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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

------------------------



FORM 10-K



[X]  ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE

SECURITIES EXCHANGE ACT OF 1934

OR

[  ]  TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE

SECURITIES EXCHANGE ACT OF 1934



FOR THE FISCAL YEAR ENDED DECEMBER 31, 1996



COMMISSION FILE NO. 0-23930



TARGETED GENETICS CORPORATION

(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)



<TABLE>

<S>                                           <C>

WASHINGTON                                    91-1549568

(STATE OF INCORPORATION)                 (IRS EMPLOYER IDENTIFICATION NO.)

</TABLE>



1100 OLIVE WAY, SUITE 100

SEATTLE, WA 98101

(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE)



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



Securities registered pursuant to Section 12(b) of the Act: None

Securities registered pursuant to Section 12(g) of the Act:

COMMON STOCK, $.01 PAR VALUE

WARRANTS FOR THE PURCHASE OF SHARES OF COMMON STOCK, $.01 PAR VALUE

PREFERRED STOCK PURCHASE RIGHTS, $.01 PAR VALUE



Indicate by check mark whether the Registrant (1) has filed all reports

required to be filed by Section 13 or 15(d) of the Securities Exchange Act of

1934 during the preceding 12 months (or for such shorter period that the

Registrant was required to file such reports), and (2) has been subject to such

filing requirements for the past 90 days.

Yes  X      No ___



Indicate by check mark if disclosure of delinquent filers pursuant to Item

405 of Regulation SK is not contained herein, and will not be contained, to the

best of Registrant's knowledge, in definitive proxy or information statements

incorporated by reference in Part III of this Form 10-K or any amendment to this

Form 10-K.  X



Indicate the aggregate market value of voting stock held by nonaffiliates

of the Registrant as of March 3, 1997: $69,785,575.



Indicate the number of shares outstanding of each of the Registrant's

classes of common stock as of March 3, 1997:



<TABLE>

<CAPTION>

TITLE OF CLASS                               NUMBER OF SHARES

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<S>                                           <C>

Common Stock, $.01 par value                           20,161,434

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DOCUMENTS INCORPORATED BY REFERENCE



(1) Portions of the Proxy Statement for the Annual Meeting of Shareholders

to be held on May 7, 1997, are incorporated by reference into Part III of this

report.



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PART I



ITEM 1. BUSINESS



FORWARD-LOOKING STATEMENTS



Certain statements within the following description of the business of

Targeted Genetics Corporation and elsewhere in this Form 10-K constitute

"forward-looking statements" within the meaning of the Private Securities

Litigation Reform Act of 1995. Such forward-looking statements involve known and

unknown risks, uncertainties and other factors which may cause the actual

results, performance or acheivements of the Company, or industry results, to be

materially different from any future results, performance or acheivements

expressed or implied by such forward-looking statements. Such factors include,

among other things, the following: technological uncertainty; results of

clinical trials; ability to obtain adequate financing in the future; uncertainty

regarding patents and proprietary rights; changes in, or failure to comply with,

governmental regulations; competition; rapid technological change; availability

of key personnel and scientific collaborators; ability to manufacture and market

products; and dependence on corporate collaborators. See "Factors Affecting

Forward-Looking Information".



OVERVIEW



Targeted Genetics is focused on the development of gene and cell therapies

for the treatment of certain acquired and inherited diseases. The Company is

developing a broad base of core technologies that it believes will allow it to

address a variety of such diseases. These technologies include proprietary viral

and non-viral gene delivery systems as well as novel techniques for cytotoxic T

lymphocyte ("CTL") immunotherapy. The Company is using its core technology

platform to develop potential products for the treatment of various genetic

disorders, cancer and infectious diseases.



The Company believes that in the area of gene therapy, different disease

targets will require different methods of gene delivery, depending on the target

cell to be modified, the duration of gene expression required and the need for

in vivo or ex vivo delivery. Accordingly, the Company is developing multiple

gene delivery systems based on three different vector technologies:

adeno-associated viral ("AAV"), non-viral and retroviral. The Company believes

these systems may provide it with the flexibility necessary to develop gene

therapies for a broader range of diseases than would be possible using a single

gene delivery system.



In the area of cell therapy, the Company's expertise with CTLs enables it

to isolate from patients and efficiently multiply antigen-specific CTLs, which

are immune cells that target and kill specific diseased cells ("Targeted CTLs").

This expertise forms the basis for a series of potential immunotherapies for the

treatment of infectious diseases and cancer. Targeted CTLs are based on the

Company's proprietary Rapid Expansion Method ("REM") technology, which is used

to grow CTLs ex vivo prior to infusion into the patient. The Company has

demonstrated that REM enables it to grow billions of CTLs from individual cloned

cells over several weeks, while preserving the cells' specific disease-fighting

capabilities.



Targeted Genetics is currently conducting or planning a number of clinical

trials based on its diversified technology platform, as shown in the following

table.



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PRODUCT DEVELOPMENT PROGRAMS



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CLINICAL TRIALS                  TECHNOLOGY                GENE                STATUS

---------------                  ----------                ----                ------

<S>                                       <C>                  <C>                      <C>

CYSTIC FIBROSIS

Maxillary sinus                         AAV vector           CFTR                     Phase II

Lung/nose                               AAV vector           CFTR                     Phase I

Lung -- aerosol                         AAV vector           CFTR                     Preclinical

CANCER

Ovarian/breast                          non-viral vector     E1A tumor suppressor     Phase I

Head and neck/breast/lung               non-viral vector     E1A tumor suppressor     Phase I

INFECTIOUS DISEASE

HIV                                     Targeted CTLs        --                       Phase I

Hepatitis B                             Targeted CTLs        --                       Preclinical

</TABLE>



In addition to the product development programs summarized above, the

Company is performing research oriented toward identifying promising new

applications of its technology base. Also, the Company is collaborating with

certain academic researchers who are using its retroviral vectors in Phase I

clinical trials focused on Gaucher disease, melanoma and HIV infection.



PRODUCT DEVELOPMENT PROGRAMS



CYSTIC FIBROSIS



Cystic fibrosis is the most common single-gene deficiency affecting the

Caucasian population, afflicting approximately 30,000 people in the United

States and 60,000 people worldwide. The disease is caused by a dysfunctional

cystic fibrosis transmembrane regulator ("CFTR") gene, which results in a

build-up of mucus in the lungs, infections and early death. Current treatments

for cystic fibrosis offer only symptomatic relief and cannot cure or halt the

progression of the disease.



tgAAV-CFTR. Based on preclinical findings by the Company and its scientific

collaborators, the Company believes that the persistence of expression and lack

of toxicity observed with its AAV-based gene delivery vector potentially make it

better suited than other types of vectors for delivery of the CFTR gene to the

lung. In preclinical studies in rabbits, the Company and its collaborators at

The Johns Hopkins University ("Johns Hopkins") were able to detect expression of

the CFTR gene in the lung for periods of up to six months with no observed side

effects. These results were confirmed in similar studies in rhesus monkeys, in

which gene transfer occurred in up to 50% of target airway cells, and gene

expression, which was confirmed in all animals, persisted for up to six months.

Based on these preclinical data, the Company began two clinical trials in late

1995 to evaluate the safety and feasibility of in vivo gene therapy for the

treatment of cystic fibrosis by direct delivery of the CFTR gene using an AAV

vector. The Company's AAV-CFTR product ("tgAAV-CFTR") has been granted orphan

drug status by the United States Food and Drug Administration (the "FDA").



The first clinical trial, which began in November 1995, is a Phase I

clinical trial at Johns Hopkins and the University of Florida in which

tgAAV-CFTR is being delivered to the nose and lung of adult cystic fibrosis

patients having mild lung disease. The trial is designed as an interpatient dose

escalation trial and will enroll a total of 16 patients. Two patients are being

treated at each of eight escalating dose levels. The tgAAV-CFTR is administered

in an open-label single dose to the right lower lobe of the lung via

bronchoscopy. Additionally, each patient is randomized to receive a single dose

of tgAAV-CFTR administered to one nostril and a placebo to the other. Patients

are monitored for, among other things, safety and assessment of gene transfer

and expression. The nasal administration is intended to determine if physiologic

measurement of CFTR function can be obtained in the nasal epithelium. The

Company expects to complete this clinical trial in early 1997. If the results of

the trial confirm the Company's preclinical findings of safety and gene

transfer, the Company intends to conduct a subsequent clinical trial later in

1997 involving aerosol delivery of tgAAV-CFTR to the whole lung. The Company is

currently developing an aerosol formulation for testing in a toxicology study

prior to beginning the clinical trial.



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A second clinical trial began in December 1995 at Stanford University. This

trial was designed as a Phase I/II trial, pursuant to which tgAAV-CFTR is

administered to the maxillary sinuses of cystic fibrosis patients with chronic

sinusitis. The Phase I part of this trial, designed as a dose escalation study,

has been completed. A total of ten patients were enrolled, and 15 sinuses were

treated, in five cohorts receiving escalating doses. The results of the trial

indicate that tgAAV-CFTR is safe and well tolerated with no resulting

inflammatory response or other side effects, even after repeat delivery.

Furthermore, administration of tgAAV-CFTR resulted in consistent gene transfer

and, in one patient, persistence of the gene for at least 70 days after

treatment. Additionally, the dose level was established for the Phase II part of

the trial, in which up to 50 patients will receive tgAAV-CFTR in one sinus and a

placebo in the other. Patients in the Phase II trial will be monitored to assess

the ability of tgAAV-CFTR to prevent the relapse of chronic sinusitis. The Phase

II part of the trial began in February 1997.



Cancer



Cancer is the second leading cause of death in the United States, with over

one million new cases diagnosed each year. The Company's primary approach to the

treatment of cancer utilizes a proprietary non-viral delivery system to deliver

in vivo an E1A tumor suppressor gene to cancer cells. A second approach involves

the use of Targeted CTLs to enhance the immune system's natural ability to

eliminate cancer cells selectively.



tgDCC-E1A. Cancer arises when the genetic pathways that control normal cell

growth and division are disrupted. Certain of these pathways are regulated by

cellular oncogenes or tumor suppressor genes. Cancer may result from the

structural alteration and abnormal expression of cellular oncogenes or from

mutation or deletion of tumor suppressor genes. Some viruses have evolved genes

that may mimic functions normally exhibited by cellular genes. One such example

is the E1A gene of the adenovirus type 5. The E1A gene was shown by Dr. Mien

Chie Hung, in experiments conducted at University of Texas M.D. Anderson Cancer

Center ("M.D. Anderson"), to function as a suppressor of the HER-2/neu oncogene,

which is known to be overexpressed in certain cancers. The Company has worldwide

rights to the use of the E1A gene as a tumor suppressor.



Overexpression of the HER-2/neu oncogene occurs in approximately 30% of

patients in a number of cancers, including ovarian, breast, head and neck,

stomach, pancreatic, liver, cervical and prostate cancer, and has been

associated with enhanced metastatic potential, drug resistance and poor survival

rates. The E1A tumor suppressor gene has been shown to inhibit the

overexpression of the HER-2/neu oncogene in certain tumor cells in vitro. In

addition, in preclinical mouse studies E1A was shown to inhibit the

intraperitoneal growth of ovarian cancer cells that were overexpressing the

HER-2/neu oncogene, and to increase significantly the long-term survival of the

mice.



Other research has suggested that E1A may have other tumor suppression

activity beyond the inhibition of HER2/neu expression. Preclinical in vitro

experiments have shown that E1A, when introduced to a variety of tumor cell

lines, is capable of altering tumor cells such that they appear to have

characteristics of normal cells. Furthermore, in vivo mouse studies involving

tumor cells not overexpressing HER-2/neu showed reduced tumor growth rates with

the administration of E1A versus the same tumor cells without E1A. E1A has also

been shown in preclinical studies to sensitize tumor cells to killing by certain

chemotherapeutic agents.



The Company's E1A product ("tgDCC-E1A") is a formulation that combines the

E1A tumor suppressor gene with the Company's proprietary non-viral gene delivery

system based on the cationic lipid DC cholesterol ("DC Chol"). In the Company's

first Phase I clinical trial, which began in July 1996 at M.D. Anderson, 12 to

24 patients with ovarian cancer and 12 to 24 patients with breast cancer having

tumors that overexpress the HER-2/neu oncogene are administered weekly doses of

tgDCC-E1A for up to six months. This trial is being conducted as an

interpatient, escalating dose study with doses of tgDCC-E1A delivered

intraperitoneally in the ovarian cancer patients and intrapleurally in the

breast cancer patients. The objectives of the trial are to assess safety, levels

of gene transfer and expression and tumor response. Two additional sites have

been added to the study and it is expected that this clinical trial will be

completed in 1997.



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A second Phase I clinical trial is expected to begin in early 1997 at M.D.

Anderson, in which 12 to 24 patients with nonoperable primary head or neck

tumors or metastatic breast or lung tumors are administered weekly doses of

tgDCC-E1A, injected directly into the patient tumor, for up to two months. The

trial is being conducted as an interpatient escalating dose study with two

patients in each cohort. The objectives of the trial are to assess safety,

levels of gene transfer and expression and tumor response. Two additional sites

are being added to the study and it is expected that this clinical trial will be

completed by the end of 1997.



In 1996, the Company entered into a license, research and marketing

agreement with Laboratoires Fournier S.C.A. ("Fournier") under which Fournier

received exclusive rights to develop and commercialize tgDCC-E1A in Europe. See

"Research and Development Collaborations."



Targeted CTLs. The Company has conducted certain preclinical experiments

directed to the isolation and ex vivo multiplication of CTLs specific to colon

tumor cells. Also, in conjunction with a recently completed

investigator-sponsored melanoma tumor vaccine clinical trial, the Company has

shown that it can generate CTLs specific to melanoma tumor cells, multiply these

CTLs in the REM process and use them to kill cancer cells in vitro. Based on

these and other experiments, the Company believes that a potentially effective

cancer therapy may be developed based on the infusion of large numbers of

Targeted CTLs that kill specific tumor cells. However, due to resource

constraints and also due to the Company's growing commitment to cancer therapy

using the E1A tumor suppressor, the Company will not pursue clinical trials of

Targeted CTLs for cancer unless a corporate collaboration in this area is

completed.



INFECTIOUS DISEASES



Human Immunodeficiency Virus ("HIV"). HIV is a retrovirus that is the cause

of AIDS, a condition that is characterized by loss of CD4 cells and progressive

immunologic impairment and death. According to the Centers for Disease Control

and Prevention, approximately one million people in the United States have been

infected with HIV. The World Health Organization estimates that approximately 17

million people worldwide have been infected with HIV and projects that the

worldwide incidence of HIV infection will grow to 30 million to 40 million

people by the end of the century.



The Company and certain other researchers believe that the key to

successful long-term treatment of HIV infection may lie in manipulating and

harnessing the cell-mediated arm of the immune response. Researchers have found

that HIV-infected people who remain symptom-free for prolonged periods have high

levels of CTLs that suppress viral proliferation in CD4 cells. The Company

believes that the provision of large quantities of cloned HIV-specific CTLs may

provide a means of allowing HIV-infected people to maintain an effective immune

response, thereby preventing progression to AIDS.



