Edgar Filing: CHIRON CORP

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-K

FOR ANNUAL AND TRANSITION REPORTS PURSUANT TO SECTIONS 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

(Mark one)

x ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934.

For the fiscal year ended December 31, 2004

o TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934.

For the transition period from to

Commission File Number: 0-12798

CHIRON CORPORATION

(Exact name of registrant as specified in its charter)

Delaware	94-2754624
(State or other jurisdiction of incorporation or organization)	(I.R.S. Employer Identification No.)
4560 Horton Street, Emeryville, California	94608
(Address of principal executive offices)	(Zip code)

(510) 655-8730

(Registrant’s telephone number, including area code)

Not Applicable

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

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

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

Common Stock, $0.01 Par Value
Warrant to Purchase Common Stock, $0.01 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: o

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K 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. o

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act). Yes: x No: o

The aggregate market value of the voting and non-voting stock held by non-affiliates of the registrant, based upon the closing price of Common Stock on June 30, 2004 as reported on the NASDAQ National Market, was approximately $3.7 billion. Shares of Common Stock held by each executive officer and director and by each shareholder whose beneficial ownership exceeds 5% of the outstanding Common Stock at June 30, 2004 have been excluded in that such persons may be deemed to be affiliates. This determination of affiliate status is not necessarily a conclusive determination for other purposes.

The aggregate market value of voting and non-voting stock held by non-affiliates of the registrant as of January 31, 2005 was $2.7 billion. The number of shares outstanding of each of the registrant’s classes of common stock as of January 31, 2005:

Title of Class		Number of shares
Common Stock, $0.01 par value		187,069,957

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the Proxy Statement to be filed in connection with the solicitation of proxies for the Annual Meeting of Stockholders to be held on May 26, 2005 are incorporated by reference into Part III of this Report.

PART I

ITEM 1. BUSINESS

Our Policy on Forward-Looking Statements

This 10-K contains forward-looking statements regarding our expectations, hopes or intentions regarding the future, including statements relating to sales growth, product development initiatives, new product marketing, acquisitions, competition, and licensing activities that involve risks and uncertainties and are subject to change. The forward-looking statements contained in this 10-K reflect our current expectations on the date of this 10-K. Actual results, performance or outcomes may differ materially from current expectations. Our actual performance may differ from current expectations due to many factors, including additional adverse developments resulting from the suspension from October 5, 2004 through March 2, 2005 of Chiron’s UK license to manufacture FLUVIRIN® influenza virus vaccine, the announcement of such suspension and the litigation and investigations relating to these matters, the outcome of clinical trials, regulatory review and approvals, manufacturing capabilities, intellectual property protections and defenses, stock price and marketing effectiveness. In particular, there can be no assurance that we will increase sales of existing products, successfully develop and receive approval to market new products, or achieve market acceptance for such new products. No assurances can be given that additional issues with respect to FLUVIRIN® vaccine or Chiron’s manufacturing generally will not arise in the future, or that we will successfully address matters raised in a warning letter from the U.S. Food and Drug Administration with respect to our FLUVIRIN vaccine manufacturing facilities. There can be no assurance that our out-licensing activity will generate significant revenue, or that our in-licensing activities will fully protect us from claims of infringement by third parties. In addition, we may engage in business opportunities, the successful completion of which is subject to certain risks, including approval by Novartis, regulatory approvals and the integration of operations. We have discussed the important factors that we believe could cause actual results to differ from what is expressed in the forward-looking statements, in Part II, Item 7, of this 10-K, “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” under the caption “Factors That May Affect Future Results.” We do not undertake an obligation to update the forward-looking information contained in this 10-K.

Overview

We are a global biopharmaceutical company that participates in three healthcare markets: blood testing, vaccines, and biopharmaceuticals. Our revenues, which totaled $1.7 billion in 2004, consist of product sales, revenues from a joint business contractual arrangement, collaborative agreement revenues, royalty and license fee revenues and other revenues, primarily consisting of contract manufacturing and grant revenues. Our research and development efforts are focused on developing products for oncology and infectious and pulmonary disease.

