UNITED
      STATES


SECURITIES
      AND EXCHANGE COMMISSION


WASHINGTON,
      D.C. 20549


**FORM
      10-Q**


(Mark
                One)x
            QUARTERLY
                REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
                1934
                FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2007o
            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
                of Incorporation)
            (I.R.S.
                Employer Identification No.)




1100
      Olive Way, Suite 100 Seattle, WA 98101





(Address
      of principal executive offices)(Zip Code)





(206)
      623-7612





(Registrant’s
      telephone number, including area code)







(Former
      name, former address and former fiscal year, if changed since last
      report)





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 the filing requirements
      for
      at least the past 90 days. Yes x No o





Indicate
      by check mark whether the registrant is a large accelerated filer, an
      accelerated filer, or a non-accelerated filer. See definition of “accelerated
      filer” and “large accelerated filer” in Rule 12b-2 of the Exchange Act.
      (check one):





Large
      accelerated filer o    Accelerated
      filer o    Non-accelerated
      filer x





Indicate
      by check mark whether the registrant is a shell company (as defined in Rule
      12b-2 of the Exchange Act). o Yes
      x No





Shares
      of
      Common Stock, par value $0.01 per share, outstanding as of October 29, 2007:
      19,814,161












**TARGETED
      GENETICS CORPORATION**


Quarterly
      Report on Form 10-Q


For
      the
      quarter ended September 30, 2007




TABLE
      OF
      CONTENTS


Page No**.**PART I
              
              FINANCIAL
                  INFORMATIONItem 1.
              
              Financial
                  Statementsa)
              
              Condensed
                  Consolidated Balance Sheets at September 30, 2007 and December
                  31, 2006
              
              1b)
              
              Condensed
                  Consolidated Statements of Operations for the three and nine months
                  ended
                  September 30, 2007 and 2006
              
              2c)
              
              Condensed
                  Consolidated Statements of Cash Flows for the nine months ended
                  September
                  30, 2007 and 2006
              
              3d)
              
              Notes
                  to Condensed Consolidated Financial Statements
              
              4Item
                  2.
              
              Management’s
                  Discussion and Analysis of Financial Condition and Results of
                  Operations
              
              10Item
                  3.
              
              Quantitative
                  and Qualitative Disclosures About Market Risk
              
              16Item
                  4T.
              
              Controlsand
                  Procedures
              
              17PART
                  II
              
              OTHER
                  INFORMATION
              
              17Item
                  1.
              
              Legal
                  Proceedings
              
              17Item
                  1A.
              
              Risk
                  Factors
              
              17Item
                  2.
              
              Unregistered
                  Sales of Equity Securities and Use of Proceeds
              
              20Item
                  3.
              
              Defaults
                  Upon Senior Securities
              
              20Item
                  4.
              
              Submission
                  of Matters to a Vote of Security Holders
              
              20Item
                  5.
              
              Other
                  Information
              
              20Item
                  6.
              
              Exhibits
              
              20SIGNATURES
              
              21INDEX
                  TO EXHIBITS
              
              22





i


**PART
      I    FINANCIAL INFORMATION**




**Item
      1.** ***Financial
      Statements*** ****




**TARGETED
      GENETICS CORPORATION**




**CONDENSED
      CONSOLIDATED BALANCE SHEETS**


**(Unaudited)**




**September 30,**
            
            **December 31,****2007**
            
            **2006****ASSETS**Current
                assets:Cash
                and cash equivalents
            
            $
            20,531,000
            
            $
            6,206,000Accounts
                receivable
            
            
            1,544,000
            
            
            1,498,000Prepaid
                expenses and other
            
            
            321,000
            
            
            531,000Total
                current assets
            
            
            22,396,000
            
            
            8,235,000Property
                and equipment, net
            
            
            986,000
            
            
            1,100,000Goodwill
            
            
            7,926,000
            
            
            7,926,000Other
                assets
            
            
            200,000
            
            
            206,000Total
                assets
            
            $
            31,508,000
            
            $
            17,467,000**LIABILITIES
                AND SHAREHOLDERS’ EQUITY**Current
                liabilities:Accounts
                payable and accrued expenses
            
            $
            2,058,000
            
            $
            1,901,000Accrued
                employee expenses
            
            
            702,000
            
            
            861,000Accrued
                restructure charges
            
            
            1,643,000
            
            
            1,046,000Deferred
                revenue
            
            
            218,000
            
            
            251,000Current
                portion of long-term obligations
            
            
            504,000
            
            
            1,129,000Total
                current liabilities
            
            
            5,125,000
            
            
            5,188,000Accrued
                restructure charges
            
            
            5,506,000
            
            
            6,331,000Long-term
                obligations
            
            
            —
            
            
            570,000Deferred
                rent
            
            
            9,000
            
            
            11,000Commitments
                and ContingenciesShareholders’
                equity:Preferred
                stock, $0.01 par value, 600,000 shares authorized:Series
                A preferred stock, 180,000 shares designated, none issued and
                outstanding
            
            
            —
            
            
            —Common
                stock, $0.01 par value, 30,000,000 shares authorized, 19,814,161
                shares
                issued and outstanding at September 30, 2007 and 10,921,736 shares
                issued
                and outstanding at December 31, 2006
            
            
            198,000
            
            
            109,000Additional
                paid-in capital
            
            
            315,744,000
            
            
            289,324,000Accumulated
                deficit
            
            
            (295,080,000
            )
            
            (284,027,000
            )Accumulated
                other comprehensive gain (loss)
            
            
            6,000
            
            
            (39,000
            )Total
                shareholders’ equity
            
            
            20,868,000
            
            
            5,367,000Total
                liabilities and shareholders’ equity
            
            $
            31,508,000
            
            $
            17,467,000





See
      accompanying notes to condensed consolidated financial statements





1


**TARGETED
      GENETICS CORPORATION**




**CONDENSED
      CONSOLIDATED STATEMENTS OF OPERATIONS**


**(Unaudited)**





**Three months ended****September
                30,**
            
            **Nine months ended****September
                30,****2007**
            
            **2006**
            
            **2007**
            
            **2006**Revenue:Collaborative
                revenue
            
            $
            1,943,000
            
            $
            2,012,000
            
            $
            6,612,000
            
            $
            5,856,000Licensing
                revenue
            
            
            500,000
            
            
            —
            
            
            500,000
            
            
            —Total
                revenue
            
            
            2,443,000
            
            
            2,012,000
            
            
            7,112,000
            
            
            5,856,000Operating
                expenses:Research
                and development
            
            
            3,874,000
            
            
            3,123,000
            
            
            12,840,000
            
            
            10,483,000General
                and administrative
            
            
            1,694,000
            
            
            1,687,000
            
            
            4,821,000
            
            
            4,736,000Restructure
                charges
            
            
            183,000
            
            
            413,000
            
            
            809,000
            
            
            1,818,000Goodwill
                impairment charge
            
            
            —
            
            
            —
            
            
            —
            
            
            23,723,000Total
                operating expenses
            
            
            5,751,000
            
            
            5,223,000
            
            
            18,470,000
            
            
            40,760,000Loss
                from operations
            
            
            (3,308,000
            )
            
            (3,211,000
            )
            
            (11,358,000
            )
            
            (34,904,000
            )Investment
                income
            
            
            277,000
            
            
            147,000
            
            
            305,000
            
            
            468,000Interest
                expense
            
            
            —
            
            
            (126,000
            )
            
            (1,000
            )
            
            (362,000
            )Net
                loss
            
            $
            (3,031,000
            )
            $
            (3,190,000
            )
            $
            (11,054,000
            )
            $
            (34,798,000
            )Net
                loss per common share (basic and diluted)
            
            $
            (0.15
            )
            $
            (0.32
            )
            $
            (0.72
            )
            $
            (3.64
            )Shares
                used in computation of basic and diluted net loss per common
                share
            
            
            19,814,000
            
            
            9,894,000
            
            
            15,388,000
            
            
            9,548,000




See
      accompanying notes to condensed consolidated financial statements




2


**TARGETED
      GENETICS CORPORATION**




**CONDENSED
      CONSOLIDATED STATEMENTS OF CASH FLOWS**


**(Unaudited)**





**Nine months ended****September
                30,****2007**
            
            **2006**Operating
                activities:Net
                loss
            
            $
            (11,054,000
            )
            $
            (34,798,000
            )Adjustments
                to reconcile net loss to net cash used in operating
                activities:Depreciation
            
            
            447,000
            
            
            537,000Stock-based
                compensation
            
            
            514,000
            
            
            691,000Stock
                issued to outside service providers
            
            
            —
            
            
            141,000Goodwill
                impairment charge
            
            
            —
            
            
            23,723,000Gain
                on the sale of property and equipment
            
            
            (22,000
            )
            
            —Loss
                (gain) on investments
            
            
            251,000
            
            
            (8,000
            )Changes
                in assets and liabilities:Increase
                in accounts receivable
            
            
            (46,000
            )
            
            (233,000
            )Decrease
                (increase) in prepaid expenses and other
            
            
            (12,000
            )
            
            48,000Decrease
                in other assets
            
            
            6,000
            
            
            8,000Increase
                (decrease) in current liabilities
            
            
            (1,000
            )
            
            38,000Increase
                (decrease) in deferred revenue
            
            
            (33,000
            )
            
            45,000Decrease
                in deferred rent
            
            
            (2,000
            )
            
            (99,000
            )Increase
                (decrease) in accrued restructure expenses
            
            
            (228,000
            )
            
            385,000Net
                cash used in operating activities
            
            
            (10,180,000
            )
            
            (9,522,000
            )Investing
                activities:Purchases
                of property and equipment
            
            
            (333,000
            )
            
            (72,000
            )Proceeds
                from the sale of property and equipment
            
            
            22,000
            
            
            —Proceeds
                from sale of investments
            
            
            16,000
            
            
            49,000Net
                cash used in investing activities
            
            
            (295,000
            )
            