In early 1996, the Company began a Phase I clinical trial at the Fred

Hutchinson Cancer Research Center (the "Hutchinson Center") in which up to eight

HIV-infected patients are being administered five escalating doses of Targeted

CTLs specific to the HIV gag protein. The first three doses will consist of

unmarked cells and the last two will consist of cells modified with a retroviral

vector containing a marker gene. Patients in the trial will be monitored for

safety, persistence of the infused Targeted CTLs and changes in viral burden.

This trial is expected to be completed in 1997.



Hepatitis B. Hepatitis B virus ("HBV") is a disease of global significance,

with over 300 million carriers worldwide. HBV is the cause of up to 80% of cases

of primary liver cancer. Over 75% of the chronic carriers of HBV are in Asia. It

is estimated that 200,000 to 300,000 HBV infections occur annually in the United

States and that chronic infection develops in approximately 10% of those cases.



During acute HBV infection most patients develop a strong immune response

that is capable of clearing the virus. In contrast, the CTL response to HBV is

usually not detectable in chronically infected patients. The lack of core

specific CTL response may contribute to failure of virus elimination resulting

in chronic inflammation. Thus, the Company believes that restoring the immune

response by administering Targeted CTLs specific for HBV may provide an

effective means to treat patients with this chronic disease.



In 1997, the Company plans to take the necessary steps to adapt its

Targeted CTL technology to the treatment of HBV in preparation for a preclinical

study in which chimpanzees infected with HBV will be



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administered Targeted CTLs. The objective of the study, expected to begin in

late 1997, is to establish safety of the therapy and, potentially, obtain proof

of concept that HBV-specific Targeted CTLs may be promising as a treatment for

humans infected with HBV.



CORE TECHNOLOGIES



The Company is developing a broad range of core technologies that it

believes will allow it to address issues specific to a variety of diseases. The

Company believes that in the area of gene therapy, different disease targets

will require different methods of gene delivery, depending on the target cell to

be modified, the duration of gene expression required and the need for in vivo

or ex vivo delivery. Accordingly, the Company is developing multiple gene

delivery systems based on three different vector technologies: AAV, non-viral

and retroviral. In certain treatments, for which in vivo modification of slowly

dividing or nondividing target cells is required or preferred, such as

modification of lung cells to treat cystic fibrosis, the Company is utilizing

its AAV vector technology. The Company uses its retroviral vector technology in

therapeutic areas where permanent modification of rapidly dividing cells is

necessary. In therapeutic indications where the use of AAV and retroviral

vectors is not desirable or feasible, the Company is utilizing its non-viral

delivery systems. The Company believes that non-viral vectors may provide

greater flexibility relating to the size and sequence of transfered genes and

may also allow targeted delivery in vivo.



In the area of cell therapy, the Company's expertise in isolating and

multiplying CTLs forms the basis for a series of potential immunotherapies.



GENE THERAPY



Overview. Gene therapy is an approach to the treatment and prevention of

genetic and acquired diseases that involves the insertion of genetic information

into target cells to produce specific proteins needed to correct or modulate

disease conditions. Proteins are the fundamental components of all living cells

and are essential to cellular structure, growth and function. Proteins are

produced by cells from a set of genetic instructions encoded in DNA, which

contains all the information necessary to control cellular biological processes.

DNA is organized into segments called genes, with each gene containing the

information required to express, or produce, a specific protein.



An alteration in the function of, or absence of, specific genes is

responsible for causing some diseases, including inherited diseases such as

cystic fibrosis and certain types of cancer. Gene therapy may be used to treat

such diseases by replacing a missing or defective gene to facilitate the normal

protein production capabilities of cells. In addition, gene therapy may be used

to enable cells to perform additional roles in the body, such as enhancing the

function of the immune system to fight infectious diseases or cancer. Gene

therapy may also be used to inhibit production of undesirable proteins or

viruses within cells.



A key factor in the progress of gene therapy is the development of safe and

efficient methods of transferring genes into cells. For transfer into cells, the

gene is incorporated into a delivery system called a vector. Vectors may be

derived from either viral or non-viral systems. The most common gene delivery

approach to date relies on viral gene transfer, whereby modified viruses are

used to transfer the desired genetic material into host cells. The process of

gene transfer can be accomplished ex vivo (outside the body), in which cells are

removed from the patient, genetically modified, and then reinfused into the

patient, or in vivo (inside the body), in which vectors are introduced directly

into the patient's body.



The use of viruses takes advantage of their natural ability to introduce

genes into host cells and use the host's metabolic machinery to produce proteins

essential for the survival and function of the virus. In gene therapy

applications, viruses are genetically modified to contain the desired genes and

to inhibit the ability of the virus to reproduce. Successful application of

viral gene transfer to indications requiring long-term gene expression entails a

number of essential technical requirements, including the ability of the viral

vector to carry desired segments of genes, to transfer genes into a sufficient

number of target cells and to enable genes contained in the viral vector to

persist in the host cell. A number of different viral vectors, including AAV and

retroviral vectors, are being used for potential gene therapy applications

requiring long-term gene expression.



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Current non-viral vector systems generally consist of DNA incorporating the

desired gene, combined with various compounds aimed at enabling the DNA to be

taken up by the host cell. These in vivo gene delivery approaches include

encapsulating genes into lipid carriers such as liposomes, which facilitate the

entry of DNA into cells; ionically binding negatively charged DNA to the surface

of cationic lipids which are positively charged prior to infusion; injecting

pure plasmid or "naked" DNA in an aqueous solution; and directing DNA to

receptors on target cells by combining the gene with protein carriers that are

taken up by the cell.



AAV Vectors. Targeted Genetics and its scientific collaborators have

developed significant expertise with respect to the design and use of AAV

vectors in gene therapy. The Company believes that certain features of AAV

vectors make them particularly well suited for the treatment of a number of

diseases: (i) AAV has never been associated with causing any human disease; (ii)

AAV generally cannot replicate without the presence of a helper virus; (iii) AAV

vectors contain no viral genes that, if present, might produce unwanted immune

responses leading to side effects or reduced efficacy; (iv) unlike some other

types of viral systems, AAV vectors can introduce genes into nondividing or

slowly dividing cells, such as cells lining the airway of the lung; (v) AAV

vectors may persist in the host cell to provide relatively long-term expression;

and (vi) AAV vectors can be purified and concentrated, and thereby may allow for

more efficient manufacturing.



The Company is building its proprietary position in AAV through the

development or acquisition of exclusive rights to inventions that (i) provide

important enhancements to AAV vectors; (ii) demonstrate novel approaches to the

use of AAV vectors for gene therapy; and (iii) establish new and improved

methods for large-scale production of AAV vectors. The Company has exclusive

rights from the National Institutes of Health (the "NIH") to an issued patent

for use of a novel AAV vector for cystic fibrosis.



In addition to its development program for cystic fibrosis, the Company is

conducting research to assess the potential for delivery of genes to other

target cells using AAV vectors. To date, the Company has focused its efforts in

this area to cells of the cardiovascular system and the gastrointestinal tract.

With the Company's newly increased capacity to manufacture AAV vectors for

preclinical research purposes, it plans to examine the use of AAV vectors in

additional cell types, both internally, to the extent resources are available to

do so, and through academic collaborators.



Non-Viral Vectors. The Company has exclusive rights to a significant body

of non-viral gene delivery technology based on the use of cationic lipids to

promote the uptake of DNA into cells. The Company believes that non-viral

vectors may have several characteristics that may make them particularly well

suited for the treatment of certain diseases, including (i) the ability to

target such vectors to a specific cell type; (ii) relative ease of manufacture;

and (iii) the ability to transfer relatively large segments of DNA in a single

vector. These non-viral vectors are formulated by complexing negatively charged

DNA with cationic lipids which are positively charged to promote DNA uptake by

cells. Such complexes appear to have good safety profiles and can be used in

vivo as well as ex vivo. For in vivo use, these complexes can potentially be

delivered topically, intravenously, intraperitoneally, intrapleurally or by

aerosol.



The Company intends to develop a series of these non-viral delivery systems

originated by Dr. Leaf Huang of the University of Pittsburgh. His original DC

Chol system, which appears to have a favorable clinical toxicity profile, was

used in two clinical trials by unaffiliated investigators prior to the Company

using it in its tgDCC-E1A cancer clinical trials. The Company has acquired an

exclusive license to an issued U.S. patent for the original DC Chol system for

the treatment of certain cancers, including, among others, breast, ovarian and

lung cancers. Dr. Huang is developing a series of non-viral delivery systems for

which the Company has obtained exclusive worldwide rights in the field of gene

therapy from the University of Pittsburgh. One type of system under development

employs additional analogs of DC Chol that may have a more favorable toxicity

profile. In another system, the DNA is condensed into particles of defined size

that have gene transfer efficiency that is fifty- to eighty-fold higher than the

original DC Chol system. An alternate version of this system is being developed

that includes specific ligands to enhance delivery to specific target cells and

to increase stability when delivered intravenously. An additional system being

developed also has increased efficiency of gene transduction and higher

stability in serum for intravenous delivery. Specific formulations will be

chosen for various applications based on the type of target cell, desired mode

of administration and biology of the disease.



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Retroviral Vectors. The Company uses retroviral vectors to modify T cells

and stem cells. These cells multiply to generate large numbers of progeny

(daughter) cells and are well suited as targets for retroviral vectors that can

modify only rapidly dividing cells. The Company believes that it has positioned

itself at the forefront of retroviral gene delivery technology through its

exclusive relationship with Dr. A. Dusty Miller, a leader in the development of

packaging cell lines for retroviral vectors. One of Dr. Miller's more recent

inventions in this area is a new type of retroviral vector packaging cell line

called PG13, which the Company has licensed exclusively from the Hutchinson

Center. Vectors produced in this cell line have been shown to have improved

efficiency for ex vivo transfer of genes to human blood cells such as T cells

and stem cells.



To date, the Company's internal efforts with retroviral vectors have been

primarily oriented toward improvements in the design, manufacture and methods of

using such vectors for gene transfer and expression. Additionally, the Company

has manufactured retroviral vectors for several investigator-sponsored clinical

trials. In one such clinical trial, peripheral blood stem cells were reinfused

into Gaucher disease patients after ex vivo transduction with the Company's

retroviral vectors containing the GC gene. The results of this clinical trial

have confirmed the Company's belief that current technology and know how related

to stem cell gene therapy must be improved in order to provide the increased

level of gene transfer and expression necessary to result in an effective

therapeutic product. Although the Company believes that retroviral vectors show

long-term promise for the ex vivo delivery of therapeutic genes, the Company's

only current effort internally in the area of retroviral vectors relates to the

process used to generate Targeted CTLs. Given this low level of internal

development activity related to retroviral vectors, the Company is pursuing

licensing arrangements for use of the PG13 vector for applications outside the

Company's interests.



TARGETED CTLS



Overview. The immune system is the body's major defense mechanism

responsible for protecting against disease. It functions through a complex

interplay of components and allows the body to detect foreign agents and thereby

defend against infections and diseases. The immune system recognizes parts of

proteins called antigens that are present on the surface of diseased cells but

are not present on normal cells. The immune response to an antigen involves the

integrated action of various classes of white blood cells, including

lymphocytes. Lymphocytes comprise two major classes: B cells, which produce

antibodies that mediate humoral immunity, and T cells, which direct

cell-mediated immunity.



T cells direct cell-mediated immunity by recognizing antigens on diseased

cells. The two main classes of T cells are CD4 cells and CD8 cells. In general,

CD8 cells are CTLs that recognize, contact and kill the diseased cells. CD4

cells are primarily helper cells that coordinate the function of other immune

cells, including CTLs, by secreting growth factors known as cytokines. CTLs are

disease-specific, i.e., they individually recognize and bind to only a single,

specific antigen. Furthermore, only in the presence of CD4 helper cells do these

specific CTLs proliferate to produce the large population of antigen-specific

CTLs required to elicit an effective immune response.



In some disease states, the immune system fails to mount or maintain an

effective immune response. For infectious diseases and cancer, it is believed

such failure may be associated with an inadequate CTL response. For example, HIV

infects and kills CD4 cells, which leads to subsequent loss of CTL function and,

thus, to destruction of the immune system by the virus.



Targeted CTL Cell Therapy. Targeted Genetics is working to develop a highly

targeted form of cell therapy, which is intended to produce a powerful,

disease-specific immune response through the infusion of large numbers of

antigen-specific CTLs. In the Company's Targeted CTL program, antigen-specific

CTLs are isolated from a small sample of the patient's blood, multiplied to

large numbers ex vivo and then reinfused into the patient. In essence, these

Targeted CTLs are intended to amplify the natural disease-fighting function of

the immune system relating to specific infected or cancerous cells.



The Company believes that its Targeted CTL program represents an

improvement over other approaches to immunotherapy because it is based on

cloned, antigen-specific CTLs. The Company believes that Targeted CTLs may be

more effective than other immunotherapy approaches because virtually all of the

reinfused cells will be CTLs targeting the specific diseased cells. The Company

also believes that the safety and side effect



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profile may be improved over other immunotherapy approaches because of the

uniformity and consistency of the reinfused cells.



The Company's focus on Targeted CTLs originated from research conducted by

its collaborators at the Hutchinson Center, Drs. Philip Greenberg and Stanley

Riddell. These researchers conducted a Phase I clinical trial to evaluate the

safety of infusing donor-derived, CMV-specific CTLs to bone marrow transplant

patients, and the potential of this approach for providing an immune response

against CMV during the short period in which transplant patients have a high

probability of developing CMV. This trial, which was published in The New

England Journal of Medicine in October 1995, was the first clinical trial in

which cloned, antigen-specific CTLs had been used. None of the 14 patients

receiving the CTLs developed CMV viremia or disease.



Rapid Expansion Method. The Targeted CTL program is based on the Company's

proprietary REM technology, which is used to rapidly grow CTLs prior to infusion

into the patient. REM represents a significant improvement over other methods of

multiplying T cell clones. Using REM, CTL clones can be multiplied over a

thousandfold in less than two weeks. The Company has demonstrated that REM

enables it to grow billions of CTLs from individual cloned cells over several

weeks, while preserving the cells' disease-fighting capabilities in vitro. The

Company has seen consistent results from REM in both CD8 and CD4 T cells and for

all disease specificities tested to date. The Company has shown that REM is

effective for growing Targeted CTLs specific for HIV, CMV, malignant melanoma

and prostate tumor peptides. The Company has filed patent applications, on a

worldwide basis, relating to the original REM process and to subsequent process

improvements.



RESEARCH AND DEVELOPMENT COLLABORATIONS



LABORATOIRES FOURNIER S.C.A.



In May 1996, the Company and Fournier entered into a license, research and

marketing agreement under which Fournier received exclusive rights to develop

and commercialize in Europe tgDCC-E1A and any other product candidates based on

the E1A tumor suppressor gene and developed pursuant to the agreement. Fournier

has agreed to coordinate development of tgDCC-E1A in Europe by conducting

clinical trials, preparing and filing submissions for regulatory approval in its

territory and paying all associated costs, while the Company has corresponding

responsibilities with respect to development and commercialization in the United

States.



