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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549
   FORM 10-Q   (Mark One)x
    
    QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
 For the quarterly period ended September 30, 2004 OR o
    
    TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934For the transition period from to
 Commission File Number No. 0-23930   TARGETED GENETICS CORPORATION (Exact name of Registrant as specified in its charter)
   Washington
(State of Incorporation)
    
    91-1549568
(IRS Employer Identification No.)
 1100 Olive Way, Suite 100
Seattle, WA 98101
(Address of principal executive offices, including zip code) (206) 623-7612
(Registrants telephone number, including area code)   Indicate by check mark whether the registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes x No o Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act). Yes x No o Indicate the number of shares outstanding of each of the issuers classes
of common stock, as of the latest practicable date. Common Stock, $0.01 par value
    
    81,646,802(Class)
    
    (Outstanding at October 28, 2004)




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TARGETED GENETICS CORPORATION
Quarterly Report on Form 10-Q
For the quarter ended September 30, 2004 TABLE OF CONTENTS  
 Page No.PART I
    
    FINANCIAL INFORMATION
    
    
    1Item 1.
    
    Financial Statements
    
    
    1a)
    
    Condensed Consolidated Balance Sheets at September 30, 2004 and December 31, 2003
    
    
    1b)
    
    Condensed Consolidated Statements of Operations for the three and nine months ended September 30, 2004 and 2003
    
    
    2c)
    
    Condensed Consolidated Statements of Cash Flows for the nine months ended September 30, 2004 and 2003
    
    
    3d)
    
    Notes to Condensed Consolidated Financial Statements
    
    
    4Item 2.
    
    Managements Discussion and Analysis of Financial Condition and Results of Operations
    
    
    7Item 3.
    
    Quantitative and Qualitative Disclosures About Market Risk
    
    
    20Item 4.
    
    Controls and Procedures
    
    
    20PART II
    
    OTHER INFORMATION
    
    
    22Item 1.
    
    Legal Proceedings
    
    
    22Item 2.
    
    Changes in Securities, Use of Proceeds and Issuer Purchases of Equity Securities
    
    
    22Item 3.
    
    Defaults Upon Senior Securities
    
    
    22Item 4.
    
    Submission of Matters to a Vote of Security Holders
    
    
    22Item 5.
    
    Other Information
    
    
    22Item 6.
    
    Exhibits and Reports on Form 8-K
    
    
    22SIGNATURES
    
    
    22EXHIBIT INDEX
    
    
    23EXHIBIT 31.1EXHIBIT 31.2EXHIBIT 32.1EXHIBIT 32.2
 i




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PART I            FINANCIAL INFORMATION 
 Item 1.Financial Statements TARGETED GENETICS CORPORATION 
 CONDENSED CONSOLIDATED BALANCE SHEETS September 30,
    
    December 31,2004
    
    2003(unaudited)ASSETSCurrent assets:Cash and cash equivalents
    
    $
    31,333,000
    
    
    $
    21,057,000Accounts receivable
    
    
    1,000
    
    
    
    166,000Prepaid expenses and other
    
    
    781,000
    
    
    
    409,000Total current assets
    
    
    32,115,000
    
    
    
    21,632,000Property and equipment, net
    
    
    2,756,000
    
    
    
    3,423,000Goodwill, net
    
    
    31,649,000
    
    
    
    31,649,000Other assets
    
    
    863,000
    
    
    
    968,000Total assets
    
    $
    67,383,000
    
    
    $
    57,672,000LIABILITIES AND SHAREHOLDERS EQUITYCurrent liabilities:Accounts payable and accrued expenses
    
    $
    1,833,000
    
    
    $
    1,271,000Accrued employee expenses
    
    
    613,000
    
    
    
    1,564,000Accrued restructure charges
    
    
    554,000
    
    
    
    1,404,000Deferred revenue
    
    
    504,000
    
    
    
    1,180,000Current portion of long-term obligations
    
    
    1,344,000
    
    
    
    1,290,000Total current liabilities
    
    
    4,848,000
    
    
    
    6,709,000Accrued restructure charges and deferred rent
    
    
    6,298,000
    
    
    
    5,507,000Long-term obligations
    
    
    10,235,000
    
    
    
    11,227,000CommitmentsMinority interest in preferred stock of subsidiary
    
    
    
    
    
    
    750,000Shareholders equity:Preferred stock, $0.01 par value, 6,000,000 shares authorized:Series A preferred stock, 800,000 shares designated, none
issued and outstanding
    
    
    
    
    
    
    Series B preferred stock, none issued and outstanding at
September 30, 2004 and 12,015 shares issued and outstanding
at December 31, 2003
    
    
    
    
    
    
    Common stock, $0.01 par value, 120,000,000 shares authorized,
81,646,802 shares issued and outstanding at September 30, 2004
and 66,206,230 shares issued and outstanding at December 31,
2003
    
    
    816,000
    
    
    
    662,000Additional paid-in capital
    
    
    273,800,000
    
    
    
    249,399,000Accumulated deficit
    
    
    (228,614,000
    )
    
    
    (216,582,000
    )Total shareholders equity
    
    
    46,002,000
    
    
    
    33,479,000Total liabilities and shareholders equity
    
    $
    67,383,000
    
    
    $
    57,672,000
 See accompanying notes to condensed consolidated financial statements 1




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TARGETED GENETICS CORPORATION 
 CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited) Three months ended
    
    Nine months endedSeptember 30,
    
    September 30,2004
    
    2003
    
    2004
    
    2003Revenue under
collaborative
agreements
    
    $
    2,388,000
    
    
    $
    5,002,000
    
    
    $
    6,469,000
    
    
    $
    12,694,000Operating expenses:Research and
development
    
    
    4,268,000
    
    
    
    3,947,000
    
    
    
    13,333,000
    
    
    
    12,816,000General and
administrative
    
    
    1,476,000
    
    
    
    1,133,000
    
    
    
    5,292,000
    
    
    
    3,907,000Restructure
charges
    
    
    381,000
    
    
    
    374,000
    
    
    
    797,000
    
    
    
    3,554,000Total
operating
expenses
    
    
    6,125,000
    
    
    
    5,454,000
    
    
    
    19,422,000
    
    
    
    20,277,000Loss from
operations
    
    
    (3,737,000
    )
    
    
    (452,000
    )
    
    
    (12,953,000
    )
    
    
    (7,583,000
    )Gain on sale of
majority-owned
subsidiary
    
    
    1,006,000
    
    
    
    
    
    
    
    1,006,000
    
    
    
    Investment income
    
    
    123,000
    
    
    
    38,000
    
    
    
    268,000
    
    
    
    146,000Interest expense
    
    
    (116,000
    )
    
    
    (366,000
    )
    
    
    (353,000
    )
    
    
    (1,088,000
    )Net loss
    
    $
    (2,724,000
    )
    
    $
    (780,000
    )
    
    $
    (12,032,000
    )
    
    $
    (8,525,000
    )Net loss per common
share (basic and
diluted)
    
    $
    (0.03
    )
    
    $
    (0.01
    )
    
    $
    (0.15
    )
    
    $
    (0.16
    )Shares used in
computation of
basic and diluted
net loss per common
share
    
    
    81,629,000
    
    
    
    61,270,000
    
    
    
    78,713,000
    
    
    
    54,549,000
 See accompanying notes to condensed consolidated financial statements 2




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TARGETED GENETICS CORPORATION 
 CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited) Nine months endedSeptember 30,2004
    
    2003Operating activities:Net loss
    
    $
    (12,032,000
    )
    
    $
    (8,525,000
    )Adjustments to reconcile net loss to net cash used in
operating activities:Gain on sale of majority-owned subsidiary
    
    
    (1,006,000
    )
    
    
    Depreciation and amortization
    
    
    998,000
    
    
    
    2,091,000Non-cash interest expense
    
    
    211,000
    
    
    
    749,000Changes in assets and liabilities:Decrease in accounts receivable
    
    
    165,000
    
    
    
    1,145,000Decrease/(increase) in prepaid expenses and other
    
    
    (23,000
    )
    
    
    4,000Decrease in other
assets
    
    
    146,000
    
    
    
    126,000Decrease in current liabilities
    
    
    (35,000
    )
    
    
    (616,000
    )Decrease in deferred revenue
    
    
    (676,000
    )
    
    
    (3,676,000
    )Increase/(decrease) in accrued restructure
expenses and deferred rent
    
    
    (59,000
    )
    
    
    2,156,000Net cash used in operating activities
    
    
    (12,311,000
    )
    
    
    (6,546,000
    )Investing activities:Purchases of property and equipment
    
    
    (346,000
    )
    
    
    (149,000
    )Net cash used in investing activities
    
    
    (346,000
    )
    
    
    (149,000
    )Financing activities:Net proceeds from sales of common stock
    
    
    23,805,000
    
    
    
    21,009,000Proceeds under leasehold improvements and equipment
financing arrangements
    
    
    46,000
    
    
    
    159,000Payments under leasehold improvements and equipment
financing arrangements
    
    
    (918,000
    )
    
    
    (961,000
    )Net cash provided by financing activities
    
    
    22,933,000
    
    
    
    20,207,000Net increase in cash and cash equivalents
    
    
    10,276,000
    
    
    
    13,512,000Cash and cash equivalents, beginning of period
    
    
    21,057,000
    
    
    
    12,606,000Cash and cash equivalents, end of period
    
    $
    31,333,000
    
    
    $
    26,118,000Supplemental information:Common stock issued to Elan for debt conversion
    
    $
    
    
    
    $
    9,373,000Cash paid for interest
    
    
    365,000
    
    
    
    409,000Common stock issued in exchange for minority interest
in CellExSys
    
    
    750,000
    
    
    
