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

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

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

     Indicate by check mark whether the registrant:  (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.

Yes  [x]    No  [ ]

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

     Common Stock, $.01 par value                     42,262,194
     ----------------------------         ---------------------------------
               (Class)                    (Outstanding at November 1, 2000)

                                      -1-
<PAGE>

                               Explanatory Note
                               ----------------


Targeted Genetics files this amendment to its Quarterly Report on Form 10-Q for
the quarter ended September 30, 2000 to reflect amendments to the financial
information concerning the acquisition of Genovo, Inc., which is set forth in
footnote 2 to the Consolidated Financial Statements. The revisions to the Genovo
financial information consist of immaterial adjustments to paid in capital,
assets acquired and liabilities assumed in the Genovo transaction. Targeted
Genetics filed the original Form 10-Q for the quarter ended September 30, 2000
on November 14, 2000.


                                      -2-
<PAGE>

                         TARGETED GENETICS CORPORATION

                         Quarterly Report on Form 10-Q
                   For the quarter ended September 30, 2000

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

Item 1.    Financial Statements

     a)    Consolidated Balance Sheets as of September 30, 2000 and December 31, 1999                    4
     b)    Consolidated Statements of Operations for the three and nine
           months ended September 30, 2000 and 1999                                                      5
     c)    Consolidated Statements of Cash Flows for the nine months
           ended September 30, 2000 and 1999                                                             6
     d)    Notes to Consolidated Financial Statements                                                    7

Item 2.    Management's Discussion and Analysis of Financial Condition and Results of Operations        16

Item 3.    Quantitative and Qualitative Disclosure About Market Risk                                    28

PART II    OTHER INFORMATION

Item 1.    Legal Proceedings                                                                             *
Item 2.    Changes in Securities and Use of Proceeds                                                    29
Item 3.    Defaults Upon Senior Securities                                                               *
Item 4.    Submission of Matters to a Vote of Security Holders                                           *
Item 5.    Other Information                                                                             *
Item 6.    Exhibits and Reports on Form 8-K                                                             30

SIGNATURES                                                                                              30

</TABLE>

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

                                      -3-
<PAGE>

PART I    FINANCIAL INFORMATION

Item 1.   Consolidated Financial Statements

                         TARGETED GENETICS CORPORATION
                          CONSOLIDATED BALANCE SHEETS

<TABLE>
<CAPTION>
                                                        September 30,    December 31,
                                                             2000           1999
                                                        -------------   -------------
ASSETS                                                   (Unaudited)
<S>                                                     <C>             <C>
Current assets:
  Cash and cash equivalents                             $  38,831,228   $   4,100,798
  Securities available for sale                                     -       3,052,471
  Accounts receivable                                         638,762       1,837,212
  Prepaid expenses and other                                  357,810         269,864
                                                        -------------   -------------
      Total current assets                                 39,827,800       9,260,345

Property, plant and equipment, net                          4,504,561       4,021,466
Goodwill and other purchased intangibles                   39,337,812               -
Other assets                                                  959,434         410,667
                                                        -------------   -------------
                                                        $  84,629,607   $  13,692,478
                                                        =============   =============

LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
  Accounts payable                                      $   4,543,841   $   2,278,338
  Deferred revenue                                          1,334,000               -
  Accrued payroll and other liabilities                       565,621       1,181,555
  Current portion of long-term obligations                    986,341       1,160,174
                                                        -------------   -------------
      Total current liabilities                             7,429,803       4,620,067

Long-term obligations                                       2,640,071       2,106,897
Deferred revenue                                            2,625,000               -

Shareholders' equity:
  Series A preferred stock, $.01 par value; 6,000,000
    shares authorized, none outstanding                             -               -
  Series B convertible exchangeable preferred
    stock, $.001 par value; 12,015 shares authorized,
    issued and outstanding at September 30, 2000
    and December 31, 1999                                  13,047,172      12,390,513
  Common stock $.01 par value; 80,000,000 shares
    authorized, 42,117,297 and 34,019,175
    shares outstanding at September 30, 2000
    and December 31, 1999                                 198,070,708      98,122,922
  Accumulated deficit                                    (138,911,980)   (103,532,432)
  Deferred compensation                                      (271,167)              -
  Accumulated other comprehensive loss                              -         (15,489)
                                                        -------------   -------------
      Total shareholders' equity                           71,934,733       6,965,514
                                                        -------------   -------------
                                                        $  84,629,607   $  13,692,478
                                                        =============   =============
</TABLE>

         The accompanying notes are an integral part of this statement.

                                      -4-
<PAGE>

                         TARGETED GENETICS CORPORATION
                     CONSOLIDATED STATEMENTS OF OPERATIONS
                                  (Unaudited)

<TABLE>
<CAPTION>
                                                    Three months ended            Nine months ended
                                                      September 30,                 September 30,
                                               ----------------------------  ----------------------------
                                                   2000           1999           2000           1999
                                               ------------   ------------   ------------   ------------
<S>                                            <C>            <C>            <C>            <C>
Revenue:
  Collaborative agreements                     $  5,842,928   $  1,364,545   $  8,916,394   $  3,987,662
  Collaborative agreements with affiliates          499,854              -      1,353,914              -
                                               ------------   ------------   ------------   ------------
      Total revenue                               6,342,782      1,364,545     10,270,308      3,987,662

Operating expenses:
  Research and development                        4,498,131      3,636,415     12,753,931     10,296,869
  Technology license fee                                  -              -              -      3,200,000
  Acquired in-process research
     and development                             28,029,000              -     28,029,000              -
  Amortization of acquisition
     related intangibles                            169,190              -        169,190              -
  General and administrative                      1,107,931        967,624      3,306,504      2,408,474
                                               ------------   ------------   ------------   ------------
      Total operating expenses                   33,804,252      4,604,039     44,258,625     15,905,343
                                               ------------   ------------   ------------   ------------

Loss from operations                            (27,461,470)    (3,239,494)   (33,988,317)   (11,917,681)

Equity in loss of joint venture                    (622,695)   (12,015,000)    (1,794,226)   (12,015,000)
Investment income                                   576,819        123,589      1,256,076        344,744
Interest expense                                    (67,957)       (57,632)      (196,422)      (163,335)
                                               ------------   ------------   ------------   ------------

Net loss                                        (27,575,303)   (15,188,537)   (34,722,889)   (23,751,272)

Accretion of dividend on preferred stock           (224,106)      (163,602)      (656,659)      (163,602)
                                               ------------   ------------   ------------   ------------

Net loss applicable to common stock            $(27,799,409)  $(15,352,139)  $(35,379,548)  $(23,914,874)
                                               ============   ============   ============   ============

Basic and diluted net loss per common share          $(0.75)        $(0.46)        $(0.98)        $(0.76)
                                               ============   ============   ============   ============

Shares used in computation of basic and
  diluted net loss per common  share             37,301,598     33,190,783     36,182,094     31,559,622
                                               ============   ============   ============   ============
</TABLE>

        The accompanying notes are an integral part of this statement.