Fournier has paid a $5 million upfront license fee and $1.5 million of

milestone payments through the end of 1996. The agreement provides that Fournier

will make additional milestone payments to the Company upon the achievement of

specified goals by Fournier or the Company and royalties on sales of resulting

products, if any. In addition, if the parties are able to negotiate a mutually

acceptable supply agreement, the Company will be entitled to manufacture

products for Fournier in return for manufacturing fees. Pursuant to the

agreement, the Company has agreed to indemnify Fournier with respect to claims

incurred as a result of the manufacture, supply or sale of tgDCC-E1A. The

agreement may be terminated if the parties mutually agree on or about the second

anniversary of the agreement that the results of the collaboration are

unsatisfactory.



PASTEUR MERIEUX



In December 1995, the Company entered into an agreement with Pasteur

Merieux pursuant to which Pasteur Merieux was granted an exclusive worldwide

license and sublicense to certain technology and patent rights relating to DC

Chol as an immunoadjuvant in traditional vaccines. In consideration of such

grant, Pasteur Merieux paid a process development fee and an upfront license

fee. In addition, the Company may receive milestone payments upon realization of

certain benchmarks and a royalty on sales of the products, if any, incorporating

the underlying technology.



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RELATIONSHIP WITH IMMUNEX CORPORATION



Targeted Genetics was formed in 1989 as a subsidiary of Immunex Corporation

("Immunex"), a biotechnology company developing immunoregulatory proteins as

therapeutics. In February 1992, Targeted Genetics and Immunex entered into a

technology license agreement. In exchange for shares of Preferred Stock, which

were converted into 1,920,000 shares of Common Stock at the time of the

Company's initial public offering, Immunex granted a worldwide, exclusive field

of use license to Targeted Genetics for certain Immunex proprietary technology

specifically applicable to Targeted Genetics' gene therapy business. The

technology transferred from Immunex to Targeted Genetics relates to gene

identification and cloning, panels of retroviral vectors, packaging cell

technology, recombinant cytokines, DNA constructs, cell lines, promoter/enhancer

elements and immunological assays. In addition, until February 1999, the Company

has the option to acquire a nonexclusive, worldwide, fully paid royalty-free

license (and in certain cases an opportunity to negotiate the conversion of a

nonexclusive license into an exclusive license) for certain additional

technology relating to Targeted Genetics' gene therapy business. Targeted

Genetics granted to Immunex a right of first offer and a 30-day right of first

refusal on technology the Company intends to out-license that is based on

Immunex technology. The Company may accept or reject any offers made by Immunex

under such rights. Immunex currently owns approximately 13% of the Company's

outstanding common stock.



PATENTS AND PROPRIETARY RIGHTS



Patents and licenses are important to the Company's business. The Company's

policy is to file patent applications to protect technology, inventions and

improvements to inventions that are considered important to the development of

its business. The Company also relies on trade secrets, know how, continuing

technological innovations and licensing opportunities to develop and maintain

its competitive position. To date, the Company has filed or exclusively licensed

39 patent applications relating to its product and technology development

programs with the United States Patent and Trademark Office (the "USPTO"), as

well as foreign counterparts of certain of these applications in Europe, Japan

and certain other countries. Of these patent applications, 5 patents have been

issued or allowed by the USPTO.



In addition to the intellectual property that Targeted Genetics owns or has

exclusively licensed, the Company has licensed several issued and pending

patents that relate to its development programs on a nonexclusive basis. Among

these are the two key patents that relate to the use of AAV vectors for gene

therapy licensed from the NIH and the University of Florida Research Foundation.

In addition, the Company has acquired nonexclusive rights to the cystic fibrosis

gene being delivered in an AAV vector.



The patent positions of pharmaceutical and biotechnology firms, including

the Company, are uncertain and involve complex legal and factual questions for

which important legal principles are largely unresolved, particularly in regard

to human therapeutic uses. In addition, the coverage claimed in a patent

application can be significantly reduced before a patent is issued.

Consequently, the Company does not know whether any patent applications will

result in the issuance of patents or, if any patents are issued, whether the

patents will be subjected to further proceedings limiting their scope, whether

they will provide significant proprietary protection or will be circumvented or

invalidated. Since patent applications in the United States are maintained in

secrecy until patents issue and patent applications in certain other countries

generally are not published until more than 18 months after they are filed, and

since publication of discoveries in scientific or patent literature often lags

behind actual discoveries, the Company cannot be certain that it or any licensor

was the first creator of inventions covered by pending patent applications or

that it or such licensor was the first to file patent applications for such

inventions. Moreover, the Company is currently involved in one patent

interference proceeding declared by the USPTO to determine priority of invention

relating to certain components that may be useful in retroviral vectors and may

have to participate in additional interference proceedings. Although the Company

does not anticipate that material expenditures will be made in connection with

such proceedings, participation could result in substantial cost to the Company,

even if the eventual outcome were favorable to it. In addition, although the

Company believes that the technology which is the subject of the current patent

interference proceeding is not material to its current product development

programs, there can be no assurance that such technology will not become

material in the future. If the outcome of the current or any additional

interference proceeding were unfavorable, the Company may be



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unable to obtain rights to the invention involved. There can be no assurance

that the Company's patents, if issued, would be held valid or enforceable by a

court or that a competitor's technology or product would be found to infringe

such patents. Litigation, which could result in substantial cost to the Company,

may be necessary to enforce the Company's patents or to determine the scope and

validity of other parties' proprietary rights. If the outcome of any such

litigation were adverse, the Company's business could be materially adversely

affected. The Company is unable to predict how courts will resolve any future

issues relating to the validity and scope of its patents should they be

challenged.



A number of pharmaceutical and biotechnology companies and research and

academic institutions have developed technologies, filed patent applications or

received patents on various technologies that may be related to the Company's

business. Some of these technologies, applications or patents may conflict with

the Company's technologies or patent applications. Such conflict could limit the

scope of the patents, if any, that the Company may be able to obtain or result

in denial of the Company's patent applications. In addition, if patents that

cover the Company's activities are issued to other companies, there can be no

assurance that the Company would be able to develop or obtain alternative

technology.



Furthermore, as the biotechnology industry expands and more patents are

issued, the risk increases that the Company's processes and potential products

may give rise to claims that they infringe the patents of others. Such other

persons could bring legal actions against the Company claiming damages and

seeking to enjoin clinical testing, manufacturing and marketing of the affected

product or use of the affected process. Litigation may be necessary to enforce

patents issued to the Company, to protect trade secrets or know how owned by the

Company or to determine the enforceability, scope and validity of proprietary

rights of others. If the Company becomes involved in such litigation, it could

result in substantial expense to the Company and significant diversion of effort

by the Company's technical and management personnel. If there were an adverse

outcome of any such litigation, the Company's business could be materially

adversely affected. In addition to any potential liability for significant

damages, the Company could be required to obtain a license to continue to

manufacture or market the affected product or use the affected process. Costs

associated with any licensing arrangement may be substantial and could include

ongoing royalties. There can be no assurance that any license required under any

such patent would be made available to the Company on acceptable terms, if at

all.



In addition to patent protection, the Company relies upon trade secret

protection for its confidential and proprietary information. There can be no

assurance that others will not independently develop substantially equivalent

proprietary information and techniques or otherwise gain access to the Company's

trade secrets or disclose such technology. To protect its trade secrets, the

Company requires its employees, consultants, scientific advisors and parties to

collaborative agreements to execute confidentiality agreements upon the

commencement of employment, the consulting relationship or the collaboration

with the Company. In the case of employees, the agreements also provide that all

inventions resulting from work performed by them while in the employ of the

Company will be the exclusive property of the Company. There can be no

assurance, however, that these agreements will provide meaningful protection of

the Company's trade secrets or adequate remedies in the event of unauthorized

use or disclosure of such information.



COMPETITION



The Company is aware of a number of companies and institutions that are

developing or considering the development of potential gene therapy and cell

therapy treatments, including early-stage gene therapy companies, fully

integrated pharmaceutical companies, universities, research institutions,

governmental agencies and other healthcare providers. In addition, the Company's

potential products will be required to compete with existing pharmaceutical

products, or products developed in the future, that are based on established

technologies. Many of the Company's competitors have substantially more

financial and other resources, larger research and development staffs, and more

experience and capabilities in researching, developing and testing products in

clinical trials, in obtaining FDA and other regulatory approvals, and in

manufacturing, marketing and distribution than the Company. In addition, the

competitive positions of other early-stage companies may be enhanced

significantly through their collaborative arrangements with large pharmaceutical

companies or academic institutions. The Company's competitors may succeed in

developing,



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obtaining patent protection for, receiving FDA and other regulatory approvals

for, or commercializing products more rapidly than the Company. If the Company

is successful in commercializing its products, it will be required to compete

with respect to manufacturing efficiency and marketing capabilities, areas in

which it has no experience. The Company also competes with others in acquiring

products or technology from research institutions or universities. The Company's

competitors may develop new technologies and products that are available for

sale prior to the Company's potential products or that are more effective than

the Company's potential products. In addition, competitive products may be

manufactured and marketed more successfully than the Company's potential

products. Such developments could render the Company's potential products less

competitive or obsolete, and could have a material adverse effect on the

Company's business, financial condition and results of operations.



GOVERNMENTAL REGULATION



All of the Company's potential products will require regulatory approval by

U.S. and foreign governmental agencies prior to commercialization in such

countries. Human therapeutic products are subject to rigorous preclinical and

clinical testing and other premarket approval procedures administered by the FDA

and similar authorities in foreign countries. The FDA exercises regulatory

authority over the development, testing, formulation, manufacture, labeling,

storage, record keeping, reporting, quality control, advertising, promotion,

export and sale of the Company's potential products. Similar requirements are

imposed by foreign regulators. In some cases, state requirements also apply.



Gene therapy and cell therapy are relatively new technologies and have not

been extensively tested in humans. The regulatory requirements governing gene

and cell therapy products and related clinical procedures are uncertain and are

subject to change. Obtaining approval from the FDA and other regulatory

authorities for a new therapeutic product is likely to take several years, if

ever, and involve substantial expenditures. Moreover, ongoing compliance with

applicable requirements can entail the expenditure of substantial resources.

Difficulties or unanticipated costs may be encountered by the Company in its

efforts to secure necessary governmental approvals, which could delay or

preclude the Company from marketing its products.



The activities required before a new therapeutic agent may be marketed in

the United States begin with preclinical testing. Preclinical tests include

laboratory evaluation and may require animal studies to assess the product's

potential safety and efficacy. Animal safety studies must be conducted in

accordance with the FDA's Good Laboratory Practice regulations. The results of

these studies must be submitted to the FDA as part of an Investigational New

Drug application ("IND"), which must be reviewed and cleared by the FDA before

proposed clinical testing can begin. Clinical trials must be conducted in

accordance with Good Clinical Practices under protocols that detail the

objectives of the trial, the parameters to be used to monitor safety and the

efficacy criteria to be evaluated. Each protocol must be submitted to the FDA as

part of the IND. The FDA's review or approval of a study protocol does not

necessarily mean that, if the trial is successful, it will constitute proof of

efficacy or safety. Further, each clinical trial must be approved by and

conducted under the auspices of an independent Institutional Review Board

("IRB") at the institution at which the trial will be conducted. The IRB will

consider, among other things, ethical factors, the safety of human subjects and

the possible liability of the institution. The IRB is also responsible for

continuing oversight of the approved protocols in active trials. An IRB may

require changes in a protocol, and there can be no assurance that an IRB will

permit any given trial to be initiated or completed.



Clinical trials are typically conducted in three sequential phases,

although the phases may overlap. In Phase I, gene therapy clinical trials

generally are conducted with a small number of patients, who may or may not be

afflicted with a specific disease, to determine the preliminary safety profile.

In Phase II, clinical trials are conducted with larger groups of patients

afflicted with a specific disease in order to determine preliminary efficacy and

optimal dosages and to obtain expanded evidence of safety. In Phase III,

large-scale, multicenter, comparative clinical trials are conducted with

patients afflicted with a target disease in order to provide enough data for the

statistical proof of efficacy and safety required by the FDA and others for

market approval. The FDA receives reports on the progress of each phase of

clinical testing, and it may require the modification, suspension or termination

of clinical trials if an unwarranted risk is presented to patients. Because gene

therapy products are a new category of therapeutics, there can be no assurance

as to the length of the clinical



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trial period or the number of patients the FDA will require to be enrolled in

the clinical trials in order to establish to its satisfaction the safety and

efficacy of such products.



FDA marketing approval must be obtained after completion of clinical trials

of a new product. The Company expects that its products will be regulated as

biologic drugs. According to the FDA's 1993 notice outlining its regulatory

approach to somatic and gene therapy products, these products are also subject

to the drug provisions of the Federal Food, Drug and Cosmetic Act. This notice

also stated, however, that the FDA's regulatory approach may evolve as

scientific knowledge increases in the area of somatic and gene therapy. Current

regulations relating to biologic drugs will require the Company to submit to the

FDA both a Product License Application ("PLA") and an Establishment License

Application ("ELA"), which must be approved by the FDA before commercial

marketing is permitted. The PLA/ELA must include results of product development

activities, preclinical studies and clinical trials, in addition to detailed

manufacturing information. FDA approval of PLA/ELAs generally takes at least one

year. The process may take substantially longer if the FDA has questions or

concerns about a product. The FDA may also request additional data relating to

safety or efficacy. Notwithstanding the submission of relevant data, the FDA may

ultimately decide that a PLA/ELA does not satisfy its regulatory criteria for

approval. The FDA may also modify the scope of the desired claims or require the

addition of warnings or other safety-related information and require additional

clinical tests following approval to confirm product safety and efficacy (Phase

IV trials). Even if FDA regulatory clearances are obtained, a marketed product

is subject to continual review, and later discovery of previously unknown

problems or failure to comply with the applicable regulatory requirements may

result in restrictions on marketing a product or in withdrawal of the product

from the market, as well as possible civil or criminal sanctions.



The FDA recently amended its regulations to eliminate the ELA requirement

for therapeutic DNA plasmid products, therapeutic synthetic peptide products of

40 or fewer amino acids, monoclonal antibody products for in vivo use, and

therapeutic recombinant DNA-derived products. Manufacturers of these products

will instead be required to submit a biologics license application, which will

include, among other information, nonclinical and clinical data demonstrating

that the manufactured product meets prescribed standards for safety, purity and

potency, and information pertaining to manufacturing methods. It is unclear

whether any of the Company's products will fall within the category of products

for which the ELA requirement has been eliminated, or what effect such

elimination may have on product development and FDA review.



The FDA requires that manufacturers of a product comply with current Good

Manufacturing Practices ("cGMP") requirements, both as a condition of product

approval and on a continuing basis. In complying with cGMP requirements,

manufacturers must expend time, money and effort on a continuing basis in

production, record keeping and quality control. Manufacturing facilities are

subject to periodic inspections by the FDA to ensure compliance. Failure to pass

such inspections may subject the manufacturer to possible FDA action such as the

suspension of manufacturing, seizure of the product, withdrawal of approval or

other regulatory sanctions. The FDA may also require the manufacturer to recall

a product.