    
 See accompanying notes to condensed consolidated financial statements 3




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TARGETED GENETICS CORPORATION 
 NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited) 1. Basis of Presentation The unaudited condensed consolidated financial statements included in this
quarterly report have been prepared by Targeted Genetics Corporation, or
Targeted Genetics, without audit, according to the rules and regulations of the
Securities and Exchange Commission, or SEC. Our condensed consolidated
financial statements include the accounts of Targeted Genetics, our wholly
owned subsidiaries Genovo, Inc. (inactive)and TGCF Manufacturing Corporation
(inactive),and until its sale in July 2004, our majority-owned subsidiary,
CellExSys, Inc., or CellExSys. CellExSys was merged into Chromos Molecular
Systems, Inc., or Chromos, on July 27, 2004. The condensed consolidated
balance sheet as of December 31, 2003, and our results of operations for the
three and nine months ended September 30, 2003, do not include the accounts of
Emerald Gene Systems, Ltd., or Emerald, our majority-owned research and
development joint venture with Elan International Services Ltd., or Elan,
because we did not have operating control of Emerald during those periods. In
connection with a termination agreement with Elan effective March 31, 2004, we
acquired all of Elans equity interest in Emerald. As a result, Emerald became
a wholly-owned subsidiary as of March 31, 2004, and is consolidated into our
financial statements as of that date. The operations of Emerald terminated
during 2002; therefore, the impact of consolidating the accounts of Emerald
into our financial results is not significant. We are in the process of
dissolving Emerald. All significant inter-company transactions have been
eliminated in consolidation. Certain information and footnote disclosures
normally included in financial statements prepared in accordance with generally
accepted accounting principles have been omitted in accordance with the SECs
rules and regulations. The financial statements reflect, in the opinion of
management, all adjustments which consist solely of normal recurring
adjustments necessary to present fairly our financial position and results of
operations as of and for the periods indicated. Certain reclassifications have
been made to conform prior period results to the current period presentation. We do not believe that our results of operations for the three and nine
months ended September 30, 2004 are necessarily indicative of the results to be
expected for the full year. The unaudited condensed consolidated financial statements included in this
quarterly report should be read in conjunction with our audited consolidated
financial statements and related footnotes included in our annual report on
Form 10-K for the year ended December 31, 2003. 2. Long-Term Obligations Long-term obligations consisted of the following: September 30,
    
    December 31,2004
    
    2003Loan payable to Biogen, due August 2006
    
    $
    10,000,000
    
    
    $
    10,000,000Equipment financing obligations
    
    
    879,000
    
    
    
    1,501,000Loan payable to Biogen, due September 2005
    
    
    650,000
    
    
    
    650,000Chromos advances
    
    
    
    
    
    
    300,000Other obligations
    
    
    50,000
    
    
    
    66,000Total obligations
    
    
    11,579,000
    
    
    
    12,517,000Less current portion
    
    
    (1,344,000
    )
    
    
    (1,290,000
    )Total long-term obligations
    
    $
    10,235,000
    
    
    $
    11,227,000
 Future aggregate principal payments related to long-term obligations are
$284,000 for the remainder of 2004, $1,114,000 in 2005, $10,154,000 in 2006,
$26,000 in 2007, and $1,000 in 2008. 4




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3. Accrued Restructure Charges We record accrued restructure charges as they relate to the leases on our
facilities in Bothell, Washington and Sharon Hill, Pennsylvania. In December
2002, we began to pursue options to sublease or terminate our lease on the
Bothell facility and in February 2003, we closed our Sharon Hill facility.
Accrued restructure charges represent our best estimate of the fair value of
the liability as determined under Statement of Financial Accounting Standards,
or SFAS, No. 146, Accounting for Costs Associated with Exit or Disposal
Activities,and is computed as the fair value of the difference between the
remaining lease payments due on these leases and the estimated sub-lease market
rates. These assumptions are periodically reviewed and updated as appropriate
and adjustment is made to the accrued restructure charge. We record accretion expense
based upon changes in the accrued restructure liability that result from the
passage of time and the assumed discount rate of 10% that we use to determine
the accrued liability.  Accretion expense is recorded on an ongoing basis and
is reflected as a charge in the accompanying statements of operations as a
restructuring charge. If we proceed with further development or commercialization of any of our
product candidates, we may need the use of the Bothell facility to fulfill our
manufacturing requirements. As a result, we do not currently intend to
sublease a portion of the Bothell facility to accommodate our potential
manufacturing needs. Net sublease income as it relates to that portion of the
facility is expensed ratably as research and development expense over the
remaining term of the lease. Further, if we decide to utilize this facility,
any remaining accrued restructure charges related to the manufacturing facility
will be reversed and recorded as a one-time credit to restructure charges,
reflected in the period in which use is resumed. Any decision to resume use of
the facility will be based on a number of factors, including the progress of
our product candidates in clinical development, the estimated duration of
facility design and construction, the estimated timing of product manufacturing
requirements, the ability of our current manufacturing capabilities to meet
demand, and the availability of resources. However, unless we resume use of the
Bothell facility, we will continue to account for the lease in accordance with
SFAS No. 146 and will periodically evaluate the assumptions and record
additional restructure charges if necessary. Because we compute restructure
charges using estimates and assumptions regarding the timing and amounts of
future events, 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. The tables below present our total estimated restructure charges and a
reconciliation of the associated liability: Incurred in
    
    Incurred in
    
    Incurred in
    
    Estimated
    
    Total expected toRestructure charges
    
    2002
    
    2003
    
    2004
    
    future charges
    
    be incurredEmployee termination benefits
    
    $
    725,000
    
    
    $
    5,000
    
    
    $
    
    
    
    $
    
    
    
    $
    730,000Contract termination costs
    
    
    1,601,000
    
    
    
    5,153,000
    
    
    
    797,000
    
    
    
    2,678,000
    
    
    
    10,229,000Other associated costs
    
    
    
    
    
    
    32,000
    
    
    
    
    
    
    
    
    
    
    
    32,000Total
    
    $
    2,326,000
    
    
    $
    5,190,000
    
    
    $
    797,000
    
    
    $
    2,678,000
    
    
    $
    10,991,000
 December 31,
    
    
    
    
    
    
    
    
    
    
    
    
    
    September 30,2003
    
    Incurred in
    
    Paid in
    
    
    
    
    
    2004Reconciliation
    
    Liability
    
    2004
    
    2004
    
    Adjustments
    
    LiabilityEmployee termination benefits
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    Contract termination costs
    
    
    6,870,000
    
    
    
    797,000
    
    
    
    (889,000
    )
    
    
    
    
    
    
    6,778,000Other associated costs
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Total
    
    $
    6,870,000
    
    
    $
    797,000
    
    
    $
    (889,000
    )
    
    $
    
    
    
    $
    6,778,000
 Charges incurred in 2004 represent accretion expense of $385,000 and
additional charges of $136,000 due to a change in estimate related to the
Sharon Hill facility to reflect our belief that we can not secure a sublease
tenant prior to the expiration of the lease and $276,000 related to additional
time that we believe it may require to identify a sublease tenant for the
portion of our Bothell facility that we intend to sublease. Estimated future
charges represent our estimate of the accretion expense throughout the
remainder of the lease term. 4. Shareholders Equity Stock Compensation As permitted by the provisions of SFAS No. 123, Accounting for
Stock-Based Compensation, we have elected to follow Accounting Principles
Board Opinion No. 25, Accounting for Stock Issued to Employees,and related
interpretations in accounting for employee stock option grants. In addition, we
follow the disclosure requirements of SFAS No. 148, Accounting for Stock-Based
Compensation  Transition and Disclosure  an amendment of SFAS No. 123,which
require prominent disclosures in both annual and interim financial statements
about the method of accounting for stock-based employee compensation and the
effect of the method used on reported results. We do not recognize any
compensation expense for options 5




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granted to employees because we grant all options at fair market value on
the date of grant. Options and warrants to purchase common stock granted to
non-employees are recorded as an expense over their service period based on
their fair value, which is determined using the Black-Scholes method. No such
options or warrants have been issued during any of the periods presented. As allowed by SFAS No. 123, we do not recognize compensation expense on
stock options or warrants granted to employees and directors. If we had elected
to recognize compensation expense based on the fair market value at the grant
dates for stock options granted, the pro forma net loss and net loss per common
share would have been as follows: Three months ended
    
    Nine months endedSeptember 30,
    
    September 30,2004
    
    2003
    
    2004
    
    2003Net loss:As reported
    
    $
    (2,724,000
    )
    
    $
    (780,000
    )
    
    $
    (12,032,000
    )
    
    $
    (8,525,000
    )Proforma stock-based
compensation expense
    
    
    (520,000
    )
    
    
    (380,000
    )
    
    
    (1,094,000
    )
    
    
    (365,000
    )Pro forma
    
    $
    (3,244,000
    )
    
    $
    (1,160,000
    )
    
    $
    (13,126,000
    )
    
    $
    (8,890,000
    )Basic net loss per share:As reported
    
    $
    (0.03
    )
    
    $
    (0.01
    )
    
    $
    (0.15
    )
    
    $
    (0.16
    )Pro forma
    
    
    (0.04
    )
    
    
    (0.02
    )
    
    
    (0.17
    )
    
