UNITED
      STATES


SECURITIES
      AND EXCHANGE COMMISSION


WASHINGTON,
      D.C. 20549


**FORM
      10-Q**


(Mark
      One)


x
            QUARTERLY
                REPORT UNDER SECTION 13 OR 15(d) OFTHE
                SECURITIES EXCHANGE ACT OF 1934 FOR THEQUARTERLY
                PERIOD ENDED JUNE 30, 2007o
            TRANSITION
                REPORT PURSUANT TO SECTION 13 OR 15(d)OF
                THE SECURITIES EXCHANGE ACT OF 1934 FOR THETRANSITION
                PERIOD
                FROM           
                TO





COMMISSION
      FILE NUMBER: 0-23930





**TARGETED
      GENETICS CORPORATION**





(EXACT
      NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)




Washington
            
            91-1549568(State
                of Incorporation)
            
            (I.R.S.
                Employer Identification No.)




1100
      Olive Way, Suite 100 Seattle, WA 98101





(Address
      of principal executive offices)(Zip Code)





(206)
      623-7612





(Registrant’s
      telephone number, including area code)








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





Indicate
      by check mark whether the registrant (1) has filed all reports required to
      be
      filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
      the
      preceding 12 months (or for such shorter period that the registrant was required
      to file such reports), and (2) has been subject to the filing requirements
      for
      at least the past 90 days. Yes x No o





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





Large
      accelerated filer  ̈ Accelerated
      filer  ̈ Non-accelerated
      filer ý





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




Shares
      of
      Common Stock, par value $0.01 per share, outstanding as of August 3, 2007:
      19,814,161








**TARGETED
      GENETICS CORPORATION**


Quarterly
      Report on Form 10-Q


For
      the
      quarter ended June 30, 2007




TABLE
      OF
      CONTENTS


Page No**.**PART I
                
                FINANCIAL
                    INFORMATIONItem 1.
                
                Financial
                    Statementsa)
                Condensed
                    Consolidated Balance Sheets at June 30, 2007 and December 31,
                    2006
                1b)
                Condensed
                    Consolidated Statements of Operations for the three and six months
                    ended
                    June 30, 2007 and 2006
                2c)
                Condensed
                    Consolidated Statements of Cash Flows for the six months ended
                    June 30,
                    2007 and 2006
                3d)
                Notes
                    to Condensed Consolidated Financial Statements
                4Item
                    2.
                
                Management’s
                    Discussion and Analysis of Financial Condition and Results of
                    Operations
                9Item
                    3.
                
                Quantitative
                    and Qualitative Disclosures About Market Risk
                15Item
                    4T.
                
                Controls
                    and Procedures
                16PART
                    II
                
                OTHER
                    INFORMATIONItem
                    1.
                
                Legal
                    Proceedings
                17Item
                    1A.
                
                Risk
                    Factors
                17Item
                    2.
                
                Unregistered
                    Sales of Equity Securities and Use of Proceeds
                19Item
                    3.
                
                Defaults
                    Upon Senior Securities
                19Item
                    4.
                
                Submission
                    of Matters to a Vote of Security Holders
                20Item
                    5.
                
                Other
                    Information
                21Item
                    6.
                
                Exhibits
                21SIGNATURES
                22INDEX
                    TO EXHIBITS
                23




i




**PART
      I    FINANCIAL INFORMATION**




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




**TARGETED
      GENETICS CORPORATION**




**CONDENSED
      CONSOLIDATED BALANCE SHEETS**


**(Unaudited)**




**June
                30,**
              **2007**
            
            **December
                31,**
              **2006****ASSETS**Current
                assets:Cash
                and cash equivalents
            
            $
            26,045,000
            
            $
            6,206,000Accounts
                receivable
            
            
            1,874,000
            
            
            1,498,000Prepaid
                expenses and other
            
            
            375,000
            
            
            531,000Total
                current assets
            
            
            28,294,000
            
            
            8,235,000Property
                and equipment, net
            
            
            1,053,000
            
            
            1,100,000Goodwill
            
            
            7,926,000
            
            
            7,926,000Other
                assets
            
            
            200,000
            
            
            206,000Total
                assets
            
            $
            37,473,000
            
            $
            17,467,000**LIABILITIES
                AND SHAREHOLDERS’ EQUITY**Current
                liabilities:Accounts
                payable and accrued expenses
            
            $
            4,005,000
            
            $
            1,901,000Accrued
                employee expenses
            
            
            624,000
            
            
            861,000Accrued
                restructure charges
            
            
            678,000
            
            
            1,046,000Deferred
                revenue
            
            
            67,000
            
            
            251,000Current
                portion of long-term obligations
            
            
            1,224,000
            
            
            1,129,000Total
                current liabilities
            
            
            6,598,000
            
            
            5,188,000Accrued
                restructure charges
            
            
            6,634,000
            
            
            6,331,000Long-term
                obligations
            
            
            454,000
            
            
            570,000Deferred
                rent
            
            
            10,000
            
            
            11,000Commitments
                and ContingenciesShareholders’
                equity:
              Preferred
                stock, $0.01 par value, 600,000 shares authorized:Series
                A preferred stock, 180,000 shares designated, none issued and
                outstanding
            
            
            —
            
            
            —Common
                stock, $0.01 par value, 30,000,000 shares authorized, 19,814,161
                shares
                issued and outstanding at June 30, 2007 and 10,921,736 shares issued
                and
                outstanding at December 31, 2006
            
            
            198,000
            
            
            109,000Additional
                paid-in capital
            
            
            315,628,000
            
            
            289,324,000Accumulated
                deficit
            
            
            (292,049,000
            )
            
            (284,027,000
            )Accumulated
                other comprehensive loss
            
            
            —
            
            
            (39,000
            )Total
                shareholders’ equity
            
            
            23,777,000
            
            
            5,367,000Total
                liabilities and shareholders’ equity
            
            $
            37,473,000
            
            $
            17,467,000




See
      accompanying notes to condensed consolidated financial statements


1




**TARGETED
      GENETICS CORPORATION**




**CONDENSED
      CONSOLIDATED STATEMENTS OF OPERATIONS**


**(Unaudited)**





**Three months ended**
              **June 30,**
            
            **Six months ended**
              **June 30,****2007**
            
            **2006**
            
            **2007**
            
            **2006**Revenue
                under collaborative agreements
            
            $
            3,008,000
            
            $
            1,414,000
            
            $
            4,669,000
            
            $
            3,844,000Operating
                expenses:Research
                and development
            
            
            5,270,000
            
            
            3,683,000
            
            
            8,966,000
            
            
            7,360,000General
                and administrative
            
            
            1,575,000
            
            
            1,568,000
            
            
            3,127,000
            
            
            3,049,000Restructure
                charges
            
            
            442,000
            
            
            363,000
            
            
            626,000
            
            
            1,405,000Goodwill
                impairment charge
            
            
            —
            
            
            23,723,000
            
            
            —
            
            
            23,723,000Total
                operating expenses
            
            
            7,287,000
            
            
            29,337,000
            
            
            12,719,000
            
            
            35,537,000Loss
                from operations
            
            
            (4,279,000
            )
            
            (27,923,000
            )
            
            (8,050,000
            )
            
            (31,693,000
            )Investment
                income
            
            
            93,000
            
            
            170,000
            
            
            28,000
            
            
            321,000Interest
                expense
            
            
            (1,000
            )
            
            (123,000
            )
            
            (1,000
            )
            
            (236,000
            )Net
                loss
            
            $
            (4,187,000
            )
            $
            (27,876,000
            )
            $
            (8,023,000
            )
            $
            (31,608,000
            )Net
                loss per common share (basic and diluted)
            
            $
            (0.31
            )
            $
            (2.83
            )
            $
            (0.61
            )
            $
            (3.37
            )Shares
                used in computation of basic and diluted net loss per common
                share
            
            
            13,408,000
            
            
            9,854,000
            
            
            13,138,000
            
            
            9,371,000





See
      accompanying notes to condensed consolidated financial
      statements


2


**TARGETED
      GENETICS CORPORATION**




**CONDENSED
      CONSOLIDATED STATEMENTS OF CASH FLOWS**


**(Unaudited)**





**Six
                months ended****June
                30,****2007**
            
            **2006**Operating
                activities:Net
                loss
            
            $
            (8,023,000
            )
            $
            (31,608,000
            )Adjustments
                to reconcile net loss to net cash used in operating
                activities:Depreciation
            
            
            290,000
            
            
            364,000Stock-based
                compensation
            
            
            395,000
            
            
            464,000Stock
                issued to outside vendors
            
            
            —
            
            
            86,000Goodwill
                impairment charge
            
            
            —
            
            
            23,723,000Loss
                (gain) on investments
            
            
            251,000
            
            
            (8,000
            )Changes
                in assets and liabilities:Decrease
                (increase) in accounts receivable
            
            
            (376,000
            )
            
            90,000Increase
                in prepaid expenses and other
            
            
            (72,000
            )
            
            (243,000
            )Decrease
                in other assets
            
            
            6,000
            
            
            5,000Increase
                in current liabilities
            
            
            1,868,000
            
            
            385,000Decrease
                in deferred revenue
            
            
            (184,000
            )
            