In addition to regulations enforced by the FDA, the Company is also subject

to regulation under the Occupational Safety and Health Act, the Environmental

Protection Act, the Toxic Substances Control Act, the Resource Conservation and

Recovery Act and other federal, state and local regulations. The Company's

research and development activities involve the controlled use of hazardous

materials, chemicals, biological materials and radioactive compounds. Although

the Company believes that its safety procedures for handling and disposing of

such materials comply with the standards prescribed by state and federal laws

and regulations, the risk of accidental contamination or injury from these

materials cannot be completely eliminated. In the event of such an accident, the

Company could be held liable for any resulting damages, and any such liability

could exceed the Company's resources.



HUMAN RESOURCES



At December 31, 1996, Targeted Genetics had 88 employees; 69 of these

employees were directly involved in research and development, of whom 17 had

Ph.D. or M.D. degrees. A significant number of the



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Company's management and professional employees have prior experience with other

biotechnology or pharmaceutical companies. The Company considers its relations

with its employees to be good.



The Company's success will depend in large part on its ability to attract

and retain key employees and scientific advisors. Competition among

biotechnology and pharmaceutical companies for highly skilled scientific and

management personnel is intense. There can be no assurance that the Company will

be successful in retaining its existing personnel or advisors, or in attracting

additional qualified employees.



EXECUTIVE OFFICERS



The following are the executive officers of Targeted Genetics who will

serve in the capacities noted until their successors are duly appointed and

qualified.



<TABLE>

<CAPTION>

NAME                  AGE                              POSITION

- ------------------------------------  ---         --------------------------------------------------

<S>                                   <C>         <C>

H. Stewart Parker                     41          President, Chief Executive Officer and Director

Barrie J. Carter, Ph.D.               52          Executive Vice President and Director of Research

and Development

Richard Daifuku, M.D., Ph.D.          44          Vice President, Clinical Affairs

James A. Johnson                      40          Vice President, Finance, Chief Financial Officer,

Treasurer and Secretary

</TABLE>



H. STEWART PARKER managed the formation of Targeted Genetics as a wholly

owned subsidiary of Immunex and has been President, Chief Executive Officer and

a director since the Company's inception in 1989. She served in various

capacities at Immunex from August 1981 through December 1991, most recently as

Vice President, Corporate Development. Ms. Parker also served as President and a

director of Receptech Corporation, a company formed by Immunex in 1989 to

accelerate the development of soluble cytokine receptor products ("Receptech"),

from February 1991 to January 1993. She received her B.A. and M.B.A. from the

University of Washington.



BARRIE J. CARTER is Executive Vice President and Director of Research and

Development of Targeted Genetics. He joined the Company in August 1992. For the

previous 22 years he was employed by the NIH in Bethesda, Maryland where he was

Chief of the Laboratory of Molecular and Cellular Biology in the National

Institute for Diabetes and Digestive and Kidney Diseases from 1982 to 1992. Dr.

Carter received his B.Sc. (Honors) from the University of Otago, Dunedin, New

Zealand and his Ph.D. in the Biochemistry Department of the University of Otago

Medical School. He then spent a period of postdoctoral training at the Imperial

Cancer Research Fund Laboratories in London, England before joining the NIH. His

long-term research interests are in molecular biology of viruses, development of

AAV vectors and gene therapy. Dr. Carter serves on the Editorial Boards of Human

Gene Therapy and Molecular Therapeutics: Gene Therapy & Oligonucleotides and as

an Associate Editor of Virology. Since 1995, he has been an Affiliate Professor

of Medicine at the University of Washington Medical School.



RICHARD DAIFUKU joined the Company in January 1995 as Vice President,

Clinical Affairs. Prior to that, from January 1992 to January 1995, Dr. Daifuku

served in a variety of positions at Amgen Corporation (a biotechnology company),

including Associate Director, Infectious Diseases and Product Development Team

Leader. From June 1990 to January 1992, he was Associate Medical Director at

Cetus Corporation (a biotechnology company) and a Clinical Instructor at the

University of California at San Francisco. Dr. Daifuku is board certified in

internal medicine and from 1987 to 1990, completed his fellowship in infectious

disease at the UCLA Center for Health Sciences. Dr. Daifuku received his B.A. in

biology from Boston University, his M.S. in Environmental Health Sciences from

Harvard School of Public Health, and his M.D. and Ph.D. in Epidemiology from the

University of Washington.



JAMES A. JOHNSON joined the Company in March 1994 as Vice President,

Finance, Chief Financial Officer, Treasurer and Secretary. He was employed by

Immunex from January 1988 to February 1994, initially as Director of Finance and

as Vice President, Finance since February 1990. While at Immunex, Mr. Johnson

served as Treasurer of Targeted Genetics from its inception in 1989. From

November 1989 to



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January 1993, he also served as Treasurer and Assistant Secretary of Receptech.

He received his B.A. from the University of Washington.



FACTORS AFFECTING FORWARD-LOOKING INFORMATION



Early Stage of Product Development, Technological Uncertainty. The Company

has no commercial products and all of its potential products are in research,

development or early-stage clinical trials. Prior to any commercial use, these

potential products will require significant additional research and development,

extensive clinical testing and regulatory approval. There can be no assurance

that the Company's efforts to develop, test and gain regulatory approval of its

potential products will be successful.



History of Losses and Uncertainty of Future Results. Targeted Genetics is a

development stage company and has generated minimal revenues and significant net

losses since inception. The Company expects to incur substantial additional

losses over at least the next several years. To achieve profitable operations,

Targeted Genetics, alone or with corporate collaborative partners, must

successfully develop, manufacture, obtain regulatory approvals and market its

potential products. There can be no assurance that the Company's efforts in

these areas will be successful.



Uncertainties Relating to Clinical Trials. Existing data on the safety and

efficacy of gene and cell therapy treatments are very limited. There can be no

assurance that clinical trials of the Company's potential products will

demonstrate safety and efficacy. Furthermore, there can be no assurance that the

Company will not encounter unacceptable side effects or other problems in

clinical trials of its potential products that will cause the Company to delay

or discontinue development of such products. The rate of completion of the

Company's clinical trials depends on, among other factors, the rate of patient

enrollment. Delays in patient enrollment may result in increased costs, delays

or termination of clinical trials.



Need for Additional Capital. The Company expects negative cash flow from

operations to continue and to increase for the foreseeable future. The Company

will require substantial additional funds to continue the development and

commercialization of its potential products. Adequate funds, whether obtained

through financial markets or from collaborative or other arrangements with

corporate partners or other sources, may not be available when needed or may not

be available on terms favorable to the Company. If additional funds are raised

by issuing equity securities, dilution to existing shareholders may result. If

funding is insufficient at any time in the future, the Company may be required

to delay, scale back or eliminate some or all of its research and development

programs. Furthermore, if at any time the Company's funds are depleted, the

Company may be required to cease operations.



Uncertainty of Patent Position and Proprietary Rights. The failure of the

Company or its licensors to obtain and maintain patent protection for the

Company's technology could have a material adverse effect on the Company. Patent

positions in the biotechnology field are highly uncertain and involve complex

legal, scientific and factual questions. There can be no assurance that any

patent application relating to the technology used by the Company will result in

a patent being issued or that, if issued, the patent will afford protection

against competitors. As the biotechnology industry expands and more patents are

issued, the risk increases that the Company's processes and potential products

may give rise to claims that they infringe the patents of others. If the Company

becomes involved in patent litigation, it could result in substantial expense to

the Company and significant diversion of effort by the Company's technical and

management personnel. In addition to any potential liability for significant

damages, the Company could be required to obtain a license to continue to

manufacture or market the affected product or use the affected process. There

can be no assurance that any license required under any such patent would be

made available to the Company on acceptable terms, if at all. The Company also

relies upon unpatented proprietary technology. There can be no assurance that

the Company can meaningfully protect its rights in such unpatented proprietary

technology. See "Business -- Patents and Proprietary Rights."



Uncertainty of Governmental Regulatory Requirements; Lengthy Approval

Process. The process of obtaining regulatory approvals for clinical trials or

for the manufacturing or marketing of the Company's potential products is costly

and time-consuming and is subject to unanticipated delays. There can be no

assurance that the Company will be able to obtain the necessary regulatory

approvals for manufacturing or



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marketing any of its product candidates. Even if regulatory approval of a

potential product is obtained, later discovery of previously unknown problems or

failure to comply with the applicable regulatory requirements may result in

restrictions on marketing a product or withdrawal of the product from the

market, as well as possible criminal or civil sanctions. All manufacturing

operations also are subject to the FDA's current Good Manufacturing Practice

("cGMP") requirements on an ongoing basis. There can be no assurance that the

Company will be able to attain or maintain compliance with cGMP requirements.

See "Business -- Governmental Regulation."



Dependence on Corporate Collaborators. The Company will depend to a

significant extent on collaborative partners, licensees or other entities for

development, manufacturing and commercialization of its potential products.

Although the Company believes that such collaborative partners would have an

economic motivation to commercialize products that result from the Company's

research and development efforts, the amount and timing of resources devoted to

these activities would be controlled by such partners. Furthermore, there can be

no assurance that present or future collaborators will not pursue existing or

alternative technologies in preference to potential products being developed in

collaboration with the Company.



Competition. The Company is experiencing intense competition from companies

developing gene and cell therapy technologies as well as those using more

traditional approaches to treating human diseases. Many of these competitors

have substantially more financial and other resources, larger research and

development staffs, and more experience and capabilities in researching,

developing and testing products in clinical trials, in obtaining FDA and other

regulatory approvals, and in manufacturing, marketing and distribution than the

Company. Consequently, the Company's competitors may succeed in commercializing

products more rapidly than the Company. The Company's competitors may also

manufacture and market competitive products more successfully than the Company's

potential products. Such developments could render the Company's potential

products less competitive or obsolete. See "Business -- Competition."



Rapid Technological Change. Gene and cell therapy are new and rapidly

evolving fields and are expected to continue to undergo significant and rapid

technological change. Rapid technological development could result in actual and

proposed technologies, products or processes of the Company becoming obsolete

prior to successful commercialization.



Dependence on Key Personnel and Scientific Collaborators. The Company's

success will depend in large part on its ability to attract and retain key

employees and scientific collaborators. There can be no assurance that the

Company will be successful in retaining its existing personnel or in attracting

additional qualified employees. The Company also depends on the continued

availability of outside scientific collaborators who perform research in certain

areas relevant to the Company's research. There can be no assurance that the

Company will be successful in maintaining its relationships with scientific

collaborators, or that inventions or processes developed by the Company's

collaborators will become the property of the Company.



No Commercial Manufacturing or Marketing Capability. The Company's current

facilities and staff will need to be expanded, or supplemented through the use

of contract providers, for large-scale clinical or commercial production of its

potential products. In addition, the Company has no experience in sales and

marketing. To market any products that may result from its development programs,

Targeted Genetics will have to develop marketing and sales capabilities, either

on its own or in conjunction with others. There can be no assurance that the

Company will be successful in obtaining the necessary manufacturing or marketing

capabilities. Furthermore, the Company's dependence upon third parties for the

manufacture, marketing and sale of its potential products may materially

adversely affect the Company's ability to develop and deliver products on a

timely and competitive basis.



Hazardous Materials; Environmental Matters. The Company's research and

development activities involve the controlled use of hazardous materials,

chemicals, biological materials and radioactive compounds. Although the Company

believes that its safety procedures for handling and disposing of such materials

comply with the standards prescribed by applicable laws and regulations, the

risk of accidental contamination or injury from these materials cannot be

completely eliminated. In the event of such an accident, the Company could be

held liable for any resulting damages, and any such liability could exceed the

Company's resources.



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Product Liability. The testing, manufacture, marketing and sale of human

healthcare products entail the inherent risk of liability claims or product

recalls and associated adverse publicity. The Company currently has a limited

amount of product liability insurance. Such insurance is expensive and there can

be no assurance that it will continue to be available in sufficient amounts and

on acceptable terms, if at all. A product liability claim or product recall

could have a material adverse effect on the Company's business, financial

condition and results of operations.



ITEM 2. PROPERTIES



Targeted Genetics currently occupies approximately 33,000 square feet of

laboratory and office space in a single facility in Seattle, Washington. The

lease expires on April 1, 1999 and includes options to extend the lease term for

three consecutive five-year periods. The average annual rent payment during the

initial term of the lease is approximately $408,000. In 1996, the Company

entered into a lease for approximately 4,700 square feet of office space in an

office complex adjoining its primary facility. The lease expires on March 31,

2004 and includes options to extend the lease term for two consecutive five-year

periods. The average annual rent payment during the initial term of the lease is

approximately $95,000. The Company believes its current facilities, together

with approximately 2,000 square feet of expansion space remaining in its primary

facility and additional expansion space available in the adjoining office

complex, will be adequate to meet its projected needs for the next several

years. Within that time frame, the Company may be required to locate alternative

facilities, depending on the Company's growth and development.



ITEM 3. LEGAL PROCEEDINGS



The Company is not a party to any legal proceedings.



ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS



No matters were submitted to a vote of the Company's security holders

during the fourth quarter of its fiscal year ended December 31, 1996.



PART II



ITEM 5. MARKET PRICE OF THE REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER

MATTERS



The Company's common stock trades on The Nasdaq Stock Market under the

symbol TGEN. At March 1, 1997, there were approximately 1,400 holders of the

Company's common stock. The Company has never paid cash dividends and does not

anticipate paying them in the foreseeable future. The following table sets forth

for each calendar quarter indicated, the high and low sale prices for the

Company's common stock.



<TABLE>

<S>                                                     <C>         <C>

1995

1st Quarter...........................................  $ 6 3/8     $ 3 7/8

2nd Quarter...........................................    5 5/8       3 1/2

3rd Quarter...........................................    6 1/2       3 5/8

4th Quarter...........................................    5 5/8       3 3/4



1996

1st Quarter...........................................  $ 7 1/4     $ 4

2nd Quarter...........................................    6 1/4       3 7/8

3rd Quarter...........................................    5           2 7/8

4th Quarter...........................................    5 1/4       3 1/2

</TABLE>



On February 21, 1996, the Company issued to Lehman Brothers, Inc. an

aggregate of 2,461 shares of its common stock in payment of certain advisory

fees in a transaction not involving a public offering and therefore exempt

pursuant to Section 4(2) of the Securities Act of 1933, as amended (the

"Securities



18

19



Act"). On June 19, 1996, the Company issued 3,636,364 shares of its common stock

in connection with the merger of a wholly-owned subsidiary of the Company into

RGene Therapeutics, Inc. ("RGene"). Such shares were issued to the former

shareholders of RGene in a transaction not involving a public offering and

therefore exempt pursuant to Section 4(2) of the Securities Act and Rule 506

promulgated thereunder. On December 20, 1996, the Company issued 16,000 shares

of its common stock to the University of Pittsburgh as partial consideration for

rights granted to the Company under a license agreement. Such shares were issued

in a transaction not involving a public offering and therefore exempt pursuant

to Section 4(2) of the Securities Act.