            (23,000
            )Financing
                activities:Net
                proceeds from sales of common stock
            
            
            25,956,000
            
            
            4,826,000Proceeds
                from the exercise of stock options
            
            
            39,000
            
            
            12,000Payments
                under debt and equipment financing arrangements
            
            
            (1,195,000
            )
            
            (135,000
            )Net
                cash provided by financing activities
            
            
            24,800,000
            
            
            4,703,000Net
                increase (decrease) in cash and cash equivalents
            
            
            14,325,000
            
            
            (4,842,000
            )Cash
                and cash equivalents, beginning of period
            
            
            6,206,000
            
            
            14,122,000Cash
                and cash equivalents, end of period
            
            $
            20,531,000
            
            $
            9,280,000




See
      accompanying notes to condensed consolidated financial statements




3


**TARGETED
      GENETICS CORPORATION**





**NOTES
      TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**




**(Unaudited)**




**1.   Summary
      of Significant Accounting Policies**





***Basis
      of Presentation***





The
      unaudited condensed consolidated financial statements included in this quarterly
      report have been prepared by Targeted Genetics Corporation, or Targeted
      Genetics, according to the rules and regulations of the Securities and Exchange
      Commission, or SEC, and according to accounting principles generally accepted
      in
      the United States of America, or GAAP, for interim financial statements. The
      accompanying balance sheet information as of December 31, 2006 is derived from
      our audited financial statements. Certain information and footnote disclosures
      normally included in financial statements prepared in accordance with GAAP
      have
      been omitted in accordance with the SEC’s rules and regulations. Our condensed
      consolidated financial statements include the accounts of Targeted Genetics
      and
      our inactive, wholly-owned subsidiaries, Genovo, Inc. and TGCF Manufacturing
      Corporation *.* All
      significant intercompany transactions have been eliminated in consolidation.
      The
      financial statements reflect, in the opinion of management, all adjustments
      which consist solely of normal recurring adjustments necessary to present fairly
      our financial position and results of operations as of and for the periods
      indicated. Certain reclassifications have been made to conform prior period
      results to the current period presentation.




We
      do not
      believe that our results of operations for the three and nine months ended
      September 30, 2007 are necessarily indicative of the results to be expected
      for
      the full year.





The
      unaudited condensed consolidated financial statements included in this quarterly
      report should be read in conjunction with our audited consolidated financial
      statements and related footnotes included in our annual report on Form 10-K
      for
      the year ended December 31, 2006.





Our
      combined cash and cash equivalents totaled $20.5 million at September 30, 2007. We
      believe that our current resources, including the capital raised in January
      and
      June 2007 and the cash anticipated to be received from our collaborative
      partners, are sufficient to fund our currently planned operations, including
      our
      clinical trials, for at least a year.  This
      estimate is based on our ability to perform planned research and development
      activities and the receipt of planned, but not yet approved, funding from our
      collaborators. Our
      near-term financing strategy includes leveraging our development capabilities
      and intellectual property assets into additional commercial opportunities,
      advancing our clinical development programs, and accessing the public and
      private capital markets at appropriate times. Depending on our ability to successfully access additional funding, we may
      be
      forced to preserve our cash position through a combination of cost reduction
      measures, sales of assets likely at values significantly below their potential
      worth, or the pursuit of alternative financing transactions that would likely
      be
      on terms disadvantageous to us and dilutive to our shareholders.  We
      have
      prepared the accompanying financial statements on a going concern basis, which
      assumes that we will realize our assets and satisfy our liabilities in the
      normal course of business.  The
      accompanying financial statements do not include any adjustments that may impact
      the amount and classifications of assets or liabilities that may result from
      these liquidity uncertainties.





***Accounting
      for Uncertainties in Income Taxes***





Effective
      the beginning of 2007, we adopted Financial Accounting Standards Board, or
      FASB,
      Interpretation No. 48, “*Accounting
      for Uncertainty in Income Taxes,”*or
      FIN
      48. FIN 48 provides guidance to address uncertainty in tax positions and
      clarifies the accounting for income taxes by specifying a minimum recognition
      threshold which income tax positions must achieve before being recognized in
      the
      financial statements. The adoption of FIN 48 had no impact on our net loss,
      earnings per share or financial position for the three and nine months ended
      September 30, 2007.





***Recently
      Issued Accounting Standards***




In
      September 2006, the FASB issued Statement of Financial Accounting Standards
      No. 157, *“Fair
      Value Measurements,”* or SFAS
      No. 157. SFAS No. 157 provides guidance for using fair value to
      measure assets and liabilities and requires expanded information about the
      extent to which companies measure assets and liabilities at fair value, the
      information used to measure fair value, and the effect of fair value
      measurements on earnings. The standard applies whenever other standards require
      or permit assets or liabilities to be measured at fair value. The standard
      does
      not expand the use of fair value in any new circumstances. SFAS No. 157 is
      effective for fiscal years beginning after November 15, 2007. We are in the
      process of evaluating the adoption of SFAS No. 157 and have not yet
      determined its impact, if any.




4


**2.   Long-Term
      Obligations**




Long-term
      obligations consist of the following:




**September 30,**
            
            **December 31,****2007**
            
            **2006**Loans
                payable to Biogen Idec
            
            $
            501,000
            
            $
            1,672,000Equipment
                financing obligations
            
            
            3,000
            
            
            27,000Total
                obligations
            
            
            504,000
            
            
            1,699,000Less
                current portion
            
            
            (504,000
            )
            
            (1,129,000
            )Total
                long-term obligations
            
            $
            —
            
            $
            570,000





As
      of
      September 30, 2007, we owed $501,000 to Biogen Idec, a beneficial owner of
      approximately 11% of our outstanding common shares. This
      debt
      is the remaining balance of a $10.0 million loan from Biogen Idec initiated
      in
      2001. In the fourth quarter of 2006, as
      part
      of a debt restructuring, we agreed to terms that resulted in a loan payable
      balance of $2.2 million, which consisted of $2.0 million principal and $167,000
      of estimated future interest payments to be paid to Biogen Idec in two
      installments: $1.0 million plus accrued interest, which we paid on August 1,
      2007, and the remaining balance which is due on August 1, 2008.  We
      must
      apply one-third of certain up-front payments received from potential future
      corporate collaborations and one-third of certain milestone payments to the
      outstanding balance on this loan payable, first to repayment of any accrued
      and
      unpaid interest on the principal being repaid, and second to the repayment
      of
      outstanding principal. Since December 2006, as a result of the receipt of
      upfront payments in the fourth quarter of 2006 and the first three quarters
      of
      2007, we have made principal and interest payments totaling $917,000. The note
      balance of $501,000 as of September 30, 2007 includes principal of $410,000
      and
      interest of $91,000. As of September 30, 2007, future aggregate principal
      payments related to the Biogen Idec debt are $410,000 in 2008 and zero there
      after. Subsequent to quarter end, we made a $161,000 principal payment in
      October 2007.





**3.   Accrued
      Restructure Charges**





We
      apply
      the provisions of SFAS No. 146, *“Accounting
      for Costs Associated with Exit or Disposal Activities,”* as
      it
      relates to our facility in Bothell, Washington and record restructure charges
      on
      the operating lease for the facility as a result of our 2003 decision to
      discontinue use of the facility. Accrued restructure charges represent our
      best
      estimate of the fair value of the liability as determined under SFAS No. 146
      and
      are computed as the fair value of the difference between the remaining lease
      payments, net of assumed sublease income and expense. We also record accretion
      expense based upon changes in the accrued liability that results from the
      passage of time at an assumed discount rate of 10%. Accretion expense is
      recorded on an ongoing basis through the end of the lease term in September
      2015
      and is reflected as a restructuring charge in the accompanying condensed
      consolidated statements of operations.





The
      table
      below presents a reconciliation of the accrued restructure liability for the
      nine month period ended September 30, 2007:





**ContractTermination**
              **Costs**December
                31, 2006 accrued liability
            
            $
            7,377,000Charges
                related to changes in lease assumptions
            
            
            260,000Accretion
                expense
            
            
            549,000Amount
                paid
            
            
            (1,037,000
            )September
                30, 2007 accrued liability
            
            $
            7,149,000





During
      the second quarter of 2007, we recorded additional restructure charges of
      $260,000 as a result of updating our estimates of costs and sublease income
      associated with exiting the Bothell facility. As part of this assessment we
      extended the anticipated lead time for subleasing the facility. In addition
      to
      this adjustment to the accrued restructure liability, we incurred $183,000
      of
      accretion expense for the three months ended September 30, 2007 and $549,000
      of
      accretion expense for the nine months ended September 30, 2007. The total of
      these charges and adjustments to the liability are reflected as restructure
      charges in the accompanying consolidated statements of operations.





Through
      September 30, 2007, we have recorded contract termination costs totaling $10.8
      million for our Bothell facility. As of September 30, 2007, we expect to incur
      an additional $2.6 million in accretion expense through the expiration of the
      Bothell lease in September 2015. If we were to determine that we were unable
      to
      sublease the facility, we would record additional restructure charges of $1.2
      million.





5




We
      periodically evaluate our restructuring estimates and assumptions and record
      additional restructure charges as necessary. Because restructure charges are
      estimates based upon assumptions regarding the timing and amounts of future
      events, significant adjustments to the accrual may be necessary in the future
      based on the actual outcome of events and as we become aware of new facts and
      circumstances.




**4. 
       Equity**





***Financing***





On
      June
      27, 2007, we sold 6.7 million shares of our common stock in a private placement
      at a price of $2.905 per share and received net proceeds of approximately $17.8
      million. In addition, in connection with the financing, we issued warrants
      to
      purchase up to 6.7 million shares of our common stock. These warrants expire
      in
      June 2012 and are exercisable at a price of $3.25 per share. We also issued
      a
      warrant with the same terms as those issued pursuant to our private placement
      to
      purchase 334,989 shares of our common stock as compensation to the placement
      agent in this transaction.