            (135,000
            )Decrease
                in deferred rent
            
            
            (1,000
            )
            
            (99,000
            )Increase
                (decrease) in accrued restructure expenses
            
            
            (65,000
            )
            
            336,000Net
                cash used in operating activities
            
            
            (5,911,000
            )
            
            (6,640,000
            )Investing
                activities:Purchases
                of property and equipment
            
            
            (243,000
            )
            
            (57,000
            )Proceeds
                from sale of investments
            
            
            16,000
            
            
            49,000Net
                cash used in investing activities
            
            
            (227,000
            )
            
            (8,000
            )Financing
                activities:Net
                proceeds from sales of capital stock and warrants
            
            
            25,959,000
            
            
            4,797,000Proceeds
                from the exercise of stock options
            
            
            39,000
            
            
            11,000Payments
                under leasehold improvements and equipment financing
                arrangements
            
            
            (21,000
            )
            
            (111,000
            )Net
                cash provided by financing activities
            
            
            25,977,000
            
            
            4,697,000Net
                increase (decrease) in cash and cash equivalents
            
            
            19,839,000
            
            
            (1,951,000
            )Cash
                and cash equivalents, beginning of period
            
            
            6,206,000
            
            
            14,122,000Cash
                and cash equivalents, end of period
            
            $
            26,045,000
            
            $
            12,171,000




See
      accompanying notes to condensed consolidated financial
      statements


3




**TARGETED
      GENETICS CORPORATION**





**NOTES
      TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**




**(Unaudited)**







**1.   Summary
      of Significant Accounting Policies**





***Basis
      of Presentation***





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




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





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





Our
      combined cash and cash equivalents totaled $26.0 million at June 30, 2007. We
      believe that our current resources, including the capital raised in January
      2007
      and June 2007 and the cash anticipated to be received from our collaborative
      partners, are sufficient to fund our currently planned operations, including
      our
      clinical trials, for at least a year.  This
      estimate is based on our ability to perform planned research and development
      activities and the receipt of planned funding from our collaborators. Our
      near-term financing strategy includes leveraging our development capabilities
      and intellectual property assets into additional commercial opportunities,
      advancing our clinical development programs, and accessing the public and
      private capital markets at appropriate times. Depending on our ability to successfully access additional funding, we may
      be
      forced to preserve our cash position through a combination of cost reduction
      measures, sales of assets likely at values significantly below their potential
      worth, or the pursuit of alternative financing transactions that would likely
      be
      on terms disadvantageous to us and dilutive to our shareholders.  We
      have
      prepared the accompanying financial statements on a going concern basis, which
      assumes that we will realize our assets and satisfy our liabilities in the
      normal course of business.  The
      accompanying financial statements do not include any adjustments that may impact
      the amount and classifications of assets or liabilities that may result from
      these liquidity uncertainties.





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





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





***Recently
      Issued Accounting Standards***





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




4




**2.   Long-Term
      Obligations**




Long-term
      obligations consist of the following:





**June 30,******
              **2007**
            
            **December 31,******
              **2006**Loans
                payable to Biogen Idec
            
            $
            1,672,000
            
            $
            1,672,000Equipment
                financing obligations
            
            
            6,000
            
            
            27,000Total
                obligations
            
            
            1,678,000
            
            
            1,699,000Less
                current portion
            
            
            (1,224,000
            )
            
            (1,129,000
            )Total
                long-term obligations
            
            $
            454,000
            
            $
            570,000





As
      of
      June 30, 2007, we owed $1.7 million to Biogen Idec, a beneficial owner of
      approximately 11% of our outstanding common shares. This
      debt
      is the remaining balance of a $10.0 million loan from Biogen Idec initiated
      in
      2001. As
      part
      of our 2006 debt restructuring, we agreed to terms that resulted in a loan
      payable balance of $1.7 million, which consisted of $1.5 million principal
      and
      $167,000 of estimated future interest payments, to be paid to Biogen Idec in
      two
      installments: $1.0 million plus accrued interest, which we paid on August 1,
      2007, and the remaining balance on August 1, 2008. We must apply one-third
      of
      certain up-front payments received from potential future corporate
      collaborations to the outstanding balance on this loan payable, first to
      repayment of any accrued and unpaid interest on the principal being repaid,
      and
      second to the repayment of outstanding principal in reverse order of maturity.
      Outstanding borrowings under this unsecured loan agreement bear interest at
      the
      one-year London Interbank Offered Rate, or LIBOR, plus 1%, which is reset
      quarterly. Since the estimated future interest payments are included in the
      balance of the obligation, we do not incur further interest charges attributable
      to this debt. The loan contains financial covenants that limit our ability
      to
      declare or pay cash dividends.





As
      of
      June 30, 2007, future aggregate principal payments related to the $1.7 million
      Biogen Idec debt are $1.1 million in 2007, which includes a $115,000 principal
      payment made in July 2007 and the $1 million August 1, 2007 principal
      installment, $410,000 in 2008 and zero there after. The long-term portion of
      $454,000 includes principal of $410,000 and interest of $44,000.





**3.   Accrued
      Restructure Charges**





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





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





**Contract**
              **Termination**
              **Costs**December
                31, 2006 accrued liability
            
            $
            7,377,000Charges
                related to changes in lease assumptions
            
            
            260,000Accretion
                expense
            
            
            366,000Amount
                paid
            
            
            (691,000
            )June
                30, 2007 accrued liability
            
            $
            7,312,000





During
      the second quarter of 2007, we recorded additional restructure charges of
      $260,000 as a result of updating our estimates of costs and sublease income
      associated with exiting the Bothell facility. As part of this assessment we
      extended the anticipated lead time for subleasing the facility. In addition
      to
      this adjustment to the accrued restructure liability, we incurred $182,000
      of
      accretion expense for the three months ended June 30, 2007 and $366,000 of
      accretion expense for the six months ended June 30, 2007. The total of these
      charges and adjustments to the liability are reflected as restructure charges
      in
      the accompanying consolidated statement of operations.




5





Through
      June 30, 2007, we have recorded contract termination costs totaling $10.6
      million for our Bothell facility. We expect to incur an additional $2.8 million
      in accretion expense through the expiration of the Bothell lease in September
      2015.





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





**4.
      Equity**





***Financing***





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





On
      January 11, 2007, we sold approximately 2.2 million shares of our common stock
      in a private placement at a price of $4.00 per share and received net proceeds
      of approximately $8.1 million. In addition, in connection with the financing,
      we
      issued warrants to purchase up to 763,000 shares of our common stock. These
      warrants expire in January 2012 and are exercisable at $5.41 per share beginning
      July 19, 2007. We also issued a warrant with the same terms as the ones issued
      pursuant to the private placement to purchase 16,119 shares of our common stock
      as compensation to the placement agent in this transaction.





***Stock
      Based Compensation***





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





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


6





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





**Three months ended**
                **June 30,**
              
              **Six months ended**
                **June 30,****2007**
              
              **2006**
              
              **2007**
              
              **2006**Stock
                  options:Research
                  and development expense
              
              $
              99,000
              
              $
              137,000
              
              $
              194,000
              
              $
              262,000General
                  and administrative expense
              
              
              61,000
              
              
              106,000
              
              
              150,000
              
              
              202,000Restricted
                  stock units:Research
                  and development expense
              
              
              17,000
              
              
              —
              
              
              17,000
              
              
              —General
                  and administrative expense
              
              
              34,000
              
              
              —
              
              
              34,000
              
              
              —Total
                  compensation expense
              
              $
              211,000
              
              $
              243,000
              
              $
              395,000
              
              $
              464,000




***Stock
      Options***





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





**Shares**
            
            **Weighted**
              **Average**
              **Exercise**
              **Price**
            
            **Remaining**
              **Average**
              **Contractual**
              **Term (Years)**
            
            **Intrinsic**
              **Value**Outstanding,
                December 31, 2006
            
            
            835,085
            
            $
            15.39Granted
            
            
            15,800
            
            
            3.88Exercised
            
            
            (12,632
            )
            
            3.10Expired
            
            
            (13,892
            )
            
            40.66Forfeited
            
            
            (41,439
            )
            
            9.19Outstanding,
                June 30, 2007
            
            
            782,922
            
            $
            15.23
            
            
            6.77
            
            $
            226,000Exercisable
                at June 30, 2007
            
            
            672,233
            
            $
            16.29
            
            
            6.57
            
            $
            195,000




The
      aggregate intrinsic value is determined using the closing price of our common
      stock of $2.72 on June 30, 2007. The intrinsic value of stock options exercised
      was $22,000 during the six months ended June 30, 2007 and $3,000 during the
      six
      months ended June 30, 2006. We received $39,000 from the exercise of stock
      options for the six months ended June 30, 2007.





As
      of
      June 30, 2007, total unrecognized compensation cost related to unvested options
      was approximately $219,000, net of estimated forfeitures, which we expect to
      recognize over a weighted average period of approximately 1 year.