    
    (0.16
    )
 On March 31, 2004 the Financial Accounting Standards
Board, or FASB, issued an Exposure Draft, Share-Based
Payment  An Amendment of FASB
Statements No. 123 and 95, or Proposed SFAS No. 123R, which currently is expected
to be effective for public companies in periods beginning after
June 15, 2005.
Under Proposed SFAS No. 123R we would be required to implement the proposed
standard no later than the quarter that begins July 1, 2005.
Proposed SFAS No. 123R
would eliminate our ability to account for share-based compensation transactions
using Accounting Principles Board Opinion No. 25, and generally would require us
to account for these transactions using a fair-value based method. As proposed,
companies would be required to recognize an expense for compensation cost related
to share-based payment arrangements including stock options and employee stock
purchase plans. The FASB expects to issue a final standard by
December 31, 2004.
We are currently evaluating option valuation methodologies and assumptions in
light of the Proposed SFAS No. 123R related to employee stock options. Current
estimates of option values using the Black-Scholes method (as shown above)
may not be indicative of results from valuation methodologies ultimately adopted
in the final rules. 5. Merger Agreement Between CellExSys, Inc. and Chromos Molecular Systems, Inc. On July 27, 2004, Chromos acquired all of the outstanding shares of
CellExSys through a merger between CellExSys and Chromos Inc., a wholly owned
subsidiary of Chromos. Under the terms of the merger agreement, Chromos has
issued to CellExSys shareholders 1,500,000 shares of Chromos common stock and a
secured convertible debenture totaling approximately
$2.5 million ($3.4 million Canadian). The
debenture bears annual interest of 2% and is payable in two annual installments
on the first and second anniversary of the closing. Each shareholder of CellExSys will receive a pro rata distribution of
Chromos common stock and principal and interest payments received on the
debenture, based on the shareholders equity interest in CellExSys as of July
27, 2004, the date of closing. We owned approximately 79% of CellExSys at the
time of the merger. The debenture is repayable by Chromos at its option in
either cash or by the issuance of shares of Chromos common stock, assuming
certain limited conditions are met by Chromos. In combination with the shares
of Chromos common stock issued at closing, if the debenture is fully paid in
shares of Chromos common stock, the shareholders of CellExSys would receive up
to a total of 3.5 million shares, which represent approximately 17.2 percent of
Chromos, based on issued and outstanding shares of Chromos as of the date of
closing. Chromos had funded certain of CellExSys operational costs through
the closing of the merger in the form of deposits totaling $502,000. As a result of the merger, we recorded a gain during the quarter ended
September 30, 2004 which is comprised of the following. Deposits received from Chromos to fund pre-closing operating
costs
    
    $
    502,000Estimated fair value of merger consideration
received
    
    
    453,000Net liabilities assumed by Chromos
    
    
    51,000$
    1,006,000
 In accordance with the Merger Agreement, the purchase price is subject to
limited adjustment. For a limited period of time, we have agreed to provide
certain transition services and assistance to CellExSys, which Chromos will for
pay on a monthly basis. We will continue to evaluate the merger consideration
received from Chromos for value impairment and will record a reduction in the
carrying value if we determine that there is an impairment in value that is
deemed to be other than temporary. This evaluation will be based on several
factors including the market price of Chromos common stock and the financial
condition of Chromos. As of September 30, 2004, we do not believe that there
is evidence of an impairment in value that warrants adjustment to our carrying
value of the merger consideration. 6




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The following table presents pro forma results assuming the sale of
CellExSys occurred at the beginning of each period presented: Three months ended
    
    Nine months endedSeptember 30,
    
    September 30,2004
    
    2003
    
    2004
    
    2003As Reported:Revenue
    
    $
    2,388,000
    
    
    $
    5,002,000
    
    
    $
    6,469,000
    
    
    $
    12,694,000Net loss
    
    
    (2,724,000
    )
    
    
    (780,000
    )
    
    
    (12,032,000
    )
    
    
    (8,525,000
    )Net loss per
common share
(basic and
diluted)
    
    
    (0.03
    )
    
    
    (0.01
    )
    
    
    (0.15
    )
    
    
    (0.16
    )Pro Forma:Revenue
    
    $
    2,388,000
    
    
    $
    5,002,000
    
    
    $
    6,469,000
    
    
    $
    12,694,000Net loss
    
    
    (2,556,000
    )
    
    
    (333,000
    )
    
    
    (11,003,000
    )
    
    
    (6,924,000
    )Net loss per
common share
(basic and
diluted)
    
    
    (0.03
    )
    
    
    (0.01
    )
    
    
    (0.14
    )
    
    
    (0.13
    )
 
 Item 2.Managements Discussion and Analysis of Financial Condition and Results of Operations Forward-Looking Statements This quarterly report on Form 10-Q contains forward-looking statements
that involve risks and uncertainties. Forward-looking statements include
statements about our product development and commercialization goals and
expectations, potential market opportunities, our plans for and anticipated
results of our clinical development activities and the potential advantage of
our product candidates, and other statements that are not historical facts.
Words such as may, will, believes, estimates, expects, anticipates,
plans and intends, or statements concerning potential or opportunity
and other words of similar meaning or the negative thereof, may identify
forward-looking statements, but the absence of these words does not mean that
the statement is not forward-looking. In making these statements, we rely on a
number of assumptions and make predictions about the future. Our actual results
could differ materially from those stated in, or implied by, forward-looking
statements for a number of reasons, including the risks described in the
section entitled Factors Affecting Our Operating Results, Our Business and Our
Stock Price in Part I, Item 2 of this quarterly report. You should not unduly rely on these forward-looking statements, which
speak only as of the date of this quarterly report. We undertake no obligation
to publicly revise any forward-looking statement after the date of this
quarterly report to reflect circumstances or events occurring after the date of
this quarterly report or to conform the statement to actual results or changes
in our expectations. You should, however, review the factors, risks and other
information we provide in the reports we file from time to time with the SEC. Business Overview Targeted Genetics Corporation develops gene therapy products and
technologies for treating both acquired and inherited diseases. Our gene
therapy product candidates are designed to treat disease by regulating cellular
function at a genetic level. This involves introducing genetic material into
target cells and expressing it in a manner that provides the desired effect. We
have assembled a broad base of proprietary intellectual property that we
believe gives us the potential to address the significant diseases that are the
primary focus of our business. Our proprietary intellectual property includes
genes, methods of transferring genes into cells, processes to manufacture our
lead gene delivery product candidates and other proprietary technologies and
processes. In addition, we have established expertise and development
capabilities focused in the areas of preclinical research and biology,
manufacturing and manufacturing process scale-up, quality control, quality
assurance, regulatory affairs and clinical trial design and implementation. We
believe that our focus and expertise will enable us to develop products based
on our proprietary intellectual property. Gene therapy products involve the use of delivery vehicles, called
vectors, to place genetic material into target cells. Our proprietary vector
technologies include both viral and synthetic vectors. Our viral vector
development activities, which use modified viruses to deliver genes into cells,
focus primarily on adeno-associated virus, or AAV, a common virus that has not
been associated with any human disease or illness. We believe that AAV provides
a number of safety and gene delivery advantages over other viruses for several
of our potential gene therapy products. Our synthetic vectors deliver genes
into cells using lipids, which are fatty, water-insoluble organic substances
that can promote gene uptake through cell membranes. We believe that 7




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synthetic vectors may provide a number of gene delivery advantages for
repeated, efficient delivery of therapeutic genes into rapidly dividing cells,
such as certain types of tumor cells. Although our current product development
candidates utilize AAV as the delivery vector, we believe that possessing
capabilities in both viral and synthetic approaches provides advantages in our
corporate partnering efforts and increases the range of our potential products
that may reach the market. We have an AAV-based product candidate under development for treating
cystic fibrosis that is being evaluated in a second Phase II clinical trial
that was initiated in July 2003. We designed this trial to enroll up to 100
patients and are conducting it in collaboration with the Cystic Fibrosis
Foundation, or CF Foundation. In June 2004, we announced that an independent
data monitoring committee, or DMC, met for a scheduled interim analysis of this
Phase II clinical trial. Based upon its review, the DMC recommended
continuation of the study as planned. The DMC provided its recommendation based
upon safety parameters and an analysis of whether or not there was a chance
that, upon full patient enrollment, the study could show a statistically
significant positive impact on lung function measurements in patients treated
with tgAAVCF compared to placebo. We expect to complete patient accrual and
dosing by the end of 2004 and to present data from the trial in the first half
of 2005. This second Phase II trial follows an initial repeat dosing trial for
which we announced final data in June 2003. Data from this trial showed a good
safety profile and indicated a statistically significant improvement in lung
function at day 30 and a decrease in levels of an inflammatory cytokine at day
14 in patients treated with tgAAVCF when compared to placebo. We have an AAV-based prophylactic vaccine candidate for high-risk
populations in developing nations to protect against the progression of Human
Immunodeficiency Virus, or HIV, infection to Acquired Immune Deficiency
Syndrome, or AIDS. This program is being developed in a collaboration with
the International AIDS Vaccine Initiative, or IAVI, a non-profit organization,
and The Columbus Childrens Research Institute at Childrens Hospital in
Columbus, Ohio, or CCRI. In December 2003, we initiated a Phase I initial dose
escalation safety trial in humans for our AIDS vaccine product candidate in
Europe. This dose-escalation safety trial is designed to enroll up to 50
volunteers who are uninfected with HIV and in good health. In September 2004,
we announced the completion of enrolment and dosing of the 50 volunteers
planned for this study. Each participant in this trial received a single
injection of the vaccine candidate or placebo and will be monitored for safety
and immune response. We will continue to monitor these volunteers in
accordance with our clinical trial protocol. After the required follow-up, we
will complete analysis of the safety and immune response data and expect to
present results in the first half of 2005. As part of the clinical development
of the tgAAC09 vaccine, we are also assessing the evaluation of this vaccine in
other non-industrialized countries for which this vaccine is designed. In
addition, we continue to pursue a multi-component AIDS vaccine strategy that
will include AAV-mediated delivery of multiple HIV genes. We have an AAV-based product candidate for the treatment of rheumatoid
arthritis. In March 2004, we initiated a Phase I clinical trial for this
product candidate for treating rheumatoid arthritis. This dose-escalation
safety trial is designed to enroll up to 32 patients with rheumatoid arthritis
and is being conducted at multiple sites in the United States and Canada.
Patients will be monitored for safety and secondarily for improvements in
arthritis signs and symptoms. We expect to complete patient accrual and dosing
in this trial and to be able to present data from the trial in the first half
of 2005. We have developed processes to manufacture our potential products using
methods and at a scale amenable to clinical development and expandable to
large-scale production for advancing our potential products to
commercialization. These methods are similar to the methods used to manufacture
other biologics. As a result, we evaluated and continue to evaluate
opportunities to utilize excess capacity to manufacture biologics for other
companies. In March 2003, we entered into a manufacturing services agreement
with GenVec, Inc., or GenVec, to manufacture clinical supply of GenVecs cancer
product candidate, an adeno-viral-based gene therapy product. Earlier in 2004,
we completed our manufacturing work for GenVec. We also believe that we have
established broad capabilities in applying our gene delivery technologies and
our development infrastructure into several potential new areas that are beyond
the scope of our three core programs under development. We believe that this
may enable us to establish new strategic or collaborative relationships with
others. We believe that a wide range of diseases may potentially be treated, or
prevented, with gene-based products, including cancer, genetic diseases and
infectious diseases. We believe that there is also a significant opportunity to
treat diseases that are currently treated using proteins and monoclonal
antibodies, or small molecule drugs. These diseases may be more effectively
treated by gene-based therapies due to their ability to provide a long-term or
a localized method of treatment. Additionally, we believe that there are
potential therapeutic applications where a gene-based approach to delivering a
therapeutic protein may be preferred due to inherent difficulties in delivering
the therapeutic protein itself. Our business strategy is to develop multiple
gene delivery systems, which we believe will maximize our product
opportunities. Using AAV gene delivery systems, we are developing product
candidates across multiple diseases with the belief that gene-based therapies
may provide a means to treat diseases not fully treatable with current biologic
and pharmaceutical drugs. We believe that, if successful, we can establish
significant market potential for our product candidates. There currently are no
commercially available gene therapy products in the United States. 8