ITEM 6. SELECTED FINANCIAL DATA



<TABLE>

<CAPTION>

YEAR ENDED DECEMBER 31,

----------------------------------------------------------------------

1996          1995          1994          1993            1992

------------   -----------   -----------   -----------     -----------

<S>                                      <C>            <C>           <C>           <C>             <C>

RESULTS OF OPERATIONS

Revenues...............................  $  2,254,178   $   842,460   $   448,822   $   412,076     $   548,549

Expenses...............................    28,292,220    10,764,744     8,848,167     5,477,588       1,943,011

Net loss...............................   (26,038,042)   (9,922,284)   (8,399,345)   (5,065,512)     (1,394,462)

Net loss per share.....................         (1.59)         (.94)        (1.40)         N.M.(1)         N.M.(1)



FINANCIAL CONDITION

Cash, cash equivalents and securities

available for sale...................  $ 19,051,070   $14,442,562   $11,474,787   $ 6,797,182     $15,266,485

Total assets...........................    25,139,052    19,960,460    17,045,881    12,115,184      15,876,914

Long-term obligations, including

current portion......................     3,378,420     3,286,508     2,837,370     1,184,706          14,659

Shareholders' equity...................    19,507,788    15,772,836    13,242,145    12,115,184      15,296,537

</TABLE>



- ---------------



(1) Per share amounts are not meaningful.



ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS

OF OPERATIONS



OVERVIEW



Targeted Genetics Corporation, a development stage company, was

incorporated in March 1989 as a wholly owned subsidiary of Immunex Corporation.

The Company's activities were carried out as a project within Immunex through

December 31, 1991. In 1992, the Company began to operate independently from

Immunex and raised $16.6 million, net of expenses, in a private placement of

preferred stock. Through public offerings, the Company has raised an additional

$38.4 million. In June 1996, the Company completed a merger with RGene

Therapeutics, Inc. ("RGene"), a privately-held biotechnology company. Currently,

the Company's only significant revenue sources are a research and development

collaborative agreement and interest income earned on investments. The Company

has generated an accumulated deficit of $53.6 million through December 31, 1996.



It is not anticipated that the Company will have any product-related

revenues for a number of years. Accordingly, the Company expects to generate

substantial additional losses in the future attributable to the continuation of

preclinical and clinical research programs, development of manufacturing

capabilities and the preparation for commercialization of its products under

development. The Company's ability to achieve profitability depends in part on

its ability alone and/or with others to complete the development of product

candidates, obtain regulatory approvals, comply with applicable regulatory

requirements and manufacture and market such products, of which there can be no

assurance.



RISKS AND UNCERTAINTIES



This discussion contains forward-looking statements that are subject to

certain risks and uncertainties that could cause actual results to differ

materially from those projected. The Company's future cash requirements and

expense levels will depend on many factors, including continued scientific

progress in its research and development programs; the results of research and

development, preclinical studies and clinical



19

20



trials; acquisition of products or technology, if any; relationships with

corporate collaborators; competing technological and market developments; the

time and costs involved in filing, prosecuting and enforcing patent claims; the

time and costs of manufacturing scale-up and commercialization activities; and

other factors. Readers are cautioned not to place undue reliance on these

forward-looking statements, which speak only as of the date of this report. The

Company undertakes no obligation to publicly release the results of any

revisions to these forward-looking statements that may be made to reflect events

or circumstances after the date of this report or to reflect the occurrence of

unanticipated events.



RESULTS OF OPERATIONS



For the year ended December 31, 1996, revenue under collaborative

agreements increased to $1.2 million from $75,000 for the year ended December

31, 1995. The increase primarily resulted from receipt of milestone payments

totaling $1.5 million net of $375,000 of royalty and other such payments due as

a result of receiving such milestone payments under the Company's collaborative

agreement with Laboratoires Fournier S.C.A. The milestones were earned through

the enrollment of patients in a U.S. clinical trial for the treatment of breast

and ovarian cancer and through completion of certain related regulatory

activities. This agreement provides for additional milestone-based payments in

the future; however, there can be no assurance that such milestones will be

achieved.



Investment income increased each year over the three-year period ended

December 31, 1996. The increases in both 1996 and 1995 were attributable to a

higher average investment balance during the year and higher rates of return on

those balances.



Research and development expenses have steadily increased over the three

years ended December 31, 1996. Contributing to the $3.3 million increase in 1996

expense was approximately $1.6 million related to the RGene merger and

continuation of the acquired research, development and clinical programs. Of

this amount, approximately $1.3 million represented recurring, routine charges

related to the RGene technology, and approximately $300,000 represented

non-recurring employee termination payments. Also contributing to the increase

in expenses in both 1996 and 1995 were a moderate increase in the level of

expenses supporting the advancement of clinical, manufacturing process

development and regulatory programs, as well as additional employees and related

expenses in preclinical immunology. Research and development expenses are

expected to increase in the future, primarily resulting from increased clinical

trial activity. Continued growth, however, is dependent on the availability of

capital.



A one-time expense resulting from the acquisition of RGene was charged

against income in 1996. Of the total RGene purchase price, $13.5 million was

written-off in the second quarter to in-process research and development

expense.



General and administrative expenses increased to $2.9 million for the year

ended December 31, 1996, compared with $2.3 million and $1.9 million for the

years 1995 and 1994, respectively. The increase in 1996 general and

administrative expenses included $338,000 incurred as a result of the RGene

acquisition. These expenses were non-recurring in nature, with no expected

impact on future periods. Other factors contributing to the increases in 1996

and 1995 expenses were increases in business development and investor relations

activities and, to a lesser extent, modest growth in administrative staff.



Interest expense increased to $397,000 for the year ended December 31,

1996, compared to $302,000 and $193,000 for the years 1995 and 1994,

respectively. This expense item relates to equipment financing transactions. The

increase each year is due to an increase in the amount of equipment purchases

financed. The Company expects that it will continue to finance equipment

purchases, if favorable terms are available.



LIQUIDITY AND CAPITAL RESOURCES



At December 31, 1996, the Company had cash, cash equivalents and securities

available for sale totaling $19.1 million, compared to $14.4 million at December

31, 1995. The increase was primarily attributable to the completion of a public

stock offering and the cash held by RGene at the time of its acquisition in June

1996. The stock offering resulted in net proceeds of $14.6 million and the

acquisition resulted in net cash received of



20

21



$1.6 million. The Company also completed equipment financing transactions

totaling $1.1 million during 1996. Offsetting these increases, the Company used

$10.4 million to fund its operations, $1.7 million for purchases of equipment,

facility expansion and acquisition of technology and $1.0 million for payments

under equipment leases and notes.



The Company expects that its cash needs will continue to increase in future

periods due to expansion of research and development programs, including those

programs acquired as a result of the RGene merger, increased clinical trial

activity, growth of administrative staff and expansion of its facilities to

accommodate increased numbers of employees. Accordingly, the Company will need

to raise substantial additional funds to continue development and

commercialization of its products. The Company's future cash requirements will

be affected by a number of factors, as described above in the section entitled

"Risks and Uncertainties".



The Company estimates that at its current rate of spending, its existing

cash, cash equivalents and securities available for sale will be sufficient to

meet capital requirements at least through the end of 1997. The Company intends

to strengthen its cash position by entering into agreements with corporate

partners that would provide license fees, research and development funding and,

potentially, equity investment. There can be no assurance that the Company will

be successful in establishing any such collaborative arrangements or that any

such future partner would be successful in commercializing products. Also, up to

approximately $3.6 million of additional capital would be provided if warrant

holders were to exercise approximately 770,000 outstanding warrants expiring in

July 1997 and having an exercise price of $4.68. Depending on market conditions,

the Company may also seek additional sources of public or private equity

capital. Any additional funding received by the Company from any of these

potential sources would be expected to extend the period over which the

Company's cash resources would fund its capital requirements. There can be no

assurance, however, that the warrants will be exercised or that adequate funds

will be available when needed or will be available on terms favorable to the

Company.



ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA



<TABLE>

<CAPTION>

PAGE IN

FORM 10-K

---------

<S>                                                                                 <C>

Consolidated Balance Sheets at December 31, 1996 and 1995.........................     22

Consolidated Statements of Operations for the years ended

December 31, 1996, 1995, and 1994 and for the period from March 9, 1989 (date of

inception) through December 31, 1996............................................     23

Consolidated Statement of Shareholders' Equity for the period from March 9, 1989

(date of inception) through December 31, 1996...................................     24

Consolidated Statements of Cash Flows for the years ended December 31, 1996, 1995,

and 1994 and for the period from March 9, 1989 (date of inception) through

December 31, 1996...............................................................     25

Notes to Consolidated Financial Statements........................................  26 - 33

Report of Ernst and Young LLP, Independent Auditors...............................     34

</TABLE>



21

22



ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA



TARGETED GENETICS CORPORATION

(A DEVELOPMENT STAGE COMPANY)



CONSOLIDATED BALANCE SHEETS



ASSETS



<TABLE>

<CAPTION>

DECEMBER 31,

---------------------------

1996            1995

-----------     -----------

<S>                                                                 <C>             <C>

Current assets:

Cash and cash equivalents.......................................  $ 3,532,568     $ 2,154,814

Securities available for sale...................................   15,518,502      12,287,748

Prepaid expenses and other......................................      468,671         196,150

-----------     -----------

Total current assets.........................................   19,519,741      14,638,712

Property, plant and equipment, net................................    4,991,017       4,959,502

Other assets......................................................      628,294         362,246

-----------     -----------

$25,139,052     $19,960,460

===========     ===========



LIABILITIES AND SHAREHOLDERS' EQUITY

Current liabilities:

Accounts payable................................................  $ 1,887,880     $   564,403

Accrued payroll and other liabilities...........................      364,964         336,713

Current portion of long-term obligations........................    1,250,263         881,210

-----------     -----------

Total current liabilities....................................    3,503,107       1,782,326

Long-term obligations.............................................    2,128,157       2,405,298

Commitments

Shareholders' equity:

Preferred stock, $.01 par value, 6,000,000 shares authorized,

none outstanding.............................................           --              --

Common stock, $.01 par value, 40,000,000 shares authorized,

20,136,468 and 12,317,183 outstanding at December 31, 1996

and 1995, respectively.......................................   73,115,362      43,295,436

Unrealized gains on securities available for sale...............       19,387          66,319

Deficit accumulated during development stage....................  (53,626,961)    (27,588,919)

-----------     -----------

Total shareholders' equity...................................   19,507,788      15,772,836

-----------     -----------

$25,139,052     $19,960,460

===========     ===========

</TABLE>



See accompanying notes to consolidated financial statements.



22

23



TARGETED GENETICS CORPORATION

(A DEVELOPMENT STAGE COMPANY)



CONSOLIDATED STATEMENTS OF OPERATIONS



<TABLE>

<CAPTION>

PERIOD FROM

MARCH 9, 1989

(DATE OF

YEAR ENDED DECEMBER 31,                   INCEPTION)

--------------------------------------------          THROUGH

1996            1995            1994         DECEMBER 31, 1996

------------     -----------     -----------     -----------------

<S>                                 <C>              <C>             <C>             <C>

Revenues:

Collaborative agreements........  $  1,202,965     $    75,000     $        --       $   1,277,965

Investment income...............       923,720         667,835         448,822           3,001,002

Other...........................       127,493          99,625              --             227,118

------------     -----------     -----------        ------------

Total revenues..........     2,254,178         842,460         448,822           4,506,085

------------     -----------     -----------        ------------

Expenses:

Research and development........    11,502,584       8,194,913       6,763,549          34,273,704

In-process research and

development..................    13,517,911              --              --          13,517,911

General and administrative......     2,874,316       2,267,516       1,891,947           9,449,036

Interest........................       397,409         302,315         192,671             892,395

------------     -----------     -----------        ------------

Total expenses..........    28,292,220      10,764,744       8,848,167          58,133,046

------------     -----------     -----------        ------------

Net loss..........................  $(26,038,042)    $(9,922,284)    $(8,399,345)      $ (53,626,961)

============     ===========     ===========        ============

Net loss per share................  $      (1.59)    $     (0.94)    $     (1.40)

============     ===========     ===========

Shares used in computation of net

loss per share..................    16,407,928      10,532,950       6,005,141

============     ===========     ===========

</TABLE>



See accompanying notes to consolidated financial statements.



23

24



TARGETED GENETICS CORPORATION

(A DEVELOPMENT STAGE COMPANY)



CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY

PERIOD FROM MARCH 9, 1989 (DATE OF INCEPTION) THROUGH DECEMBER 31, 1996



<TABLE>

<CAPTION>

UNREALIZED

GAINS         DEFICIT

(LOSSES)      ACCUMULATED

COMMON STOCK          ADVANCES     ON SECURITIES      DURING          TOTAL

PREFERRED     ------------------------      FROM       AVAILABLE FOR   DEVELOPMENT    SHAREHOLDERS'

STOCK         SHARES       AMOUNT        IMMUNEX         SALE           STAGE          EQUITY

------------   ----------   -----------   -----------   -------------   ------------   -------------

<S>                          <C>            <C>          <C>           <C>           <C>             <C>            <C>

Net loss from March 9, 1989

(date of inception)

through December 31,

1991.....................  $         --           --   $        --   $ 2,807,316     $      --     $(2,807,316)   $         --

Sale of common stock.....            --    1,080,000        27,600            --            --              --          27,600

Issuance of 1,920,000

shares of Series A

preferred stock to

Immunex in repayment of

advances...............     2,807,316           --            --    (2,807,316)           --              --              --

Sale of 3,675,986 shares

of Series B preferred

stock, net of issuance

costs of $772,415......    16,597,399           --            --            --            --              --      16,597,399

Issuance of common stock

as compensation........            --      120,000        66,000            --            --              --          66,000

Net loss -- 1992.........            --           --            --            --            --      (1,394,462)     (1,394,462)

------------   ----------   -----------   -----------   -------------   ------------   -------------

Balance at December 31,

1992.....................    19,404,715    1,200,000        93,600            --            --      (4,201,778)     15,296,537

Net loss -- 1993.........            --           --            --            --            --      (5,065,512)     (5,065,512)

------------   ----------   -----------   -----------   -------------   ------------   -------------

Balance at December 31,

1993.....................    19,404,715    1,200,000        93,600            --            --      (9,267,290)     10,231,025

Sale of common stock in

initial public

offering, net of

issuance costs of

$1,404,056.............            --    2,154,345    11,522,014            --            --              --      11,522,014

Conversion of Series A

and B preferred stock

to common stock........   (19,404,715)   5,595,986    19,404,715            --            --              --              --

Exercise of stock

options................            --        8,500         4,555            --            --              --           4,555

Unrealized losses on

securities available

for sale...............            --           --            --            --      (116,104)             --        (116,104)

Net loss -- 1994.........            --           --            --            --            --      (8,399,345)     (8,399,345)

------------   ----------   -----------   -----------   -------------   ------------   -------------

Balance at December 31,

1994.....................            --    8,958,831    31,024,884            --      (116,104)    (17,666,635)     13,242,145

Sale of common stock and

830,598 warrants, net

of issuance costs of

$214,519...............            --    3,322,392    12,244,461            --            --              --      12,244,461

Exercise of stock

options................            --       35,960        26,091            --            --              --          26,091

Unrealized gains on

securities available

for sale...............            --           --            --            --       182,423              --         182,423

Net loss -- 1995.........            --           --            --            --            --      (9,922,284)     (9,922,284)