Blood Testing

Our blood-testing segment is dedicated to preventing the spread of infectious diseases through the development and sale of novel blood-screening assays and equipment that protect the world’s blood supply. Our blood-testing segment, which reported total revenues of $494.1 million in 2004, is a world leader in nucleic acid testing, or NAT, blood screening with leading market share in the U.S, a strong presence in Europe, and sales in Asia. The segment also generates revenues from a joint business contractual arrangement, a collaboration agreement, royalties and license fees.

Our blood-testing segment consists of two separate collaborations: an alliance with Gen-Probe Incorporated for NAT products, and a joint business contractual arrangement with Ortho-Clinical Diagnostics for immunodiagnostic products. Our collaboration with Gen-Probe was formed in 1998 and is focused on developing and commercializing NAT products to screen donated blood, plasma, organs and

tissue for viral infection. We sell the collaboration’s assays and instruments to blood banks under the PROCLEIX® brand name. Our joint business contractual arrangement with Ortho-Clinical Diagnostics was formed in 1989 to develop and sell immunodiagnostic tests to detect retroviruses and hepatitis viruses in blood. Ortho-Clinical Diagnostics manufactures and sells the assays and instrument systems. Our blood-testing segment also earns royalties and license fees from third parties based on their sales of immunodiagnostic and nucleic acid testing probe diagnostic products utilizing our hepatitis C virus and HIV-related patents, for use in blood screening and plasma fractionation markets.

Research and development is focused on programs to improve blood safety, including the development of ZymeQuest’s enzyme conversion system that converts groups A, B and AB red blood cells to enzyme-converted universal blood group O, and the development of an assay for variant Creutzfeldt-Jakob disease (vCJD).

Vaccines

Our vaccines segment is the fifth largest vaccines business in the world with net product sales of $479.0 million in 2004. We offer more than 20 pediatric and adult vaccines including influenza, meningococcal, travel and pediatric vaccines. These vaccines have protected millions of people globally from potentially fatal diseases such as polio, measles and meningococcal disease. We market our vaccines primarily in the United States, Germany, Italy and the United Kingdom.

Our heritage in vaccines is traced to the three European manufacturers we acquired over the past two decades, all of which were founded 100 or more years ago: Italy-based Sclavo was acquired in 1992, Germany-based Behring was acquired in 1998 and United Kingdom-based PowderJect Pharmaceutical plc, or PowderJect, was acquired in July 2003. We acquired a number of vaccines including FLUVIRIN® influenza vaccine as part of our acquisition of PowderJect.

As discussed in Item 7 of this report on Form 10-K, “Management’s Discussion and Analysis of Financial Condition and Results of Operations”, on October 5, 2004 the MHRA prohibited us from releasing any FLUVIRIN vaccine doses manufactured at our Liverpool facility since March 2, 2004 and suspended our license to manufacture influenza virus vaccine in our Liverpool facility from October 5, 2004 through March 2, 2005. In addition, following the MHRA’s decision and an inspection by the FDA, the FDA sent us a warning letter on December 9, 2004 citing violations of good manufacturing practices. We provided the FDA with a written response to the warning letter on January 7, 2005. In a subsequent letter to us, the FDA stated that our responses appear to be adequate, but that implementation and effectiveness of our corrective actions and overall compliance would be evaluated in a subsequent inspection. As a result of the suspension of our license, we did not release any FLUVIRIN vaccine product during the 2004-2005 influenza season. On March 2, 2005, the MHRA notified us that it had lifted the suspension of our license to manufacture FLUVIRIN vaccine at our Liverpool facility, effective March 2, 2005, giving Chiron clearance to initiate full production of FLUVIRIN vaccine, conditioned on the understanding that Chiron’s commitment to its remediation plan will continue. The FDA is still expecting to conduct a full inspection to determine whether deficiencies noted in its warning letter have been resolved. If we fail to adequately address the matters discussed in the warning letter, the FDA may modify our U.S. license in an adverse manner, take action that could result in the imposition of fines, require temporary or permanent cessation of future selling of FLUVIRIN vaccine or take other action that could reduce our ability to market FLUVIRIN vaccine. For additional information concerning the risks we continue to face as a result of these events relating to FLUVIRIN vaccine, see Item 7 of this Report on Form 10-K—”Factors That May Affect Future Results—The recent developments with respect to FLUVIRIN vaccine will harm our business and results of operations.” For additional information on litigation and investigations relating to the FLUVIRIN vaccine developments, see Part I, Item 3. “Legal Proceedings” of this Report on Form 10-K.