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We intend to pursue product development programs to enable us to
demonstrate proof of concept and eventually commercialize gene-based
therapeutics to address currently unmet medical needs in treating disease. The development of pharmaceutical products, including our possible cystic
fibrosis, AIDS and rheumatoid arthritis products discussed above, involves
extensive preclinical development followed by human clinical trials that take
several years or more to complete. The length of time required to completely
develop any product candidate varies substantially according to the type,
complexity and novelty of the product candidate, the degree of involvement by a
development partner, and the intended use of the product candidate. Our
commencement and rate of completion of clinical trials may vary or be delayed
for many reasons, including those discussed in the section entitled Factors
Affecting Our Operating Results, Our Business and Our Stock Price in Part I,
Item 2 of this quarterly report. Results of Operations Revenue Revenue. Revenue decreased to $2.4 million for the three months ended
September 30, 2004 from $5.0 million for the same period in 2003 and decreased
to $6.5 million for the nine months ended September 30, 2004 from $12.7 million
for the same period in 2003. Revenues in 2004 primarily reflect revenues
earned under our AIDS vaccine collaboration with IAVI and to a lesser degree,
revenues earned under our contract manufacturing relationship with GenVec that
was completed during the second quarter of 2004. Revenue for the three months
ended September 30, 2003 includes $3.4 million of previously deferred payments
received under our former collaboration with Biogen that ended in September
2003. Revenue for the nine months ended September 30, 2003 includes $3.9
million of revenue related to the termination of our collaboration with Wyeth
Pharmaceuticals, in February 2003 and $5.1 million under our Biogen
collaboration. We expect that our revenue for the remainder of 2004 will consist
primarily of research and development revenue from our collaboration with IAVI.
As a result of the conclusion of our former collaborations with Biogen and
Wyeth in 2003, we expect total revenue in 2004 to be less than 2003. Our
revenue for the next several years will depend on the continuation of the
current collaboration with IAVI and our success with entering into and
performing under potential new collaborations. Operating Expenses Research and Development Expenses. Research and development expenses
increased to $4.3 million for the three months ended September 30, 2004 from
$3.9 million for the same period in 2003, and increased to $13.3 million for
the nine months ended September 30, 2004 from $12.8 million for the same period
in 2003. These increases generally reflect higher costs in our AIDS vaccine
and rheumatoid arthritis programs, which moved out of preclinical development
and into clinical testing in late 2003 and early 2004. These increases are
partially offset by lower research and pre-clinical development costs as a
result of our July 2004 sale of CellExSys. As a result, the costs associated
with these programs are included in the costs of programs in clinical
development, which increased in 2004 compared to 2003. The following is an allocation of our total research and development costs
between our programs in clinical development and those that are in research or
preclinical stages of development: Three months ended
    
    Nine months endedSeptember 30,
    
    September 30,2004
    
    2003
    
    2004
    
    2003Programs in clinical development:Cystic fibrosis
    
    $
    206,000
    
    
    $
    178,000
    
    
    $
    658,000
    
    
    $
    396,000AIDS vaccine
    
    
    1,094,000
    
    
    
    
    
    
    
    2,664,000
    
    
    
    Rheumatoid arthritis
    
    
    540,000
    
    
    
    
    
    
    
    1,446,000
    
    
    
    Indirect costs
    
    
    1,528,000
    
    
    
    270,000
    
    
    
    4,096,000
    
    
    
    590,000Total clinical development program expense
    
    
    3,368,000
    
    
    
    448,000
    
    
    
    8,864,000
    
    
    
    986,000Research and preclinical development
program expense
    
    
    900,000
    
    
    
    3,499,000
    
    
    
    4,469,000
    
    
    
    11,830,000Total research and development expense
    
    $
    4,268,000
    
    
    $
    3,947,000
    
    
    $
    13,333,000
    
    
    $
    12,816,000
 Research and development costs attributable to programs in clinical
development include the applicable costs of salaries, benefits, clinical
trials, outside services, materials and supplies incurred to support the
programs, and any preclinical activities conducted in support of the clinical
program. Indirect costs allocated to clinical programs include facility and
occupancy costs, 9




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research and development administrative costs, and license and royalty
payments. Our development partners separately fund the clinical trial costs of
our cystic fibrosis and AIDS vaccine programs. As a result, we do not include
those costs in our research and development expenses. Costs attributed to research and preclinical programs represent our
earlier stage development activities, including costs incurred on programs
prior to their transition into clinical trials, as well as costs that are not
allocable to a clinical development program, such as unallocated manufacturing
infrastructure costs. Because we conduct multiple research projects and
utilize resources across several programs, our research and preclinical
development costs are not directly assigned to individual programs. For purposes of reimbursement from our collaboration partners, we capture
the level of effort expended on a program through our project management
system, which is based primarily on human resource time allocated to each
program, supplemented by an allocation of indirect costs and other specifically
identifiable costs, if any. As a result, the costs allocated to a program do
not necessarily reflect the actual costs of the program. We initiated clinical testing of our AIDS vaccine product candidate in
December 2003 and our rheumatoid arthritis product candidate in March 2004. As
a result, all related development activities associated with our cystic
fibrosis, rheumatoid arthritis and AIDS vaccine programs are reflected as costs
associated with programs in clinical development as of the date of initiation
of clinical testing. Therefore, during 2004, we expect our research and
development expenses associated with programs under clinical development to
increase, reflecting the transition of these programs into clinical testing. General and Administrative Expenses. General and administrative
expenses increased to $1.5 million for the three months ended September 30,
2004, from $1.1 million for the same period in 2003, and increased to $5.3
million for the nine months ended September 30, 2004 from $3.9 million for the
same period in 2003. This increase primarily reflects higher professional
service costs related to patent issuances and regulatory compliance, and higher
personnel costs. Restructure Charges.Restructure charges increased to $381,000 for the
three months ended September 30, 2004, from $374,000 for the same period in
2003, and decreased to $797,000 for the nine months ended September 30, 2004,
from $3.6 million for the same period in 2003. Restructuring charges in 2004
consists of accretion expense and additional charges related to updated
assumptions as to rental income that may be achieved under a sublease
arrangement of our Sharon Hill facility totaling $136,000 recorded in June 2004
and $276,000 attributable to our Bothell facility recorded in September 2004.
We record accretion expense based upon changes in the accrued restructure liability
that result from the passage of time and the assumed discount rate of 10%
that we use to determine the accrued liability. Accretion expense is recorded on an
ongoing basis and is reflected as a charge in the accompanying statements
of operations as a restructuring charge. Restructuring charges in 2003 include accretion expense and an additional
charge of $2.9 million recorded in June 2003 to reflect changes in our
expectations regarding market conditions and sublease assumptions for our
Bothell facility. Other Income and Expense Gain on sale of majority-owned subsidiary. On July 27, 2004, Chromos
Molecular Systems, Inc., or Chromos, acquired all of the outstanding shares of
our majority-owned subsidiary, CellExSys, Inc., or CellExSys, through a merger
between CellExSys and Chromos Inc., a wholly-owned subsidiary of Chromos.
Under the terms of the merger agreement, Chromos has issued to CellExSys
shareholders 1,500,000 shares of Chromos common stock and a secured convertible
debenture totaling approximately $3.4 million Canadian, subject to certain
purchase price adjustments. The debenture bears annual interest of 2% and is
payable in two annual installments on July 27, 2005 and July 27, 2006. The
debenture and the related interest is repayable by Chromos at its option in
either cash or by the issuance of shares of Chromos common stock, assuming
certain limited conditions are met by Chromos. At the time of the merger, we
owned approximately 79% of CellExSys. As a result of the merger, we recorded a
gain of $1,006,000 during the quarter ended September 30, 2004 as our share of
the merger consideration. This gain is comprised of $51,000 of net liabilities
assumed by Chromos, $502,000 received from Chromos to fund pre-closing
operating costs and merger consideration with a fair value of $453,000. Investment Income. Investment income increased to $123,000 for the
three months ended September 30, 2004, from $38,000 for the same period in
2003. This increase resulted from an increase in the net yield of our cash
equivalents. Investment income increased to $268,000 for the nine months ended
September 30, 2004, from $146,000 for the same period in 2003. This increase
resulted from higher average cash balances in 2004 as a result of our financing
completed in February 2004. Interest Expense. Interest expense relates to interest on outstanding
loans from our collaborative partners, notes and obligations under equipment
financing arrangements and installment loans we use to finance purchases of
laboratory and computer equipment, furniture and leasehold improvements.
Interest expense decreased to $116,000 for the three months ended September 30,
2004, from $366,000 for the same period in 2003 and decreased to $353,000 for
the nine months ended September 10