On
      January 11, 2007, we sold 2.2 million shares of our common stock in a private
      placement at a price of $4.00 per share and received net proceeds of
      approximately $8.1 million. In addition, in connection with the financing,
      we
      issued warrants to purchase up to 763,000 shares of ou r common stock. These
      warrants expire in January 2012 and are exercisable at $5.41 per share. We
      also
      issued a warrant with the same terms as those issued pursuant to the private
      placement to purchase 16,119 shares of our common stock as compensation to
      the
      placement agent in this transaction.





***Stock
      Based Compensation***





In
      May
      2007, our shareholders approved our proposal to amend, restate and rename the
      Targeted Genetics Corporation 1999 Stock Option Plan into the Targeted Genetics
      Corporation Stock Incentive Plan (Stock Incentive Plan). The Stock Incentive
      Plan provides for the issuance of long-term incentive awards (Awards) in the
      form of nonqualified and incentive stock options (Options), stock appreciation
      rights, stock grants and restricted stock units. The Awards may be granted
      by
      our Board of Directors to our employees, directors and officers and to
      consultants, agents, advisors and independent contractors who provide services
      to us. The exercise price for Options must not be less than the fair market
      value of the shares on the date of grant. Options expire no later than ten
      years
      from the date of grant and generally vest and become exercisable over a
      four-year period following the date of grant. In 2006, as part of an employee
      retention plan, we granted options to purchase an aggregate of 306,500 shares
      of
      our common stock with a twelve-month vesting period. Restricted stock units
      expire no later than 10 years from the date of grant and generally vest over
      a
      three-year period following the date of grant. Every non-employee member of
      our
      Board of Directors receives an annual nonqualified stock option or restricted
      stock unit grant and these awards vest over a twelve-month period provided
      the
      grantee continues service to us. Upon the exercise of stock options and the
      vesting of restricted stock units, we issue new shares from shares reserved
      for
      issuance under our Stock Incentive Plan.





Effective
      January 2006, we adopted SFAS No. 123R, *“Share-Based
      Payment”* which
      requires us to expense the fair value of share-based payments granted over
      the
      vesting period. This compensation expense includes: (a) compensation cost for
      all share-based stock options granted prior to, but not yet vested as of January
      1, 2006, based on the grant-date fair value used for prior pro forma disclosures
      and (b) compensation cost for all share-based payments granted subsequent to
      January 1, 2006, based on the grant-date fair value estimate in accordance
      with
      the provisions of SFAS No. 123R. We value awards granted subsequent to January
      1, 2006 at fair value in accordance with provisions of SFAS No. 123R and
      recognize stock-based compensation expense on a straight line basis over the
      service period of each award. Stock-based
      compensation expense is reduced by an estimated forfeiture rate that we derived
      from historical employee termination behavior. If the actual number of
      forfeitures differs from our estimates, we may record adjustments to increase
      or
      decrease compensation expense in future periods.


6


Following
      is a summary of our compensation expense for the three and nine months ended
      September 30, 2007:





**Three
                months ended**
              **September
                30,**
            
            **Nine
                months ended**
              **September
                30,****2007**
            
            **2006**
            
            **2007**
            
            **2006**Stock
                options:Research
                and development expense
            
            $
            1,000
            
            $
            117,000
            
            $
            195,000
            
            $
            379,000General
                and administrative expense
            
            
            7,000
            
            
            110,000
            
            
            157,000
            
            
            312,000Restricted
                stock units:Research
                and development expense
            
            
            38,000
            
            
            —
            
            
            55,000
            
            
            —General
                and administrative expense
            
            
            73,000
            
            
            —
            
            
            107,000
            
            
            —Total
                compensation expense
            
            $
            119,000
            
            $
            227,000
            
            $
            514,000
            
            $
            691,000




***Stock
      Options***





Following
      is a summary of stock option activity and related prices for the first nine
      months of 2007:





**Shares**
            
            **Weighted**
              **Average**
              **Exercise**
              **Price**
            
            **Remaining**
              **Average**
              **Contractual****Term(Years)**
            
            **Intrinsic**
              **Value**Outstanding,
                December 31, 2006
            
            
            835,085
            
            $
            15.39Granted
            
            
            15,800
            
            
            3.88Exercised
            
            
            (12,632
            )
            
            3.10Expired
            
            
            (13,892
            )
            
            40.66Forfeited
            
            
            (43,353
            )
            
            8.95Outstanding,
                September 30, 2007
            
            
            781,008
            
            $
            15.26
            
            
            6.51
            
            $
            3,000Exercisable
                at September 30, 2007
            
            
            688,694
            
            $
            16.17
            
            
            6.34
            
            $
            1,000






The
      aggregate intrinsic value is determined using the closing price of our common
      stock of $1.87 on September 28, 2007. The intrinsic value of stock options
      exercised was $22,000 during the nine months ended September 30, 2007 and $3,000
      during the nine months ended September 30, 2006. We received $39,000 from the
      exercise of stock options for the nine months ended September 30, 2007 and
      $2,000 for the nine months ended September 30, 2006.




As
      of
      September 30, 2007, total unrecognized compensation cost related to unvested
      options was approximately $171,000, net of estimated forfeitures, which we
      expect to recognize over a weighted average period of approximately one year.




Stock
      options outstanding and exercisable as of September 30, 2007 are summarized
      below:





**Outstanding**
            
            **Exercisable****Range
                of Exercise Prices**
            
            **Number of**
              **Option**
              **Shares**
            
            **Weighted**
              **Average**
              **Exercise**
              **Price**
            
            **Weighted Average**
              **Remaining**
              **Contractual
                Life**
              **(Years)**
            
            **Number
                of**
              **Option
                Shares**
            
            **Weighted**
              **Average**
              **Exercise**
              **Price**$1.80
                - $3.24
            
            
            94,233
            
            $
            2.50
            
            
            8.31
            
            
            82,725
            
            $
            2.543.80 - 3.80
            
            
            187,000
            
            
            3.80
            
            
            8.69
            
            
            187,000
            
            
            3.803.87 - 9.10
            
            
            167,245
            
            
            7.28
            
            
            7.11
            
            
            113,561
            
            
            7.2710.80 - 14.90
            
            
            157,370
            
            
            13.10
            
            
            6.28
            
            
            131,435
            
            
            13.1015.30 - 148.80
            
            
            175,160
            
            
            43.92
            
            
            2.85
            
            
            173,973
            
            
            44.07Balance,
                September 30, 2007
            
            
            781,008
            
            $
            15.26
            
            
            6.51
            
            
            688,694
            
            $
            16.17





The
      fair
      value of each stock option award is estimated on the date of the grant using
      the
      Black-Scholes-Merton option pricing model. The
      weighted average fair value of options granted during the nine months ended
      September 30, 2007 was $3.88 and was $1.84 for the nine months ended September
      30, 2006.


7


The
      following are the weighted average assumptions for the periods
      noted:





**Nine Months****ended September 30,****2007**
            
            **2006**Expected
                dividend rate
            
            Nil
            
            NilExpected
                stock price volatility
            
            
            1.047
                - 1.114
            
            
            1.067-1.107Risk-free
                interest rate range
            
            
            4.54
                - 4.58%
            
            
            4.25-4.85%Expected
                life of options
            
            
            4
                - 5 years
            
            
            4-5
                years





*Expected
      Dividend:* We
      do not
      anticipate any dividends. The terms of our Biogen Idec loan restricts our
      ability to declare or pay dividends.





*Expected
      Life:* Our
      expected life represents the period that our stock-based awards are expected
      to
      be outstanding. We determine expected life based on historical experience and
      vesting schedules of similar awards.





*Expected
      Volatility:* Our
      expected volatility represents the weighted average historical volatility of
      the
      shares of our common stock for the most recent four-year and five-year periods.





*Risk-Free
      Interest Rate:* We
      base the risk-free interest rate used on the implied yield currently available
      on U.S. Treasury zero-coupon issues with an equivalent remaining term.
      Where the expected term of our stock-based awards do not correspond with the
      terms for which interest rates are quoted, we perform a straight-line
      interpolation to determine the rate from the available term
      maturities.





***Restricted
      Stock Units***





**Shares**
            
            **Weighted**
              **Average**
              **Grant
                Date****Fair
                Value**Nonvested,
                December 31, 2006
            
            
            —
            
            $
            —Granted
            
            
            528,000
            
            
            3.10Vested
            
            
            —
            
            
            —Forfeited
            
            
            (2,500
            )
            
            3.14Nonvested,
                September 30, 2007
            
            
            525,500
            
            $
            3.10





As
      of
      September 30, 2007, total unrecognized compensation cost related to unvested
      restricted stock units was approximately $802,000, net of estimated forfeitures,
      which we expect to recognize over a weighted average period of approximately
      2.4
      years.





**5.  
      Other Comprehensive Loss**




Comprehensive
      loss is the total of net loss and all other non-owner changes in equity.
      Comprehensive loss includes net unrealized gains from investments and foreign
      currency translations on our common stock investment in Chromos Molecular
      Systems Inc., or Chromos, as presented in the following table:




**Three
                    months ended**
                  **September
                    30,**
                
                **Nine
                      months ended**
                    **September
                      30,****2007**
                
                **2006**
                
                **2007**
                
                **2006**Net
                    loss as reported
                
                $
                (3,031,000
                )
                $
                (3,190,000
                )
                $
                (11,054,000
                )
                $
                (34,798,000
                )Other
                    comprehensive income or loss:Unrealized
                    gain (loss) on available-for-sale securities
                
                
                —
                
                
                (22,000
                )
                
                —
                
                
                26,000Foreign
                    currency translation adjustment
                
                
                6,000
                
                
                2,000
                
                
                6,000
                
                
                15,000Comprehensive
                    loss
                
                $
                (3,025,000
                )
                $
                (3,210,000
                )
                $
                (11,048,000
                )
                $
                (34,757,000
                )





**6.  
      Investments**





As
      of
      September 30, 2007, w e
      held
      approximately 2.4 million shares of Chromos, a
      publicly traded company whose common stock is listed on the Toronto Stock
      Exchange. Periodically, we sell these shares on a specific identification method
      based on when we received the shares. During the nine months ended September
      30,
      2007, we sold 100,000 shares resulting in a realized gain of
      $1,000.