                                      -5-
<PAGE>

                         TARGETED GENETICS CORPORATION
                     CONSOLIDATED STATEMENTS OF CASH FLOWS
                                  (Unaudited)

<TABLE>
<CAPTION>
                                                                                    Nine months ended
                                                                                      September 30,
                                                                               ---------------------------
                                                                                    2000          1999
                                                                               ------------   ------------
<S>                                                                            <C>            <C>
Operating activities:
Net loss                                                                       $(35,379,548)  $(23,914,874)
Adjustments to reconcile net loss to net cash
 provided by operating activities:
  In-process research and development                                            28,029,000              -
  Equity in loss of joint venture                                                 1,794,226     12,015,000
  Technology license fee paid with common stock and warrants                              -      3,200,000
  Depreciation and amortization                                                   1,316,038      1,133,704
  Accretion on preferred stock                                                      656,659              -
  Changes in operating assets and liabilities:
     Increase in deferred revenue                                                 3,959,000              -
     Decrease (increase) in accounts receivable                                   1,198,450     (1,240,199)
     Decrease (increase) in other assets                                           (486,908)       206,317
     Decrease in accounts payable and accrued liabilities                          (779,879)      (143,322)
     Decrease in accrued interest on securities
       available for sale                                                            44,026         79,531
                                                                               ------------   ------------
  Net cash provided by (used in) operating activities                               351,064     (8,663,843)
                                                                               ------------   ------------

Investing activities:
Maturities of securities available for sale                                       3,023,934      6,881,277
Investment in unconsolidated joint venture                                       (1,794,226)             -
Cash acquired in acquisition                                                        358,892              -
Purchases of property, plant and equipment                                         (800,208)    (1,379,568)
Purchases of securities available for sale                                                -       (494,314)
                                                                               ------------   ------------
     Net cash provided by investing activities                                      788,392      5,007,395
                                                                               ------------   ------------

Financing activities:
Net proceeds from issuance of equity securities                                  32,720,625      6,575,208
Proceeds from leasehold improvement and equipment financing                         671,594        960,283
Net proceeds from stock option and warrant exercises                              1,097,428         21,333
Payments under capital leases and installment loans                                (898,673)      (794,859)
                                                                               ------------   ------------
  Net cash provided by financing activities                                      33,590,974      6,761,965
                                                                               ------------   ------------

Net increase in cash and cash equivalents                                        34,730,430      3,105,517
Cash and cash equivalents, beginning of period                                    4,100,798      1,870,841
                                                                               ------------   ------------
Cash and cash equivalents, end of period                                       $ 38,831,228   $  4,976,358
                                                                               ============   ============

Supplemental disclosure of noncash investing and financing activities:
  Investment in joint venture                                                  $          -   $ 12,015,000
  Equipment financed through capital lease                                          105,451        153,677
  Equity instruments issued for acquisitions                                     66,129,733              -

</TABLE>

         The accompanying notes are an integral part of this statement.

                                      -6-
<PAGE>

                         TARGETED GENETICS CORPORATION
                  NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                                  (Unaudited)

Note 1.   Basis of Presentation

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

     The results of operations for the three months and nine months ended
September 30, 2000, are not necessarily indicative of the results to be expected
for the full year. The accompanying consolidated financial statements and
related footnotes should be read in conjunction with the audited and unaudited
consolidated financial statements and accompanying footnotes for the year ended
December 31, 1999 included in the Targeted Genetics' annual report on Form 10-K
for the year ended December 31, 1999 and the quarters ended March 31 and June
30, 2000, included in Targeted Genetics' quarterly reports on Form 10-Q for the
quarters ended March 31, 2000 and June 30, 2000, respectively.

Note 2.   Acquisition of Genovo

     On September 19, 2000, Targeted Genetics acquired all of the outstanding
shares of capital stock of Genovo, Inc, a development-stage biotechnology
company specializing in viral gene delivery. Targeted Genetics accounted for the
acquisition of Genovo as a purchase transaction. Aggregate consideration for the
acquisition was approximately $66.4 million, which consisted of the
following:

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

</TABLE>

                                      -7-
<PAGE>

     The 5,250,805 shares issued as merger consideration were valued at $11.1337
per share based on the average share price of Targeted Genetics common stock for
the time period beginning four trading days before the announcement of the
acquisition through four trading days after the announcement. The common stock
issued in connection with the acquisition includes 851,873 shares issued to
Biogen, Inc. in exchange for its rights to certain Genovo technologies. These
shares represent the negotiated value of the Genovo technology rights which were
previously transferred by Genovo to Biogen. Merger consideration also includes
550,872 shares of Targeted Genetics common stock that are held in escrow pending
the resolution of specified legal and contractual issues.

     Stock option consideration included in the acquisition consideration
represents the aggregate value of Genovo stock options converted into Targeted
Genetics options less approximately $301,000, the intrinsic value of the options
that vest over future service periods. The fair value of the 1,302,034 options
issued as merger consideration include employee stock options to purchase
679,444 shares and Genzyme's option to purchase 622,590 shares of common stock.

     Transaction costs include attorney fees, accounting fees, valuation
advisory fees and printing costs.

     Under two circumstances, subsequent to the merger of Targeted Genetics and
Genovo, Targeted Genetics may issue additional shares of its common stock as
merger consideration to the former Genovo common stockholders and stock-option-
plan optionholders as follows:

     .  Because certain Genovo licensing arrangements were unresolved at the
        time of the merger, Targeted Genetics and Genovo agreed to establish an
        escrow of 700,000 shares of Targeted Genetics common stock as potential
        additional merger consideration pending resolution of these issues.
        These shares are held in escrow for the benefit of former Genovo
        stockholders. All or a portion of the shares will be released to the
        stockholders if Targeted Genetics successfully renegotiates these
        license terms no later than 18 months after the merger.

     .  In connection with the merger and an August 1999 collaborative research
        agreement between Genzyme Corporation and Genovo, Targeted Genetics
        assumed Genzyme's outstanding option to purchase Genovo capital stock in
        two tranches. Subsequent to the merger, Genzyme exercised the first
        option tranche to purchase 311,295 shares of Targeted Genetics common
        stock at $12.8495 per share. In August 2001, Genzyme may exercise the
        second option tranche and acquire up to an additional 311,295 shares of
        Targeted Genetics common stock (as successor company to Genovo) also at
        a price of $12.8495 per share. If at that time, Genzyme should elect to
        purchase fewer than 311,295 shares of Targeted Genetics stock, the
        former Genovo shareholders and optionholders will receive additional
        purchase price consideration in the form of shares equal to one-half the
        difference between the number of shares purchased by Genzyme and the
        311,295 shares purchasable by Genzyme.

                                      -8-
<PAGE>

     The potential issuance of the escrowed shares and the additional purchase
price consideration is not included in the calculation of the purchase price as
it is contingent upon future events. In each case, the fair value of the shares
issued to the former Genovo shareholders, if any, will be determined on the date
of resolution of the matters and will be reflected as additional purchase price.

     While at the time of acquisition none of the Genovo technology programs was
at a stage beyond early research and development, each identified program had
specific objectives and data supporting its intended purpose in the field of
gene delivery. The aggregate purchase price exceeded the fair value of tangible
and intangible assets acquired by approximately $28.0 million. This amount was
allocated to in-process research and development (IPR&D) and expensed during the
third quarter of 2000. The aggregate purchase price was allocated, based on
estimated fair values on the acquisition date, as follows:

<TABLE>
<S>                                             <C>
Acquired in-process research and development     $28,029,000
Assembled work force                                 605,000
Employment contracts                               1,010,000
Tangible assets acquired                           1,850,000
Liabilities assumed                               (2,974,000)
Acquired AAV know-how                             12,723,000
Goodwill                                          25,169,000
                                                 -----------
Total purchase price                             $66,412,000
                                                 ===========
</TABLE>

     The Company will amortize the acquired assets associated with the Genovo
purchase as follows:

<TABLE>
<S>                                             <C>
Acquired asset:                                 Amortization period
Assembled work force                                 4 years
Employment contracts                                 2 years
Tangible assets acquired                          remaining life
Acquired AAV know-how                                7 years
Goodwill                                             7 years

</TABLE>

     Acquired in-process research and development in the merger was evaluated
utilizing the present value of the estimated after-tax cash flows expected to be
generated by the purchased technology, which had not reached technological
feasibility at the effective time of the merger. The cash flow projections for
revenue are based on estimates of growth rates and the aggregate size of the
markets for each product or technology; the probability of technical success
given the stage of development at the time of acquisition; royalty rates based
on prior licensing agreements; product sales cycles; and the estimated life of
the product's underlying technology. Estimated operating expenses and income
taxes were deducted from estimated revenue projections to arrive at estimated
after-tax cash flows. The rates utilized to discount projected cash flows were
30% to 45% for in-process technologies depending on the relative risk of each
in-process technology and were based primarily on Targeted Genetics' internal
rates of return, cost of capital, rates of return for research and development
and the weighted average cost of

                                      -9-
<PAGE>

capital at the time of acquisition. Projected operating expenses include general
and administrative expenses, and research and development costs.