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30, 2004, from $1,088,000 for the same period in 2003. These decreases
reflect lower average principal balances as the result of our conversion of
approximately $9.4 million of debt owed to Elan into shares of our common stock
in September 2003. Liquidity and Capital Resources Our combined cash and cash equivalents increased to $31.3 million at
September 30, 2004, compared to $21.1 million at December 31, 2003 and our net
working capital increased to $27.3 million at September 30, 2004, compared to
$14.9 million at December 31, 2003. The principal sources of cash causing both
our cash balances and net working capital to increase were $23.8 million in net
proceeds from the issuance of approximately 10.9 million shares of our common
stock in February 2004 and collaborative funding received from partners. Our
principal use of cash was $12.3 million to fund our operations during the
period. Our shareholders equity increased to $46.0 million at September 30, 2004,
compared to $33.5 million at December 31, 2003. This increase includes net
proceeds of $23.8 million from the February 2004 sale of our common stock and
our February 2004 acquisition of the minority interest in CellExSys of
$750,000, reduced by the net loss during the period of $12.0 million. We have financed our product development activities and general corporate
functions primarily through proceeds from public and private sales of our
equity securities, through cash payments received from our collaborative
partners and proceeds from the issuance of debt. To a lesser degree, we have
also financed our operations through interest earned on cash and cash
equivalents, loan funding under equipment leasing agreements and research
grants. These financing sources have historically allowed us to maintain
adequate levels of cash and investments. Our cystic fibrosis product candidate is in a second Phase II clinical
trial, our AIDS vaccine candidate and our rheumatoid arthritis product
candidate are both in Phase I clinical trials. We expect to continue incurring
significant expense in advancing our product candidates toward
commercialization. As a result, we do not expect to generate sustained positive
cash flow from our operations for at least the next several years and only then
if we can successfully develop and commercialize our product candidates. We
will require substantial additional financial resources to fund the development
and commercialization of our product candidates and expand research and
development of our product candidates for treating additional diseases. We have an ongoing collaboration with IAVI and CCRI to develop an AIDS
vaccine. The term of this collaboration has been extended through December
2006. The approved work plan and budget for the AIDS vaccine program provides
up to $10.7 million in funding from IAVI to cover the costs of this program in
2004. We do not believe that we will conduct all of the planned work activities
during 2004 or to incur all of the associated costs of those work activities
and therefore believe that we will not receive the entire $10.7 million in
funding set forth in the work plan and budget with IAVI during 2004. As a
result, we expect that our overall use of cash for 2004 will increase over 2003
levels by approximately 30% to approximately $16 to $17 million. Several of
the activities originally planned for 2004 are now expected to occur in 2005
and will be included in the work plan and budget for 2005, which is currently
being determined with IAVI. We also have a collaboration with the CF
Foundation related to our second Phase II clinical trial for our product
candidate for treating cystic fibrosis. Under this collaboration, the CF
Foundation is providing funding to the sites conducting this trial to cover
their direct costs of the trial. We expect that our cash and cash equivalents at September 30, 2004, plus
the funding we expected from IAVI to fund 2004 work under our AIDS vaccine
collaboration, will be sufficient to fund our operations until at least the
beginning of 2006. We believe that this will be sufficient time to complete
each of our current clinical trials, evaluate the results, and assuming
satisfactory results, plan or initiate further clinical testing. In August
2006, our $10 million note payable to Biogen becomes due, which will require
that we raise additional capital to repay the note or seek an alternative
arrangement to repay the note. We also have a $650,000 loan from Biogen that
becomes due in September 2005. Although our development collaboration with
IAVI has been extended through the end of 2006, the development plan and budget
under the collaboration is established on an annual basis. While we expect this
program to continue through at least the duration of the current collaboration
term, we have not established the work plan and budget for 2005 and 2006 with
IAVI and have therefore not yet made an assumption as to the level of funding
that we may receive from IAVI in those years. We expect the level of our future operating expenses to be driven by the
needs of our product development programs, offset by the availability of funds
through partner-funded collaborations, equity offerings or other financing
activities. The size, scope and pace of our development activities depend on
the availability of these resources. Our future cash requirements will depend
on many factors, including:  
    
    the rate and extent of scientific progress in our research and
development programs;
    
    the timing, costs and scope of, and our success in, clinical trials,
obtaining regulatory approvals and filing, prosecuting and enforcing
patents; 11




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
    
    competing technological and market developments;
    
    the timing and costs of, and our success in, any product
commercialization activities and facility expansions, if and as required;
and
    
    the expense and outcome of any litigation or administrative proceedings
involving our intellectual property, or access to third-party
intellectual property through licensing agreements. IAVI has the right to terminate our collaboration and its obligation to
provide research funding at any time for any reason with 90 days notice. If we
were to lose the collaborative funding expected from IAVI and were unable to
obtain alternative sources of funding for the AIDS vaccine product candidate,
we may be unable to continue our research and development program for that
product candidate. The CF Foundation has the right to terminate our funding
agreement at any time for any reason. We are seeking partners for our hemophilia and cancer programs and
evaluating other opportunities to obtain additional capital to fund our future
operations. Additional sources of financing could involve one or more of the
following:  
    
    entering into additional product development and funding collaborations
or other strategic transactions, or extending or expanding our current
collaborations;
    
    selling or licensing our technology or product candidates;
    
    borrowing under loan or equipment leasing arrangements;
    
    issuing equity in the public or private markets; or
    
    issuing debt. Additional funding may not be available to us on reasonable terms, if at
all. Depending on our ability to successfully access additional funding, we may
be forced to implement significant cost reduction measures. These adjustments
may include scaling back, delaying or terminating one or more research and
development programs, curtailing capital expenditures or reducing other
operating activities. We may also be required to relinquish some rights to our
technology or product candidates or grant licenses on unfavorable terms, either
of which would reduce the ultimate value to us of the technology or product
candidates. Factors Affecting Our Operating Results, Our Business and Our Stock Price In addition to the other information contained in this quarterly report,
you should carefully read and consider the following risk factors. If any of
these risks actually occur, our business, operating results or financial
condition could be harmed. This could cause the trading price of our stock to
decline, and you could lose all or part of your investment. Risks Related to Our Business We expect to continue to operate at a loss and may never become profitable. Substantially all of our revenue has been derived under collaborative
research and development agreements relating to the development of our
potential product candidates. We have incurred, and will continue to incur for
the foreseeable future, significant expense to develop our research and
development programs, conduct preclinical studies and clinical trials, seek
regulatory approval for our product candidates and provide general and
administrative support for these activities. As a result, we have incurred
significant net losses since inception, and we expect to continue to incur
substantial additional losses in the future. As of September 30, 2004, we had
an accumulated deficit of approximately $229 million. We may never generate
profits and, if we do become profitable, we may be unable to sustain or
increase profitability. All of our product candidates are in early-stage clinical trials or preclinical
development, and if we are unable to successfully develop and commercialize our
product candidates we will be unable to generate sufficient capital to maintain
our business. In July 2003, we initiated a confirmatory Phase II clinical trial for our
cystic fibrosis product candidate in the United States. In December 2003, we
initiated a Phase I trial for our AIDS vaccine product candidate in Europe. In
March 2004, we initiated a 12




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Phase I trial for our rheumatoid arthritis product candidate in the United
States and Canada. Our product candidates for cancer have been evaluated in
Phase I and Phase II clinical trials. We will not generate any product revenue
for at least several years and then only if we can successfully develop and
commercialize our product candidates. Commercializing our potential products
depends on successful completion of additional research and development and
testing, in both preclinical development and clinical trials. Clinical trials
may take several years or more to complete. The commencement, cost and rate of
completion of our clinical trials may vary or be delayed for many reasons,
including the risks discussed elsewhere in this section. If we are unable to
successfully complete preclinical and clinical development of some or all of
our product candidates in a timely manner, we may be unable to generate
sufficient product revenue to maintain our business. Even if our potential products succeed in clinical trials and are approved
for marketing, these products may never achieve market acceptance. If we are
unsuccessful in commercializing our product candidates for any reason,
including greater effectiveness or economic feasibility of competing products
or treatments, the failure of the medical community or the public to accept or
use any products based on gene delivery, inadequate marketing and distribution
capabilities or other reasons discussed elsewhere in this section, we will be
unable to generate sufficient product revenue to maintain our business. If we are unable to raise additional capital when needed, we will be unable to
conduct our operations and develop our potential products. Because internally generated cash flow will not fund development and
commercialization of our product candidates, we will require substantial
additional financial resources. Our future capital requirements will depend on
many factors, including:  
    
    the rate and extent of scientific progress in our research and
development programs;
    
    the timing, costs and scope of, and our success in, conducting clinical
trials, obtaining regulatory approvals and pursuing patent prosecutions;
    
    competing technological and market developments;
    
    the timing and costs of, and our success in, any commercialization
activities and facility expansions, if and as required; and
    
    the existence and/or outcome of any litigation or administrative
proceedings involving intellectual property. As of September 30, 2004, we had approximately $31.3 million in cash and
cash equivalents. We expect that our cash resources at September 30, 2004 and
the funding expected from IAVI to fund 2004 and 2005 work under our AIDS
vaccine collaboration will be sufficient to fund our operations until at least
the beginning of 2006. We are evaluating opportunities to obtain additional
capital to fund our operations beyond that time. Additional sources of
financing could involve one or more of the following:  
    
    extending or expanding our current collaborations;
    
    entering into additional product development collaborations;
    
    selling or licensing our technology or product candidates;
    
    borrowing under loan or equipment leasing arrangements;
    
    issuing equity in the public or private markets; or
    
    issuing debt. Additional funding may not be available to us on reasonable terms, if at
all. The funding that we expect to receive from IAVI depends on continued
scientific progress under the collaboration and IAVIs ability and willingness
to continue or extend the collaboration. If we are unable to successfully
access additional capital, we may need to scale back, delay or terminate one or
more of our key development programs, curtail capital expenditures or reduce
other operating activities. We may also be required to relinquish some rights
to our technology or product candidates or grant or take licenses on
unfavorable terms, either of which would reduce the ultimate value to us of our
technology or product candidates. 13