8


We
      record
      our common stock investment in Chromos at fair market value and record changes
      in the fair market value of this stock in accumulated other comprehensive loss
      in the accompanying condensed consolidated balance sheets .
      We
      periodically evaluate our Chromos stock for signs of impairment that may be
      other-than-temporary, which would necessitate a reduction in the carrying value
      of the investment and charge to expense. During the first and second quarters
      of
      2007, due to the declining market value of the Chromos securities and a decline in Chromos’
current financial position, we determined that our investment is
      other-than-temporarily impaired. Accordingly, we wrote the asset down to the
      fair market value of the Chromos stock on both March 31, 2007 and June 30,
      2007
      and recognized a realized loss of $208,000 in the first quarter and an
      additional realized loss of $44,000 in the second quarter. We evaluated the
      investment again on September 30, 2007 and based on additional facts about
      Chromos, we determined that our investment was not further impaired at that
      date. We recognized an unrealized gain due to a change in the exchange rate
      for
      the Canadian dollar during the third quarter of 2007. We continue to monitor
      the
      status of Chromos.





Following
      is a summary of our Investment activity for the nine months ended September
      30,
      2007:





**Fair**
              **Value**
            
            **Unrealized**
              **Gain**
            
            **Proceeds**
              **from
                the**
              **sale
                of**
              **securities**
            
            **Net**
              **Realized**
              **Loss**Marketable
                equity securities
            
            $
            95,000
            
            $
            6,000
            
            $
            16,000
            
            $
            (251,000
            )





**7.  
      Goodwill**





We
      perform goodwill impairment tests in accordance with SFAS No. 142, *“Goodwill
      and Other Intangible Assets”* on an
      annual basis or more frequently if events and changes in business conditions
      indicate that the carrying amount of our goodwill may not be recoverable.
      Normally, we perform our annual impairment test as of October 1. However, in
      the
      second quarter of 2006, as a result of a decline in market price of our common
      stock in June 2006, to a level that reduced our market capitalization to an
      amount less than the fair value of our net assets, we concluded that this was
      an
      indicator of impairment of our goodwill and therefore we were required to
      perform an interim goodwill impairment test. In the first step of this testing,
      since we are comprised of only one reporting unit, we compared our fair value,
      as measured by market capitalization and discounted cash flow analysis, to
      the
      net carrying value of our assets. Since our indicated fair value in this June
      2006 test was less than the net carrying value of our assets, we were then
      required to perform the second step of the evaluation and measure the amount
      of
      the impairment loss. This analysis required us to determine the implied value
      of
      goodwill by allocating our estimated fair value to its assets and liabilities
      including intangible assets such as in-process research and development,
      completed technology, and trademarks and trade names using a hypothetical
      purchase price allocation as if we had been acquired in a business combination
      as of the date of the impairment test. This evaluation resulted in an implied
      goodwill balance of $7.9 million and a second quarter 2006 non-cash goodwill
      impairment charge of $23.7 million. Since the second quarter of 2006, we have
      had no further indications of impairment on our goodwill balance.





**8.  
      Income Taxes**




We
      adopted the provisions of FASB Interpretation No. 48, *“Accounting
      for Uncertainty in Income Taxes”* ,
      or FIN
      48, on January 1, 2007. We have been in a net operating loss position since
      inception and have not recognized any tax benefits for any of our income tax
      positions as a result of a full valuation allowance. There were no changes
      to
      the amount of recognized tax benefits as a result of adopting FIN 48, and there
      were no changes to the recognized tax benefits during the three and nine months
      ended September 30, 2007.





Historically,
      we have not incurred any interest or penalties associated with tax matters
      and
      no interest or penalties were recognized during the three and nine months ended
      September 30, 2007. We have adopted a policy whereby amounts related to interest
      and penalties associated with tax matters are classified as additional income
      tax expense when incurred.





Tax
      years
      that remain open for examination include 2003, 2004, 2005, and 2006. In
      addition, tax years from our inception in 1992 to 2002 may be subject to
      examination in the event we utilize the net operating losses from those years
      in
      our current or future year tax returns.


9





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




**Forward-Looking
      Statements**




This
      quarterly report on Form 10-Q contains forward-looking statements within the
      meaning of the private Securities Litigation Reform Act of 1995. All statements
      other than statements of historical fact are forward-looking and involve risks
      and uncertainties. Forward-looking statements include statements about our
      product development and commercialization goals and expectations, potential
      market opportunities, our plans for and anticipated results of our clinical
      development activities and the potential advantage of our product candidates,
      our future cash requirements and the sufficiency of our cash and cash
      equivalents to meet these requirements, our ability to raise capital when needed
      and other statements that are not historical facts. Words such as “may,” “will,”
“believes,” “estimates,” “expects,” “anticipates,” “plans” and “intends,” or
      statements concerning “potential” or “opportunity” and other words of similar
      meaning or the negative thereof, may identify forward-looking statements, but
      the absence of these words does not mean that a statement is not
      forward-looking. In making these statements, we rely on a number of assumptions
      and make predictions about the future. Our actual results could differ
      materially from those stated in, or implied by, forward-looking statements
      for a
      number of reasons, including the risks described in greater detail in the
      section entitled “Risk Factors” in Part I, Item IA of our annual report on Form
      10-K for the year ended December 31, 2006, as supplemented by the section
      entitled “Risk Factors” in Part II, Item 1A of this quarterly
      report.





You
      should not unduly rely on these forward-looking statements, which speak only
      as
      of the date of this quarterly report. We undertake no obligation to publicly
      revise any forward-looking statement after the date of this quarterly report
      to
      reflect circumstances or events occurring after the date of this quarterly
      report or to conform the statement to actual results or changes in our
      expectations. You should, however, review the risk factors and other information
      we provide in the reports we file from time to time with the SEC.





**BUSINESS
      OVERVIEW**





We
      are a
      clinical-stage therapeutic biotechnology company. We are at the forefront of
      developing, with the goal of commercializing, a new class of therapeutic
      products called gene therapeutics. We believe that a wide range of diseases
      may
      potentially be treated or prevented with gene therapeutics. In addition to
      treating diseases that have not had treatments in the past, we believe that
      there is also a significant opportunity to use gene therapeutics to more
      effectively treat diseases that are currently treated using other therapeutic
      classes of drugs such as protein-based drugs, monoclonal antibodies or small
      molecule drugs.





Gene
      therapeutics consist of a delivery vehicle, called a vector, and genetic
      material. The role of the vector is to carry the genetic material into a target
      cell. Once delivered into the cell, the gene can express or direct production
      of
      the specific proteins encoded by the gene. Gene therapeutics may be used to
      treat disease facilitating the normal protein production or gene regulation
      capabilities of cells. Gene therapeutics may be used to enable cells to produce
      more of a certain protein or different proteins than they normally produce
      thereby treating a disease state. Gene therapeutics may also be used for RNAi
      interference, or RNAi, to deliver small RNA molecules that once delivered into
      the cell may shut down or interfere with cellular functions.





We
      and
      our partners, Celladon Corporation, or Celladon, the National Institute of
      Allergy and Infectious Diseases, or NIAID, the International
      AIDS Vaccine Initiative, or IAVI ,
      the
      Children’s Hospital of Philadelphia, or CHOP, and The Research Institute at
      Nationwide Children’s Hospital (formerly known as the Columbus Children’s
      Research Institute), or NCH, are primarily focused on the following adeno-associated
      viral vectors, or AAV, based product
      development programs:




**Description**
              
              **Indication**
              
              **Partners**
              
              **Development**
                **Status**AAV
                  delivery of TNF-alpha antagonist
              
              Inflammatory
                  Arthritis
              
              None
              
              Phase
                  I/IIAAV
                  delivery of HIV antigens
              
              HIV/AIDS
              
              IAVI,
                  CHOP and NCH
              
              Phase
                  IIAAV
                  delivery of SERCA2a
              
              Congestive
                  Heart Failure
              
              Celladon
              
              Phase
                  IAAV
                  delivery of HIV antigens
              
              HIV/AIDS
              
              CHOP,
                  NCH and NIAID
              
              PreclinicalAAV
                  expression of htt shRNA (RNAi)
              
              Huntington’s
                  disease
              
              Sirna
                  Therapeutics as a subsidiary of Merck
              
              Preclinical





10




In
      the
      first nine months of 2007, we made progress in our development collaborations
      and our product development programs and expanded and leveraged our patent
      portfolio. More specifically:





·
            In
                June 2007, we reported additional data from our ongoing Phase I/II
                clinical trial of our inflammatory arthritis candidate that demonstrated
                safety and a trend in two-point reduction in swelling in treated
                joints
                compared to placebo. We completed enrollment and initial dosing in
                this
                trial in May 2007. However, the trial was placed on clinical hold
                in July
                2007after a patient participating in the clinical trial experienced a
                serious
                adverse event, or SAE, and subsequently died. In September 2007,
                the
                National Institutes of Health Recombinant DNA Advisory Committee
                held a
                public hearing which reviewed the SAE. Evidence presented at the
                hearing
                suggested that the subject died of an invasive fungal infection.
                The
                medications the subject was on are known to be a risk factor for
                histoplasma infection, which is a fungal infection. Biochemical evidence
                that the subject already had fungal infection prior to the second
                dose was
                also reported at the meeting. Additionally, initial molecular tests
                showed
                there was no amplification of vector and only trace amounts of vector
                DNA
                in tissues outside the joint. Consequently, we believe these data
                suggest
                it is unlikely that our experimental inflammatory arthritis candidate
                contributed to the conditions that caused the death.