     Targeted Genetics based all of the foregoing estimates and projections
regarding the Genovo acquisition on assumptions that it believed to be
reasonable at the time of the acquisition, but which are inherently uncertain
and unpredictable. If Targeted Genetics does not successfully develop the
projects and technologies considered in these estimates, its business, operating
results, and financial condition may be adversely affected. As of the date of
the acquisition, management concluded that the technologies under development,
once completed, could be economically used only for their specifically intended
purposes and that the in-process technology had no alternative future use after
taking into consideration the overall objectives of the project, progress toward
the objectives, and uniqueness of developments to these objectives. If Targeted
Genetics fails in its development efforts, no alternative economic value will
result from these technologies. If the projects fail, the economic contribution
projected to be made by the IPR&D will not materialize. The risk of unsuccessful
or untimely completion includes the risk that Targeted Genetics' competitors
will develop alternative gene delivery technologies or will develop more
effective or economically feasible technologies using more traditional
approaches to treating human diseases.

     The following table reflects unaudited consolidated pro forma results of
operations for the nine months ended September 30, 2000 which give effect to the
Genovo acquisition as if it had occurred on January 1, 2000 and for the nine
months ended September 30, 1999 which give effect to the Genovo acquisition as
if it had occurred on January 1, 1999. These pro forma amounts are not
necessarily indicative of what the actual consolidated results of operations
would have been if the acquisition had been effective at the beginning of each
of these periods. The pro forma information does not include the one-time
charges for purchased IPR&D or other transaction-related costs relating to the
acquisition of Genovo:

For the nine months ended:

<TABLE>
<CAPTION>
                                             September 30, 2000     September 30, 1999
                                             ------------------     ------------------
<S>                                          <C>                    <C>
 Revenue                                         $ 14,129,000           $  7,451,000
 Net loss                                         (20,192,000)           (33,080,000)
 Basic and diluted net loss per share                   (0.49)                 (0.90)
 Shares used in computation of basic and
  diluted net loss per common  share               41,462,000             36,810,000

</TABLE>

                                     -10-
<PAGE>

Note 3.   Biogen Collaboration

     On September 19, 2000, Targeted Genetics established a multiple-product
development and commercialization collaboration with Biogen, Inc. Under the
terms of the Biogen agreements, Targeted Genetics will develop up to four new
gene therapy product candidates with Biogen. The specific genes to be delivered
will be determined by Biogen and Targeted Genetics over the next three years. In
addition, Targeted Genetics will provide process development assistance related
to Biogen's manufacturing of an existing gene therapy product candidate
currently in clinical development for the treatment of glioma, resulting in a
total of up to five products covered by the collaboration. Biogen paid Targeted
Genetics $8 million upon initiation of the collaboration and will provide
Targeted Genetics with a minimum of $3 million in research and development
funding over three years, at a rate of $1 million per year. The $8 million up-
front payment made by Biogen included prepaid research and development funding
of $3 million. Under the terms of the collaborative agreements, Targeted
Genetics granted Biogen an exclusive worldwide license to sell products
developed in the collaboration and assumed responsibility for manufacturing and
supplying bulk vector supplies to support product development, clinical trials
and product commercialization.

     In the third quarter of 2000, Targeted Genetics recognized $5 million of
up-front revenue from the Biogen collaboration. Targeted Genetics will recognize
revenue on the remaining $3 million of up-front payment and the $1 million of
minimum annual project funding as it performs research and development efforts.
Targeted Genetics performed no research and development efforts attributable to
the Biogen collaboration agreements in the quarter ending September 30, 2000.

     Biogen also agreed to provide loans up to $10 million to Targeted Genetics
over the next five years and to purchase up to $10 million of Targeted Genetics
common stock, each at the discretion of Targeted Genetics. Targeted Genetics may
make up to five draws against the $10 million loan amount with any draws bearing
interest at market rates. Targeted Genetics can elect to have Biogen purchase
the common stock in one or more tranches during the first three years of the
agreement. The price per share for each purchase shall equal the average of the
daily closing prices of a share of Company common stock for a certain period of
time before and after each exercise date.

     Assuming successful commercialization of products under the collaboration
with Biogen, Targeted Genetics could receive an aggregate of up to $125 million
in license fees, development funding, milestone payments, loans and equity
investments connected to the Biogen agreements. Targeted Genetics will receive
royalties based upon sales of products that result from the collaborative
product development efforts or will sell product to Biogen at transfer prices
that include sales-based and cost-based components. The research and development
funding agreement is effective to September 30, 2003 with options to extend the
term if both parties agree. The product manufacturing and supply provisions of
the agreement are effective for the term of the patents covering the Targeted
Genetics technology. Although Biogen may terminate the development agreements
any time following the first anniversary of the agreements, Biogen's obligations
to pay the minimum annual project funding (totaling $3 million over three years)
would continue.

                                     -11-
<PAGE>

Note 4.   Genzyme Collaboration

     On August 30, 1999, Genovo entered into a Development and License Agreement
with Genzyme Corporation under which Genovo was committed to perform, at its own
cost, up to $2.9 million per year of research and development activities for up
to three years. A separate agreement also provided for Genzyme to purchase up to
$11.4 million of Genovo equity, of which $3.4 million has been purchased as of
September 30, 2000. Upon the achievement of certain regulatory milestones,
Genzyme is be required to make milestone payments to Genovo and pay royalties to
Genovo on sales of products developed under the agreement. The initial term of
the agreement is three years and may be cancelled by Genzyme at any time with
notice. Targeted Genetics assumed the Genzyme agreements when it acquired
Genovo. None of the aforementioned milestones has been reached as of September
30, 2000.

     On November 4, 2000, Targeted Genetics and Genzyme agreed to amend the
August 1999 Development and License Agreement originally established with Genovo
by expanding the technological scope and financial terms. Genzyme and Targeted
Genetics also agreed to a development plan for the second year of the three-year
collaborative effort. Subsequently, Genzyme exercised its option to purchase
311,295 shares of Targeted Genetics' common stock at the purchase price of
$12.8495, providing $4.0 million of proceeds to the Company.

