At Targeted Genetics, we have always focused on developing therapeutic products and vaccines for serious diseases in which treatment options are limited or unavailable. Maintaining this perspective throughout 2006 was a catalyst for achieving numerous milestones in our product development programs, collaborations and corporate development efforts. Specifically, we continued to demonstrate the power and flexibility of our adeno-associated virus (AAV) technology platform to enable new treatment approaches to diseases with substantial markets and tremendous medical need. As a result of our focus and execution, we have a robust development pipeline and have never been more excited about the opportunities ahead of us.

Focusing On Clinical Development

We made substantial progress in our two clinical development programs: tgAAC94 for the treatment of inflammatory arthritis and tgAAC09, a vaccine for HIV/AIDS. These product candidates are being evaluated for the treatment or prevention of diseases that drastically reduce patient quality of life. We believe that each of these programs has the potential to change the treatment or prevention of the diseases they target, improving patient outcomes.

tgAAC94 for Inflammatory Arthritis
The American College of Rheumatology and the Centers for Disease Control and Prevention (CDC) estimate that 2-3 million people in the United States are living with inflammatory arthritis. We are developing tgAAC94 as a potential supplement to systemic TNF-a therapy in patients with inflammatory arthritis who have one or more joints that do not respond to systemic treatment. This exciting product candidate uses our AAV vector technology to deliver a DNA sequence that encodes a soluble form of the TNF-a receptor (TNFR:Fc). Soluble TNFR inhibits the inflammatory activity of TNF-a. Direct injection of tgAAC94 into affected joints leads to the localized production of soluble TNFR, reducing the activity of TNF-a within the joint and, potentially, leading to a decrease in the signs and symptoms of inflammatory disease and inhibition of joint destruction.

In March 2006, we received approval from the U.S. Food and Drug Administration to amend the clinical protocol of our ongoing Phase I trial of tgAAC94 in patients with inflammatory arthritis to include a higher dose and increase the number of patients targeted for enrollment. Importantly, the amendment of the protocol also supported a change in the designated development status of the trial for Phase I to Phase I/II. We believe that the amended protocol will shorten the timeline to generating data that establish efficacy of this approach and enable the design and initiation of later-stage trials.

Over the course of 2006, we presented interim data from this Phase I/II trial at three scientific conferences. The most recent data, which were presented in November 2006 at the American College of Rheumatology Annual Meeting, support the safety and tolerability of intra-articular administration of tgAAC94 to affected joints and suggest that tgAAC94 may lead to a decrease in signs and symptoms of arthritis. Importantly, these decreases were observed in patients who were taking concurrent systemic TNF-a antagonist therapies as well as those who were not. This finding is significant because many patients with inflammatory arthritis fail to achieve sufficient disease control in one or more joints and continue to experience pain and discomfort despite treatment. It is anticipated that the enrollment of all 120 subjects in the study will be completed in the next few months, and we plan to present additional interim data at multiple scientific venues during 2007.

tgAAC94 is designed as a localized therapy that increases the amount and duration of TNF-a inhibition in the problem joint to improve response and decrease the possibility that the inflammation will lead to destruction processes. We believe that the successful commercialization of this first-ever gene therapeutic for inflammatory arthritis will enable individualized treatments that combine systemic and local therapy to achieve the best outcome possible for each patient. This has the potential to improve significantly the treatment of millions of arthritis patients.