·
            In
                February 2007, we reported results from a Phase I clinical trial
                of our
                investigational HIV/AIDS vaccine candidate which we have partnered
                with
                IAVI. The results of this study, which was funded and run by
                IAVI,indicated favorable safety and tolerability profiles consistent with
                the
                results observed in clinical trials to date, and provided the rationale
                for evaluating the vaccine at higher doses and at different dosing
                intervals.The
                Phase I clinical trial was a dose escalation safety trial and was
                conducted in Germany, Belgium and India.
                In addition, in August 2007, we presented interim results from a
                separate
                Phase II clinical trial of our partnered investigational HIV/AIDS
                vaccine
                candidate that demonstrated that the vaccine was safe and well tolerated
                and that modest immune responses were shown in some recipients who
                received higher doses. The Phase II clinical trial is also being
                funded
                and run by IAVI and is being conducted in South Africa, Uganda and
                Zambia
                to evaluate a higher dose and to systematically evaluate the utility
                and
                optimal timing of boost vaccination.





·
            In
                May 2007, the first patient was dosed in the Phase I clinical trial
                of
                MYDICAR, which is our partnered congestive heart failure product
                candidate
                under development through our collaboration with Celladon.





·
            In
                May 2007, in collaboration with theUniversity
                College London's Institute of Ophthalmology and Moorfields Eye Hospital,
                a
                Phase I/II clinical trial was initiated to test the use of an
                AAVvector to deliver RPE65 to treata
                form of childhood blindness. Weproduced
                the vector used in this trial. The trial is funded by the UK Department
                of
                Health.





·
            In
                September 2007, we received a milestone payment from Amsterdam Molecular
                Therapeutics upon initiation of a clinical trial for AMT-011, an
                AAV1-based therapy for LPL
                deficiency.





·
            We
                have received issuances of additional patents, strengthening our
                AAV
                vector patent portfolio and expanding the potential applications
                of
                AAV-based gene delivery.





Most
      of
      our expenses are related to advancing our research and development programs,
      conducting preclinical studies and clinical trials and for general and
      administrative support of these activities. We have financed the company
      primarily through proceeds from public and private sales of our equity
      securities, cash payments received from our collaborative partners for product
      development and manufacturing activities, proceeds from the issuance of debt
      and, to a lesser extent, through loan funding under equipment financing
      arrangements. During 2007, we completed two private placements of our common
      stock generating approximately $26.0 million to fund our programs and
      operations. On June 27, 2007, we sold 6.7 million shares of our common stock
      in
      a private placement at a price of $2.905 per share and received net proceeds
      of
      approximately $17.8 million. In connection with the financing we issued
      five-year warrants to purchase up to 6.7 million shares of our common stock.
      We
      also issued a warrant to purchase 334,989 shares of our common stock as
      compensation to the placement agent in this transaction. On January 11, 2007,
      we
      sold 2.2 million shares of our common stock in a private placement at a price
      of
      $4.00 per share and received net proceeds of approximately $8.1 million. In
      connection with this financing we issued warrants to purchase up to 763,000
      shares of our common stock. We also issued a warrant to purchase 16,119 shares
      of our common stock as compensation to the placement agent in this
      transaction.





As
      of
      September 30, 2007, our accumulated deficit totaled $295.1 million. We expect
      to
      generate substantial additional losses for the foreseeable future, primarily
      due
      to the costs associated with funding our inflammatory arthritis clinical
      development program, developing and maintaining our manufacturing capabilities
      and developing our intellectual property assets.





To
      enable
      us to successfully develop our lead inflammatory arthritis product candidate
      and
      other product candidates we will require access to significantly higher amounts
      of capital than we currently have. We may be unable to obtain required funding
      when needed or on acceptable terms, obtain or maintain corporate partnerships,
      or complete acquisition transactions necessary or desirable to complete the
      development of our product candidates.


11




**CRITICAL
      ACCOUNTING POLICIES, ESTIMATES AND ASSUMPTIONS**





Other
      than with respect to those items described below, there have been no material
      changes from the critical accounting policies, estimates and assumptions as
      disclosed in Item 7 “Management’s Discussion and Analysis of Financial Condition
      and Results of Operations” of the Company’s annual report on Form 10-K for the
      year ended December 31, 2006. The critical accounting policies, estimates and
      assumptions described below have been updated to provide more recent financial
      and factual information as of September 30, 2007.





***Accounting
      for Uncertainties in Income Taxes***





Effective
      the beginning of 2007, we adopted FASB Interpretation No. 48, “ *Accounting
      for Uncertainty in Income Taxes,”* or
      FIN
      48. FIN 48 provides guidance to address uncertainty in tax positions and
      clarifies the accounting for income taxes by specifying a minimum recognition
      threshold which income tax positions must achieve before being recognized in
      the
      financial statements. The adoption of FIN 48 had no impact on our net loss,
      earnings per share or financial position for the three and nine months ended
      September 30, 2007.




The
      application of income tax law is inherently complex. Laws and regulations in
      this area are voluminous and are often ambiguous. As such, we are required
      to
      make many subjective assumptions and judgments regarding our income tax
      exposures. Interpretations of and guidance surrounding income tax laws and
      regulations change over time. Changes in our subjective assumptions and
      judgments can materially affect amounts recognized in the consolidated balance
      sheets and statements of income.





**RESULTS
      OF OPERATIONS**





***Revenue***





Revenue
      increased to $2.4 million for the three months ended September 30, 2007 as
      compared to $2.0 million for the same period in 2006. Revenue increased to
      $7.1
      million for the nine months ended September 30, 2007 compared to $5.9 million
      for the same period in 2006. The increase in revenue for both the three and
      nine
      month periods primarily reflects an increase in research and development
      activities under the NIAID-funded HIV/AIDS vaccine project in collaboration
      with
      CHOP and NCH and licensing revenue from a milestone payment received in the
      third quarter. These increases were partially offset by lower research and
      development activities under our collaboration with IAVI
      as a
      result of less development activity as the project is largely focused on
      clinical testing. We
      expect
      that our revenue for the remainder of 2007 will continue to consist primarily
      of
      research and development revenue earned from the NIAID-funded HIV/AIDS vaccine
      project in collaboration with CHOP and NCH and to a lesser extent, work under
      our collaboration with Celladon. For the next several years, our revenue will
      depend on the continuation of the current collaborations and our success in
      entering into and performing under new collaborations.





***Operating
      Expenses***





*Research
      and Development Expenses* .    Research
      and development expenses increased to $3.9 million for the three months ended
      September 30, 2007 compared to $3.1 million for the same period in 2006 and
      increased to $12.8 million for the nine months ended September 30, 2007 compared
      to $10.5 million for the same period in 2006. Costs for both the three and
      nine
      month periods are higher due to increased research and development costs for
      our
      preclinical programs, specifically the NIAID-funded HIV/AIDS vaccine program
      in
      collaboration with CHOP and NCH and costs incurred to support the initiation
      of
      clinical trials for the congestive heart failure product, which began in May
      2007. Costs related to our inflammatory arthritis program increased due to
      a
      higher number of enrolled subjects in our Phase I/II clinical trial. This cost
      increase was partially offset by lower costs related to our HIV/AIDS vaccine
      collaboration with IAVI as a result of less development activity. We expect
      that
      our research and development expenses for the remainder of 2007 will vary
      depending on the amount and timing of development efforts and outside services
      necessary to advance both our self-funded and partnered clinical programs,
      the
      NIAID-funded HIV/AIDS vaccine project in collaboration with CHOP and NCH and
      other programs in preclinical development.


12





The
      following is an allocation of our total research and development costs between
      our programs in clinical development and those that are in research or
      preclinical stages of development:





**Three months ended**
              **September 30,**
            
            **Nine months ended**
              **September 30,****2007**
            
            **2006**
            
            **2007**
            
            **2006**Programs
                in clinical development:Inflammatory
                arthritis
            
            $
            1,091,000
            
            $
            771,000
            
            $
            2,948,000
            
            $
            2,204,000Congestive
                heart failure (1)
            
            
            170,000
            
            
            —
            
            
            373,000
            
            
            —IAVI
                HIV/AIDS vaccine
            
            
            33,000
            
            
            383,000
            
            
            202,000
            
            
            1,494,000Indirect
                costs and other
            
            
            631,000
            
            
            556,000
            
            
            2,161,000
            
            
            2,187,000Total
                clinical development program expense
            
            
            1,925,000
            
            
            1,710,000
            
            
            5,684,000
            
            
            5,885,000Research
                and preclinical development program expense
            
            
            1,949,000
            
            
            1,413,000
            
            
            7,156,000
            
            
            4,598,000Total
                research and development expense
            
            $
            3,874,000
            
            $
            3,123,000
            
            $
            12,840,000
            
            $
            10,483,000





(1)
      Includes costs incurred after the clinical trial was initiated in May 2007.
      Costs incurred prior to that are included as research and preclinical
      development program expense.





Research
      and development costs attributable to programs in clinical development include
      salaries and benefits, clinical trial costs, outside services, and materials
      and
      supplies incurred to support the clinical programs. Indirect costs allocated
      to
      clinical programs include facility and occupancy costs, research and development
      administrative costs, and license and royalty payments. These costs are further
      allocated between clinical and preclinical programs based on relative levels
      of
      program activity. Celladon separately manages and funds the clinical trial
      costs
      of our congestive heart failure program and IAVI separately manages and funds
      the clinical trial costs of our HIV/AIDS vaccine program for the developing
      world. As a result, we do not include those costs in our research and
      development expenses.





Costs
      attributed to research and preclinical programs represent our earlier-stage
      development activities and include costs incurred for development activities
      for
      the NIAID-funded HIV/AIDS vaccine project in collaboration with CHOP and NCH
      as
      well as other programs prior to their transition into clinical trials. Research
      and preclinical development program expense also includes costs that are not
      allocable to a clinical development program, such as unallocated manufacturing
      infrastructure costs. Because we conduct multiple research projects and utilize
      resources across several programs, our research and preclinical development
      costs are not directly assigned to individual programs.