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





**Outstanding**
            
            **Exercisable****Range of Exercise Prices**
            
            **Number of**
              **Option******
              **Shares**
            
            **Weighted**
              **Average**
              **Exercise**
              **Price**
            
            **Weighted****Average**
              **Remaining**
              **Contractual Life**
              **(Years)**
            
            **Number of**
              **Option Shares**
            
            **Weighted**
              **Average**
              **Exercise**
              **Price**$1.80
                - $3.24
            
            
            95,483
            
            $
            2.50
            
            
            8.57
            
            
            83,001
            
            $
            2.543.80
                - 3.80
            
            
            187,000
            
            
            3.80
            
            
            8.95
            
            
            187,000
            
            
            3.803.87
                - 9.10
            
            
            167,821
            
            
            7.28
            
            
            7.36
            
            
            105,994
            
            
            7.2310.80
                - 14.90
            
            
            157,445
            
            
            13.10
            
            
            6.53
            
            
            122,860
            
            
            13.1015.30
                - 148.80
            
            
            175,173
            
            
            43.92
            
            
            3.11
            
            
            173,378
            
            
            44.13Balance,
                June 30, 2007
            
            
            782,922
            
            $
            15.23
            
            
            6.77
            
            
            672,233
            
            $
            16.29





The
      fair
      value of each stock option award is estimated on the date of the grant using
      the
      Black-Scholes-Merton option pricing model. The
      weighted average fair value of options granted during the six months ended
      June
      30, 2007 was $3.88 and was $1.85 for the six months ended June 30, 2006.


7





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





**Six Months ended June 30,****2007**
            **2006**Expected
                dividend rate
            Nil
            NilExpected
                stock price volatility
            1.047
                - 1.114
            1.086-1.107Risk-free
                interest rate range
            4.54
                - 4.58%
            4.25-4.85%Expected
                life of options
            4
                -
                5 years
            4-5
                years





*Expected
      Dividend:* We
      do not
      anticipate any dividends based on our current dividend restrictions related
      to
      our Biogen Idec note.





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





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





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





***Restricted
      Stock Units***





**Shares**
            
            **Weighted**
              **Average**
              **Grant Date**
              **Fair****Value**Nonvested,
                December 31, 2006
            
            —
            
            $
            —Granted
            
            
            517,000
            
            
            3.13Vested
            
            
            —
            
            
            —Forfeited
            
            
            —
            
            
            —Nonvested,
                June 30, 2007
            
            
            517,000
            
            $
            3.13





As
      of
      June 30, 2007, total unrecognized compensation cost related to unvested
      restricted stock units was approximately $904,000, net of estimated forfeitures,
      which we expect to recognize over a weighted average period of approximately
      2.5
      years.





**5.  
      Other Comprehensive Loss**





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





**Three months ended**
                **June 30,**********
              
              **Six months ended**
                **June 30,****2007**
              
              **2006**
              
              **2007**
              
              **2006**Net
                  loss as reported
              
              $
              (4,187,000
              )
              $
              (27,876,000
              )
              $
              (8,023,000
              )
              $
              (31,608,000
              )Other
                  comprehensive income:Unrealized gain on available-for-sale securities
              
              
              —
              
              
              —
              
              
              —
              
              
              48,000Foreign
                  currency translation adjustment
              
              
              —
              
              
              15,000
              
              
              —
              
              
              13,000Other
                  comprehensive loss
              
              $
              (4,187,000
              )
              $
              (27,861,000
              )
              $
              (8,023,000
              )
              $
              (31,547,000
              )





**6.  
      Investments**





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





8




We
        record
        our common stock investment in Chromos at fair market value and record changes
        in the fair market value of this stock in accumulated other comprehensive
        loss
        in the accompanying condensed consolidated balance sheet .
        We
        periodically evaluate our Chromos stock for signs of impairment that may
        be
        other-than-temporary, which would necessitate a reduction in the carrying
        value
        of the investment and charge to expense. During the first and second quarters
        of
        2007, due to the declining market value of the Chromos securities and a decline in Chromos’
current financial position, we determined that our investment is
        other-than-temporarily impaired. Accordingly, we wrote the asset down to
        the
        fair market value of the Chromos stock on both March 31, 2007 and June 30,
        2007
        and recognized a realized loss of $208,000 in the first quarter and an
        additional realized loss of $44,000 in the second quarter.
 
 **FairValue**
              
              **UnrealizedLosses**
              
              **Proceedsfrom
                  thesale ofsecurities**
              
              **RealizedLoss**Marketable
                  equity securities
              
              $
              89,000
              
              $
              —
              
              $
              16,000
              
              $
              (251,000
              )
 
 **7.
        Goodwill**
 
 We
        perform goodwill impairment tests in accordance with SFAS No. 142, *“Goodwill
        and Other Intangible Assets”* on an
        annual basis or more frequently if events and changes in business conditions
        indicate that the carrying amount of our goodwill may not be recoverable.
        Normally, we perform our annual impairment test as of October 1. However,
        as a
        result of a decline in market price of our common stock in June 2006, to
        a level
        that reduced our market capitalization to an amount less than the fair value
        of
        our net assets, we concluded that this was an indicator of impairment of
        our
        goodwill and therefore we were required to perform an interim goodwill
        impairment test. In the first step of this testing, since we are comprised
        of
        only one reporting unit, we compared our fair value, as measured by market
        capitalization and discounted cash flow analysis, to the net carrying value
        of
        our assets. Since our indicated fair value was less than the net carrying
        value
        of our assets, we were then required to perform the second step of the
        evaluation and measure the amount of the impairment loss. This analysis required
        us to determine the implied value of goodwill by allocating our estimated
        fair
        value to its assets and liabilities including intangible assets such as
        in-process research and development, completed technology, and trademarks
        and
        trade names using a hypothetical purchase price allocation as if we had been
        acquired in a business combination as of the date of the impairment test.
        This
        evaluation resulted in an implied goodwill balance of $7.9 million and a
        second
        quarter 2006 non-cash goodwill impairment charge of $23.7 million.
 
 **8.  
        Income Taxes**
  We adopted the provisions of FASB Interpretation No. 48, *“Accounting
        for Uncertainty in Income Taxes”* ,
        or FIN
        48, on January 1, 2007. We have been in a net operating loss position since
        inception and have not recognized any tax benefits for any of our income
        tax
        positions as a result of a full valuation allowance. There were no changes
        to
        the amount of recognized tax benefits as a result of adopting FIN 48, and
        there
        were no changes to the recognized tax benefits during the three and six months
        ended June 30, 2007.
 
 Historically,
        we have not incurred any interest or penalties associated with tax matters
        and
        no interest or penalties were recognized during the three and six months
        ended
        June 30, 2007. We have adopted a policy whereby amounts related to interest
        and
        penalties associated with tax matters are classified as additional income
        tax
        expense when incurred.
 
 Tax
        years
        that remain open for examination include 2003, 2004, 2005, and 2006. In
        addition, tax years from 1992 to 2002 may be subject to examination in the
        event
        that we utilize the net operating losses from those years in our current
        or
        future year tax returns.
 
 **Item
        2.** ***Management’s
        Discussion and Analysis of Financial Condition and Results of
        Operations*** ****
  **Forward-Looking
        Statements**
  This
        quarterly report on Form 10-Q contains forward-looking statements within
        the
        meaning of the private Securities Litigation Reform Act of 1995. All statements
        other than statements of historical fact are forward-looking and involve
        risks
        and uncertainties. Forward-looking statements include statements about our
        product development and commercialization goals and expectations, potential
        market opportunities, our plans for and anticipated results of our clinical
        development activities and the potential advantage of our product candidates,
        our future cash requirements and the sufficiency of our cash and cash
        equivalents to meet these requirements, our ability to raise capital when
        needed
        and other statements that are not historical facts. Words such as “may,” “will,”
“believes,” “estimates,” “expects,” “anticipates,” “plans” and “intends,” or
        statements concerning “potential” or “opportunity” and other words of similar
        meaning or the negative thereof, may identify forward-looking statements,
        but
        the absence of these words does not mean that a statement is not
        forward-looking. In making these statements, we rely on a number of assumptions
        and make predictions about the future. Our actual results could differ
        materially from those stated in, or implied by, forward-looking statements
        for a
        number of reasons, including the risks described in greater detail in the
        section entitled “Risk Factors” in Part I, Item IA of our annual report on Form
        10-K for the year ended December 31, 2006, as supplemented by the section
        entitled “Risk Factors” in Part II, Item 1A of this quarterly
        report.
  9
  You
        should not unduly rely on these forward-looking statements, which speak only
        as
        of the date of this quarterly report. We undertake no obligation to publicly
        revise any forward-looking statement after the date of this quarterly report
        to
        reflect circumstances or events occurring after the date of this quarterly
        report or to conform the statement to actual results or changes in our
        expectations. You should, however, review the risk factors and other information
        we provide in the reports we file from time to time with the SEC.
  **BUSINESS
        OVERVIEW**
 
 We
        are a
        clinical-stage therapeutic biotechnology company. We are at the forefront
        of
        developing, with the goal of commercializing, a new class of therapeutic
        products called gene therapeutics. We believe that a wide range of diseases
        may
        potentially be treated or prevented with gene therapeutics. In addition to
        treating diseases that have not had treatments in the past, we believe that
        there is also a significant opportunity to use gene therapeutics to more
        effectively treat diseases that are currently treated using other therapeutic
        classes of drugs such as protein-based drugs, monoclonal antibodies or small
        molecule drugs.
 