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The regulatory approval process for our product candidates is costly,
time-consuming and subject to unpredictable changes and delays, and our product
candidates may never receive regulatory approval. No gene therapy products have received regulatory approval for marketing
from the U.S. Food and Drug Administration, or FDA. Because our product
candidates involve new and unproven technologies, we believe that the
regulatory approval process may proceed more slowly compared to clinical trials
involving traditional drugs. The FDA and applicable state and foreign
regulators must conclude at each stage of clinical testing that our clinical
data suggest acceptable levels of safety in order for us to proceed to the next
stage of clinical trials. In addition, gene therapy clinical trials conducted
at institutions that receive funding for recombinant DNA research from the U.S.
National Institutes of Health, or NIH, are subject to review by the NIHs
Office of Biotechnology Activities Recombinant DNA Advisory Committee, or RAC.
Although NIH guidelines do not have regulatory status, the RAC review process
can impede the initiation of the trial, even if the FDA has reviewed the trial
and approved its initiation. Moreover, before a clinical trial can begin at an
NIH-funded institution, that institutions Institutional Biosafety Committee
must review the proposed clinical trial to assess the safety of the trial. The regulatory process for our product candidates is costly,
time-consuming and subject to unpredictable delays. The clinical trial
requirements of the FDA, NIH and other agencies and the criteria these
regulators use to determine the safety and efficacy of a product candidate vary
substantially according to the type, complexity, novelty and intended use of
the potential products. In addition, regulatory requirements governing gene and
cell therapy products have changed frequently and may change in the future.
Accordingly, we cannot predict how long it will take or how much it will cost
to obtain regulatory approvals for clinical trials or for manufacturing or
marketing our potential products. Some or all of our product candidates may
never receive regulatory approval. A product candidate that appears promising
at an early stage of research or development may not result in a commercially
successful product. Our clinical trials may fail to demonstrate the safety and
efficacy of a product candidate or a product candidate may generate
unacceptable side affects or other problems during or after clinical trials.
Should this occur, we may have to delay or discontinue development of the
product candidate, and the corporate partner that supports development of that
product candidate may terminate its support. Delay or failure to obtain, or
unexpected costs in obtaining, the regulatory approval necessary to bring a
potential product to market could decrease our ability to generate sufficient
product revenue to maintain our business. If we are unable to obtain or maintain licenses for necessary third-party
technology on acceptable terms or to develop alternative technology, we may be
unable to develop and commercialize our product candidates. We have entered into exclusive and nonexclusive license agreements that
give us and our partners rights to use technologies owned or licensed by
commercial and academic organizations in the research, development and
commercialization of our potential products. For example, we have a gene
transfer technology license agreement with Amgen Inc., or Amgen, as the
successor to Immunex Corporation, or Immunex, under which we have license
rights to certain Immunex proprietary technology specifically applicable to
gene therapy applications. In a February 2004 letter, Amgen took the position
that we are not licensed, either exclusively or non-exclusively, to use Immunex
intellectual property covering TNFR:Fc or therapeutic uses for TNFR:Fc. We have
responded with a letter confirming our confidence that the gene transfer
technology license agreement provides us with an exclusive worldwide license to
use the gene construct coding for TNFR:Fc for gene therapy applications. We
have had and continue to have further communications with Amgen regarding our
differences. Notwithstanding our confidence, it is possible that a resolution
of those differences, through litigation or otherwise, could cause delay or
discontinuation of our development of tgAAC94 or our inability to commercialize
any resulting product. We believe that we will need to obtain additional licenses to use patents
and unpatented technology owned or licensed by others for use, compositions,
methods, processes to manufacture compositions, processes to manufacture and
purify gene delivery product candidates and other technologies and processes
for our present and potential product candidates. If we are unable to maintain
our current licenses for third-party technology or obtain additional licenses
on acceptable terms, we may be required to expend significant time and
resources to develop or license replacement technology. If we are unable to do
so, we may be unable to develop or commercialize the affected product
candidates. In addition, the license agreements for technology for which we
hold exclusive licenses typically contain provisions that require us to meet
minimum development milestones in order to maintain the license on an exclusive
basis for some or all fields of the license. We also have license agreements
for some of our technologies, which may require us to sublicense certain of our
rights. If we do not meet these requirements, our licensor may convert all or a
portion of the license to a nonexclusive license or, in some cases, terminate
the license. In many cases, patent prosecution of our licensed technology is controlled
solely by the licensor. If our licensors fail to obtain and maintain patent or
other protection for the proprietary intellectual property we license from
them, we could lose our rights to the intellectual property or our exclusivity
with respect to those rights, and our competitors could market competing
products using the intellectual property. Licensing of intellectual property is
of critical importance to our business and involves complex 14




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legal, business and scientific issues and is complicated by the rapid pace
of scientific discovery in our industry. Disputes may arise regarding
intellectual property subject to a licensing agreement, including:  
    
    the scope of rights granted under the license agreement and other
interpretation-related issues;
    
    the extent to which our technology and processes infringe on
intellectual property of the licensor that is not subject to the
licensing agreement;
    
    the sublicensing of patent and other rights under our collaborative
development relationships;
    
    the ownership of inventions and know-how resulting from the joint
creation or use of intellectual property by our licensors and us and our
partners; and
    
    the priority of invention of patented technology. If disputes over intellectual property that we have licensed prevent or
impair our ability to maintain our current licensing arrangements on acceptable
terms, we may be unable to successfully develop and commercialize the affected
product candidates. Failure to recruit patients could delay or prevent clinical trials of our
potential products, which could delay or prevent the development of potential
products. Identifying and qualifying patients to participate in clinical trials of
our potential products is critically important to our success. The timing of
our clinical trials depends on the speed at which we can recruit patients to
participate in testing our product candidates. We have experienced delays in
some of our clinical trials, and we may experience similar delays in the
future. If patients are unwilling to participate in our gene therapy trials
because of negative publicity from adverse events in the biotechnology or gene
therapy industries or for other reasons, including competitive clinical trials
for similar patient populations, the timeline for recruiting patients,
conducting trials and obtaining regulatory approval of potential products will
be delayed. These delays could result in increased costs, delays in advancing
our product development, delays in testing the effectiveness of our technology
or termination of the clinical trials altogether. Litigation involving intellectual property, product liability or other claims
and product recalls could strain our resources, subject us to significant
liability, damage our reputation or result in the invalidation of our
proprietary rights. As our product development efforts progress, especially in potentially
significant markets such as AIDS or rheumatoid arthritis therapies, the risk
increases that others may claim that our processes and potential products
infringe on their intellectual property rights. In addition, administrative
proceedings, litigation or both may be necessary to enforce our intellectual
property rights or determine the rights of others. Defending or pursuing these
claims, regardless of their merit, would be costly and would likely divert
managements attention and resources away from our operations. If there were to
be an adverse outcome in litigation or an interference proceeding, we could
face potential liability for significant damages or be required to obtain a
license to the patented process or technology at issue, or both. If we are
unable to obtain a license on acceptable terms, or to develop or obtain
alternative technology or processes, we may be unable to manufacture or market
any product or potential product that uses the affected process or technology. Clinical trials and the marketing of any potential products may expose us
to liability claims resulting from the testing or use of our products. Gene
therapy treatments are new and unproven, and potential known and unknown side
effects of gene therapy may be serious and potentially life-threatening.
Product liability claims may be made by clinical trial participants, consumers,
healthcare providers or other sellers or users of our products. Although we
currently maintain liability insurance, the costs of product liability and
other claims against us may exceed our insurance coverage. In addition, we may
require increased liability coverage as additional product candidates are used
in clinical trials and commercialized. Liability insurance is expensive and may
not continue to be available on acceptable terms. A product liability or other
claim or product recall not covered by or exceeding our insurance coverage
could significantly harm our financial condition. In addition, adverse
publicity resulting from a product recall or a liability claim against us, one
of our partners or another gene therapy company could significantly harm our
reputation and make it more difficult to obtain the funding and collaborative
partnerships necessary to maintain our business. If we lose IAVI as a partner, we may be unable to develop our AIDS vaccine
product candidate. We have a collaborative development agreement with IAVI, which expires in
December 2006, that we expect to provide us with funding to reimburse research
and development and manufacturing expenses we incur in connection with the
collaboration. 15