Even as we advance tgAAC94 in the clinic, we continue to optimize and build on our inflammatory arthritis product development platform. tgAAC94 is based upon AAV serotype 2. In June 2006, we reported preclinical data demonstrating that delivery of the gene that encodes soluble TNFR with a vector based on AAV serotype 1 (AAV1) resulted in potent anti-inflammatory effects. AAV1 vectors have been shown to deliver genes to muscle cells with high efficiency and to support expression and secretion of proteins produced from those genes into the blood stream. We believe that intramuscular administration of AAV vectors may provide a new paradigm for systemic treatment of inflammatory arthritis. If successful, this approach could significantly expand the market opportunity for AAV-based therapies for inflammatory arthritis.

tgAAC09 for HIV/AIDS
HIV/AIDS is one of the most devastating diseases of our time. Although new drug
therapies have increased the length and quality of life for HIV positive individuals, a safe and effective preventive vaccine is critical to stemming the pandemic, particularly in the developing world where access to these drugs remains limited. We are proud to be collaborating with multiple not-for-profit, government and academic organizations to bring the power of our AAV platform to bear on the global HIV/AIDS crisis.

tgAAC09 is a vaccine candidate that utilizes an AAV vector to deliver genes that encode HIV proteins. The vaccine is designed to stimulate both antibody and cell-mediated immune responses against HIV, and is intended to protect people uninfected with HIV from contracting the disease.

A Phase II clinical trial of tgAAC09 is ongoing in Southern Africa, and parallel trials were initiated in Uganda and Zambia in the first half of 2006. These trials demonstrate how international collaboration is critical to addressing and solving global health challenges.

Toward this end, we revised a collaboration and license agreement with the International AIDS Vaccine Initiative (IAVI), Children’s Hospital of Philadelphia (CHOP) and Columbus Children’s Research Institute (CCRI) in support of the development and commercialization of HIV/AIDS vaccines for the developing world. The revised agreement recognizes the substantial progress that we have made in the development of tgAAC09 and reflects the potential of AAV-based vaccines for HIV/AIDS. IAVI has provided significant funding for our HIV vaccine program and we look forward to their ongoing support as we work together to develop a safe and effective vaccine for this devastating disease.

We also made progress during 2006 in our Phase I trial of tgAAC09, which was
conducted in Europe and India. The Phase I study was designed to assess safety and immune responses following a single injection of tgAAC09 in healthy volunteers who are uninfected with HIV. Data from this trial were most recently reported in early 2007 at the 14th Conference on Retroviruses and Opportunistic Infections. The results covered 80 healthy volunteers in Europe and India who received a single intramuscular injection of tgAAC09 at different doses. Additionally, 21 of the 50 European volunteers received a booster vaccination of either tgAAC09 at the highest dose tested, or placebo.

The data showed that tgAAC09 appears to be safe and well tolerated and stimulated
a modest cellular immune response against gag, the principal HIV protein encoded by the vaccine. HIV-specific T-cell responses were observed in 20 percent of participants receiving the highest dose of tgAAC09 tested. Based on the dose-response correlation observed in this trial, it is our hope that higher doses may enhance the vigor of the immune response elicited by tgAAC09. We intend to conduct additional studies of tgAAC09 and other AAV-based vaccines using alternative HIV serotypes or gene sequences, in order to identify the most effective way forward to commercialization.

Expanding Our Leadership in
AAV-Based Product Development
Our leadership in the innovation, development and manufacture of AAV-based product candidates gives us diverse opportunities to create value for patients and for our investors. The safety and broad utility of our AAV vectors opens the door to developing new approaches to protein therapy, novel vaccines and first-in-class therapies focused on disease targets that have not been amenable to pharmaceutical intervention. Key to building, maintaining and expanding our leadership in all areas of AAV-based product development is our broad portfolio of intellectual property.

In 2006, we enhanced our portfolio of AAV-related intellectual property through the issuance of numerous additional U.S. patents. These patents cover multiple aspects of our proprietary AAV vector manufacturing process, our AAV1 platform and, of particular significance, the delivery of expressed ribonucleic acid (RNA). This last patent is important because it covers the use of AAV to deliver RNA therapeutics, such as those for RNA interference (RNAi).