Note 5.   Emerald Gene Systems

     In July 1999, Targeted Genetics and Elan Corporation, plc ("Elan") formed
Emerald Gene Systems, Ltd. ("Emerald"), a joint venture to develop enhanced gene
delivery technology and products utilizing Targeted Genetics' gene therapy
expertise and Elan's drug delivery expertise. Targeted Genetics currently owns
an 80.1% interest in Emerald and Elan owns 19.9% (non-voting). Although Targeted
Genetics owns 100% of the voting common shares, Elan and its subsidiaries have
retained significant minority investor rights that are considered "participating
rights," as defined by the FASB's Emerging Issues Task Force Bulletin 96-16,
Investors' Accounting for an Investee When the Investor Has a Majority of the
Voting Interest but the Minority Shareholder Has Certain Approval or Veto
Rights. Elan's participating rights prevent Targeted Genetics from exercising
control over Emerald. Accordingly, Targeted Genetics does not consolidate the
financial statements of Emerald but instead accounts for its investment in
Emerald under the equity method of accounting. Targeted Genetics recognized
$500,000 and $1.4 million of revenue during the quarter and nine month periods
ended September 30, 2000. The Company recognized no revenue from Emerald during
the third quarter or first nine months of 1999 as the Emerald collaboration
began in the fourth quarter of 1999. Emerald's unaudited results for the three
and nine months ended September 30, 2000 were as follows:

                                     -12-
<PAGE>

                          EMERALD GENE SYSTEMS, LTD.

                           CONDENSED BALANCE SHEETS

<TABLE>
<CAPTION>
                                                September 30, 2000   December 31, 1999
                                                -------------------  ------------------
                                                    (unaudited)
<S>                                             <C>                  <C>
ASSETS

Current assets:
     Cash and cash equivalents                        $      3,831        $          -
     Prepaid expenses                                        3,801               2,250
                                                      ------------        ------------
       Total current assets                           $      7,632        $      2,250
                                                      ============        ============

LIABILITIES AND SHAREHOLDERS' DEFICIT

Current liabilities:
     Accounts payable and accrued expenses            $      9,658        $      6,350
     Due to shareholders and related parties               263,761             738,346
                                                      ------------        ------------
          Total current liabilities                        273,419             744,696
                                                      ------------        ------------

Shareholders' equity:
     Share capital                                          12,000              12,000
     Contributed surplus                                17,706,668          14,988,000
     Accumulated deficit                               (17,984,455)        (15,742,446)
                                                      ------------        ------------
       Total shareholders' deficit                        (265,787)           (742,446)
                                                      ------------        ------------
                                                      $      7,632        $      2,250
                                                      ============        ============

</TABLE>

                          EMERALD GENE SYSTEMS, LTD.

                      CONDENSED STATEMENTS OF OPERATIONS
                                  (Unaudited)

<TABLE>
<CAPTION>

                                   Three months ended    Nine months ended
                                   September 30, 2000   September 30, 2000
                                   -------------------  -------------------
<S>                                <C>                  <C>
Revenue                                     $       2          $       177
Operating expenses:
     Research and development                 776,058            2,224,108
     General and administrative                 3,367               18,078
                                            ---------          -----------
                                              779,425            2,242,186
                                            ---------          -----------
Net loss                                    $(779,423)         $(2,242,009)
                                            =========          ===========
</TABLE>

                                     -13-
<PAGE>

                          EMERALD GENE SYSTEMS, LTD.

                       CONDENSED STATEMENT OF CASH FLOWS
                                  (Unaudited)

<TABLE>
                                                         Nine months ended
                                                         September 30, 2000
                                                         ------------------
<S>                                                      <C>
Operating activities:
Net loss                                                     $(2,242,009)
Adjustments to reconcile net loss to net cash
 used in operating activities:
  Changes in operating assets and liabilities:
     Decrease in accounts payable and accrued liabilities       (471,277)
     Decrease in other assets                                     (1,551)
                                                             -----------
  Net cash used in operating activities                       (2,714,837)
                                                             -----------

Financing activities:
Net proceeds from additional equity investment                 2,718,668
                                                             -----------
  Net cash provided by financing activities                    2,718,668
                                                             -----------
Net increase in cash and cash equivalents                          3,831

Cash and cash equivalents, beginning of period                         -
                                                             -----------
Cash and cash equivalents, end of period                     $     3,831
                                                             ===========

</TABLE>

Note 6.   Comprehensive Loss

     For the three and nine months ended September 30, 2000 and September 30,
1999, the Company's comprehensive loss was as follows:

<TABLE>
<CAPTION>
                                            Three months ended             Nine months ended
                                              September 30,                  September 30,
                                       ----------------------------  -----------------------------
                                           2000           1999            2000           1999
                                       ------------   ------------    ------------   ------------
<S>                                    <C>            <C>            <C>             <C>
Net loss                               $(27,575,303)  $(15,188,537)   $(34,722,889)  $(23,751,272)
Other comprehensive income:
  Unrealized holding gains (losses)
     during the period                        3,357          8,327          15,489        (42,549)
                                       ------------   ------------    ------------   ------------
Total comprehensive income             $(27,571,946)  $(15,180,210)   $(34,707,400)  $(23,793,821)

</TABLE>

                                     -14-
<PAGE>

Note 7.   Recent Accounting Changes

     In December 1999, the SEC issued Staff Accounting Bulletin No. 101, Revenue
Recognition in Financial Statements (SAB 101), which provides the SEC's views on
applying generally accepted accounting principles to revenue recognition issues.
The Company will adopt SAB 101 in the fourth quarter of 2000. Targeted Genetics
is evaluating SAB 101's potential future impact on its financial position and
results of operations with respect to up-front fees and milestone payments it
earned under collaborative agreements and manufacturing agreements. Targeted
Genetics continues to recognize fees in accordance with its historical revenue
recognition policy while it evaluates the impact of SAB 101. It is possible
that, under SAB 101, certain of these fees, including the $5 million up-front
fee received from Biogen as described in Note 3 and a $5 million up-front fee
received from Celltech Group plc in November 1998 with respect to Targeted
Genetics' cystic fibrosis collaboration, would be required to be deferred and
recognized as revenue over future periods rather than immediately on a one-time
basis.

     In June 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 133, Accounting for Derivative Instruments
and Hedging Activities. Standard No. 133, as amended, is effective for fiscal
years beginning after June 15, 2000 and requires that all derivative instruments
be recorded on the balance sheet at their fair value. Changes in the fair value
of derivatives are recorded for each period in current earnings or other
comprehensive income, depending on whether a derivative is designated as part of
a hedge transaction and, if it is, the type of hedge transaction. Targeted
Genetics does not expect the adoption of Standard No. 133 to have a material
impact on its consolidated financial statements as Targeted Genetics does not
currently hold any derivative instruments.

Note 8.   Subsequent Events

     In November 2000, the Company announced that it had entered into a
collaboration to develop gene therapy products for the treatment of hemophilia
with Genetics Institute, the biotech research division of Wyeth-Ayerst, a
division of American Home Products Corporation. Under the terms of the
agreement, Targeted Genetics has agreed to collaborate on the development of
adeno-associated virus (AAV) vector based products for hemophilia A and,
potentially, for hemophilia B.

     Genetics Institute has agreed to pay Targeted Genetics $5 million in up-
front payments, up to $15 million for development of the hemophilia A product
over the next three years and, subject to the achievement of specified
objectives, development and commercialization milestones. Targeted Genetics also
granted Genetics Institute an option to collaborate on the development of
hemophilia B products which, if developed, would trigger additional payments to
Targeted Genetics. Genetics Institute, has agreed to manage and fund the costs
of clinical trials and related regulatory filings required for product approval
and marketing. Wyeth/Genetics Institute will retain global marketing rights for
any products resulting from the alliance.

     Under the terms of the agreements, Genetics Institute also has agreed to
loan Targeted Genetics, up to $10 million to finance certain manufacturing
facility expansions. In addition,

                                     -15-
<PAGE>

Genetics Institute has agreed to pay Targeted Genetics to manufacture product
for clinical trials and, upon approval, for commercial use according to a sales-
based formula.