 Gene
        therapeutics consist of a delivery vehicle, called a vector, and genetic
        material. The role of the vector is to carry the genetic material into a
        target
        cell. Once delivered into the cell, the gene can express or direct production
        of
        the specific proteins encoded by the gene. Gene therapeutics may be used
        to
        treat disease facilitating the normal protein production or gene regulation
        capabilities of cells. Gene therapeutics may be used to enable cells to produce
        more of a certain protein or different proteins than they normally produce
        thereby treating a disease state. Gene therapeutics may also be used for
        RNAi
        interference, or RNAi, to deliver small RNA molecules that once delivered
        into
        the cell may shut down or interfere with cellular functions.
 
 We
        are
        primarily focused on the following adeno-associated
        viral vectors, or AAV, based product
        development programs:
  **Description**
                
                **Indication**
                
                **Partners**
                
                **DevelopmentStatus**AAV
                    delivery of TNF-alpha antagonist
                
                Inflammatory
                    Arthritis
                
                None
                
                Phase
                    I/IIAAV
                    delivery of HIV antigens
                
                HIV/AIDS
                
                IAVI
                
                Phase
                    IIAAV
                    delivery of SERCA2a
                
                Congestive
                    Heart Failure
                
                Celladon
                
                Phase
                    IAAV
                    delivery of HIV antigens
                
                HIV/AIDS
                
                CHOP,
                    CCRI and NIAID
                
                PreclinicalAAV
                    expression of htt shRNA (RNAi)
                
                Huntington’s
                    disease
                
                Sirna
                    Therapeutics as asubsidiary of Merck
                
                Preclinical
  In
        the
        first half of 2007, we made progress in our development collaborations and
        our
        product development programs and expanded and leveraged our patent portfolio.
        More specifically:
 
 ·
              In
                  February and May 2007, we reported additional data on the results
                  of our
                  ongoing Phase I/II clinical trial of our inflammatory arthritis
                  candidate
                  that demonstrated the results continue to show evidence for sustained
                  improvement in signs and symptoms of the
                  disease.
 
 ·
              In
                  February 2007, we reported results from IAVI’s Phase I clinical trial of
                  our investigational HIV/AIDS vaccine candidate.The
                  results reported indicated favorable safety and tolerability profiles
                  consistent with the results observed in clinical trials to date,
                  and
                  provide the rationale for evaluating the vaccine at higher doses
                  and at
                  different dosing intervals.
 
 ·
              In
                  May 2007, in collaboration with theUniversity
                  College London's Institute of Ophthalmology and Moorfields Eye
                  Hospital, a
                  Phase I/II clinical trial was initiated to test the use of an
                  AAVvector to deliver RPE65 to treata
                  form of childhood blindness. Weproduced
                  the vector used in this trial. The trial is funded by the UK Department
                  of
                  Health.
 
 ·
              In
                  May 2007, the first patient was dosed in the Phase I clinical trial
                  of
                  MYDICAR, the congestive heart failure product candidate under development
                  through our collaboration with
                  Celladon.
  10
  ·
              In
                  May 2007, we completed enrollment and initial dosing in the Phase
                  I/II
                  clinical trial of our inflammatory arthritis candidate though this
                  clinical trial has more recently been placed on clinical hold.
                  Please see
                  "Risk Factors" in Item 1A for more information on this development.
 
 ·
              Issuance
                  of patents strengthening our AAV vector patent
                  portfolio.
 
 Most
        of
        our expenses are related to advancing our research and development programs,
        conducting preclinical studies and clinical trials and for general and
        administrative support of these activities. We have financed the company
        primarily through proceeds from public and private sales of our equity
        securities, through cash payments received from our collaborative partners
        for
        product development and manufacturing activities, through proceeds from the
        issuance of debt and to a lesser extent through loan funding under equipment
        financing arrangements. During 2007, we completed two private placements
        of our
        common stock generating approximately $25.9 million to fund our programs.
        On
        June 27, 2007, we sold approximately 6.7 million shares of our common stock
        in a
        private placement at a price of $2.905 per share and received net proceeds
        of
        approximately $17.8 million. In connection with the financing we issued
        five-year warrants to purchase up to approximately 6.7 million shares of
        our
        common stock. We also issued a warrant to purchase 334,989 shares of our
        common
        stock as compensation to the placement agent in this transaction. On January
        11,
        2007, we sold approximately 2.2 million shares of our common stock in a private
        placement at a price of $4.00 per share and received net proceeds of
        approximately $8.1 million. In connection with this financing we issued
        five-year warrants to purchase up to 763,000 shares of our common stock.
        We also
        issued a warrant to purchase 16,119 shares of our common stock as compensation
        to the placement agent in this transaction.
 
 As
        of
        June 30, 2007, our accumulated deficit totaled $292.0 million. We expect
        to
        generate substantial additional losses for the foreseeable future, primarily
        due
        to the costs associated with funding our inflammatory arthritis clinical
        development program, developing and maintaining our manufacturing capabilities
        and developing our intellectual property assets.
 
 We
        will
        require access to significantly higher amounts of capital than we currently
        have
        in order to successfully develop our lead inflammatory arthritis product
        candidate and other product candidates. We may be unable to obtain required
        funding when needed or on acceptable terms, obtain or maintain corporate
        partnerships, or complete acquisition transactions necessary or desirable
        to
        complete the development of our product candidates.
 
 **CRITICAL
        ACCOUNTING POLICIES, ESTIMATES AND ASSUMPTIONS**
 
 Other
        than with respect to those items described below, there have been no material
        changes from the critical accounting policies, estimates and assumptions
        as
        disclosed in Item 7 “Management’s Discussion and Analysis of Financial Condition
        and Results of Operations” of the Company’s annual report on Form 10-K for the
        year ended December 31, 2006. The critical accounting policies, estimates
        and
        assumptions described below have been updated to provide more recent financial
        and factual information as of June 30, 2007.
 
 ***Accounting
        for Uncertainties in Income Taxes***
 
 Effective
        the beginning of 2007, we adopted FASB Interpretation No. 48, “ *Accounting
        for Uncertainty in Income Taxes,”* or
        FIN
        48. FIN 48 provides guidance to address uncertainty in tax positions and
        clarifies the accounting for income taxes by specifying a minimum recognition
        threshold which income tax positions must achieve before being recognized
        in the
        financial statements. The adoption of FIN 48 had no impact on our net loss,
        earnings per share or financial position for the three and six months ended
        June
        30, 2007.
  The
        application of income tax law is inherently complex. Laws and regulations
        in
        this area are voluminous and are often ambiguous. As such, we are required
        to
        make many subjective assumptions and judgments regarding our income tax
        exposures. Interpretations of and guidance surrounding income tax laws and
        regulations change over time. Changes in our subjective assumptions and
        judgments can materially affect amounts recognized in the consolidated balance
        sheets and statements of income.
 
 **RESULTS
        OF OPERATIONS**
 
 ***Revenue***
 
 Revenue
        increased to $3.0 million for the three months ended June 30, 2007 as compared
        to $1.4 million for the same period in 2006. Revenue increased to $4.7 million
        for the six months ended June 30, 2006 as compared to $3.8 million for the
        same
        period in 2006. The increase in revenue reflects an increase in research
        and
        development activities under the National Institute of Allergy and Infectious
        Diseases, or NIAID, funded HIV/AIDS vaccine project in collaboration with
        the
        Children’s Hospital of Philadelphia, or CHOP, and the Columbus Children’s
        Research Institute, or CCRI, and under our collaboration with Celladon
        Corporation, or Celladon. This increase is partially offset by lower research
        and development activities under our collaboration with the
        International AIDS Vaccine Initiative, or IAVI. We
        expect
        that our revenue for the remainder of 2007 will continue to consist primarily
        of
        research and development revenue earned from the NIAID-funded HIV/AIDS vaccine
        project in collaboration with CHOP and CCRI and work under our collaboration
        with Celladon. For the next several years, our revenue will depend on the
        continuation of the current collaborations and our success in entering into
        and
        performing under new collaborations.
  11
  ***Operating
        Expenses***
 
 *Research
        and Development Expenses* .    Research
        and development expenses increased to $5.3 million for the three months ended
        June 30, 2007 compared to $3.7 million for the same period in 2006. 
Research and development expenses increased to $9.0 million for the six months
        ended June 30, 2007 compared to $7.4 million for the same period in 2006.
        Costs
        for both the three and six month periods are higher due to increased research
        and development costs for our preclinical programs, specifically the
        NIAID-funded HIV/AIDS vaccine program in collaboration with CHOP and CCRI
        and
        costs incurred to support the initiation of clinical trials for the congestive
        heart failure product; which began in May 2007. Costs related to our
        inflammatory arthritis program increased due to a higher number of enrolled
        subjects and higher clinical trial activity to support the increased enrollment.
        This cost increase was partially offset by lower costs related to our HIV/AIDS
        vaccine collaboration with IAVI as a result of less development activity
        as the
        project has progressed into clinical testing. We expect that our research
        and
        development expenses for the remainder of 2007 will vary depending on the
        amount
        and timing of development efforts and outside services necessary to advance
        our
        clinical programs, our congestive heart failure collaboration with Celladon
        and
        the NIAID-funded HIV/AIDS vaccine project in collaboration with CHOP and
        CCRI.
 