------------   ----------   -----------   -----------   -------------   ------------   -------------

Balance at December 31,

1995.....................  $         --   12,317,183   $43,295,436   $        --     $  66,319     $(27,588,919)  $ 15,772,836

Sale of common stock, net

of issuance costs of

$1,476,779.............            --    4,025,000    14,623,221            --            --              --      14,623,221

Issuance of common stock

in RGene acquisition...            --    3,636,364    14,854,546            --            --              --      14,854,546

Exercise of stock

options................            --       78,460        44,179            --            --              --          44,179

Exercise of warrants.....            --       61,000       285,480            --            --              --         285,480

Issuance of common stock

in payment for

consulting and license

fees...................            --       18,461        12,500            --            --              --          12,500

Unrealized losses on

securities available

for sale...............            --           --            --            --       (46,932)             --         (46,932)

Net loss -- 1996.........            --           --            --            --            --     (26,038,042)    (26,038,042)

------------   ----------   -----------   -----------   -------------   ------------   -------------

Balance at December 31,

1996.....................  $         --   20,136,468   $73,115,362   $        --     $  19,387     $(53,626,961)  $ 19,507,788

=============  ==========   ============  ============  =============   ============== =============

</TABLE>



24

25



TARGETED GENETICS CORPORATION

(A DEVELOPMENT STAGE COMPANY)



CONSOLIDATED STATEMENTS OF CASH FLOWS



<TABLE>

<CAPTION>

PERIOD FROM

MARCH 9, 1989

YEAR ENDED DECEMBER 31,             (DATE OF INCEPTION)

------------------------------------------         THROUGH

1996           1995           1994        DECEMBER 31, 1996

------------   ------------   ------------   --------------------

<S>                                    <C>            <C>            <C>            <C>

Operating activities:

Net loss...........................  $(26,038,042)  $ (9,922,284)  $ (8,399,345)      $(53,626,961)

Adjustments to reconcile net loss

to net cash used in operating

activities:

Expenses paid with common

stock.........................        12,500             --             --             78,500

In-process research and

development...................    12,867,986             --             --         12,867,986

Depreciation and amortization...     1,919,510      1,484,549      1,264,848          5,082,391

Increase in prepaid expenses and

other.........................      (201,575)       (49,865)      (161,827)          (496,865)

Increase in accrued interest on

securities available for

sale..........................       (72,570)        (9,287)       (29,750)          (155,498)

Increase (decrease) in current

liabilities...................     1,141,275        (17,955)        88,493          1,911,266

------------    -----------    -----------       ------------

Net cash used in operating

activities...............   (10,370,916)    (8,514,842)    (7,237,581)       (34,339,181)

Investing activities:

Purchases of property, plant and

equipment.......................    (1,542,594)    (1,335,876)      (885,604)        (8,713,191)

Purchases of securities available

for sale........................   (23,574,123)   (13,047,852)   (12,990,428)       (78,664,645)

Sales of securities available for

sale............................    20,369,007     10,119,622      9,369,127         63,321,027

Net cash received in RGene

acquisition.....................     1,594,386             --             --          1,594,386

Increase in other assets...........      (145,000)       (76,500)      (177,500)          (719,179)

------------    -----------    -----------       ------------

Net cash used in investing

activities...............    (3,298,324)    (4,340,606)    (4,684,405)       (23,181,602)

------------    -----------    -----------       ------------

Financing activities:

Advances from Immunex..............            --             --             --          2,807,316

Net proceeds from sale of capital

stock...........................    14,952,880     12,270,552     11,526,569         55,375,000

Proceeds from equipment financing

transactions....................     1,097,588      1,089,789      1,950,391          4,943,882

Payments under capital leases and

installment loans...............    (1,003,474)      (657,058)      (412,315)        (2,072,847)

------------    -----------    -----------       ------------

Net cash provided by

financing activities.....    15,046,994     12,703,283     13,064,645         61,053,351

------------    -----------    -----------       ------------

Net increase (decrease) in cash and

cash equivalents...................     1,377,754       (152,165)     1,142,659          3,532,568

Cash and cash equivalents, beginning

of period..........................     2,154,814      2,306,979      1,164,320                 --

------------    -----------    -----------       ------------

Cash and cash equivalents, end of

period.............................  $  3,532,568   $  2,154,814   $  2,306,979       $  3,532,568

============    ===========    ===========       ============

Supplemental disclosures of non-cash

investing and financing activities:

Deferred sales tax on leasehold

improvements and equipment......  $         --   $     16,407   $    114,589       $    509,588

============    ===========    ===========       ============

Preferred stock issued to Immunex

in payment of advances..........  $         --   $         --   $         --       $  2,807,316

============    ===========    ===========       ============

</TABLE>



See accompanying notes to consolidated financial statements.



25

26



TARGETED GENETICS CORPORATION

(A DEVELOPMENT STAGE COMPANY)



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS



1. ORGANIZATION



Targeted Genetics Corporation (the "Company") is developing gene therapy

products for the treatment of certain acquired and inherited diseases. As a

development stage company, the Company has devoted substantially all its efforts

to date to conducting research and development activities, recruiting personnel

and raising capital.



The Company was incorporated in the state of Washington in March 1989 as a

wholly owned subsidiary of Immunex Corporation ("Immunex"). In February 1992,

the Company issued 1,920,000 shares of Series A convertible preferred stock to

Immunex in exchange for the grant of a license to certain technology, settlement

of advances from Immunex and cancellation of 40,000 shares of common stock

issued by the Company to Immunex on March 28, 1989. At December 31, 1996,

Immunex held 13% of the outstanding stock of the Company.



The Company estimates that, at its current rate of expenditures, its

existing cash, cash equivalents and securities available for sale will be

sufficient to meet operating requirements at least through the end of 1997.

Accordingly, the Company is pursuing collaborative arrangements with corporate

partners, with the intent of generating both research and development funding

and equity capital. The Company may also elect to seek additional equity capital

via the public or private markets, depending on market conditions.



2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES



Principles of Consolidation



The consolidated financial statements include the accounts of the Company

and its wholly owned subsidiary. All intercompany transactions and balances have

been eliminated in consolidation.



Cash Equivalents



The Company considers all short-term investments with a purchased maturity

of three months or less to be cash equivalents. Cash equivalents, valued at cost

which approximates market, consist principally of money market accounts and

short-term government obligations.



Securities Available for Sale



Securities available for sale consist primarily of corporate debt

securities and U.S. Government notes, all of which mature within two years.

Management currently classifies the Company's entire investment portfolio, other

than cash equivalents, as securities available for sale. Such securities are

stated at market value, with the unrealized gains and losses included as a

component of shareholders' equity. The cost of debt securities in this category

is adjusted for amortization of premiums and accretion of discounts to maturity,

which are included in investment income. Realized gains and losses and declines

in value judged to be other than temporary on securities available for sale are

also included in investment income. The cost of securities sold is calculated

using the specific identification method.



Property, Plant and Equipment



Property, plant and equipment are stated at cost. Depreciation of furniture

and equipment is provided using the straight-line method over the assets'

estimated useful lives, ranging from three to seven years. Furniture and

equipment under capitalized leases are amortized over the life of the lease.

Leasehold improvements are amortized over the life of the improvements or the

term of the lease, whichever is shorter.



26

27



TARGETED GENETICS CORPORATION

(A DEVELOPMENT STAGE COMPANY)



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)



Stock Compensation



In adopting the provisions of Statement of Financial Accounting Standards

(SFAS) No. 123 "Accounting for Stock-Based Compensation," the Company has

elected to apply the disclosure-only provisions and related interpretations for

accounting for its stock option plans. The Company does not recognize any

compensation expense related to the plans since all options are granted at fair

market value on the date of grant.



Revenue Under Collaborative Agreements



Revenue under collaborative agreements is recognized as defined under the

terms of the respective collaborative agreements. Revenue related to milestones

is recognized upon the achievement of the related milestone and when collection

is probable. Royalty payments and other similar payments due as a direct result

of such revenues being earned and received are offset against and recognized in

the same period as such revenue.



Net Loss Per Share



Net loss per share is computed based upon the weighted average number of

common shares outstanding during the period. Common equivalent shares are not

included in the computation because the effect of their inclusion would be

antidilutive, except that, in accordance with Securities and Exchange Commission

requirements, common equivalent shares issued during the twelve months prior to

the Company's initial public offering have been included in the calculation as

if they were outstanding through March 31, 1994.



Use of Estimates



The preparation of financial statements in conformity with generally

accepted accounting principles requires management to make estimates and

assumptions that affect the amounts reported in the financial statements and

accompanying notes. Actual results may differ from those estimates.



Reclassification



Certain reclassifications have been made to prior year financial statements

to conform to the current year presentation.



27

28



TARGETED GENETICS CORPORATION

(A DEVELOPMENT STAGE COMPANY)



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)



3. SECURITIES AVAILABLE FOR SALE



Securities available for sale consisted of the following:



<TABLE>

<CAPTION>

GROSS        GROSS

AMORTIZED    UNREALIZED   UNREALIZED     MARKET

COST         GAINS        LOSSES        VALUE

-----------   ----------   ----------   -----------

<S>                                <C>           <C>          <C>          <C>

December 31, 1996:

U.S. corporate securities......  $ 3,905,454    $  4,311     $  4,665    $ 3,905,100

U.S. Treasury securities and

obligations of U.S.

government agencies.........   11,593,661      26,686        6,945     11,613,402

-----------     -------      -------    -----------

$15,499,115    $ 30,997     $ 11,610    $15,518,502

===========     =======      =======    ===========

December 31, 1995:

U.S. corporate securities......  $ 2,473,549    $  8,803     $     --    $ 2,482,352

U.S. Treasury securities and

obligations of U.S.

government agencies.........    9,747,880      57,516           --      9,805,396

-----------     -------      -------    -----------

$12,221,429    $ 66,319     $     --    $12,287,748

===========     =======      =======    ===========

</TABLE>



The gross realized gains on sales of securities available for sale totaled

$27,300, $25,047 and $15,901, and the gross realized losses totaled $1,097,

$48,013, and $55,576 in 1996, 1995, and 1994, respectively.



4. PROPERTY, PLANT AND EQUIPMENT



Property, plant and equipment consisted of the following:



<TABLE>

<CAPTION>

DECEMBER 31,

-------------------------

1996           1995

----------     ----------

<S>                                                   <C>            <C>

Furniture and equipment.............................  $5,248,913     $3,862,632

Leasehold improvements..............................   4,420,590      3,948,678

----------     ----------

9,669,503      7,811,310

Less accumulated depreciation and amortization......   4,678,486      2,851,808

----------     ----------

$4,991,017     $4,959,502

==========     ==========

</TABLE>



The Company has leased furniture and equipment, primarily laboratory

equipment, under four capital leases. The total cost of furniture and equipment

leased at December 31, 1996 and 1995 was $3,796,152 and $2,655,998,

respectively, with related accumulated depreciation of $1,840,284 and $1,076,712

at December 1996 and 1995, respectively.



At December 31, 1996, the Company had pledged furniture and equipment,

having a net book value of $474,428, as collateral under an installment loan

agreement.



28

29



TARGETED GENETICS CORPORATION

(A DEVELOPMENT STAGE COMPANY)



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)



5. LONG-TERM OBLIGATIONS



Long-term obligations consisted of the following:



<TABLE>

<CAPTION>

DECEMBER 31,

-------------------------

1996           1995

----------     ----------

<S>                                                   <C>            <C>

Deferred state sales tax............................  $  467,540     $  509,588

Installment note payable, effective rate of 16.73%,

due in monthly installments through 1999..........     634,609        822,214

Capitalized lease obligations (see note 8)..........   2,276,271      1,954,706

----------     ----------

3,378,420      3,286,508

Less current portion................................   1,250,263        881,210

----------     ----------

$2,128,157     $2,405,298

==========     ==========

</TABLE>



The state of Washington granted the Company a deferral of state sales tax

on new construction and equipment used in research and development activities.

The remaining obligation is payable over the next four years.



Principal payments related to long-term obligations for each of the five

years ending December 31, 2001 are $1,250,263, $898,792, $764,904, $355,542, and

$0, respectively.



6. SHAREHOLDERS' EQUITY



Warrants



In July 1995, the Company issued warrants to purchase 830,598 shares in

conjunction with an offering of its common stock. At December 31, 1996, 769,598

of such warrants were outstanding and exercisable at a price of $4.68 per share,

expiring July 1997. The Company has issued a total of 62,016 warrants related to

equipment financing agreements. These warrants have a weighted average price of

$6.00 per share and expire from May 1999 to December 2003. At December 31, 1996,

831,614 shares of common stock were reserved for all such warrants.



Shareholder Rights Plan



In October 1996, the Company adopted a Shareholder Rights Plan under which

it distributed a dividend of one right for each outstanding share of common

stock. The issuance of these rights had no dilutive effect, did not impact

reported earnings per share and is not taxable to the Company or the Company's

shareholders. These rights could cause substantial dilution to certain persons

or groups that attempt to acquire the Company on terms not approved by the Board

of Directors.



Stock Options



The Company has two stock option plans under which 2,120,000 shares of

common stock were reserved for issuance. Generally, options vest in annual

increments over a three- or five-year period. All options expire ten years from

date of grant. Options have been granted at market value or, prior to the

Company's initial public offering, at the estimated fair value at the date of

grant as established by the Company's Board of Directors. As of December 31,

1996, options on 782,666 shares were available for future grant.