For
      purposes of reimbursement from our collaboration partners, we capture the level
      of effort expended on a program through our project management system, which
      is
      based primarily on human resource time allocated to each program, supplemented
      by an allocation of indirect costs and other specifically identifiable costs,
      if
      any. As a result, the costs allocated to programs identified in the table above
      do not necessarily reflect the actual costs of the program.





*General
      and Administrative Expenses* .    General
      and administrative expenses remained consistent at $1.7 million for the three
      months ended September 30, 2007 and September 30, 2006. General and
      administrative expense increased to $4.8 million for the nine months ended
      September 30, 2007 from $4.7 million for the nine months ended September 30,
      2006. **** General
      and administrative expenses consist primarily of salaries, patent costs, legal
      and audit fees and shareholder costs.





*Restructure
      Charges.* Restructure
      charges decreased to $183,000 for the three months ended September 30, 2007
      compared to $413,000 for the same period in 2006. Restructure charges decreased
      to $809,000 for the nine months ended September 30, 2007 compared to $1.8
      million for the same period in the prior year. Restructuring charges for the
      nine months ended September 30, 2007 include $260,000 related to changes in
      our
      estimates of the anticipated lead time to sublease the Bothell facility.
      Restructuring charges for the first nine months of 2006 include charges of
      $860,000 related to changes in our expectations regarding market conditions
      for
      the Bothell facility subleasing market, charges of $219,000 related to employee
      termination benefits of our restructuring efforts to realign our cost structure
      and charges of $174,000 in relation to the early termination of a portion of
      our
      Seattle facility lease resulting from the head count reductions. Restructuring
      charges also include accretion expense of $549,000 for the nine months ended
      September 30, 2007 and $564,000 for the nine months ended September 30, 2006.





*Goodwill
      Impairment Charge.* We
      periodically and annually on October 1 st evaluate
      the carrying value of our goodwill in accordance with SFAS No. 142, *“Goodwill
      and Other Intangible Assets”* and ** if
      there
      is evidence of an impairment in value, we reduce the carrying value of the
      asset. As discussed in Note 7 of the notes to our condensed consolidated
      financial statements, we recognized a non-cash loss on impairment of goodwill
      during second quarter of 2006. As a result of a decline in our share price
      during June 2006, to a level which reduced market capitalization to an amount
      less than the fair value of our net assets, we were required to perform an
      interim goodwill impairment test. As a result of this evaluation, during the
      second quarter of 2006, we recognized a non-cash impairment charge of $23.7
      million, which was equal to the recorded value of goodwill in excess of its
      implied value.


13





***Other
      Income and Expense***





*Investment
      Income* .    
      Investment income reflects interest income earned on our short term investments
      and realized gains or losses on our investment in Chromos Molecular Systems
      Inc,
      or Chromos. Investment income increased to $277,000 for the three months ended
      September 30, 2007 compared to income of $147,000 for the same period in 2006.
      The increase is due to income earned on higher average cash balances during
      the
      third quarter of 2007. Investment income decreased to $305,000 for the nine
      months ended September 30, 2007 compared to $468,000 for the same period in
      2006. Investment income for the nine month period reflects a net realized loss
      of $251,000 recognized in the first and second quarters of 2007 related to
      an
      other-than-temporary impairment loss on our investment in Chromos due to the
      declining market value of Chromos’ securities combined with a decline in
      Chromos’ current financial position. ****





*Interest
      Expense* .    
      Interest expense decreased to zero for the three months ended September 30,
      2007, compared to $126,000 for the same period in 2006. Interest expense
      decreased to $1,000 for the nine months ended September 30, 2007, compared
      to
      $362,000 for the same period in the prior year. In November 2006, we
      restructured a $8.15 million outstanding loan from Biogen Idec by exchanging
      $5.65 million of the balance for common shares of our stock, making a $500,000
      payment and establishing a new repayment schedule for the remaining balance.
      As
      a result of restructuring the Biogen Idec debt, the $501,000 carrying value
      of
      the remaining debt as of September 30, 2007 includes the related estimated
      future interest payments and accordingly, we did not record interest expense
      on
      the Biogen Idec debt in the three month and nine month periods ended September
      30, 2007. We do not expect to record future interest expense on this
      restructured debt.





**LIQUIDITY
      AND CAPITAL RESOURCES**




We
      had
      cash and cash equivalents of $20.5 million at September 30, 2007 compared to
      $6.2 million at December 31, 2006. Our cash and cash equivalents increased
      in the nine months ended September 30, 2007 primarily reflecting the net
      proceeds of $25.9 million from our January and June 2007 sales of our common
      stock, partially offset by our net loss and the resulting cash used in
      operations of $10.2 million and debt payments of $1.2 million made to Biogen
      related to our outstanding loan.





On
      June
      27, 2007, we sold 6.7 million shares of our common stock in a private placement
      at a price of $2.905 per share and received net proceeds of approximately $17.8
      million. In addition, in connection with the financing, we issued warrants
      to
      purchase up to 6.7 million shares of our common stock. We also issued a warrant
      to purchase 334,989 shares of our common stock as compensation to the placement
      agent in this transaction. On January 11, 2007, we sold 2.2 million shares
      of
      our common stock in a private placement at a price of $4.00 per share and
      received net proceeds of approximately $8.1 million. In addition, in connection
      with the financing we issued warrants to purchase up to 763,000 shares of our
      common stock. **** We
      also
      issued a warrant to purchase 16,119 shares of our common stock as compensation
      to the placement agent in this transaction. We
      intend
      to continue to seek appropriate opportunities to access the public and private
      capital markets, however, our ability to issue equity securities at the current
      market price will likely be adversely affected by the fact that we are presently
      ineligible under SEC rules to utilize Form S-3 for primary offerings of our
      securities because the aggregate market value of our outstanding common stock
      held by non-affiliates is less than $75 million.





Our
      primary expenses are related to the development of our research and development
      programs, the conduct of preclinical studies and clinical trials and general
      and
      administrative support for these activities. Our partnered HIV/AIDS vaccine
      candidate for the developing world, our inflammatory arthritis product candidate
      and our partnered congestive heart failure product candidate are all in the
      clinical phase of development. We expect to continue incurring significant
      expense in developing and advancing our technology and product candidates toward
      commercialization. As a result, we do not expect to generate sustained positive
      cash flow from our operations for at least the next several years and only
      then
      if we can successfully develop and commercialize our product candidates. We
      currently have 84,453 of unreserved authorized shares at September 30, 2007
      and
      will require substantial additional financial resources to fund the development
      and commercialization of our lead product candidate in inflammatory
      arthritis.





We
      are
      currently focusing our development funding on our inflammatory arthritis product
      candidate, which is in Phase I/II clinical trials. We currently fund all costs
      of this program from our working capital and expect to do so for the foreseeable
      future, although our strategy is to ultimately seek a partner to fund
      later-stage development of this program.





In
      addition to the funding necessary to advance our product development candidates
      and fund our ongoing operations, we also have significant long-term lease
      commitments that draw on our cash resources. Our most significant obligation
      is
      approximately $12.3 million of lease payments remaining on our Bothell facility,
      which we are obligated to pay at $1.4 million to $1.6 million per year until
      the
      year 2015.


14





We
      expect
      the level of our future operating expenses to be driven by the needs of our
      product development programs, our debt obligations and our lease obligations,
      offset by the availability of funds through equity offerings, partner-funded
      collaborations or other financing or business development activities. The size,
      scope and pace of our product development activities depend on the availability
      of these resources. Our future cash requirements will depend on many factors,
      including:





•
            the
                rate and extent of scientific progress in our research and development
                programs;





•
            the
                timing, costs and scope of, and our success in, conducting clinical
                trials, obtaining regulatory approvals and pursuing patent
                prosecutions;





•
            competing
                technological and market developments;





•
            the
                timing and costs of, and our success in, any product commercialization
                activities and facility expansions, if and as required;
                and





•
            the
                existence and outcome of any litigation or administrative proceedings
                involving intellectual property.





We
      have
      financed our product development activities and general corporate functions
      primarily through proceeds from public and private sales of our equity
      securities, through cash payments received from our collaborative partners
      and
      proceeds from the issuance of debt. To a lesser degree, we have also financed
      our operations through interest earned on cash and cash equivalents and loan
      funding under equipment financing agreements. These financing sources have
      historically allowed us to maintain adequate levels of cash and cash
      equivalents.





Our
      development collaborations have typically provided us with funding in several
      forms, including purchases of our equity securities, loans, payments for
      reimbursement of research and development costs and milestone fees and payments.
      We and our partners typically agree on a target disease and create a development
      plan for the product candidate, which generally extends for multiple one-year
      terms and is subject to termination or extension. For example, when the IAVI
      collaboration was initiated in 2000, it originally had a three-year term yet
      the
      work plan was established and funded on an annual basis. In 2004, we and IAVI
      agreed to extend the underlying program through the end of 2006 and in 2006
      we
      agreed to further extend the program until the expiration of the term of the
      last patent within the patent rights controlled by us and utilized in the IAVI
      vaccine. In 2005, we extended the scope of our HIV/AIDS vaccine program
      activities to the developed world, via a NIAID-funded HIV/AIDS vaccine project
      in collaboration with CHOP and NCH. To date we have received $4.2 million under
      this subcontract and our portion of the remaining project funding could be
      up to
      an additional $14.0 million over the remaining three years of the contract.
      Funding for this subcontract is awarded to us in annual installments based
      on an
      approved work plan and achievement of milestones.





The
      funding we receive from each of our collaborative partners fully offsets our
      incremental program costs related to each collaboration and our overhead and
      fixed costs. Our revenue from collaborative agreements and licenses totaled
      $9.9
      million in 2006 and, assuming that we complete all of the planned development
      activities for each of these funded projects, we expect collaborative agreement
      and license revenue of up to $10 million in 2007.