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In addition, our collaboration with IAVI provides funding for the Phase I
clinical trial for our AIDS vaccine product candidate. A significant portion of
our operating and clinical trial expenses are funded through our collaborative
agreements with IAVI. IAVI has the right to terminate the collaboration or its obligation to
provide funding at any time for any reason with 90 days notice, which would
significantly affect our operating activities. The loss of significant amounts
of collaborative or clinical trial funding could cause the delay, reduction or
termination of the related research and development programs, and a reduction
in capital expenditures and other operating activities necessary to support
general operations. Such a reduction could further impede our ability to
develop our product candidates. If we do not attract and retain qualified personnel, we may be unable to
develop and commercialize some of our potential products. Our future success depends in large part on our ability to attract and
retain key technical and management personnel. All of our employees, including
our executive officers, can terminate their employment with us at any time. We
have programs in place designed to retain personnel, including competitive
compensation packages and programs to create a positive work environment. Other
companies, research and academic institutions and other organizations in our
field compete intensely for employees, however, and we may be unable to retain
our existing personnel or attract additional qualified employees and
consultants. If we experience significant turnover or difficulty in recruiting
new personnel, our research and development of product candidates could be
delayed and we could experience difficulty in generating sufficient revenue to
maintain our business. If our partners or scientific consultants terminate, reduce or delay our
relationships with them, we may be unable to develop our potential products. Our partners provide funding, manage regulatory filings, aid and augment
our internal research and development efforts and provide access to important
intellectual property and know-how. Their activities include, for example,
support in processing the regulatory filings of our product candidates and
funding clinical trials. Our outside scientific consultants and contractors
perform research, develop technology and processes to advance and augment our
internal efforts and provide access to important intellectual property and
know-how. Their activities include, for example, clinical evaluation of our
product candidates, product development activities performed under our research
collaborations, research under sponsored research agreements and contract
manufacturing services. Collaborations with established pharmaceutical and
biotechnology companies and academic, research and public health organizations
often provide a measure of validation of our product development efforts in the
eyes of securities analysts, investors and the medical community. The
development of certain of our potential products, and therefore the success of
our business, depends on the performance of our partners, consultants and
contractors. If they do not dedicate sufficient time, regulatory or other
technical resources to the research and development programs for our product
candidates or if they do not perform their obligations as expected, we may
experience delays in, and may be unable to continue, the preclinical or
clinical development of those product candidates. Each of our collaborations
and scientific consulting relationships concludes at the end of the term
specified in the applicable agreement unless we and our partners agree to
extend the relationship. Any of our partners may decline to extend the
collaboration, or may be willing to extend the collaboration only with a
significantly reduced scope, for a number of scientific or business reasons.
Competition for scientific consultants and partners in gene therapy is intense.
We may be unable to successfully maintain our existing relationships or
establish additional relationships necessary for the development of our product
candidates on acceptable terms, if at all. If we are unable to do so, our
research and development programs may be delayed or we may lose access to
important intellectual property or know-how. The success of our clinical trials and preclinical studies may not be
indicative of results in a large number of patients of either safety or
efficacy. The successful results of our technology in preclinical studies using
animal models may not be predictive of the results that we will see in our
clinical trials. In addition, results in early-stage clinical trials are based
on limited numbers of patients and generally test for drug safety rather than
efficacy. Our reported progress and results from our early phases of clinical
testing of our product candidates may not be indicative of progress or results
that will be achieved from larger populations, which could be less favorable.
Moreover, we do not know if the favorable results we have achieved in clinical
trials will have a lasting effect. If a larger group of patients does not
experience positive results, or if any favorable results do not demonstrate a
beneficial effect, our product candidate for cystic fibrosis, or any other
potential products that we advance to clinical trials, may not receive approval
from the FDA for further clinical trials or commercialization. We may be unable to adequately protect our proprietary rights domestically or
overseas, which may limit our ability to successfully market any product
candidates. 16




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Our success depends substantially on our ability to protect our
proprietary rights and operate without infringing on the proprietary rights of
others. We own or license patents and patent applications, and will need to
license additional patents, for genes, processes, practices and techniques
critical to our present and potential product candidates. If we fail to obtain
and maintain patent or other intellectual property protection for this
technology, our competitors could market competing products using those genes,
processes, practices and techniques. The patent process takes several years and
involves considerable expense. In addition, patent applications and patent
positions in the field of biotechnology are highly uncertain and involve
complex legal, scientific and factual questions. Our patent applications may
not result in issued patents and the scope of any patent may be reduced both
before and after the patent is issued. Even if we secure a patent, the patent
may not provide significant protection and may be circumvented or invalidated. We also rely on unpatented proprietary technology and technology that we
have licensed on a nonexclusive basis. While we take precautions to protect our
proprietary unpatented technology, we may be unable to meaningfully protect
this technology from unauthorized use or misappropriation by a third party. Our
competitors could also obtain rights to our nonexclusively licensed proprietary
technology. In any event, other companies may independently develop equivalent
proprietary information and techniques. If our competitors develop and market
competing products using our unpatented or nonexclusively licensed proprietary
technology or substantially similar technology, our products, if successfully
developed, could suffer a reduction in sales or be forced out of the market. If we do not develop adequate manufacturing, sales, marketing and distribution
capabilities, either alone or with our business partners, we will be unable to
generate sufficient product revenue to maintain our business. We currently do not have the physical capacity to manufacture large-scale
quantities of our potential products. This could limit our ability to conduct
large clinical trials of a product candidate and to commercially launch a
successful product candidate. In order to manufacture product at such scale, we
will need to expand or improve our current facilities and staff or supplement
them through the use of contract providers. If we are unable to obtain and
maintain the necessary manufacturing capabilities, either alone or through
third parties, we will be unable to manufacture our potential products in
quantities sufficient to sustain our business. Moreover, we are unlikely to
become profitable if we, or our contract providers, are unable to manufacture
our potential products in a cost-effective manner. In addition, we have no experience in sales, marketing and distribution.
To successfully commercialize any products that may result from our development
programs, we will need to develop these capabilities, either on our own or with
others. We intend to enter into collaborations with other entities to utilize
their mature marketing and distribution capabilities, but we may be unable to
enter into marketing and distribution agreements on favorable terms, if at all.
If our current or future collaborative partners do not commit sufficient
resources to timely marketing and distributing our future products, if any, and
we are unable to develop the necessary marketing and distribution capabilities
on our own, we will be unable to generate sufficient product revenue to sustain
our business. Post-approval manufacturing or product problems or failure to satisfy
applicable regulatory requirements could prevent or limit our ability to market
our products. Commercialization of any products will require continued compliance with
FDA and other federal, state and local regulations. For example, our current
manufacturing facility, which is designed for manufacturing our AAV vectors for
clinical and development purposes, is subject to the Good Manufacturing
Practices requirements and other regulations of the FDA, as well as to other
federal, state and local regulations such as the Occupational Health and Safety
Act, the Toxic Substances Control Act, the Resource Conservation and Recovery
Act and the Environmental Protection Act. Any future manufacturing facilities
that we may construct for large-scale commercial production will also be
subject to regulation. We may be unable to obtain regulatory approval for or
maintain in operation this or any other manufacturing facility. In addition, we
may be unable to attain or maintain compliance with current or future
regulations relating to manufacture, safety, handling, storage, record keeping
or marketing of potential products. If we fail to comply with applicable
regulatory requirements or discover previously unknown manufacturing,
contamination, product side effects or other problems after we receive
regulatory approval for a potential product, we may suffer restrictions on our
ability to market the product or be required to withdraw the product from the
market. Risks Related to Our Industry Adverse events in the field of gene therapy could damage public perception of
our potential products and negatively affect governmental approval and
regulation. Public perception of our product candidates could be harmed by negative
events in the field of gene therapy. For example, in 2002, although ten
patients in a French academic clinical trial being treated for x-linked severe
combined immunodeficiency in a 17




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gene therapy trial using a retroviral vector showed correction, two
developed leukemia. Serious adverse events, including patient deaths have
occurred in clinical trials. Adverse events and the resulting publicity, as
well as any other adverse events in the field of gene therapy that may occur in
the future, could result in a decrease in demand for any products that we may
develop. The commercial success of our product candidates will depend in part
on public acceptance of the use of gene therapy for preventing or treating
human diseases. If public perception is influenced by claims that gene therapy
is unsafe, our product candidates may not be accepted by the general public or
the medical community. The public and the medical community may conclude that
our technology is unsafe. Future adverse events in gene therapy or the biotechnology industry could
also result in greater governmental regulation, unfavorable public perception,
stricter labeling requirements and potential regulatory delays in the testing
or approval of our potential products. Any increased scrutiny could delay or
increase the costs of our product development efforts or clinical trials. Our use of hazardous materials exposes us to liability risks and regulatory
limitations on their use, either of which could reduce our ability to generate
product revenue. Our research and development activities involve the controlled use of
hazardous materials, including chemicals, biological materials and radioactive
compounds. Our safety procedures for handling, storing and disposing of these
materials must comply with federal, state and local laws and regulations,
including, among others, those relating to solid and hazardous waste
management, biohazard material handling, radiation and air pollution control.
We may be required to incur significant costs in the future to comply with
environmental or other applicable laws and regulations. In addition, we cannot
eliminate the risk of accidental contamination or injury from hazardous
materials. If a hazardous material accident were to occur, we could be held
liable for any resulting damages, and this liability could exceed our financial
resources. Accidents unrelated to our operations could cause federal, state or
local regulatory agencies to restrict our access to hazardous materials needed
in our research and development efforts, which could result in delays in our
research and development programs. Paying damages or experiencing delays caused
by restricted access could reduce our ability to generate revenue and make it
more difficult to fund our operations. The intense competition and rapid technological change in our market may result
in pricing pressures and failure of our potential products to achieve market
acceptance. We face increasingly intense competition from a number of commercial
entities and institutions that are developing gene therapy and cell therapy
technologies. Our competitors include early-stage and more established gene
delivery companies, other biotechnology companies, pharmaceutical companies,
universities, research institutions and government agencies developing gene
therapy products or other biotechnology-based therapies designed to treat the
diseases on which we focus. We also face competition from companies using more
traditional approaches to treating human diseases, such as surgery, medical
devices and pharmaceutical products. As our product candidates become
commercial gene therapy products that may affect commercial markets of the
analogous protein or traditional pharmaceutical therapy, disputes including
lawsuits, demands, threats or patent challenges may arise in an effort to slow
our development. In addition, we compete with other companies to acquire
products or technology from research institutions or universities. Many of our
competitors have substantially more financial and infrastructure resources and
larger research and development staffs than we do. Many of our competitors also
have greater experience and capabilities than we do in:  
    
    research and development;
    
    clinical trials;
    
    obtaining FDA and other regulatory approvals;
    
    manufacturing; and
    
    marketing and distribution. In addition, the competitive positions of other companies, institutions
and organizations, including smaller competitors, may be strengthened through
collaborative relationships. Consequently, our competitors may be able to
develop, obtain patent protection for, obtain regulatory approval for, or
commercialize new products more rapidly than we do, or manufacture and market
competitive products more successfully than we do. This could limit the prices
we could charge for the products that we are able to market or result in our
products failing to achieve market acceptance. Gene therapy is a rapidly evolving field and is expected to continue to
undergo significant and rapid technological change and competition. Rapid
technological development by our competitors, including development of
technologies, products or processes 18