 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**
                **June
                  30,**
              
              **Six
                  months ended**
                **June
                  30,****2007**
              
              **2006**
              
              **2007**
              
              **2006**Programs
                  in clinical development:Inflammatory
                  arthritis
              
              $
              1,095,000
              
              $
              875,000
              
              $
              1,857,000
              
              $
              1,433,000IAVI
                  HIV/AIDS vaccine
              
              
              60,000
              
              
              794,000
              
              
              169,000
              
              
              1,111,000Congestive
                  heart failure(1)
              
              
              203,000
              
              
              —
              
              
              203,000
              
              
              —Indirect
                  costs and other
              
              
              1,008,000
              
              
              1,280,000
              
              
              1,530,000
              
              
              1,627,000Total
                  clinical development program expense
              
              
              2,366,000
              
              
              2,949,000
              
              
              3,759,000
              
              
              4,171,000Research
                  and preclinical development program expense
              
              
              2,904,000
              
              
              734,000
              
              
              5,207,000
              
              
              3,189,000Total
                  research and development expense
              
              $
              5,270,000
              
              $
              3,683,000
              
              $
              8,966,000
              
              $
              7,360,000
 
 (1)
        Includes costs incurred after the clinical trial was initiated in May 2007.
        Costs incurred prior to that are included as research and preclinical
        development program expense.
 
 Research
        and development costs attributable to programs in clinical development include
        salaries and benefits, clinical trial costs, outside services, and materials
        and
        supplies incurred to support the clinical programs. Indirect costs allocated
        to
        clinical programs include facility and occupancy costs, research and development
        administrative costs, and license and royalty payments. These costs are further
        allocated between clinical and preclinical programs based on relative levels
        of
        program activity. IAVI separately manages and funds the clinical trial costs
        of
        our HIV/AIDS vaccine program for the developing world and Celladon separately
        manages and funds the clinical trial costs of our congestive heart failure
        program. As a result, we do not include those costs in our research and
        development expenses.
 
 Costs
        attributed to research and preclinical programs represent our earlier-stage
        development activities and include costs incurred for development activities
        for
        the NIAID-funded HIV/AIDS vaccine in collaboration with CHOP and CCRI as
        well as
        other programs prior to their transition into clinical trials. Research and
        preclinical program expense also includes costs that are not allocable to
        a
        clinical development program, such as unallocated manufacturing infrastructure
        costs. Because we conduct multiple research projects and utilize resources
        across several programs, our research and preclinical development costs are
        not
        directly assigned to individual programs.
 
 For
        purposes of reimbursement from our collaboration partners, we capture the
        level
        of effort expended on a program through our project management system, which
        is
        based primarily on human resource time allocated to each program, supplemented
        by an allocation of indirect costs and other specifically identifiable costs,
        if
        any. As a result, the costs allocated to programs identified in the table
        above
        do not necessarily reflect the actual costs of the program.
  12
 
 *General
        and Administrative Expenses* .    General
        and administrative expenses remained consistent at $1.6 million for the three
        months ended June 30, 2007 and June 30, 2006. General and administrative
        expense
        increased to $3.1 million for the six months ended June 30, 2007 compared
        to
        $3.0 million for the same period in 2006. **** General
        and administrative expenses consist primarily of salaries, patent costs,
        legal
        and audit fees and shareholder costs.
 
 *Restructure
        Charges.* Restructure
        charges increased to $442,000 for the three months ended June 30, 2007 compared
        to $363,000 million for the same period in 2006. Restructure charges decreased
        to $626,000 for the six months ending June 30, 2007 compared to $1.4 million
        for
        the same period in the prior year. Restructuring charges in 2007 include
        $260,000 related to changes in our estimates of the anticipated lead time
        to
        sublease the facility. Restructuring charges for the first six months of
        2006
        include charges of $639,000 related to changes in our expectations regarding
        market conditions for the Bothell facility subleasing market, $219,000 related
        to employee termination benefits of our restructuring efforts to realign
        our
        cost structure and $174,000 in relation to the early termination of a portion
        of
        our Seattle facility lease resulting from the head count reductions.
        Restructuring charges also include accretion expense of $366,000 for the
        six
        months ended June 30, 2007 and $375,000 for the six months ended June 30,
        2006.
 
 *Goodwill
        Impairment Charge.* We
        periodically and annually on October 1 st evaluate
        the carrying value of our goodwill in accordance with SFAS No. 142, *“Goodwill
        and Other Intangible Assets”* and ** if
        there
        is evidence of an impairment in value, we reduce the carrying value of the
        asset. As discussed in Note 7 of the notes to our condensed consolidated
        financial statements, we recognized a non-cash loss on impairment of goodwill
        during second quarter of 2006. As a result of a decline in our share price
        during June 2006, to a level which reduced market capitalization to an amount
        less than the fair value of our net assets, we were required to perform an
        interim goodwill impairment test. As a result of this evaluation, during
        the
        second quarter of 2006, we recognized a non-cash impairment charge of $23.7
        million, which was equal to the recorded value of goodwill in excess of its
        implied value.
 
 ***Other
        Income and Expense***
 
 *Investment
        Income(Loss)* .    
        Investment income reflects interest income earned on our short term investments
        and realized gains or losses on our investment in Chromos Molecular Systems
        Inc,
        or Chromos. Investment income decreased to $93,000 for the three months ended
        June 30, 2007 compared to income of $170,000 for the same period in 2006.
        Investment income decreased to $28,000 for the six months ended June 30,
        2007
        compared to $321,000 for the same period in 2006. Investment income reflects
        a
        net realized loss of $44,000 in the three months ended June 30, 2007 and
        $251,000 in the six months ended June 30, 2007 related to an
        other-than-temporary impairment loss on our investment in Chromos due to
        the
        declining market value of the Chromos securities combined with decline in
        Chromos’ current financial position. ****
 
 *Interest
        Expense* .    
        Interest expense decreased to $1,000 for the three months ended June 30,
        2007,
        compared to $123,000 for the same period in 2006. Interest expense decreased
        to
        $1,000 for the six months ended June 30, 2007, compared to $236,000 for the
        same
        period in the prior year. In November 2006, we restructured a $8.15 million
        outstanding loan from Biogen Idec by exchanging $5.65 million of the balance
        for
        common shares of our stock, making a $500,000 payment and establishing a
        new
        repayment schedule for the remaining balance. As a result of restructuring
        the
        Biogen Idec debt, the $1.7 million carrying value of the remaining debt as
        of
        June 30, 2007 includes the related estimated future interest payments and
        accordingly, we did not record interest expense on the Biogen Idec loan in
        the three six month periods ended June 30, 2007. We do not expect to record
        future interest expense on this restructured debt.
  **LIQUIDITY
        AND CAPITAL RESOURCES**
  We
        had
        cash and cash equivalents of $26.0 million at June 30, 2007 compared to
        $6.2 million at December 31, 2006. Our cash and cash equivalents increased
        in the six months ended June 30, 2007 primarily reflecting the net proceeds
        of
        $25.9 million from our January and June 2007 sales of our common stock and
        warrants, partially offset by our net loss and the resulting cash used in
        operations of $5.9 million.
 
 On
        June
        27, 2007, we sold approximately 6.7 million shares of our common stock in
        a
        private placement at a price of $2.905 per share and received net proceeds
        of
        approximately $17.8 million. In addition, in connection with the financing,
        we
        issued five-year warrants to purchase up to approximately 6.7 million shares
        of
        our common stock. We also issued a warrant to purchase 334,989 shares of
        our
        common stock as compensation to the placement agent in this transaction.
        On
        January 11, 2007, we sold approximately 2.2 million shares of our common
        stock
        in a private placement at a price of $4.00 per share and received net proceeds
        of approximately $8.1 million. In addition, in connection with the financing
        we
        issued five-year warrants to purchase up to 763,000 shares of our common
        stock.****We also issued a warrant to purchase 16,119 shares
        of our common stock as compensation to the placement agent in this transaction.
        We intend to continue to seek appropriate opportunities to access the public
        and
        private capital markets, however, our ability to issue equity securities
        at the
        current market price will likely be adversely affected by the fact that we
        are
        presently ineligible under SEC rules to utilize Form S-3 for primary offerings
        of our securities because the aggregate market value of our outstanding common
        stock held by non-affiliates is less than $75
        million.****
  13
  Our
        primary expenses are related to the development of our research and development
        programs, the conduct of preclinical studies and clinical trials and general
        and
        administrative support for these activities. Our HIV/AIDS vaccine candidate
        for
        the developing world, our inflammatory arthritis product candidate and our
        congestive heart failure product candidate are all in 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 currently have 84,453 of unreserved authorized shares and
        will
        require substantial additional financial resources to fund the development
        and
        commercialization of our lead product candidate in inflammatory
        arthritis.
 
 We
        are
        currently focusing our development funding on our inflammatory arthritis
        product
        candidate, which is in Phase I/II clinical trials. We currently fund all
        costs
        of this program from our working capital and expect to do so for the foreseeable
        future, although our strategy is to ultimately seek a partner to fund
        later-stage development of this program.
 