The field of RNAi has shown great promise in treating diverse diseases, but the
practical application of the technology has been limited by the ability to deliver RNA molecules to inhibit disease in target tissues. A growing body of data generated by us, our corporate collaborators and numerous academic investigators demonstrate that AAV delivery of RNAi produces therapeutic effects in multiple disease models. Our collaboration with Sirna Therapeutics, for the development of an AAV-RNAi based therapy for Huntington’s disease, is our first effort in this area, and we believe that the growth and advancement of RNAi-based therapies will create significant opportunities for us.

AAV1 patents issued in 2006 and early 2007 cover both AAV1 serotype and AAV1 pseudotyped vectors and have direct application to our inflammatory arthritis and HIV vaccine programs. Significantly, the ability of AAV1 vectors to support expression and secretion for up to a year after gene delivery may open the door to developing a number of next-generation versions of protein therapies that are currently used to treat a variety of chronic diseases. These product opportunities could provide us with substantial market potential.

In 2006, we leveraged the value of our AAV patent portfolio to create additional revenue opportunities by entering into a non-exclusive sublicense agreement for two AAV1-related patents. Under this contract, we received a significant licensing fee and will receive potential milestone payments and royalties on the sale of any products commercialized using the licensed technology.

Managing Our Resources For Success
We recognize that achieving our objectives and realizing our potential requires disciplined management of our financial and intellectual resources. In 2006, we took a number of steps intended to reduce our burn rate and realign our resources around the advancement of tgAAC94 through clinical trials as quickly as possible. In addition to restructuring our organization to reduce expenses, we amended our agreement with Biogen Idec, Inc. to exchange $5.65 million of debt for one million shares of Targeted Genetics common stock and to modify the payment schedule for the remaining debt. Furthermore, we improved our overall equity structure through a reverse stock split. We also raised additional capital in the equity markets, bringing in $5 million in 2006 and another $8.7 million in January of 2007. As we move forward, we intend to continue to scrutinize our cash position and leverage the value of our programs and patents to generate additional revenue.

Maintaining Our Perspective
We have a clear set of objectives for 2007. Advancing tgAAC94 through the clinic remains a top priority, and we will continue to provide clinical updates of our progress throughout the year. These data will provide the foundation for future clinical trials and potential collaboration opportunities. We are working hard to deliver on the promise of our current partnerships in the areas of HIV/AIDS, congestive heart failure (CHF) and Huntington’s disease. In our HIV vaccine program, we expect to report Phase II clinical data from the ongoing trials of tgAAC09. We also intend to continue preclinical evaluation of a variety of vaccine candidates for use in the developed world. This work is funded by a five-year, $22 million contract awarded by the National Institute of Allergy and Infectious Diseases to CCRI in collaboration with CHOP and us.

In our CHF collaboration with Celladon, we plan to begin a Phase I clinical trial of MYDICAR™ (AAV1/SERCA2a) in patients with cardiomyopathy and symptoms of heart failure in the first half of 2007. MYDICAR utilizes an AAV1 vector to deliver the SERCA2a gene to heart muscle tissue. Previous studies have shown that SERCA2a activity is decreased in heart tissue obtained from heart failure patients and that delivery of the SERCA2a gene can improve cardiac contractility in animal models of heart failure.

We also will continue working with Sirna/Merck on the preclinical development of an AAV-based RNAi therapeutic candidate for the treatment of Huntington’s disease. Our goal is to find a promising therapeutic construct this year in order to advance this program into the clinic in 2008.

From our perspective, we see tremendous promise on the horizon, and we will focus much of our energy in 2007 on making the most of our potential. We are pursuing additional product opportunities that complement our existing capabilities in the area of inflammatory arthritis. In keeping with our practice of leveraging and monetizing the investments that we have made in our AAV-related infrastructure, we also will seek additional AAV partnering arrangements, as well as strategic relationships that create additional value for our shareholders.

These are exciting times for our company. Everyone at Targeted Genetics is committed to maintaining our perspective, seeing the path toward success and continuing to make progress toward our goals. We thank you for your continued support.

   H. Stewart Parker
   President and CEO
   Targeted Genetics Corporation