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that are more effective or more economically feasible than those we have
developed, could result in our actual and proposed technologies, products or
processes losing market share or becoming obsolete. Healthcare reform measures and the unwillingness of third-party payors to
provide adequate reimbursement for the cost of our products could impair our
ability to successfully commercialize our potential products and become
profitable. Sales of medical products and treatments depends substantially, both
domestically and abroad, on the availability of reimbursement to the consumer
from third-party payors. Our potential products may not be considered
cost-effective by third-party payors, who may not provide coverage at the price
set for our products, if at all. If purchasers or users of our products are
unable to obtain adequate reimbursement, they may forego or reduce their use of
our products. Even if coverage is provided, the approved reimbursement amount
may not be high enough to allow us to establish or maintain pricing sufficient
to realize a sufficient return on our investment. Increasing efforts by governmental and third-party payors, such as
Medicare, private insurance plans and managed care organizations, to cap or
reduce healthcare costs will affect our ability to commercialize our product
candidates and become profitable. We believe that third-party payors will
attempt to reduce healthcare costs by limiting both coverage and level of
reimbursement for new products approved by the FDA. There have been and will
continue to be a number of federal and state proposals to implement government
controls on pricing, the adoption of which could affect our ability to
successfully commercialize our product candidates. Even if the government does
not adopt any such proposals or reforms, their announcement could impair our
ability to raise capital. Risks Related to Our Common Stock Concentration of ownership of our common stock may give certain shareholders
significant influence over our business. A small number of investors own a significant number of shares of our
common stock. As of September 30, 2004, Biogen and Elan (together with its
affiliates) each held approximately 12.1 million shares of our common stock, or
approximately 14.9% of our current common shares outstanding. This
concentration of stock ownership may allow these shareholders to exercise
significant control over our strategic decisions and block, delay or
substantially influence all matters requiring shareholder approval, such as:  
    
    election of directors;
    
    amendment of our charter documents; or
    
    approval of significant corporate transactions, such as a change of control of Targeted Genetics. The interests of these shareholders may conflict with the interests of
other holders of our common stock with regard to such matters. Furthermore,
this concentration of ownership of our common stock could allow these
shareholders to delay, deter or prevent a third party from acquiring control of
Targeted Genetics at a premium over the then-current market price of our common
stock, which could result in a decrease in our stock price. Market fluctuations or volatility could cause the market price of our common
stock to decline and limit our ability to raise capital. The stock market in general and the market for biotechnology-related
companies in particular have experienced extreme price and volume fluctuations,
often unrelated to the operating performance of the affected companies. The
market price of the securities of biotechnology companies, particularly
companies such as ours without earnings and product revenue, has been highly
volatile and is likely to remain so in the future. Any report of clinical trial
results that are below the expectations of financial analysts or investors
could result in a decline in our stock price. We believe that in the past,
similar levels of volatility have contributed to the decline in the market
price of our common stock, and may do so again in the future. Trading volumes
of our common stock can increase dramatically, resulting in a volatile market
price for our common stock. In addition, the trading price of our common stock
could decline significantly as a result of sales of a substantial number of
shares of our common stock, or the perception that significant sales could
occur. For example, on March 31, 2004, we and Elan entered into a termination
agreement that permits Elan to sell shares of our common stock, subject to
certain exceptions, under the trading volume limitations of Rule 144(e)(1)
promulgated under the Securities Act of 1933, as amended. The trading volume
limitations on Elan are reduced over time subject to the terms of the 19




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termination agreement. In addition, Elan has registration rights with
respect to its holdings pursuant to a registration rights agreement dated July
21, 1999. Both the termination agreement and the registration rights agreement
permit Elan to sell quantities of stock, which could adversely impact the price
of our common stock. In the past, securities class action litigation has been brought against
companies that experience volatility in the market price of their securities.
Market fluctuations in the price of our common stock could also adversely
affect our collaborative opportunities and our future ability to sell equity
securities at a price we deem appropriate. As a result, you could lose all or
part of your investment. Our future capital-raising activities will likely involve the issuance of
equity securities, which will dilute your investment and could result in a
decline in the trading price of our common stock. Since June 1, 2003, we have issued 18.6 million shares of our common stock
in equity financings that have been priced at a discount to the then-current
market price of our common stock. These financings were completed in order to
fund our research and development programs and for other general corporate
purposes. To meet all or a portion of our future funding requirements, we will
likely sell additional securities in the public or private equity markets if
and when conditions are favorable, even if we do not have an immediate need for
additional capital at that time. Raising funds through the issuance of equity
securities will dilute the ownership of our existing shareholders. Furthermore,
we may enter into financing transactions at prices that represent a substantial
discount to market price. A negative reaction by investors and securities
analysts to any discounted sale of our equity securities could result in a
decline in the trading price of our common stock. 
 Item 3. Quantitative and Qualitative Disclosures About Market Risk Cash and cash equivalents.Because of the short-term nature of our
investments, we believe that our exposure to market rate fluctuations on those
investments is minimal. Currently, we do not use any derivative or other
financial instruments or derivative commodity instruments to hedge any market
risks and do not plan to employ these instruments in the future. At September
30, 2004, we held $31.3 million in cash and cash equivalents, which are
primarily invested in a money market fund that invests in securities that, on
the average, mature in less than 60 days and a short-term bond fund that
invests in securities that, on the average, mature in less than 12 months. An
analysis of the impact on these securities of a hypothetical 10% change in
short-term interest rates from those in effect at September 30, 2004, indicates
that such a change in interest rates would not have a significant impact on our
financial position or on our expected results of operations in 2004. Notes payable.Our results of operations are affected by changes in
short-term interest rates as a result of a loan from Biogen that contains a
variable interest rate. Interest payments on this loan are determined by the
LIBOR plus a margin of 1%. The carrying amounts of the notes payable and
equipment financing arrangements approximate fair value because the interest
rates on these instruments change with, or approximate, market rates. The
following table provides information as of September 30, 2004, about our
obligations that are sensitive to changes in interest rate fluctuations: Expected Maturity Date2004
    
    2005
    
    2006
    
    2007
    
    TotalMaturities of long-term obligations:Variable rate note
    
    $
    
    
    
    $
    
    
    
    $
    10,000,000
    
    
    $
    
    
    
    $
    10,000,000Fixed rate notes
    
    
    
    
    
    
    616,000
    
    
    
    
    
    
    
    
    
    
    
    616,000Fixed rate equipment financing
    
    
    199,000
    
    
    
    498,000
    
    
    
    154,000
    
    
    
    26,000
    
    
    
    877,000Other
    
    
    85,000
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    85,000Total
    
    $
    284,000
    
    
    $
    1,114,000
    
    
    $
    10,154,000
    
    
    $
    26,000
    
    
    $
    11,578,000
 
 Item 4. Controls and Procedures Evaluation of disclosure controls and procedures.H. Stewart Parker, our
Chief Executive Officer, and Todd E. Simpson, our Chief Financial Officer,
after evaluating the effectiveness of our disclosure controls and procedures
(as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act
of 1934, as amended, or Exchange Act) as of the end of the period covered by
this quarterly report, have concluded that, as of that date, our disclosure
controls and procedures were effective in ensuring that information required to
be disclosed by us in reports that we file or submit under the Exchange Act is
accumulated and communicated by our management, to allow timely decisions
regarding required disclosure. 20




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Changes in Internal Controls.In connection with the evaluation described
above, we identified no significant changes in our internal controls during the
period covered by this quarterly report that have materially affected, or are
reasonably likely to materially affect, our internal controls over financial
reporting in an adverse manner. 21




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PART II OTHER INFORMATION 
 Item 1. Legal Proceedings None. 
 Item 2. Changes in Securities, Use of Proceeds and Issuer Purchases of Equity Securities Certain of our loan agreements contain financial covenants establishing
limits on our ability to declare or pay cash dividends. 
 Item 3. Defaults Upon Senior Securities None. 
 Item 4. Submission of Matters to a Vote of Security Holders None. 
 Item 5. Other Information None. 
 Item 6. Exhibits and Reports on Form 8-K  (a)
    
    See the Index to Exhibits included in this quarterly report.(b)
    
    Reports on Form 8-K.  On July 29, 2004, we filed a current report on Form 8-K to furnish the
press release announcing our financial results for the quarterly period
ended June 30, 2004.On August 11, 2004, we filed a current report on Form 8-K announcing
the completion of the sale of CellExSys, Inc., our majority-owned
subsidiary, to Chromos Molecular Systems, Inc.On September 14, 2004, we filed a current report on Form 8-K announcing
the completion of enrollment of the 50 subjects planned for enrollment
in our Phase I clinical trial for our AIDS vaccine candidate. 
 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, as
amended, the registrant has duly caused this report to be signed on its behalf
by the undersigned thereunto duly authorized. TARGETED GENETICS CORPORATIONDate: November 4, 2004
    
    By:
    
    /s/ H. STEWART PARKERH. Stewart Parker,President, Chief Executive Officer and Director(Principal Executive Officer)Date: November 4, 2004
    
    By:
    
    /s/ TODD E. SIMPSONTodd E. Simpson, Vice President,Finance and Administration,Chief Financial Officer,Secretary and Treasurer(Principal Financial and Accounting Officer)
 22




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TARGETED GENETICS CORPORATION 
 INDEX TO EXHIBITS Exhibit No.
    
    Description
    
    Note3.1
    
    Restated Articles of Incorporation (Exhibit 3.1)
    
    (A)3.2
    
    Amended and Restated Bylaws (Exhibit 3.2)
    
    (B)31.1
    
    Certification of Chief Executive Officer pursuant to
Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended31.2
    
    Certification of Chief Financial Officer pursuant to
Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended32.1
    
    Certification of Chief Executive Officer pursuant to
18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 200232.2
    
    Certification of Chief Financial Officer pursuant to
18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
   (A)
    
    Incorporated by reference to the designated exhibit included with
Targeted Genetics Quarterly Report on Form 10-Q (No. 0-23930) for the
quarter ended June 30, 2002.(B)
    
    Incorporated by reference to the designated exhibit included with
Targeted Genetics Annual Report on Form 10-K (No. 0-23930) for the year
ended December 31, 1996. 23