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

Forward-Looking Statements

     Some of the statements contained in or incorporated by reference into this
quarterly report on Form 10-Q are forward-looking statements. Forward-looking
statements involve current expectations or forecasts of future events and other
statements that are not historical facts. Inaccurate assumptions and known or
unknown risks and uncertainties can affect the accuracy of forward-looking
statements. Any or all of the forward-looking statements contained in this
quarterly report, incorporated by reference into this quarterly report, or
included in any materials we release to the public from time to time may turn
out to be incorrect. Actual results could differ materially from those expressed
in the forward-looking statements for a number of reasons, including the factors
discussed in the section of this quarterly report entitled "Factors Affecting
Our Operating Results, Our Business and Our Stock Price."

     You should not unduly rely on these forward-looking statements, which speak
only as of the date of this quarterly report. We undertake no obligation to
update any forward-looking statement to reflect new information or circumstances
or the occurrence of unanticipated events. Other risks besides those described
in this quarterly report could also affect actual results. Moreover, we cannot
assess the impact of any particular risk factor on our business or the extent to
which any factor, or combination of factors, may cause actual results to differ
materially from those contained in any forward-looking statement.

Results of Operations

     Revenue.  Revenue for the quarter ended September 30, 2000 increased to
$6.3 million from $1.4 million for the third quarter of 1999. Revenue for the
nine months ended September 30, 2000 increased to $10.3 million from $4.0
million for the same period in 1999. The revenue increases in both periods were
due to receipt of a $5 million up-front payment upon the initiation of a multi-
year, multi-product collaboration with Biogen, Inc. and increases in revenue
from Emerald Gene Systems, our gene delivery joint venture with Elan
Corporation, plc. These increases were partially offset by decreased revenue
from our cystic fibrosis product development collaboration with Celltech Group
plc.

     R&D Expenses.  Research and development expenses for the quarter ended
September 30, 2000 increased to $4.5 million from $3.6 million for the third
quarter of 1999. Research and development expenses increased to $12.8 million
for the first nine months of 2000 from $10.3 million for the same period in
1999. The increases in both periods are attributable to the hiring of additional
research scientists to support our Emerald collaboration and the hiring of
additional clinical and regulatory personnel to administer our cystic fibrosis
and cancer clinical trials, to increased costs associated with our cancer and
preclinical hemophilia product development

                                     -16-
<PAGE>

efforts and to increased legal costs related to our patent portfolio. We expect
to see continued increases in quarterly research and development costs
attributable to operating the former Genovo facility and developing our
preclinical gene therapy product candidates for cancer, hemophilia, AIDS and
arthritis. Our costs will also vary depending on the level of clinical trial
activity occurring in each quarter.

     License Fees.  Technology license fees for the first nine months of 1999
were attributable to a $3.2 million noncash charge related to the issuance of
stock and warrants to Alkermes, Inc. in exchange for an exclusive sublicense to
a patent for the manufacture of adeno-associated viral (AAV) vectors, which we
use in our cystic fibrosis, hemophilia, AIDS vaccine and arthritis programs. We
issued 500,000 shares of our common stock and warrants to purchase up to
2,000,000 additional shares in exchange for this technology license. Except for
the technology license fees paid by Emerald Gene Systems, described below, we
had no technology license fee expenses in the third quarter of 2000 or the third
quarter of 1999 and had no technology license fee expenses in the first nine
months of 2000.

     IPR&D.  In the quarter ended September 30, 2000, we incurred in-process
research and development (IPR&D) expense of $28.0 million which reflects the
amount allocated to IPR&D that we acquired when we purchased Genovo, Inc.

     The IPR&D from the Genovo acquisition represents the present value of the
estimated after-tax cash flows that we expect to be generated by the purchased
technology that, as of the acquisition date, had not yet reached technological
feasibility. We based the cash flow projections for revenues on estimates of
growth rates and the aggregate size of the markets for each product, the
probability of technical success given the stage of development at the time of
acquisition, royalty rates based on prior licensing agreements, product sales
cycles, and the estimated life of the product's underlying technology. We
deducted our estimated operating expenses and income taxes from our estimated
revenue projections to arrive at our estimated after-tax cash flows. The rate
that we used to discount projected cash flows ranged from 30% to 45% for in-
process technologies, which we based primarily on internal rates of return, cost
of capital, rates of return for research and development and the weighted
average cost of capital for us at the time of acquisition. Our projected
operating expenses include general and administrative expenses and research and
development costs.

     We acquired ongoing IPR&D projects from Genovo in the fields of adeno-
associated virus (AAV) manufacturing platform, hyperlipidemia, lysosomal storage
disorders (LSD), glioma and hemophilia. Of the IPR&D amount, approximately $19.6
million is related to AAV manufacturing platform projects, approximately $7.5
million is related to hyperlipidemia projects, approximately $538,000 is related
to hemophilia projects, approximately $217,000 is related to LSD projects, and
the remaining approximately $177,000 is related to glioma projects. We assigned
values to these programs, based on the discounted cash flows currently projected
from the technologies acquired. If we do not successfully develop these
programs, our business, operating results, and financial condition may be
adversely affected.

 .  Genovo's AAV Manufacturing Platform projects are efforts to manufacture AAV
   as a stable gene therapy vector capable of delivering genes to a variety of
   dividing and non-dividing

                                     -17-
<PAGE>

   cells. Several companies are studying AAV vectors for gene transfer in a
   broad range of chronic disease indications. Genovo has identified patient
   populations for potential projects and potential partners as candidates for
   using its early-stage manufacturing platform to develop specific AAV vectors
   to deliver candidate genes. Genovo has estimated that the additional research
   and development costs to complete the AAV manufacturing platform projects in
   2007 will be approximately $23.8 million. Additional AAV platform projects in
   early development stages are scheduled for completion by 2008 and 2009. As of
   the acquisition date Genovo had made progress in this field in the areas of
   bench processes, establishing Good Laboratory Procedures (GLP) grade
   processes and scale-up processes. Significant risk for the AAV Manufacturing
   Platform projects remain in relation to completing scale-up efforts, and
   establishing, validating and commercializing Good Manufacturing (GMP) grade
   processes.

 .  Hyperlipidemia is an elevation of lipids in the bloodstream that are
   transported as part of large molecules called lipoproteins. Genovo's
   hyperlipidemia technology is targeted at patient populations requiring
   treatment of elevated cholesterol and patients with existing cardiovascular
   disease. Genovo plans to jointly develop with a partner a gene therapy
   product to treat hyperlipidemia. Genovo has estimated that a hyperlipidemia
   technology will be completed in 2007, at a cost of an additional $16.0
   million in research and development. As of the acquisition date, Genovo had
   made progress in the areas of discovery, research, and preclinical work.

 .  Lysosomal storage disorders (LSD) are a family of approximately 40 genetic
   diseases, each of which typically affects fewer than 5,000 to 10,000 people
   worldwide. These diseases are normally single-gene defects that affect the
   production of one or more lysosomal enzymes, leading to abnormal deposits of
   substrates within lysosomal vacuoles. Genovo is developing with a partner a
   gene therapy product to treat LSD. Genovo has estimated the additional costs
   to complete its LSD technologies at $9.0 million, with a targeted completion
   date in 2007. As of the acquisition date, Genovo had made progress in this
   field in the areas of discovery, research, and preclinical work.

 .  Genovo's glioma technology is intended to treat brain tumors in adults. These
   tumors, which are highly malignant, are nearly always fatal and currently
   have no known curative treatment. Genovo is developing with a partner a gene
   therapy product to treat glioma. Genovo has estimated the additional costs to
   complete its glioma technologies at $750,000, with a targeted completion date
   in 2006. As of the acquisition date, Genovo had made progress in this field
   in the areas of discovery, research, and preclinical work.