29

30



TARGETED GENETICS CORPORATION

(A DEVELOPMENT STAGE COMPANY)



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)



A summary of activity related to the Company's stock option plans follows:



<TABLE>

<CAPTION>

WEIGHTED

AVERAGE

EXERCISE

SHARES        PRICE

---------     --------

<S>                                              <C>           <C>

Balance, January 1, 1994.......................    441,200      $ 0.53

Granted......................................    411,100        4.47

Exercised....................................     (8,500)       0.54

Cancelled....................................     (5,800)       4.17

----------      -----

Balance, December 31, 1994.....................    838,000        2.44

Granted......................................    253,237        4.09

Exercised....................................    (35,960)       0.73

Cancelled....................................    (22,860)       4.00

----------      -----

Balance, December 31, 1995.....................  1,032,417        2.87

Granted......................................    332,157        4.86

Exercised....................................    (78,460)       0.56

Cancelled....................................    (71,700)       2.67

----------      -----

Balance, December 31, 1996.....................  1,214,414      $ 3.57

==========

</TABLE>



Options for 390,884, 268,620, and 130,700 shares were exercisable at

December 31, 1996, 1995, and 1994, respectively. The following table summarizes

information related to outstanding and exercisable options at December 31, 1996:



<TABLE>

<CAPTION>

OUTSTANDING

-------------------------------------------         EXERCISABLE

WEIGHTED         --------------------

WEIGHTED         AVERAGE                      WEIGHTED

AVERAGE         REMAINING                     AVERAGE

RANGE OF                       EXERCISE       CONTRACTUAL                    EXERCISE

EXERCISE PRICES      SHARES        PRICE             LIFE           SHARES       PRICE

- ---------------     ---------     --------     ----------------     -------     --------

<S>                 <C>           <C>          <C>                  <C>         <C>

$ .50 - $2.50         364,120      $  .91            6.29           220,600      $  .78

4.00 -  4.88         369,337        4.16            8.64            55,144        4.08

5.00 -  6.25         480,957        5.14            8.22           115,140        5.18

- ---------------     ---------      ------            ----           -------      ------

$ .50 - $6.25       1,214,414      $ 3.57            7.77           390,884      $ 2.54

=========                                       =======

</TABLE>



The Company has adopted the provisions of Statement of Financial Accounting

Standards (SFAS) No. 123, "Accounting for Stock-Based Compensation". In

conformity with the provisions of SFAS No. 123, the Company has elected to

follow the intrinsic value method allowed under the statement for its stock

option plans and present pro forma disclosures using the fair value accounting

approach. Had compensation costs been recorded, the following amounts would have

been reported:



<TABLE>

<CAPTION>

1996             1995

------------     ------------

<S>                                               <C>              <C>

Net loss -- as reported.........................  $(26,038,042)    $ (9,922,284)

Net loss -- pro forma...........................   (26,558,542)     (10,156,530)

Net loss per share -- as reported...............         (1.59)            (.94)

Net loss per share -- pro forma.................         (1.62)            (.96)

</TABLE>



30

31



TARGETED GENETICS CORPORATION

(A DEVELOPMENT STAGE COMPANY)



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)



The fair value of each option is estimated on the date of grant using the

Black-Scholes multiple-option approach pricing model with the following weighted

average assumptions:



<TABLE>

<CAPTION>

1996        1995

--------    --------

<S>                                                         <C>         <C>

Expected dividend rate....................................       nil         nil

Expected stock price volatility...........................      .664        .664

Risk-free interest rate...................................     6.03%       7.16%

Expected life of options from vest date...................   3 years     3 years

</TABLE>



The weighted average fair value of options granted during 1996 and 1995 was

$3.11 and $2.64, respectively, per share.



7. ACQUISITION OF RGENE THERAPEUTICS, INC.



On June 19, 1996, the Company completed its acquisition of RGene

Therapeutics, Inc. ("RGene"), a privately-held gene therapy company. The Company

issued 3,636,364 shares of common stock in exchange for all the outstanding

capital stock of RGene at approximately $4.08 per share. The shares are

currently unregistered but the company has agreed to register 50 percent of the

shares issued in the merger one year from the date of closing.



The acquisition was accounted for as a purchase and the consideration

issued by the company was allocated to tangible and intangible assets acquired

based on their estimated fair values on the acquisition date. The aggregate

purchase price of $17,821,986 consisted of:



<TABLE>

<S>                                               <C>

Market value of capital stock...................  $14,854,546

Acquisition costs and expenses..................      649,925

Liabilities assumed.............................    2,317,515

-----------

$17,821,986

===========

</TABLE>



The aggregate purchase price was allocated to RGene's tangible and

intangible assets based on their relative fair values. The amount allocated to

acquired in-process research and development was written off to operations in

the second quarter of 1996. The allocation of the aggregate purchase price was

as follows:



<TABLE>

<S>                                               <C>

Cash and cash equivalents.......................  $ 3,911,901

Other current assets............................      392,174

In-process technology...........................   13,517,911

-----------

$17,821,986

===========

</TABLE>



The following summarized unaudited pro forma results of operations for the

years ended December 31, 1996 and 1995, respectively, assume the acquisition

occurred as of the beginning of the respective periods and do not include

certain one-time charges related to the acquisition of RGene, primarily the

write-off of in-process research and development.



<TABLE>

<CAPTION>

1996             1995

------------     ------------

<S>                                               <C>              <C>

Revenue.........................................  $  6,165,213     $  1,195,737

Net loss........................................   (11,708,198)     (13,417,273)

Net loss per share..............................         (0.65)           (0.95)

</TABLE>



The Company may issue up to $5 million in additional common stock to

RGene's former stockholders based on the achievement of certain clinical and

business-related milestones prior to December 31, 1998. The



31

32



TARGETED GENETICS CORPORATION

(A DEVELOPMENT STAGE COMPANY)



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)



Company has also assumed certain long-term consulting and research funding

agreements as a result of the merger.



8. COMMITMENTS



The Company leases its research and office facilities under two

noncancellable operating leases which expire beginning April 1, 1999. The leases

may be extended under specific renewal options at the then prevailing fair

market value rental rate.



Future minimum rental payments under noncancellable leases at December 31,

1996 were as follows:



<TABLE>

<CAPTION>

OPERATING       CAPITAL

----------     ----------

<S>                                                   <C>            <C>

Year Ending December 31:

1997..............................................  $  544,919     $1,211,192

1998..............................................     561,656        629,881

1999..............................................     208,087        668,073

2000..............................................      92,376        249,075

2001..............................................      92,376             --

Thereafter........................................     316,044             --

----------     ----------

Total minimum lease payments........................  $1,815,458      2,758,221

==========

Less amount representing interest...................                    481,950

----------

Present value of minimum capitalized lease

payments..........................................                 $2,276,271

==========

</TABLE>



Rent expense under operating leases for the years ended December 31, 1996,

1995 and 1994 was $432,335, $396,220 and $321,307, respectively.



9. EMPLOYEE RETIREMENT PLAN



The Company sponsors an Employee Retirement Plan in accordance with Section

401(k) of the Internal Revenue Code. All employees 21 years old or older are

eligible to participate in the plan. Contributions made into the plan are at the

discretion of the Company's Board of Directors. The Company incurred $81,364 of

expense in 1996 related to contributions to the plan. There were no

contributions to the plan made by the Company in 1995 or 1994.



10. INCOME TAXES



At December 31, 1996, the Company had net operating loss carryforwards of

$39,270,000 and research and experimental credit carryforwards of $1,074,000.

The carryforwards are available to offset future federal income taxes and begin

to expire in 2007. At December 31, 1996 and 1995, the Company provided a

valuation allowance to offset the excess of deferred tax assets over the

deferred tax liabilities due to the uncertainty of realizing the benefits of the

net deferred tax asset. The valuation allowance increased by $5,717,000 and

$3,350,000 during 1996 and 1995, respectively.



32

33



TARGETED GENETICS CORPORATION

(A DEVELOPMENT STAGE COMPANY)



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)



Significant components of the Company's deferred tax assets and liabilities

were as follows:



<TABLE>

<CAPTION>

DECEMBER 31,

--------------------------

1996            1995

-----------     ----------

<S>                                                  <C>             <C>

Deferred tax assets:

Net operating loss carryforwards.................  $13,352,000     $8,223,000

Research and experimental credit carryforwards...    1,074,000        817,000

Depreciation.....................................      401,000        156,000

Other............................................      140,000         54,000

-----------     ----------

Total deferred tax assets..........................  $14,967,000     $9,250,000

===========     ==========

Valuation allowance for deferred tax assets........  $14,967,000     $9,250,000

===========     ==========

</TABLE>



Utilization of federal income tax carry forwards is subject to certain

limitations under Section 382 of the Internal Revenue Code of 1986. The

Company's past sales of common stock have resulted in "ownership changes" as

defined under Section 382, resulting in limitations on the future use of carry

forwards. At December 31, 1996, the Company calculated its annual limitation to

be approximately $3,782,000. However, this annual limitation is not expected to

have a material adverse effect on the Company's utilization of its net operating

loss and research credit carryforwards.



33

34



REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS



The Board of Directors and Shareholders

Targeted Genetics Corporation



We have audited the accompanying consolidated balance sheets of Targeted

Genetics Corporation (a development stage company) as of December 31, 1996 and

1995, and the related consolidated statements of operations, shareholders'

equity, and cash flows for each of the three years in the period ended December

31, 1996 and the period from March 9, 1989 (date of inception) through December

31, 1996. These financial statements are the responsibility of the Company's

management. Our responsibility is to express an opinion on these financial

statements based on our audits.



We conducted our audits in accordance with generally accepted auditing

standards. Those standards require that we plan and perform the audit to obtain

reasonable assurance about whether the financial statements are free of material

misstatement. An audit includes examining, on a test basis, evidence supporting

the amounts and disclosures in the financial statements. An audit also includes

assessing the accounting principles used and significant estimates made by

management, as well as the overall financial statement presentation. We believe

that our audits provide a reasonable basis for our opinion.



In our opinion, the financial statements referred to above present fairly,

in all material respects, the consolidated financial position of Targeted

Genetics Corporation (a development stage company) at December 31, 1996 and

1995, and the consolidated results of its operations and its cash flows for each

of the three years in the period ended December 31, 1996 and the period from

March 9, 1989 (date of inception) through December 31, 1996 in conformity with

generally accepted accounting principles.



ERNST & YOUNG LLP



Seattle, Washington

February 7, 1997



34

35



ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND

FINANCIAL DISCLOSURE



Inapplicable.



PART III



ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF REGISTRANT



(a) The information required by this item concerning the Company's

directors is incorporated by reference from the section captioned "ELECTION OF

DIRECTORS" in the Company's definitive Proxy Statement for the annual meeting to

be held on May 7, 1997.



(b) The information required by this item concerning the Company's

executive officers is set forth in Part I of this Form 10-K.



ITEM 11. EXECUTIVE COMPENSATION



The information required by this item is incorporated by reference from the

section captioned "EXECUTIVE COMPENSATION" in the Company's definitive Proxy

Statement for the annual meeting to be held on May 7, 1997.



ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT



The information required by this item is incorporated by reference from the

section captioned "PRINCIPAL TARGETED GENETICS SHAREHOLDERS" in the Company's

definitive Proxy Statement for the annual meeting to be held on May 7, 1997.



ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS



Inapplicable.



PART IV



ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K



(a) 1. FINANCIAL STATEMENTS. The following Financial Statements are included

in Part II, Item 8.



<TABLE>

<CAPTION>

PAGE(S) IN

10-K

----------

<S>                                                                         <C>

Consolidated Balance Sheets at December 31, 1996 and 1995.................     24

Consolidated Statements of Operations for the years ended December 31,

1996, 1995, and 1994 and for the period from March 9, 1989 (date of

inception) through December 31, 1996....................................     25

Consolidated Statements of Shareholders' Equity for the period from March

9, 1989 (date of inception) through December 31, 1996...................   26 - 27

Consolidated Statements of Cash Flows for the years ended December 31,

1996, 1995, and 1994 and for the period from March 9, 1989 (date of

inception) through December 31, 1996....................................     28

Notes to Consolidated Financial Statements................................   29 - 36

Report of Ernst and Young LLP, Independent Auditors.......................     37

</TABLE>



35

36



2. FINANCIAL STATEMENT SCHEDULES



All financial statement schedules have been omitted because the required

information is either included in the financial statements or the notes thereto

or is not applicable.



3. EXHIBITS



<TABLE>

<S>        <C>                                                                      <C>

2.1       Agreement and Plan of Merger dated as of April 16, 1996, by and among

Targeted Genetics Corporation, TGC Acquisition Corporation and RGene

Therapeutics, Inc. (Exhibit 2.1)                                          (E)

3.1       Amended and Restated Articles of Incorporation

3.2       Amended and Restated Bylaws

4.1       Warrant to Purchase 11,000 shares of the Common Stock of Targeted

Genetics Corporation, issued to MMC/GATX Partnership No. 1 on December

27, 1993, as amended                                                      (D)

4.2       Warrant to Purchase 11,000 shares of the Common Stock of Targeted

Genetics Corporation, issued to LINC Capital Management, Ltd. on

December 27, 1993 (Exhibit 4.3)                                           (A)

4.3       Warrant to Purchase 18,701 shares of the Common Stock of Targeted

Genetics Corporation, issued to MMC/GATX Partnership No. 1 on November

30, 1994 (Exhibit 4.3)                                                    (B)

4.4       Warrant Agreement between Targeted Genetics Corporation and First

Interstate Bank of Washington, N.A., as Warrant Agent                     (D)

4.5       Specimen Warrant Certificate (Exhibit 4.5)                                (C)

4.6       Warrant to Purchase 21,315 shares of the common stock of Targeted

Genetics Corporation, issued to Financing for Science International,

Inc. on November 30, 1995                                                 (D)

4.7       Rights Agreement, dated as of October 17, 1996, between Targeted

Genetics Corporation and ChaseMellon Shareholder Services                 (H)

10.1       Form of Indemnification Agreement between the registrant and its

officers and directors (Exhibit 10.6)                                     (A)

10.2       Form of Senior Management Employment Agreement between the registrant

and its executive officers

10.3       Non-exclusive License Agreement, dated as of November 19, 1991, between

the Fred Hutchinson Cancer Research Center and Immunex Corporation*

(Exhibit 10.7)                                                            (A)

10.4       Gene Transfer Technology License Agreement, dates as of February 18,

1992, between Immunex Corporation and Targeted Genetics Corporation*

(Exhibit 10.8)                                                            (A)

10.5       License Agreement, dated as of June 1, 1992, between Wisconsin Alumni

Research Foundation and Targeted Genetics Corporation* (Exhibit 10.9)     (A)

10.6       License Agreement, dated as of August 14, 1992, between Leland Stanford

Junior University and Targeted Genetics Corporation* (Exhibit 10.10)      (A)

10.7       PHS Patent License Agreement -- Non-exclusive, dated as of July 13,

1993, between National Institutes of Health Centers for Disease Control

and Targeted Genetics Corporation* (Exhibit 10.13)                        (A)

10.8       Non-exclusive Patent License Agreement, dated as of December 25, 1993,

between The University of Florida Research Foundation, Inc. and

Targeted Genetics Corporation* (Exhibit 10.14)                            (A)

</TABLE>



36

37



<TABLE>

<S>        <C>                                                                      <C>

10.9       Research and Exclusive License Agreement, dated as of January 1, 1994,

between Targeted Genetics Corporation and the Fred Hutchinson Cancer

Research Center* (Exhibit 10.19)                                          (A)

10.10      PHS Patent License Agreement -- Exclusive, dated as of March 10, 1994,

between National Institutes of Health Centers for Disease Control and

Targeted Genetics Corporation* (Exhibit 10.15)                            (A)

10.11      Exclusive License Agreement, dated as of March 14, 1994, between

Medical College of Ohio and Targeted Genetics Corporation* (Exhibit

10.16)                                                                    (A)

10.12      License Agreement, dated as of March 16, 1994, between the Johns

Hopkins University and Targeted Genetics Corporation* (Exhibit 10.17)     (A)

10.13      License Agreement, dated as of March 28, 1994, between Targeted

Genetics Corporation and the University of Michigan* (Exhibit 10.18)      (A)

10.14      Exclusive License Agreement dated as of March 28, 1994, between the

Fred Hutchinson Cancer Research Center and Targeted Genetics

Corporation* (Exhibit 10.20)                                              (A)

10.15      Exclusive License Agreement, dated as of August 25, 1994, between

Targeted Genetics Corporation and the Fred Hutchinson Cancer Research

Center* (Exhibit 10.20)                                                   (B)

10.16      Development Agreement dated April 6, 1994, by and between Argus

Pharmaceuticals, Inc. and RGene Therapeutics, Inc.* (Exhibit 10.28)       (F)

10.17      Patent and Technology License Agreement effective as of March 1, 1994,

by and among the Board of Regents of the University of Texas M.D.