Each
      of
      our collaborations has provisions that allow our partners the right to terminate
      both the underlying collaboration and the obligation to provide research funding
      at any time with as little as 90 days notice. If we were to lose the expected
      funding from any of our collaborators and were unable to obtain alternative
      sources of funding, we would be unable to continue our research and development
      program for that product candidate and our cash horizon would be
      shortened.





Our
      near-term financing strategy includes leveraging our development capabilities
      and intellectual property assets into additional capital raising opportunities,
      advancing our clinical development programs and accessing the public and private
      capital markets at appropriate times. Our financing strategy is focused
      around the advancement of our two programs in clinical development, advancement
      of our newer development collaborations and generating value from our
      intellectual assets and capabilities. There is a low level of success in
      clinical trials and our ability to raise capital depends in part on clinical
      trial success.





Additional
      sources of financing could involve one or more of the following:





·
            entering
                into additional product development
                collaborations;





·
            mergers
                and acquisitions;


15


·
            issuing
                equity in the public or private markets;





·
            extending
                or expanding our current
                collaborations;





·
            selling
                or licensing our technology or product candidates;





·
            borrowing
                under loan or equipment financing arrangements;
                and/or





·
            issuing
                debt.





Additional
      funding may not be available to us on reasonable terms, if at all.





We
      expect
      that our total cash requirements for 2007 will range from **$** 14
      million to $16 million and that our cash and cash equivalents at September
      30,
      2007, plus the anticipated funding from our product development collaborations
      and contracts, will be sufficient to fund our currently forecast operations
      for
      at least a year. This estimate is based on our ability to perform planned
      research and development activities and the receipt of planned funding from
      our
      collaborators.





Depending
      on our ability to successfully access additional funding, we may be forced
      to
      implement additional cost reduction measures. Further adjustments may include
      scaling back or delaying our inflammatory arthritis development program, staff
      reductions, scaling back our intellectual property prosecution, subleasing
      portions of our lab facilities, curtailing capital expenditures or reducing
      other operating activities. We may also be required to relinquish some rights
      to
      our technology or product candidates or grant licenses on unfavorable terms,
      either of which would reduce the ultimate value to us of the technology or
      product candidates.





**Item
      3.** ***Quantitative
      and Qualitative Disclosures About Market Risk*** ****




We
      are
      exposed to market risk for the effect of interest rate changes, foreign currency
      fluctuations and changes in the market values of our investments.





*Items
      with interest rate risk:*





·  *Short
      term investments* :
      Because
      of the short-term nature of our investments, we believe that our exposure to
      market rate fluctuations on our investments is minimal. Currently, we do not
      use
      any derivative or other financial instruments or derivative commodity
      instruments to hedge any market risks and do not plan to employ these
      instruments in the future. At September 30, 2007, we held $20.5 million in
      cash,
      which is primarily invested in money market funds and denominated in U.S.
      dollars. An analysis of the impact on these securities of a hypothetical 10.0%
      change in short-term interest rates from those in effect at September 30, 2007,
      indicates that such a change in interest rates would not have a significant
      impact on our financial position or on our expected results of operations in
      2007.





·  *Notes
      payable* :  Our
      results of operations are affected by changes in short-term interest rates
      as a
      result of a loan from Biogen Idec that contains a variable interest rate.
      Interest payments on this loan are established quarterly based upon LIBOR plus
      1%. Changes in market interest rates and the timing of these remaining interest
      payments may ultimately result in adjustments to the gain on debt restructuring
      we recognized in 2006. The carrying amount of the note payable approximates
      fair
      value because the interest rate on this instrument changes with, or
      approximates, market rates. The following table provides information as of
      September 30, 2007, about our obligations that are sensitive to changes in
      interest rate fluctuations:





Expected
                Maturity Date2007
            
            2008
            
            2009
            
            2010
            
            2011
            
            TotalVariable
                rate note
            
            $
            —
            
            $
            410,000
            
            $
            —
            
            $
            —
            
            $
            —
            
            $
            410,000





*Items
      with market and foreign currency exchange risk:*




·  *Investment
      in Chromos Molecular Systems, Inc.:* At
      September 30, 2007, we held 2.4 million shares of Chromos common shares with
      a
      market value of $0.04 per common share as quoted by the Toronto Stock Exchange
      and denominated in Canadian dollars. As of September 30, 2007 the Canadian
      dollar to US dollar exchange rate was US $1.00712 per CA $1.00. As of September
      30, 2007, this investment is recorded at $95,000 and is classified within
      prepaid expenses and other in
      the
      accompanying condensed consolidated balance sheet . We
      recorded a net realized loss of $251,000 in the nine months ended September
      30,
      2007 due to an other-than-temporary impairment resulting from a decline in
      market value of the Chromos securities combined with decline in Chromos’ current
      financial position. We hold these shares of common stock as available-for-sale
      securities as we periodically sell them on the Toronto Stock Exchange. As a
      result of selling 100,000 shares of Chromos stock in the nine months ended
      September 30, 2007, we recorded $1,000 of realized gains and received $16,000
      in
      cash. The amount of potential realizable value in this investment will be
      determined by the market, the exchange rate between the Canadian and US dollar
      and our ability to sell the shares in the open market.


16





**Item
      4T.*****Controls
      and Procedures*******




*Evaluation
      of disclosure controls and procedures.* Based
      on
      our management’s evaluation, with the participation of our Chief Executive
      Officer and Chief Financial Officer, of the effectiveness of our disclosure
      controls and procedures as of the end of the period covered by this quarterly
      report, our Chief Executive Officer and Chief Financial Officer have concluded
      that our disclosure controls and procedures are effective in ensuring that
      information we are required to disclose in reports that we file or submit under
      the Securities Exchange Act of 1934, as amended, is recorded, processed,
      summarized and reported within the time periods specified in the SEC rules
      and
      forms.





*Changes
      in internal control over financial reporting.* There
      was
      no change in our internal control over financial reporting, that occurred during
      the period covered by this quarterly report that materially affected, or is
      reasonably likely to materially affect, our internal control over financial
      reporting.





**PART
      II    OTHER INFORMATION**




**Item
      1. Legal Proceedings**




We
      are
      currently not a party to any legal proceedings.




**Item
      1A. Risk Factors**





Other
      than with respect to the risk factors below, there have been no material changes
      from the risk factors disclosed in “Section 1A. Risk Factors” of our annual
      report on Form 10-K for the year ended December 31, 2006 but please
      carefully consider both the risk factors of our annual report on Form 10-K
      and
      the risk factors below. The risk factors described below were previously
      disclosed on the Form 10-K but have been updated to provide more recent
      financial and factual information as of September 30, 2007.





**Risks
      Related to Our Business**





***We
      expect to continue to operate at a loss and may never become
      profitable.***





Substantially all of our revenue since 2005 has been derived from collaborative
      research and development agreements in connection with the development of our
      potential product candidates including our collaborations with IAVI and Celladon
      and our NIAID-funded subcontract with CHOP and NCH. We have incurred, and will
      continue to incur for the foreseeable future, significant expense to develop
      our
      research and development programs, conduct preclinical studies and clinical
      trials, seek regulatory approval for our product candidates and provide general
      and administrative support for these activities. As a result, we have incurred
      significant net losses since inception, and we expect to continue to incur
      substantial additional losses in the future.





As
      of
      September 30, 2007, we had an accumulated deficit of $295.1 million. We may
      never be able to commercialize our products or generate profits and, if we
      do
      become profitable, we may be unable to sustain or increase profitability.





***Our
      lead product candidate was placed on clinical hold and we do not currently
      know
      when or if the clinical trial of the product candidate will
      resume.***





On
      July
      20, 2007, we and the FDA placed a clinical hold on our Phase I/II clinical
      trial
      of tgAAC94, our inflammatory arthritis product candidate, after a patient
      participating in the clinical trial experienced a serious adverse event, or
      SAE.
      This patient subsequently died and the cause of death is currently under
      investigation.





In
      September 2007, the National Institutes of Health Recombinant DNA Advisory
      Committee held a public hearing which presented the preliminary evidence of
      the
      investigation.  Preliminary experimental evidence and autopsy findings
      presented at the hearing suggested that the subject died of an invasive fungal
      infection.  While we believe these data suggest it is unlikely that our
      experimental inflammatory arthritis candidate contributed to the conditions
      that
      caused the death, we, the FDA or others may identify concerns that could cause
      further delay or termination of the Phase I/II tgAAC94 clinical trial.  
The investigation is ongoing and no assurance can be made that the FDA will
      remove the hold or will allow us to continue the administration of tgAAC94
      in
      this study or in other future clinical studies. Any significant delay in
      removing the clinical hold from this study, or an ultimate termination of this
      study related to the clinical hold, would negatively impact our future operating
      results and would likely result in a decrease in the trading price of our common
      shares.


17





***All
      of our product candidates are in early-stage clinical trials or preclinical
      development, and if we and our partners are unable to successfully develop
      and
      commercialize our product candidates we will be unable to generate sufficient
      capital to maintain our business.***





As
      of July 2007, our congestive heart failure product candidate in collaboration
      with Celladon is in a Phase I clinical trial, our inflammatory arthritis
      candidate is in a Phase I/II trial, our HIV/AIDS product candidate in
      collaboration with IAVI is in a Phase II trial and we have no product candidates
      in Phase III trials. Of the trials that are currently being conducted, we will
      not generate any product revenue, manufacturing revenue, revenue sharing or
      royalties for at least several years, and then only if we can and/or our
      partners successfully develop and commercialize our product candidates.
      Commercializing our potential products depends on successful completion of
      additional research and development and testing, in both preclinical development
      and clinical trials. Clinical trials may take several years or more to complete.
      The commencement, cost and rate of completion of our clinical trials may vary
      or
      be delayed for many reasons. If we are unable to successfully complete
      preclinical and clinical development of some or all of our product candidates
      in
      a timely manner, we may be unable to generate sufficient product revenue to
      maintain our business.