 .  Hemophilia is an x-chromosome linked recessive clotting disorder caused by a
   mutation in one of the body's plasma proteins and results in prolonged
   external and/or internal bleeding. Genovo plans to jointly develop with a
   partner a gene therapy product to treat hemophilia. Genovo has estimated the
   additional costs to complete its hemophilia technologies at $12.0 million,
   with a targeted completion date in 2009. As of the acquisition date, Genovo
   had made progress in this field in the areas of discovery, research, and
   preclinical work.

                                     -18-
<PAGE>

     We based all of the these estimates and projections on assumptions we
believed to be reasonable at the time of the acquisition but that are inherently
uncertain and unpredictable. If we do not successfully develop these projects,
our business, operating results, and financial condition may be adversely
affected. As of the date of the acquisition, we concluded that the technologies
under development, once completed, can be economically used only for their
specifically intended purposes and that the in-process technologies have no
alternative future use after taking into consideration the overall objectives of
the project, progress toward the objectives, and uniqueness of developments to
these objectives. If the projects fail, the economic contribution we project the
IPR&D to make will not materialize. The risk of untimely completion includes the
risk that competitors will develop alternative products.

     Amortization of Acquisition Related Intangibles.  In the quarter ended
September 30, 2000 and for the first nine months of 2000 the Company recorded
amortization expense of $151,000 for goodwill, non-compete agreements and work
force know-how that we acquired when we purchased Genovo, Inc.

     General and Administrative Expenses.  General and administrative expenses
for the quarter ended September 30, 2000 increased to $1.1 million from $1.0
million for the third quarter of 1999. General and administrative expenses for
the first nine months of 2000 increased to $3.3 million from $2.4 million for
the same period in 1999. The increases in both periods reflect greater
investment in business development, increased shareholder communications costs
and costs of general support to our growing number of collaborative
partnerships.

     Losses from Emerald.  We recognized losses of $623,000 in the third quarter
of 2000 and losses of $1.8 million in the first nine months of 2000,
representing our 80.1% share in the losses of the Emerald joint venture. Results
for the third quarter and first nine months of 1999 include our 80.1% share of a
license fee paid by Emerald for exclusive rights to use specified Elan drug
delivery technologies within the gene delivery field. We did not incur any other
ongoing expenses related to Emerald in the third quarter or first nine-months of
1999.

     Investment Income.  Investment income for the quarter ended September 30,
2000 increased to $577,000 from $124,000 for the third quarter of 1999.
Investment income for the first nine months of 2000 increased to $1.3 million
from $345,000 for the comparable period in 1999. The increases in both periods
resulted from the investment of the net proceeds from our March 1, 2000 private
placement of approximately 2.2 million shares of our common stock.

     Interest Expense.  Interest expense for the quarter ended September 30,
2000 increased to $68,000 from $58,000 for the third quarter of 1999. Interest
expense for the first nine months of 2000 increased to $196,000 from $163,000 in
the same period in 1999. The increases in both periods were due primarily to
higher average outstanding principal balances in 2000.

Financial Condition

     As of September 30, 2000, we had $38.8 million in cash and cash equivalents
and $32.7 million in working capital. In comparison, at December 31, 1999, we
had $7.2 million in cash, cash equivalents and securities available for sale and
$4.6 million in working capital. The increases in cash and

                                     -19-
<PAGE>

working capital are mainly attributable to our March 2000 private placement of
approximately 2.2 million shares of our common stock, which provided net
proceeds of $28.2 million. We also increased our cash balance by $8.0 million in
September 2000 with the up-front payment we received when we entered into the
collaborative agreement with Biogen. Additionally, in July 2000, we exercised
our option under agreements related to our Emerald joint venture, to sell
382,739 shares of our stock to Elan, resulting in proceeds of $5.0 million.
These increases were partially offset by operating losses, investments in
capital equipment and principal payments on capital lease obligations. We
currently fund substantially all of our equipment purchases with capital leases.

     In conjunction with the Emerald joint venture, Elan agreed to loan us up to
$12 million, in the form of convertible debt bearing 12% interest per annum, to
fund our share of Emerald's research and development costs. In connection with
the Biogen collaboration, Biogen agreed to loan us up to $10 million, in the
form of a term loan bearing interest at market-based rates, and agreed to
purchase up to $10 million of our common stock at market rates, each at our
option. As of September 30, 2000, we have not drawn any proceeds under either
loan agreement nor exercised our right to have Biogen purchase our common stock.

     Since we began operations, our primary sources of revenue have been
research funding under collaborative agreements, license fees and income earned
from investments. These sources have covered approximately 20% of our expenses
since we started business. Gene therapy products are subject to long development
timelines and the risks of failure inherent in the development of products based
on innovative technologies. Although our technology appears promising, we do not
know whether any commercially viable products will result from our research and
development activities. Because we do not anticipate that we will have any
product-related revenue for at least the next several years, we expect to
generate substantial additional losses in the future.

     We currently estimate that, based on our current planned rate of spending,
our existing cash, cash equivalents and securities available for sale, together
with the funding projected to be provided by our existing collaborative
partners, will be sufficient to meet our operating and capital requirements well
into 2002. Although we expect to generate additional funding from new
collaborative relationships before that time, we may not be successful in
establishing additional collaborative relationships or in maintaining our
existing ones. The assumed levels of revenue and expense underlying our
estimates may not be accurate. Whether or not our assumptions prove to be
accurate and regardless of our partnering success, we expect that we will need
to raise substantial additional funds to continue developing and commercializing
our product candidates.

Recent Accounting Changes

     In December 1999, the SEC issued Staff Accounting Bulletin No. 101, Revenue
Recognition in Financial Statements (SAB 101), which provides the SEC's views on
applying generally accepted accounting principles to revenue recognition issues.
The Company will adopt SAB 101 in the fourth quarter of 2000. We are evaluating
SAB 101's potential future impact on our financial position and results of
operations with respect to how we recognize up-front fees and

                                     -20-
<PAGE>

milestone payments under collaborative agreements and manufacturing agreements.
We continue to recognize fees in accordance with our historical revenue
recognition policy while we evaluate the impact of SAB 101. In November 1998 we
received a $5 million up-front payment from Celltech Group plc with respect to
our ongoing cystic fibrosis collaboration. In September 2000 we received a $5
million up-front payment from Biogen as described in Note 3 to the consolidated
financial statements. It is possible that, under SAB 101, certain of these fees
would be required to be deferred and recognized as revenue over future periods
rather than immediately on a one-time basis.

     In June 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 133, Accounting for Derivative Instruments
and Hedging Activities. Standard No. 133, as amended, is effective for fiscal
years beginning after June 15, 2000 and requires that all derivative instruments
be recorded on the balance sheet at their fair value. Changes in the fair value
of derivatives are recorded for each period in current earnings or other
comprehensive income, depending on whether a derivative is designated as part of
a hedge transaction and, if it is, the type of hedge transaction. We do not
expect the adoption of Standard No. 133 to have a material impact on our
consolidated financial statements as we do not currently hold any derivative
instruments.

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

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

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

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

     .  technology partnerships;
     .  technology sales;
     .  technology licenses;
     .  issuing debt; or
     .  issuing equity.

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

                                     -21-
<PAGE>

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

     We have generated small amounts of revenue and incurred significant net
losses since we began business. As of September 30, 2000, we have incurred
cumulative losses totaling $138.8 million. We expect to continue to incur
substantial additional losses in the future, due primarily to the following
factors:

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

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

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

     All of our potential products are in research and development or in early-
stage clinical trials. We cannot apply for regulatory approval of our potential
products until we have performed additional research and development and
testing. Our clinical trials may not demonstrate the safety and efficacy of any
potential product, and we may encounter unacceptable side effects or other
problems in the clinical trials. Should this occur, we may have to delay or
discontinue development of the potential product. After a successful clinical
trial, we cannot market any product in the United States until we receive
regulatory approval. If we are unable to gain regulatory approval of any product
after successful clinical trials, we may be unable to generate sufficient
product revenue to maintain our business.