Anderson Cancer Center and RGene Therapeutics, Inc.* (Exhibit 10.29)      (F)

10.18      First Amended and Restated License Agreement effective October 12, 1995

between The University of Tennessee Research Corporation and RGene

Therapeutics, Inc.* (Exhibit 10.30)                                       (F)

10.19      Amendment to the First Amended and Restated License Agreement, between

The University of Tennessee Research Corporation and RGene

Therapeutics, Inc., dated as of June 19, 1996* (Exhibit 10.1)             (G)

10.20      Exclusive Sublicense Agreement effective July 23, 1996 by and between

Alkermes, Inc. and Targeted Genetics Corporation*

10.21      Revised License Agreement effective October 1, 1996, by and between the

University of Pittsburgh -- of the Commonwealth System of Higher

Education and Targeted Genetics Corporation*

10.22      Agreement dated as of May 28, 1996 by and between RGene Therapeutics,

Inc. and Laboratoires Fournier S.C.A.* (Exhibit 10.32)                    (F)

10.23      Olive Way Building Lease, dated as of November 20, 1993, between

Metropolitan Federal Savings and Loan Association and Targeted Genetics

Corporation (Exhibit 10.21)                                               (A)

10.24      First Amendment to Olive Way Building Lease, dated as of December 10,

1994, between Targeted Genetics Corporation and Metropolitan Federal

Savings and Loan Association (Exhibit 10.22)                              (B)

10.25      Second Amendment to Olive Way Building Lease, dated as of June 12,

1996, between Targeted Genetics Corporation and Ironwood Apartments,

Inc. (successor in interest to Metropolitan Federal Savings and Loan

Association)

10.26      Office Lease, dated as of October 7, 1996, by and between Benaroya

Capital Company, LLC and Targeted Genetics Corporation

</TABLE>



37

38



<TABLE>

<S>        <C>                                                                      <C>

10.27      MMC/GATX Partnership No. 1 Equipment Lease Agreement, dated as of

December 27, 1993 (Exhibit 10.22)                                         (A)

10.28      LINC Capital Management, Ltd. Equipment Lease Agreement, dated as of

December 27, 1993 (Exhibit 10.23)                                         (A)

10.29      Loan and Security Agreement, dated as of November 30, 1994, between

MMC/GATX Partnership No. 1 and Targeted Genetics Corporation (Exhibit

10.25)                                                                    (B)

10.30      Master Equipment Lease Agreement, dated as of October 17, 1995, between

Financing for Science International, Inc. and Targeted Genetics

Corporation                                                               (D)

10.31      Registration Rights Agreement dated as of April 27, 1992, among

Targeted Genetics Corporation and the holders of Series A and Series B

Convertible Preferred Stock (Exhibit 10.26)                               (A)

10.32      1992 Restated Stock Option Plan

10.33      Stock Option Plan for Nonemployee Directors

11.1       Computation of net loss per share

23.1       Consent of Ernst & Young LLP

27.1       Financial Data Schedule

</TABLE>



- ---------------



*   Confidential treatment has been granted by or requested from the Securities

and Exchange Commission for portions of these exhibits.



(A) Incorporated by reference to the designated exhibit included with the

Company's Form S-1 Registration Statement (No. 33-77054) filed on March 30,

1994, as amended.



(B) Incorporated by reference to the designated exhibit included with the

Company's Annual Report on Form 10-K for the year ended December 31, 1994.



(C) Incorporated by reference to the designated exhibit included with the

Company's Form S-1 Registration Statement (No. 33-91500) filed on April 24,

1995, as amended.



(D) Incorporated by reference to the designated exhibit included with the

Company's Annual Report on Form 10-K for the year ended December 31, 1995.



(E) Incorporated by reference to the designated exhibit included with the

Company's Form 8-K filed April 16, 1996.



(F) Incorporated by reference to the designated exhibit included with the

Company's Form S-1 Registration Statement (No. 333-03592) filed on April 16,

1996, as amended.



(G) Incorporated by reference to the designated exhibit included with the

Company's Quarterly Report on Form 10-Q for the period ended June 30, 1996.



(H) Incorporated by reference to the designated exhibit included with the

Company's Form 8-A filed October 22, 1996.



(b) REPORTS ON FORM 8-K



A Current Report on Form 8-K dated October 18, 1996 was filed with the

Securities and Exchange Commission reporting that Targeted Genetics Corporation

had adopted a Shareholder Rights Agreement.



38

39

SIGNATURES



Pursuant to the requirements of Section 13 or 15(d) 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.



<TABLE>

<S>                                           <C>

TARGETED GENETICS CORPORATION



By:   /s/ H. STEWART PARKER                   Date: March 10, 1997

-------------------------------------

H. Stewart Parker,

President and Chief Executive Officer

</TABLE>



Pursuant to the requirements of the Securities Exchange Act of 1934, this

report has been signed below by the following persons on behalf of the

registrant and in the capacities and on the dates indicated.



<TABLE>

<CAPTION>

SIGNATURE                         TITLE                     DATE

---------                         -----                     ----



<S>                                 <C>                            <C>



/s/ H. STEWART PARKER              President and Chief         March 10, 1997

- -------------------------------   Executive Officer, Director

H. Stewart Parker              (Principal Executive

Officer)



/s/ JAMES A. JOHNSON           Vice President, Finance,      March 10, 1997

- -------------------------------    Chief Financial Officer,

James A. Johnson              Treasurer and Secretary

(Principal Financial and

Accounting Officer)



/s/ JEREMY L. CURNOCK COOK               Director               March 11, 1977

- -------------------------------

Jeremy L. Curnock Cook



/s/ STEPHEN A. DUZAN                 Director               March 7, 1997

- -------------------------------

Stephen A. Duzan



/s/ JAMES D. GRANT                   Director               March 7, 1997

- -------------------------------

James D. Grant



/s/ AUSTIN M. LONG III                 Director

- -------------------------------

Austin M. Long III



/s/ DONALD E. O'NEILL                  Director               March 7, 1997

- -------------------------------

Donald E. O'Neill



/s/ MARK RICHMOND, PH.D.               Director               March 7, 1997

- -------------------------------

Mark Richmond, Ph.D.



/s/ MARTIN P. SUTTER                 Director               March 6, 1997

- -------------------------------

(Martin P. Sutter)

</TABLE>



39

40



EXHIBIT INDEX



<TABLE>

<S>        <C>                                                                      <C>

2.1       Agreement and Plan of Merger dated as of April 16, 1996, by and among

Targeted Genetics Corporation, TGC Acquisition Corporation and RGene

Therapeutics, Inc. (Exhibit 2.1)                                          (E)

3.1       Amended and Restated Articles of Incorporation

3.2       Amended and Restated Bylaws

4.1       Warrant to Purchase 11,000 shares of the Common Stock of Targeted

Genetics Corporation, issued to MMC/GATX Partnership No. 1 on December

27, 1993, as amended                                                      (D)

4.2       Warrant to Purchase 11,000 shares of the Common Stock of Targeted

Genetics Corporation, issued to LINC Capital Management, Ltd. on

December 27, 1993 (Exhibit 4.3)                                           (A)

4.3       Warrant to Purchase 18,701 shares of the Common Stock of Targeted

Genetics Corporation, issued to MMC/GATX Partnership No. 1 on November

30, 1994 (Exhibit 4.3)                                                    (B)

4.4       Warrant Agreement between Targeted Genetics Corporation and First

Interstate Bank of Washington, N.A., as Warrant Agent                     (D)

4.5       Specimen Warrant Certificate (Exhibit 4.5)                                (C)

4.6       Warrant to Purchase 21,315 shares of the common stock of Targeted

Genetics Corporation, issued to Financing for Science International,

Inc. on November 30, 1995                                                 (D)

4.7       Rights Agreement, dated as of October 17, 1996, between Targeted

Genetics Corporation and ChaseMellon Shareholder Services                 (H)

10.1       Form of Indemnification Agreement between the registrant and its

officers and directors (Exhibit 10.6)                                     (A)

10.2       Form of Senior Management Employment Agreement between the registrant

and its executive officers

10.3       Non-exclusive License Agreement, dated as of November 19, 1991, between

the Fred Hutchinson Cancer Research Center and Immunex Corporation*

(Exhibit 10.7)                                                            (A)

10.4       Gene Transfer Technology License Agreement, dates as of February 18,

1992, between Immunex Corporation and Targeted Genetics Corporation*

(Exhibit 10.8)                                                            (A)

10.5       License Agreement, dated as of June 1, 1992, between Wisconsin Alumni

Research Foundation and Targeted Genetics Corporation* (Exhibit 10.9)     (A)

10.6       License Agreement, dated as of August 14, 1992, between Leland Stanford

Junior University and Targeted Genetics Corporation* (Exhibit 10.10)      (A)

10.7       PHS Patent License Agreement -- Non-exclusive, dated as of July 13,

1993, between National Institutes of Health Centers for Disease Control

and Targeted Genetics Corporation* (Exhibit 10.13)                        (A)

10.8       Non-exclusive Patent License Agreement, dated as of December 25, 1993,

between The University of Florida Research Foundation, Inc. and

Targeted Genetics Corporation* (Exhibit 10.14)                            (A)

10.9       Research and Exclusive License Agreement, dated as of January 1, 1994,

between Targeted Genetics Corporation and the Fred Hutchinson Cancer

Research Center* (Exhibit 10.19)                                          (A)

</TABLE>



40

41



<TABLE>

<S>        <C>                                                                      <C>

10.10      PHS Patent License Agreement -- Exclusive, dated as of March 10, 1994,

between National Institutes of Health Centers for Disease Control and

Targeted Genetics Corporation* (Exhibit 10.15)                            (A)

10.11      Exclusive License Agreement, dated as of March 14, 1994, between

Medical College of Ohio and Targeted Genetics Corporation* (Exhibit

10.16)                                                                    (A)

10.12      License Agreement, dated as of March 16, 1994, between the Johns

Hopkins University and Targeted Genetics Corporation* (Exhibit 10.17)     (A)

10.13      License Agreement, dated as of March 28, 1994, between Targeted

Genetics Corporation and the University of Michigan* (Exhibit 10.18)      (A)

10.14      Exclusive License Agreement dated as of March 28, 1994, between the

Fred Hutchinson Cancer Research Center and Targeted Genetics

Corporation* (Exhibit 10.20)                                              (A)

10.15      Exclusive License Agreement, dated as of August 25, 1994, between

Targeted Genetics Corporation and the Fred Hutchinson Cancer Research

Center* (Exhibit 10.20)                                                   (B)

10.16      Development Agreement dated April 6, 1994, by and between Argus

Pharmaceuticals, Inc. and RGene Therapeutics, Inc.* (Exhibit 10.28)       (F)

10.17      Patent and Technology License Agreement effective as of March 1, 1994,

by and among the Board of Regents of the University of Texas M.D.

Anderson Cancer Center and RGene Therapeutics, Inc.* (Exhibit 10.29)      (F)

10.18      First Amended and Restated License Agreement effective October 12, 1995

between The University of Tennessee Research Corporation and RGene

Therapeutics, Inc.* (Exhibit 10.30)                                       (F)

10.19      Amendment to the First Amended and Restated License Agreement, between

The University of Tennessee Research Corporation and RGene

Therapeutics, Inc., dated as of June 19, 1996* (Exhibit 10.1)             (G)

10.20      Exclusive Sublicense Agreement effective July 23, 1996 by and between

Alkermes, Inc. and Targeted Genetics Corporation*

10.21      Revised License Agreement effective October 1, 1996, by and between the

University of Pittsburgh -- of the Commonwealth System of Higher

Education and Targeted Genetics Corporation*

10.22      Agreement dated as of May 28, 1996 by and between RGene Therapeutics,

Inc. and Laboratoires Fournier S.C.A.* (Exhibit 10.32)                    (F)

10.23      Olive Way Building Lease, dated as of November 20, 1993, between

Metropolitan Federal Savings and Loan Association and Targeted Genetics

Corporation (Exhibit 10.21)                                               (A)

10.24      First Amendment to Olive Way Building Lease, dated as of December 10,

1994, between Targeted Genetics Corporation and Metropolitan Federal

Savings and Loan Association (Exhibit 10.22)                              (B)

10.25      Second Amendment to Olive Way Building Lease, dated as of June 12,

1996, between Targeted Genetics Corporation and Ironwood Apartments,

Inc. (successor in interest to Metropolitan Federal Savings and Loan

Association)

10.26      Office Lease, dated as of October 7, 1996, by and between Benaroya

Capital Company, LLC and Targeted Genetics Corporation

10.27      MMC/GATX Partnership No. 1 Equipment Lease Agreement, dated as of

December 27, 1993 (Exhibit 10.22)                                         (A)

10.28      LINC Capital Management, Ltd. Equipment Lease Agreement, dated as of

December 27, 1993 (Exhibit 10.23)                                         (A)

</TABLE>



41

42



<TABLE>

<S>        <C>                                                                      <C>

10.29      Loan and Security Agreement, dated as of November 30, 1994, between

MMC/GATX Partnership No. 1 and Targeted Genetics Corporation (Exhibit

10.25)                                                                    (B)

10.30      Master Equipment Lease Agreement, dated as of October 17, 1995, between

Financing for Science International, Inc. and Targeted Genetics

Corporation                                                               (D)

10.31      Registration Rights Agreement dated as of April 27, 1992, among

Targeted Genetics Corporation and the holders of Series A and Series B

Convertible Preferred Stock (Exhibit 10.26)                               (A)

10.32      1992 Restated Stock Option Plan

10.33      Stock Option Plan for Nonemployee Directors

11.1       Computation of net loss per share

23.1       Consent of Ernst & Young LLP

27.1       Financial Data Schedule

</TABLE>



- ---------------



*   Confidential treatment has been granted by or requested from the Securities

and Exchange Commission for portions of these exhibits.



(A) Incorporated by reference to the designated exhibit included with the

Company's Form S-1 Registration Statement (No. 33-77054) filed on March 30,

1994, as amended.



(B) Incorporated by reference to the designated exhibit included with the

Company's Annual Report on Form 10-K for the year ended December 31, 1994.



(C) Incorporated by reference to the designated exhibit included with the

Company's Form S-1 Registration Statement (No. 33-91500) filed on April 24,

1995, as amended.



(D) Incorporated by reference to the designated exhibit included with the

Company's Annual Report on Form 10-K for the year ended December 31, 1995.



(E) Incorporated by reference to the designated exhibit included with the

Company's Form 8-K filed April 16, 1996.



(F) Incorporated by reference to the designated exhibit included with the

Company's Form S-1 Registration Statement (No. 333-03592) filed on April 16,

1996, as amended.



(G) Incorporated by reference to the designated exhibit included with the

Company's Quarterly Report on Form 10-Q for the period ended June 30, 1996.



(H) Incorporated by reference to the designated exhibit included with the

Company's Form 8-A filed October 22, 1996.



(b) REPORTS ON FORM 8-K



A Current Report on Form 8-K dated October 18, 1996 was filed with the

Securities and Exchange Commission reporting that Targeted Genetics Corporation

had adopted a Shareholder Rights Agreement.



42