Even
      if our potential products succeed in clinical trials and are approved for
      marketing, these products may never achieve market acceptance. If we are
      unsuccessful in marketing or commercializing our product candidates for any
      reason, including greater effectiveness or economic feasibility of competing
      products or treatments, the failure of the medical community or the public
      to
      accept or use any products based on gene delivery, inadequate marketing and
      distribution capabilities or other reasons discussed elsewhere in this section,
      we will be unable to generate sufficient product revenue to maintain our
      business.





***Any
      success of our clinical trials and preclinical studies may not be indicative
      of
      results in a large number of subjects of either safety or
      efficacy.***





The
      successful results of our technology in preclinical studies using animal models
      may not be predictive of the results that we will see in our clinical trials
      with human subjects. In addition, results in early-stage clinical trials
      generally test for drug safety rather than efficacy and are based on limited
      numbers of subjects. Drug development involves a high degree of risk and our
      reported progress and results from our early phases of clinical testing of
      our
      product candidates may not be indicative of progress or results that will be
      achieved from larger populations, which could be less favorable. Moreover,
      we do
      not know if any favorable results we achieve in clinical trials will have a
      lasting or repeatable effect. If a larger group of subjects does not experience
      positive results or if any favorable results do not demonstrate a beneficial
      effect, our product candidates that we advance to clinical trials may not
      receive approval from the FDA for further clinical trials or commercialization.
      For example, in March 2005, we discontinued the development of tgAAVCF, our
      product candidate for the treatment of cystic fibrosis, following the analysis
      of Phase II clinical trial data in which tgAAVCF failed to achieve the
      efficacy endpoints of the trial.





***If
      we are unable to raise additional capital when needed, we will be unable to
      conduct our operations and develop our potential
      products.***





Because
      our internally generated cash flow will not fund development and
      commercialization of our product candidates, we will require substantial
      additional financial resources. Our future capital requirements will depend
      on
      many factors, including:




•
            the
                rate and extent of scientific progress in our research and development
                programs;





•
            the
                timing, costs and scope of, and our success in, conducting clinical
                trials, obtaining regulatory approvals and pursuing patent
                prosecutions;





•
            competing
                technological and market developments;





•
            the
                timing and costs of, and our success in, any product commercialization
                activities and facility expansions, if and as required;
                and




•
            the
                existence and outcome of any litigation or administrative proceedings
                involving intellectual property.





Additional
      sources of financing could involve one or more of the following:





•
            entering
                into additional product development
                collaborations;


18





•
            mergers
                and acquisitions;





•
            issuing
                equity in the public or private markets;





•
            extending
                or expanding our current
                collaborations;





•
            selling
                or licensing our technology or product candidates;





•
            borrowing
                under loan or equipment financing arrangements; and





•
            issuing
                debt.





Additional
      funding may not be available to us on reasonable terms, if at all. Our ability
      to issue equity, and our ability to issue it at the current market price, may
      be
      adversely affected by the fact that we are presently ineligible under SEC rules
      to utilize Form S-3 for primary offerings of our securities because the
      aggregate market value of our outstanding common stock held by non-affiliates
      is
      less than $75.0 million.





The
      perceived risk associated with the possible sale of a large number of shares
      of
      our common stock could cause some of our shareholders to sell their stock,
      thus
      causing the price of our stock to decline. In addition, actual or anticipated
      downward pressure on our stock price due to actual or anticipated sales of
      stock
      could cause some institutions or individuals to engage in short sales of our
      common stock, which may itself cause the price of our stock to decline.





If
      our
      stock price declines, we may be unable to raise additional capital. A sustained
      inability to raise capital could force us to go out of business. Significant
      declines in the price of our common stock could also impair our ability to
      attract and retain qualified employees, reduce the liquidity of our common
      stock
      and result in the delisting of our common stock from the NASDAQ Capital
      Market.





The
      funding that we expect to receive from our collaborations depends on continued
      scientific progress under the collaborations and our collaborators’ ability and
      willingness to continue or extend the collaboration. If we are unable to
      successfully access additional capital, we may need to scale back, delay or
      terminate one or more of our development programs, curtail capital expenditures
      or reduce other operating activities. We may also be required to relinquish
      some
      rights to our technology or product candidates or grant or take licenses on
      unfavorable terms, either of which would reduce the ultimate value to us of
      our
      technology or product candidates.





**Risks
      Related to Our Common Stock**





***Concentration
      of ownership of our common stock may give certain shareholders significant
      influence over our business and may result in certain decisions that are
      contrary to your interests.***





A
      small
      number of investors own a significant number of shares of our common stock.
      As
      of September 30, 2007, Special Situations held approximately 2.6 million shares,
      Biogen Idec held approximately 2.2 million shares, Orbimed Advisors LLC held
      approximately 1.3 million shares and Elan held approximately 1.2 million shares,
      of our common stock. Together these holdings represent approximately 37% of
      our
      common shares outstanding as of September 30, 2007. This concentration of stock
      ownership may allow these shareholders to exercise significant control over
      our
      strategic decisions and block, delay or substantially influence all matters
      requiring shareholder approval, such as:





•
            election
                of directors;





•
            amendment
                of our charter documents; or




•
            approval
                of significant corporate transactions, such as a change of control
                of
                us.





The
      interests of these shareholders may conflict with your interests or the
      interests of other holders of our common stock with regard to such matters.
      Furthermore, this concentration of ownership of our common stock could allow
      these shareholders to delay, deter or prevent a third party from acquiring
      control of us at a premium over the then-current market price of our common
      stock, which could result in a decrease in our stock price and a reduction
      in
      the value of your investment.





Special
      Situations, Biogen Idec and Elan have all sold shares of our common stock and
      may continue to do so. Sales of significant value of stock by these investors
      may introduce increased volatility to the market price of our common stock.
      In
      accordance with the termination agreement that we entered into with Elan in
      March 2004, Elan is only permitted to sell quantities of our stock equal to
      175%
      of the volume limitation set forth in Rule 144(e)(1) promulgated under the
      Securities Act of 1933, as amended, subject to certain exceptions.


19




**Item
      2. Unregistered Sales of Securities and Use of Proceeds**





Not
      applicable.





**Item
      3. Defaults Upon Senior Securities**




Not
      applicable.





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





Not
      applicable.





**Item
      5. Other Information**




Not
      applicable.




I **tem
      6. Exhibits**




See accompanying
      Exhibit Index
      included after
      the
      signature page of this
      quarterly report
      for a list of the exhibits filed or furnished with the report.







20





**SIGNATURES**




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




TargetedGeneticsCorporationDate: October
              31, 2007
            By:
            /s/    H.
                Stewart Parker**H.
                Stewart Parker,**
              **President,
                Chief Executive Officer and Director**
              **(Principal
                Executive Officer)**




Date:October
                31, 2007
            By:
            /s/    David
                J. Poston**David
                J. Poston,**
              **Chief
                Financial Officer**
              **(Principal
                Financial and Accounting
                Officer)**


21


**INDEX
      TO EXHIBITS**





**Exhibit**
              **Number**
            
            **Exhibit
                Description**
            
            **Form**
            
            **Date
                of**
              **First
                Filing**
            
            **Exhibit**
              **Number**
            
            **Filed**
              **Herewith**3.1.1
            
            Amended
                and Restated Articles of Incorporation, dated May 9, 2006.
            
            10-Q
            
            8/7/07
            
            3.13.1.2
            
            Articles
                of Amendment to the Restated Articles of Incorporation, dated May
                17,
                2007.
            
            10-Q
            
            8/7/07
            
            3.1.23.2
            
            Amended
                and Restated Bylaws.
            
            10-K
            
            3/17/97
            
            3.24.1
            
            Registration
                Rights Agreement among Targeted Genetics Corporation and certain
                investors
                dated as of January 8, 2007.
            
            8-K
            
            1/8/07
            
            10.24.2
            
            Registration
                Rights Agreement among Targeted Genetics Corporation and certain
                purchasers dated as of June 22, 2007.
            
            8-K
            
            6/22/07
            
            10.210.1
            
            Amendment
                No. 3 to Exclusive Sublicense Agreement, dated as of March 9, 2007,
                between Targeted Genetics and Alkermes, Inc. *
            
            10-K
            
            3/29/07
            
            10.5(c)10.2
            
            Securities
                Purchase Agreement among Targeted Genetics Corporation and certain
                investors dated January 8, 2007.
            
            8-K
            
            1/8/07
            
            10.110.3
            
            Form
                of Warrant to Purchase Shares of Common Stock of Targeted Genetics
                Corporation dated January 11, 2007.
            
            8-K
            
            1/8/07
            
            10.310.4
            
            Securities
                Purchase Agreement among Targeted Genetics Corporation and certain
                purchasers dated as of June 22, 2007.
            
            8-K
            
            6/22/07
            
            10.110.5
            
            Form
                of Common Stock Purchase Warrant of Targeted Genetics Corporation
                dated as
                of June 27, 2007.
            
            8-K
            
            6/22/07
            
            10.310.6
            
            Targeted
                Genetics Corporation Stock Plan.
            
            8-K
            
            5/22/07
            
            10.131.1
            
            Certification
                of Chief Executive Officer pursuant to Rules 13a-15(e) and 15d-15(e)
                under
                the Securities Exchange Act of 1934.
            
            
            
            
            
            
            
            X31.2
            
            Certification
                of Chief Financial Officer pursuant to Rules 13a-15(e) and 15d-15(e)
                under
                the Securities Exchange Act of 1934.
            
            
            
            
            
            
            
            X32.1
            
            Certification
                of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as
                adopted
                pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
            
            
            
            
            
            
            
            X32.2
            
            Certification
                of Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as
                adopted
                pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
            
            
            
            
            
            
            
            X





*
            Portions
                of this exhibit have been omitted based on a grant of or application
                for
                confidential treatment from the SEC. The omitted portions of these
                exhibits have been filed separately with the
                SEC.





22