 In
        addition to the funding necessary to advance our product development candidates
        and fund our ongoing operations, we also have significant lease commitments,
        long-term obligations and outstanding debt that draw on our cash resources.
        Our
        most significant obligations are approximately $12.6 million of remaining
        Bothell facility lease payments, which we are obligated to pay at $1.4 million
        to $1.6 million per year until the year 2015 and $1.7 million of aggregate
        principal and interest payments to Biogen Idec under an outstanding loan
        payable. Under our 2006 modified loan agreements with Biogen Idec, t he
        loan
        bears interest at the rate of LIBOR plus 1.0% and we repaid a total of $1.1
        million of the loan in July and August 2007 and agreed to repay the remaining
        balance on August 1, 2008. The Biogen Idec loan agreement includes a provision
        that requires us to apply one-third of certain up-front payments received
        from
        potential future corporate collaborations to the outstanding balance on this
        loan payable.
 
 We
        expect
        the level of our future operating expenses to be driven by the needs of our
        product development programs, our debt obligations and our lease obligations,
        offset by the availability of funds through equity offerings, partner-funded
        collaborations or other financing or business development activities. The
        size,
        scope and pace of our product development activities depend on the availability
        of these resources. Our future cash requirements will depend on many factors,
        including:
 
 •
              the
                  rate and extent of scientific progress in our research and development
                  programs;
 
 •
              the
                  timing, costs and scope of, and our success in, conducting clinical
                  trials, obtaining regulatory approvals and pursuing patent
                  prosecutions;
 
 •
              competing
                  technological and market developments;
 
 •
              the
                  timing and costs of, and our success in, any product commercialization
                  activities and facility expansions, if and as required;
                  and
 
 •
              the
                  existence and outcome of any litigation or administrative proceedings
                  involving intellectual property.
 
 We
        have
        financed our product development activities and general corporate functions
        primarily through proceeds from public and private sales of our equity
        securities, through cash payments received from our collaborative partners
        and
        proceeds from the issuance of debt. To a lesser degree, we have also financed
        our operations through interest earned on cash and cash equivalents, loan
        funding under equipment financing agreements and research grants. These
        financing sources have historically allowed us to maintain adequate levels
        of
        cash and cash equivalents.
 
 Our
        development collaborations have typically provided us with funding in several
        forms, including purchases of our equity securities, loans, payments for
        reimbursement of research and development costs and milestone fees and payments.
        We and our partners typically agree on a target disease and create a development
        plan for the product candidate, which generally extends for multiple one-year
        terms and is subject to termination or extension. For example, when the IAVI
        collaboration was initiated in 2000, it originally had a three-year term
        yet the
        work plan was established and funded on an annual basis. In 2004, we and
        IAVI
        agreed to extend the underlying program through the end of 2006 and in 2006
        we
        agreed to further extend the program until the expiration of the term of
        the
        last patent within the patent rights controlled by us and utilized in the
        IAVI
        vaccine. In 2005, we extended the scope of our HIV/AIDS vaccine program
        activities to the developed world, via a NIAID-funded collaboration with
        CHOP
        and CCRI. To date we have received $2.6 million under this subcontract and
        our
        portion of the remaining project funding could be up to an additional $15.6
        million over the remaining three years of the contract. The funding is awarded
        to us in annual installments based on an approved work plan and achievement
        of
        milestones.
  14
  The
        funding from each of our collaborative partners fully offsets our incremental
        program costs related to each collaboration and our overhead and fixed costs.
        Our revenue from collaborative agreements and licenses totaled $9.9 million
        in
        2006 and, assuming that we complete all of the planned development activities
        for each of these funded projects, we expect revenue from our collaborative
        partners of up to $10 million in 2007.
 
 Each
        of
        our collaborations has provisions that allow our partners the right to terminate
        both the underlying collaboration and the obligation to provide research
        funding
        at any time with as little as 90 days notice. If we were to lose the expected
        funding from the NIAID-funded collaboration with CHOP and CCRI, Celladon
        or IAVI
        collaborations and were unable to obtain alternative sources of funding,
        we
        would be unable to continue our research and development program for that
        product candidate and our cash horizon would be shortened.
 
 Our
        near-term financing strategy includes leveraging our development capabilities
        and intellectual property assets into additional capital raising opportunities,
        advancing our clinical development programs and accessing the public and
        private
        capital markets at appropriate times. Our financing strategy is focused
        around the advancement of our two programs in clinical development, advancement
        of our newer development collaborations and generating value from our
        intellectual assets and capabilities. In the biotechnology industry, there
        is a
        low level of success in clinical trials and our ability to raise capital
        depends
        in part on clinical trial success.
 
 Additional
        sources of financing could involve one or more of the following:
 
 ·
              entering
                  into additional product development
                  collaborations;
 
 ·
              mergers
                  and acquisitions;
 
 ·
              issuing
                  equity in the public or private markets;
 
 ·
              extending
                  or expanding our current
                  collaborations;
 
 ·
              selling
                  or licensing our technology or product candidates;
 
 ·
              borrowing
                  under loan or equipment financing arrangements;
                  and/or
 
 ·
              issuing
                  debt.
 
 Additional
        funding may not be available to us on reasonable terms, if at all.
 
 We
        expect
        that our total cash requirements for 2007 will range from **$** 13
        million to $16 million and that our cash and cash equivalents at June 30,
        2007,
        plus the anticipated funding from our product development collaborations
        and
        contracts will be sufficient to fund our operations for at least a year.
        This
        estimate is based on our ability to perform planned research and development
        activities and the receipt of planned funding from our
        collaborators.
 
 Depending
        on our ability to successfully access additional funding, we may be forced
        to
        implement additional cost reduction measures. Further adjustments may include
        scaling back or delaying our inflammatory arthritis development program,
        staff
        reductions, scaling back our intellectual property prosecution, subleasing
        portions of our lab facilities, curtailing capital expenditures or reducing
        other operating activities. We may also be required to relinquish some rights
        to
        our technology or product candidates or grant licenses on unfavorable terms,
        either of which would reduce the ultimate value to us of the technology or
        product candidates.
 
 **Item
        3.** ***Quantitative
        and Qualitative Disclosures About Market Risk*** ****
  We are exposed to market risk for the effect of interest rate changes, foreign
        currency fluctuations and changes in the market values of our
        investments.
 
 *Items
        with interest rate risk:*
 
 ·  *Short
        term investments* :
        Because
        of the short-term nature of our investments, we believe that our exposure
        to
        market rate fluctuations on our investments is minimal. Currently, we do
        not use
        any derivative or other financial instruments or derivative commodity
        instruments to hedge any market risks and do not plan to employ these
        instruments in the future. At June 30, 2007, we held $26.0 million in cash,
        which is primarily invested in money market funds and denominated in U.S.
        dollars. An analysis of the impact on these securities of a hypothetical
        10.0%
        change in short-term interest rates from those in effect at June 30, 2007,
        indicates that such a change in interest rates would not have a significant
        impact on our financial position or on our expected results of operations
        in
        2007.
  15
  ·  *Notes
        payable* :  Our
        results of operations are affected by changes in short-term interest rates
        as a
        result of a loan from Biogen Idec that contains a variable interest rate.
        Interest payments on this loan are established quarterly based upon LIBOR
        plus
        1%. Changes in market interest rates and the timing of these remaining interest
        payments may ultimately result in adjustments to the gain on debt restructuring
        we recognized in 2006. The carrying amount of the note payable approximates
        fair
        value because the interest rate on this instrument changes with, or
        approximates, market rates. The following table provides information as of
        June
        30, 2007, about our obligations that are sensitive to changes in interest
        rate
        fluctuations:
 
 Expected
                  Maturity Date2007
              
              2008
              
              2009
              
              2010
              
              2011
              
              TotalVariable
                  rate note
              
              $
              1,115,000
              
              $
              410,000
              
              $
              —
              
              $
              —
              
              $
              —
              
              $
              1,525,000
 
 *Items
        with market and foreign currency exchange risk:*
 
 ·  *Investment
        in Chromos Molecular Systems, Inc.:* At June
        30, 2007, we held 2.4 million shares of Chromos common shares with a market
        value of $0.04 per common share as quoted by the Toronto Stock Exchange and
        denominated in Canadian dollars. As of June 30, 2007 the Canadian dollar
        to US
        dollar exchange rate was US $0.9443 per CA $1.00. As of June 30, 2007, this
        investment is recorded at $89,000 and is classified within prepaid expenses
        and
        other in
        the
        accompanying condensed consolidated balance sheet . We
        recorded a net realized loss of $44,000 in the three months ended June 30,
        2007
        and $251,000 in the six months ended June 30, 2007 due to an
        other-than-temporary impairment resulting from a decline in market value
        of the
        Chromos securities combined with decline in Chromos’ current financial position.
        We hold these shares of common stock as available-for-sale securities as
        we
        periodically sell them on the Toronto Stock Exchange. As a result of selling
        100,000 shares of Chromos stock in the six months ended June 30, 2007, we
        recorded $1,000 of realized gains and received $16,000 in cash. The amount
        of
        potential realizable value in this investment will be determined by the market,
        the exchange rate between the Canadian and US dollar and our ability to sell
        the
        shares in the open market.
 