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

     The regulatory process in the gene therapy industry is costly, time
consuming and subject to unpredictable delays. Accordingly, we cannot predict
how long it will take or how much it will cost to obtain regulatory approvals
for clinical trials or for manufacturing or marketing our potential products.
Delays in bringing a potential product to market or unexpected costs in
obtaining regulatory approval could decrease our ability to generate product
sales revenue. In addition, all manufacturing operations are subject on an
ongoing basis to the current Good Manufacturing Practices, or GMP, requirements
of the Food and Drug Administration, or FDA. While we currently anticipate that
we will be able to manufacture products that meet this requirement, we may be
unable to attain or maintain compliance with current or future GMP requirements.
If we discover previously unknown problems after we receive regulatory approval

                                     -22-
<PAGE>

of a potential product or fail to comply with applicable regulatory
requirements, we may suffer restrictions on our ability to market the product,
including mandatory withdrawal of the product from the market. This, or an
unexpected increase in the cost of compliance, could make it more difficult to
maintain or improve our financial condition.

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

     Identifying and qualifying patients to participate in testing our potential
products is critical to our near-term success. The timing of our clinical trials
depends on the speed at which we can recruit patients to participate in testing
our products. Delays in recruiting or enrolling patients to test our products
could result in increased costs, delays in advancing our product development,
delays in proving the usefulness of our technology or termination of the
clinical trials altogether. Any of these could delay or prevent the development
of our product candidates.

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

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

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

     Our success depends in part on our ability to protect our proprietary
rights. We own or have licenses to patents on a number of genes, processes,
practices and techniques critical to our present and potential products. If we
fail to obtain and maintain patent protection for this technology, our
competitors could market competing products using those genes, processes,
practices and techniques. The failure of our licensors to obtain and maintain
patent protection for technology they license to us could similarly harm our
business. Patent 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. Even if we secure a patent, the
patent may not provide meaningful protection.

     We also rely on unpatented proprietary technology. Because this technology
does not benefit from the protection of patents, we may be unable to
meaningfully protect this proprietary technology from unauthorized use or
misappropriation by a third party.

                                     -23-
<PAGE>

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

     As the biotechnology industry expands, the risk increases that other
companies may claim that our processes and potential products infringe on their
patents. Defending these claims would be costly and would likely divert
management's attention and resources away from our operations. If we infringe on
another company's patented processes or technology, we may have to pay damages
or obtain a license in order to continue manufacturing or marketing the affected
product or using the affected process. If we are unable to obtain a license, or
obtain a license on acceptable terms, we may be unable to develop or
commercialize some or all of our potential products and our business could be
harmed.

     Our potential tgAAV-CF product uses our proprietary AAV delivery technology
to deliver a normal copy of a CFTR gene to which we have rights under a
nonexclusive license. The United States Patent and Trademark Office has declared
an interference proceeding to determine the priority of invention of this gene.
If the eventual outcome does not favor our licensor, we would have to secure a
license to the CFTR gene from the prevailing party to continue developing tgAAV-
CF. The costs of licensing the CFTR gene could be substantial and could include
royalties greater than those we currently pay. If we cannot secure this license
on acceptable terms and on a timely basis, we may be unable to develop or
deliver our potential tgAAV-CF product.

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

     Our success depends on the continued availability of outside scientific
collaborators to perform research and develop processes to advance and augment
our internal efforts. Competition for collaborators in gene therapy is intense.
If we are unsuccessful in recruiting or maintaining our relationships with
scientific collaborators, we could experience delays in our research and
development or loss of access to important enabling technology. Even if we
establish new scientific collaborations or other partnerships, they may never
result in the successful development of products.

     The development and commercialization of many of our potential products,
and therefore the success of our business, substantially depends on the
performance of our collaborators. If our corporate partners do not commit
sufficient resources to our research and development programs or the
commercialization of our products, the preclinical or clinical development
related to the collaboration could be delayed or terminated. Our current or
future collaborators may develop or market competing products or alternative
technologies. In addition, disputes may arise with respect to ownership of
technology developed under any such collaborations. Moreover, our corporate
partners may terminate any existing partnerships, and we may be unable to enter
into additional collaborations on acceptable terms, or at all.

                                     -24-
<PAGE>

If we are unable to license necessary technology from third parties, we may be
unable to successfully develop and commercialize our potential products.

     Our success depends on our ability to enter into licensing arrangements
with commercial or academic organizations to obtain technology used in
developing or commercializing our or our partners' product candidates. Various
license agreements give us and our partners rights to use technologies owned or
licensed by third parties in research, development and commercialization of our
potential products. Disputes may arise regarding rights to inventions and know-
how resulting from the joint creation or use of intellectual property by us and
our licensors or scientific collaborators. In addition, many of our in-licensing
agreements contain milestone-based termination provisions. If we or any of our
corporate partners fail to meet agreed milestones, a licensor could terminate
the relevant agreement.

     If we are unable to maintain our current licenses and obtain additional
licenses in the future on acceptable terms, we and our corporate partners may be
required to expend significant time and resources to develop or in-license
replacement technology. If we are unable to do so, we may be unable to develop
or commercialize some or all of our potential products and our business may
suffer.

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

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

The intense competition and rapid technological change in our market may result
in pricing pressures and failure of our potential products to achieve market
acceptance.

     We presently face competition from other companies developing gene therapy
technologies and from companies using more traditional approaches to treating
human diseases. Most of our competitors have substantially more experience and
financial and infrastructure resources than we do in the following areas:

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

                                     -25-
<PAGE>

     .  marketing and distribution.

     Consequently, our competitors may be able to commercialize new products
more rapidly than we do, or manufacture and market competitive products more
successfully than we do. This could result in pricing pressures or our products
failing to achieve market acceptance. In addition, gene therapy is a new and
rapidly evolving field and is expected to continue to undergo significant and
rapid technological change. Rapid technological development by our competitors
could result in our actual and proposed technologies, products or processes
losing market share or becoming obsolete.

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

     Our future success depends in part on our ability to attract and retain key
employees. We have programs in place to retain personnel, including programs to
create a positive work environment and competitive compensation packages.
Because competition for employees in our field is intense, however, we may be
unable to retain our existing personnel or attract additional qualified
employees. If we experience turnover or difficulties recruiting new employees,
our research and development could be delayed and we could experience
difficulties in generating sufficient revenue to maintain our business.

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

     We currently do not have the capacity to manufacture large-scale clinical
or commercial quantities of our potential products. To do so, we will need to
expand our current facilities and staff or supplement them through the use of
contract providers. We have recently leased a building for the purpose of
developing a facility to manufacture AAV vectors for Phase III and early
commercial purposes. This manufacturing facility, if successfully developed, as
well as any future manufacturing facilities that we may construct, will be
subject to initial and ongoing regulation by the FDA and other governmental
agencies. We may be unable to obtain regulatory approval for or maintain in
operation this or any other manufacturing facility. If we are unable to obtain
and maintain the necessary manufacturing capabilities, either alone or through
third parties, we will be unable to introduce sufficient product to sustain our
business.