 **Item
        4T.*****Controls
        and Procedures*******
  *Evaluation
        of disclosure controls and procedures.* Based
        on
        our management’s evaluation, with the participation of our Chief Executive
        Officer and Chief Financial Officer, of the effectiveness of our disclosure
        controls and procedures as of the end of the period covered by this quarterly
        report, our Chief Executive Officer and Chief Financial Officer have concluded
        that our disclosure controls and procedures are effective in ensuring that
        information we are required to disclose in reports that we file or submit
        under
        the Securities Exchange Act of 1934, as amended, is recorded, processed,
        summarized and reported within the time periods specified in the SEC rules
        and
        forms.
 
 *Changes
        in internal control over financial reporting.* There
        was
        no change in our internal control over financial reporting, that occurred
        during
        the period covered by this quarterly report that materially affected, or
        is
        reasonably likely to materially affect, our internal control over financial
        reporting.
  16
  **PART
        II    OTHER INFORMATION**
  **Item
        1.    Legal Proceedings**
  We
        are
        currently not a party to any legal proceedings.
  **Item
        1A.    Risk Factors**
 
 Other
        than with respect to the risk factors below, there have been no material
        changes
        from the risk factors disclosed in “Section 1A. Risk Factors” of our annual
        report on Form 10-K for the year ended December 31, 2006 but please
        carefully consider both the risk factors of our annual report on Form 10-K
        and
        the risk factors below. The risk factors described below were previously
        disclosed on the Form 10-K but have been updated to provide more recent
        financial and factual information as of June 30, 2007.
 
 **Risks
        Related to Our Business**
 
 ***We
        expect to continue to operate at a loss and may never become
        profitable.***
 
 Substantially all of our revenue to date has been derived under collaborative
        research and development agreements relating to the development of our potential
        product candidates. We have incurred, and will continue to incur for the
        foreseeable future, significant expense to develop our research and development
        programs, conduct preclinical studies and clinical trials, seek regulatory
        approval for our product candidates and provide general and administrative
        support for these activities. As a result, we have incurred significant net
        losses since inception, and we expect to continue to incur substantial
        additional losses in the future.  As of June 30, 2007, we had an
        accumulated deficit of $292.0 million. We may never be able to
        commercialize our products or generate profits and, if we do become profitable,
        we may be unable to sustain or increase profitability.
 ***Our
          lead product candidate has been placed on clinical hold and we do not currently
          know when or if the clinical trial of the product candidate will
          resume.***
 
 On
          July
          24, 2007, the FDA placed a clinical hold on our Phase I/II clinical trial
          of
          tgAAC94, our inflammatory arthritis product candidate, after a patient
          participating in the clinical trial experienced a serious adverse event,
          or SAE.
          This patient subsequently died and the cause of death is currently under
          investigation.
 
 Based
          on
          the results of such investigation, we or the FDA may identify concerns
          that
          could cause a delay in or termination of the Phase I/II tgAAC94 clinical
          trial.
          We can make no assurance as to when or if the FDA will remove the hold
          or will
          allow us to continue the administration of tgAAC94 in this study or any
          other
          future clinical studies. Any significant delay in removing the clinical
          hold
          from this study, or termination of this study, or any significant delay
          or
          termination of any other of our clinical trials, may negatively impact
          our
          future operating results, may damage our reputation in the industry and
          may
          result in a decrease in the trading price of our common shares.
  ***All
        of our product candidates are in early-stage clinical trials or preclinical
        development, and if we and our partners are unable to successfully develop
        and
        commercialize our product candidates we will be unable to generate sufficient
        capital to maintain our business.***
 
 As
        of July 2007, our congestive heart failure product candidate in collaboration
        with Celladon is in a Phase I clinical trial, our inflammatory arthritis
        candidate is in a Phase I/II trial, our HIV/AIDS product candidate in
        collaboration with IAVI is in a Phase II trial and no product candidates
        are in
        Phase III or Phase IV trials. Of the trials that are currently being conducted,
        we will not generate any product revenue or revenue sharing for at least
        several
        years and then only if we can and/or our partners successfully develop and
        commercialize our product candidates. Commercializing our potential products
        depends on successful completion of additional research and development and
        testing, in both preclinical development and clinical trials. Clinical trials
        may take several years or more to complete. The commencement, cost and rate
        of
        completion of our clinical trials may vary or be delayed for many reasons.
        If we
        are unable to successfully complete preclinical and clinical development
        of some
        or all of our product candidates in a timely manner, we may be unable to
        generate sufficient product revenue to maintain our business.
 
 Even if our potential products succeed in clinical trials and are approved
        for
        marketing, these products may never achieve market acceptance. If we are
        unsuccessful in 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.
  17
  ***Any
        success of our clinical trials and preclinical studies may not be indicative
        of
        results in a large number of subjects of either safety or
        efficacy.***
 
 The successful results of our technology in preclinical studies using animal
        models may not be predictive of the results that we will see in our clinical
        trials. In addition, results in early-stage clinical trials generally test
        for
        drug safety rather than efficacy and are based on limited numbers of subjects.
        Drug development involves a high degree of risk and our reported progress
        and
        results from our early phases of clinical testing of our product candidates
        may
        not be indicative of progress or results that will be achieved from larger
        populations, which could be less favorable. Moreover, we do not know if any
        favorable results we achieve in clinical trials will have a lasting or
        repeatable effect. If a larger group of subjects does not experience positive
        results or if any favorable results do not demonstrate a beneficial effect,
        our
        product candidates that we advance to clinical trials may not receive approval
        from the FDA for further clinical trials or commercialization. For example,
        in
        March 2005, we discontinued the development of tgAAVCF, our product candidate
        for the treatment of cystic fibrosis, following the analysis of Phase II
        clinical trial data in which tgAAVCF failed to achieve the efficacy endpoints
        of
        the trial.
 
 ***If
        we are unable to raise additional capital when needed, we will be unable
        to
        conduct our operations and develop our potential
        products.***
 
 Because
        internally generated cash flow will not fund development and commercialization
        of our product candidates, we will require substantial additional financial
        resources. Our future capital requirements will depend on many factors,
        including:
  •
              the
                  rate and extent of scientific progress in our research and development
                  programs;
 
 •
              the
                  timing, costs and scope of, and our success in, conducting clinical
                  trials, obtaining regulatory approvals and pursuing patent
                  prosecutions;
 
 •
              competing
                  technological and market developments;
 
 •
              the
                  timing and costs of, and our success in, any product commercialization
                  activities and facility expansions, if and as required;
                  and
 
 •
              the
                  existence and outcome of any litigation or administrative proceedings
                  involving intellectual property.
 
 Additional
        sources of financing could involve one or more of the following:
 
 •
              entering
                  into additional product development
                  collaborations;
 
 •
              mergers
                  and acquisitions;
 
 •
              issuing
                  equity in the public or private markets;
 
 •
              extending
                  or expanding our current
                  collaborations;
 
 •
              selling
                  or licensing our technology or product candidates;
 
 •
              borrowing
                  under loan or equipment financing arrangements; and
 
 •
              issuing
                  debt.
 
 Additional
        funding may not be available to us on reasonable terms, if at all. Our ability
        to issue equity, and our ability to issue it at the current market price,
        may be
        adversely affected by the fact that we are presently ineligible under SEC
        rules
        to utilize Form S-3 for primary offerings of our securities because the
        aggregate market value of our outstanding common stock held by non-affiliates
        is
        less than $75.0 million.
 
 The
        perceived risk associated with the possible sale of a large number of shares
        of
        our common stock could cause some of our shareholders to sell their stock,
        thus
        causing the price of our stock to decline. In addition, actual or anticipated
        downward pressure on our stock price due to actual or anticipated sales of
        stock
        could cause some institutions or individuals to engage in short sales of
        our
        common stock, which may itself cause the price of our stock to decline.
  18
  If
          our
          stock price declines, we may be unable to raise additional capital. A sustained
          inability to raise capital could force us to go out of business. Significant
          declines in the price of our common stock could also impair our ability
          to
          attract and retain qualified employees, reduce the liquidity of our common
          stock
          and result in the delisting of our common stock from the NASDAQ Capital
          Market.
 
 The
          funding that we expect to receive from our collaborations depends on continued
          scientific progress under the collaborations and our collaborators’ ability and
          willingness to continue or extend the collaboration. If we are unable to
          successfully access additional capital, we may need to scale back, delay
          or
          terminate one or more of our development programs, curtail capital expenditures
          or reduce other operating activities. We may also be required to relinquish
          some
          rights to our technology or product candidates or grant or take licenses
          on
          unfavorable terms, either of which would reduce the ultimate value to us
          of our
          technology or product candidates.
 
 **Risks
          Related to Our Common Stock**
 
 ***Concentration
          of ownership of our common stock may give certain shareholders significant
          influence over our business.***
 
 A
          small
          number of investors own a significant number of shares of our common stock.
          As
          of June 30, 2007, Special Situations held approximately 2.6 million shares,
          Biogen Idec held approximately 2.2 million shares, Orbimed Advisors LLC
          held
          approximately 1.4 million shares and Elan held approximately 1.2 million
          shares,
          of our common stock. Together these holdings represent approximately 37%
          of our
          common shares outstanding as of June 30, 2007. This concentration of stock
          ownership may allow these shareholders to exercise significant control
          over our
          strategic decisions and block, delay or substantially influence all matters
          requiring shareholder approval, such as:
 
 •  election
          of directors;
 
 •  amendment
          of our charter documents; or
  •  approval
          of significant corporate transactions, such as a change of control of
          us.
 