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

     Our research and development activities involve the controlled use of
hazardous materials. Although we believe that our safety procedures for handling
and disposing of these materials comply with applicable laws and regulations, we
cannot eliminate the risk of accidental contamination or injury from hazardous
materials. If a hazardous material accident occurred, we

                                     -26-
<PAGE>

would be liable for any resulting damages. This liability could exceed our
financial resources. Additionally, hazardous materials are subject to regulatory
oversight. Accidents unrelated to our operations could cause federal, state or
local regulatory agencies to restrict our access to hazardous materials needed
in our research and development efforts. If our access to these materials is
limited, we could experience delays in our research and development programs.
Paying damages or experiencing delays caused by restricted access could reduce
our ability to generate revenue and make it more difficult to fund our
operations.

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

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

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

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

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

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

                                     -27-
<PAGE>

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

     In recent years the stock market in general and the market for
biotechnology-related companies in particular have experienced extreme price and
volume fluctuations, often unrelated to the operating performance of the
affected companies. Our common stock has experienced, and is likely to continue
to experience, these fluctuations in price, regardless of our performance. These
fluctuations could cause the market price of our common stock to decline.

Item 3.   Quantitative and Qualitative Disclosure About Market Risk

     This item discusses our exposure to market risk related to changes in
interest rates and to our credit risk.

Interest Rate Sensitivity

Short-Term Investments

We do not use derivative financial instruments in our operations or investment
portfolio. However, we regularly invest excess operating cash in deposits with
major financial institutions, money market funds and limited maturity bond
mutual funds that can be readily purchased or sold using established markets. We
believe that the market risk arising from our holdings of these financial
instruments is minimal.

Long-Term Obligations

     As of September 30, 2000, we had outstanding long-term obligations totaling
$2.6 million, primarily related to capital equipment leases, leasehold
improvements and our loan agreement with Celltech, at fixed interest rates of up
to 13.64%. We do not have any material exposure to market risks associated with
changes in interest rates because we have no variable-interest-rate debt
outstanding. Increases in interest rates could, however, increase the interest
expense associated with any future borrowings. We do not hedge against interest
rate increases.

Market and Credit Risk

     We do not use derivative financial instruments in our investment portfolio
to manage interest rate risk. We limit our exposure to interest rate and credit
risk by establishing and strictly monitoring clear policies and guidelines for
our fixed income portfolios. At the present time we limit to one year the
maximum average maturity period of securities in our investment portfolio. Our
guidelines also establish credit quality standards, limits on exposure to
duration and credit risk criteria. We do not expect our exposure to market and
credit risk to be material.

Equity Price Risk

     Our equity investments are limited to our ownership of 100% of the stock in
Genovo, Inc., 80.1% of Emerald, our joint venture with Elan, and an immaterial
equity interest we have in

                                     -28-
<PAGE>

a privately-held biotechnology company. Accordingly, we do not hedge against
equity price changes.

Foreign Currency Exchange Rate Risk

     We realize all of our revenue in dollars and receive substantially all of
our cash from Celltech's U.S.-based operations and Emerald's Bermuda-based
operations. Therefore, we do not have any significant direct foreign currency
exchange rate risk and we do not hedge against foreign currency exchange rate
changes.

PART II   OTHER INFORMATION

Item 2.   Changes in Securities and Use of Proceeds.

     On September 19, 2000, we acquired Genovo, Inc., a privately held
biotechnology company, by merging a wholly owned subsidiary of Targeted Genetics
with and into Genovo. In connection with the acquisition, we issued the
following unregistered securities:

 .  an aggregate of 5,007,925 shares of common stock to the former stockholders
   of Genovo, in exchange for an aggregate of 2,428,161 shares of Genovo common
   stock and common stock equivalents outstanding at the effective time of the
   merger;

 .  options to purchase an aggregate of 679,444 shares of common stock, to the
   holders of assumed options to purchase an aggregate of 493,184 shares of
   Genovo common stock issued under the Genovo stock option plan; and

 .  options to purchase 622,590 shares of common stock to Genzyme Corporation,
   upon our assumption of an option held by Genzyme to purchase Genovo preferred
   stock.

     The options granted to the former Genovo optionholders are fully vested and
may be exercised at any time, at an exercise price equal to the exercise price
of the former Genovo option multiplied by the exchange ratio applicable to the
Genovo common stock. Genzyme's options are exercisable in two tranches, at an
exercise price equal to the exercise price of the former Genzyme options
adjusted to reflect the preferred stock liquidation preference Genzyme was
entitled to receive in the merger.

     In addition, we issued 942,873 shares of unregistered common stock to
Biogen, Inc. in exchange for Biogen's release to us of specified rights to
Genovo technology.

     These transactions did not involve a public offering and therefore were
exempt from registration under section 4(2) and Regulation D of the Securities
Act of 1933.

                                     -29-
<PAGE>

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.

     (1)  On August 23, 2000, we filed a current report on Form 8-K reporting
          that on August 8, 2000, we agreed to acquire Genovo, Inc., a privately
          held delivery company, pursuant to an agreement and plan of merger
          among Targeted Genetics, Genovo, TGC Acquisition Corporation and
          Biogen, Inc.

     (2)  On September 13, 2000, we filed a current report on Form 8-K reporting
          that on August 8, 2000, we entered into a product development and
          marketing collaboration with Biogen, Inc.

     (3)  On October 2, 2000, we filed a current report on Form 8-K reporting
          that on September 19, 2000, we completed the acquisition of Genovo
          through a merger of a wholly owned subsidiary of Targeted Genetics
          with and into Genovo, Inc., pursuant to the August 8, 2000 agreement
          and plan of merger.

     (4)  On November 9, 2000, we filed an updated current report on Form 8-K/A
          to include financial statements related to our acquisition of Genovo.

                                   SIGNATURES

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

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



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


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

                                     -30-
<PAGE>

                         Targeted Genetics Corporation

                               INDEX TO EXHIBITS

<TABLE>
<CAPTION>
  Exhibit No.     Description                                                                          Note
<C>               <S>                                                                                  <C>
       3.1        Restated Articles of Incorporation                                                    (A)

       3.2        Amended and Restated Bylaws (Exhibit 3.2)                                             (C)

       4.1        Rights Agreement, dated as of October 17, 1996, between Targeted Genetics and         (B)
                  ChaseMellon Shareholder Services, L.L.C. (Exhibit 2.1)

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

       4.3        Registration Rights Agreement, dated as of July 21, 1999, between Targeted            (E)
                  Genetics and Elan International Services, Ltd. (Exhibit 1.2)

       4.4        Warrant Agreements to purchase 2,000,000 shares of Targeted Genetics common           (D)
                  stock, issued to Alkermes, Inc. on June 9, 1999. (Exhibit 10.38)

      10.1        Agreement and Plan of Merger dated as of August 8, 2000, among Targeted Genetics,     (F)
                  Genovo, Inc., TGC Acquisition Corporation and Biogen,* (Exhibit 2.1)

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

      10.3        Funding Agreement dated as of August 8, 2000, between Targeted Genetics and           (G)
                  Biogen, Inc. (Exhibit 10.2)
</TABLE>

____________

* Portions of this exhibit have been omitted pursuant to a request for
confidential treatment filed with the Securities and Exchange Commission. The
omitted portions have been filed separately with the SEC.

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

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

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

(D)  Incorporated by reference to the designated exhibit included with Targeted
Genetics' Quarterly Report on Form 10-Q for the period ending June 30, 1999,
filed on August 5, 1999.

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

(F)  Incorporated by reference to the designated exhibit included with Targeted
Genetics' Targeted Genetics Current Report on Form 8-K, filed on August 23,
2000.

                                     -31-
<PAGE>

(G)  Incorporated by reference to the designated exhibit included with Targeted
Genetics' Targeted Genetics Current Report on Form 8-K, filed on September 13,
2000.

                                     -32-