 The
          interests of these shareholders may conflict with the interests of other
          holders
          of our common stock with regard to such matters. Furthermore, this concentration
          of ownership of our common stock could allow these shareholders to delay,
          deter
          or prevent a third party from acquiring control of us at a premium over
          the
          then-current market price of our common stock, which could result in a
          decrease
          in our stock price.
 
 Special
          Situations, Biogen Idec and Elan have all sold shares of our common stock
          and
          may continue to do so. Sales of significant value of stock by these investors
          may introduce increased volatility to the market price of our common stock.
          In
          accordance with the termination agreement that we entered into with Elan
          in
          March 2004, Elan is only permitted to sell quantities of our stock equal
          to 175%
          of the volume limitation set forth in Rule 144(e)(1) promulgated under the
          Securities Act of 1933, as amended, subject to certain exceptions.
  **Item
          2. Unregistered Sales of Securities and Use of
          Proceeds**
 
 On
          June
          22, 2007, we entered into a securities purchase agreement with certain
          institutional and other accredited purchasers to sell an aggregate of 6,699,793
          shares of the Company's common stock at a price of $2.905 per share, together
          with five-year warrants to purchase, upon exercise, an aggregate of 6,699,793
          shares of the company's common stock, or the Offering. The warrants issued
          in
          the transaction are exercisable at $3.25 per share. The Offering closed
          on June
          27, 2007.
 
 In
          connection with the Offering, Targeted Genetics issued an additional five-year
          warrant, on the same terms as those received by the purchasers to the securities
          purchase agreement, to the placement agent of the Offering to purchase,
          upon
          exercise, up to 334,989 shares of the Company's common stock.
 
 The
          Company received net proceeds of approximately $17.8 million in connection
          with
          the Offering.
 
 **Item
          3. Defaults Upon Senior Securities**
  Not
          applicable.
  19
  **Item
          4. Submission of Matters to a Vote of Security Holders**
 
 We
          held
          our Annual Meeting of Shareholders in Seattle, Washington on May 17, 2007.
          Of
          the 13,108,735 shares issued and outstanding as of the record date for
          the
          Annual Meeting, there were present at the meeting, in person or by proxy,
          shareholders of the Company who were holders of 9,804,216, or 74.79%, of
          the
          total shares eligible to vote. At the Annual Meeting, our shareholders
          approved
          the following matters by the votes indicated below:
  (i)  Election
          of Directors;
  At
          the
          Annual Meeting, our shareholders approved the election of the persons named
          below to our Board of Directors as Class 1 Directors for a two-year term
          expiring in 2009, or until the successor of each is elected and qualified,
          by
          the votes set forth below:
 
 **Nominee**
                
                **Votes
                    For**
                
                **Votes
                    Withheld**Jack
                    L. Bowman
                
                9,681,481
                
                122,734Jeremy
                    L. Curnock Cook (chairman)
                
                9,679,397
                
                124,818
 
 The
          Board
          members whose terms in office continued after the Annual Meeting were Joseph
          M.
          Davie, Roger L. Hawley, Nelson L. Levy, H. Stewart Parker and Michael S.
          Perry.
  (ii)  **Approval
          of amendment to amended and restated articles of
          incorporation;**
  Our
          shareholders approved an amendment to the amended and restated articles
          of
          incorporation to increase the authorized number of shares of our common
          stock
          from 18,000,000 to 30,000,000 by the votes set forth below:
 
 **Voted**Votes
                    For
                9,399,591Votes
                    Against
                396,427Abstain
                8,197Broker
                    Non-Votes
                3,304,519
 
 (iii)  **Approval
          of amendment to the Company's 1999 Stock Option Plan, or the Plan;
          and**
  Our
          shareholders approved an amendment and restatement of the Plan to (a) increase
          the maximum number of shares of our common stock available for issuance
          under
          the Plan from 1,297,944 shares to 2,547,944, an increase of 1,250,000 shares,
          (b) provide for the issuance of stock appreciation rights, stock grants
          and
          stock units, in addition to stock options, and (c) to rename the Plan the
          "Targeted Genetics Corporation Stock Incentive Plan," by the votes set
          forth
          below:
 
 **Voted**Votes
                    For
                4,829,468Votes
                    Against
                261,438Abstain
                22,979Broker
                    Non-Votes
                7,994,850
 
 (iv)  **Ratification
          of auditor.**
  Our
          shareholders ratified the appointment of Ernst & Young LLP as the Company's
          independent registered public accounting firm for the fiscal year ending
          December 31, 2007 by the votes set forth below:
  **Voted**Votes
                    For
                9,741,388Votes
                    Against
                51,361Abstain
                11,468Broker
                    Non-Votes
                3,304,518
  20
  **Item
          5. Other Information**
  Not
          applicable.
  **Item
          6. Exhibits**
  See accompanying
          Exhibit Index included after
          the
          signature page of this
          quarterly report
          for a list of the exhibits filed or furnished with the report.
 
 21
  **SIGNATURES**
  Pursuant
          to the requirements of the Securities Exchange Act of 1934, the registrant
          has
          duly caused this report to be signed on its behalf by the undersigned thereunto
          duly authorized.
  Targeted
                    Genetics CorporationDate:
                
                August
                    7, 2007
                By:
                
                /s/    H.
                    StewartParker
                  **H.
                    Stewart Parker,**
                  **President,
                    Chief Executive Officer and Director**
                  **(Principal
                    Executive Officer)**
  Date:
                
                August
                    7, 2007
                By:
                
                /s/    David
                    J. Poston
                  **David
                    J. Poston,**
                  **Chief
                    Financial Officer**
                  **(Principal
                    Financial and Accounting
                    Officer)**
 
 
  22
  **INDEX
          TO EXHIBITS**
  **Exhibit**
                  **Number**
                
                **Exhibit
                    Description**
                
                **Form**
                
                **Date
                    of**
                  **First
                    Filing**
                
                **Exhibit**
                  **Number**
                
                **Filed**
                  **Herewith**3.1.1
                
                Amended
                    and Restated Articles of Incorporation, dated May 9, 2006.
                
                
                
                
                
                
                
                X3.1.2
                
                Articles
                    of Amendment to the Restated Articles of Incorporation, dated
                    May 17,
                    2007.
                
                
                
                
                
                
                
                X3.2
                
                Amended
                    and Restated Bylaws.
                
                10-K
                
                3/17/97
                
                3.24.1
                
                Registration
                    Rights Agreement among Targeted Genetics Corporation and certain
                    investors
                    dated as of January 8, 2007.
                
                8-K
                
                1/8/07
                
                10.24.2
                
                Registration
                    Rights Agreement among Targeted Genetics Corporation and certain
                    purchasers dated as of June 22, 2007.
                
                8-K
                
                6/22/07
                
                10.210.1
                
                Amendment
                    No. 3 to Exclusive Sublicense Agreement, dated as of March 9,
                    2007,
                    between Targeted Genetics and Alkermes, Inc. *
                
                10-K
                
                3/29/07
                
                10.5(c)10.2
                
                Securities
                    Purchase Agreement among Targeted Genetics Corporation and certain
                    investors dated January 8, 2007.
                
                8-K
                
                1/8/07
                
                10.110.3
                
                Form
                    of Warrant to Purchase Shares of Common Stock of Targeted Genetics
                    Corporation dated January 11, 2007.
                
                8-K
                
                1/8/07
                
                10.310.4
                
                Securities
                    Purchase Agreement among Targeted Genetics Corporation and certain
                    purchasers dated as of June 22, 2007.
                
                8-K
                
                6/22/07
                
                10.110.5
                
                Form
                    of Common Stock Purchase Warrant of Targeted Genetics Corporation
                    dated as
                    of June 27, 2007.
                
                8-K
                
                6/22/07
                
                10.310.6
                
                Targeted
                    Genetics Corporation Stock Plan.
                
                8-K
                
                5/22/07
                
                10.131.1
                
                Certification
                    of Chief Executive Officer pursuant to Rules 13a-15(e) and 15d-15(e)
                    under
                    the Securities Exchange Act of 1934.
                
                
                
                
                
                
                
                X31.2
                
                Certification
                    of Chief Financial Officer pursuant to Rules 13a-15(e) and 15d-15(e)
                    under
                    the Securities Exchange Act of 1934.
                
                
                
                
                
                
                
                X32.1
                
                Certification
                    of Chief Executive Officer pursuant to 18 U.S.C. Section 1350,
                    as adopted
                    pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
                
                
                
                
                
                
                
                X32.2
                
                Certification
                    of Chief Financial Officer pursuant to 18 U.S.C. Section 1350,
                    as adopted
                    pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
                
                
                
                
                
                
                
                X
 
 *
                Portions
                    of this exhibit have been omitted based on a grant of or application
                    for
                    confidential treatment from the SEC. The omitted portions of
                    these
                    exhibits have been filed separately with the
                    SEC.
 
 23