Biopharmaceuticals

Our biopharmaceuticals segment discovers, develops, manufactures and markets a range of therapeutic products for cancer and infectious and pulmonary disease. The biopharmaceutical segment, which includes both product sales and royalties, reported net product sales and BETAFERON® interferon beta-1b royalties of $563.3 million for the year 2004. Our marketed products include TOBI® tobramycin solution for inhalation for pseudomonal lung infections in cystic fibrosis patients; PROLEUKIN® (aldesleukin) for injection for metastatic melanoma and renal cell carcinoma; and BETASERON® (interferon beta-1b) for SC injection for multiple sclerosis. In 2004, we filed for marketing approval for two additional products: PULMINIQ™ (cyclosporine, USP) inhalation solution for the increase in survival and prevention of chronic rejection in patients receiving allogeneic lung transplants, in combination with standard immunosuppressive therapy, and CUBICIN® (daptomycin for injection) for complicated skin and soft tissue infections. Research and development efforts include advancing clinical programs and product improvements in oncology and pulmonary and infectious disease, including the use of PROLEUKIN aldesleukin to enhance the benefit of monoclonal antibodies in cancer treatment, the development of new formulations of TOBI solution and the clinical advancement of tifacogin for treatment of severe community-acquired pneumonia, CHIR-258, a growth factor kinase inhibitor, and CHIR-12.12, a monoclonal antibody.

Royalties and License Fee Revenue

We earn royalty and license fee revenue in all three segments by licensing some of our key intellectual property in areas such as hepatitis C and HIV. In addition, we generate royalties through agreements with development and marketing partners, including royalties from Schering AG’s sales of BETAFERON® (interferon beta-1b) for SC injection in Europe. Some royalties and license fees are not considered to be associated with any particular business segment and are recorded separately in the segment data as Other Royalty and License Fee Revenues. Financial information for the reportable segments is included in Note 18, “Segment Information” of Notes to Consolidated Financial Statements.

We were incorporated in California in 1981 and merged into a Delaware corporation in November 1986. Our principal executive offices are located at 4560 Horton Street, Emeryville, California 94608, and our main telephone number is (510) 655-8730.

Product Descriptions

Blood Testing

Our collaboration with Gen-Probe is focused on developing and commercializing NAT products using transcription-mediated amplification, or TMA, technology to screen donated blood, plasma, organs and tissue for viral infection. Compared to immunodiagnostic testing, where infection is determined by the presence of antibodies, testing directly for the presence of viral nucleic acids improves the sensitivity of testing and enables infection to be detected earlier than with previously approved technologies.

We sell assays and instrumentation under the PROCLEIX® brand name, and Gen-Probe receives a percentage of our sales revenues. Under the terms of the collaboration agreement, Gen-Probe performs certain product development and manufacturing functions, while Chiron and Gen-Probe jointly participate in new assay and instrument research and development.

Assays developed with Gen-Probe, and their status in the United States and the rest of world include:

	U.S.	Ex-U.S.
PROCLEIX® HIV-1/HCV	Marketed	Marketed
PROCLEIX® ULTRIO™ (HIV-1, HCV, and HBV test)	Biologics License Application filed	Marketed
PROCLEIX® West Nile Virus	Investigational-only use; Biologics License Application filed	N/A

The PROCLEIX® HIV-1/HCV Assay is a NAT product that was co-developed with Gen-Probe for the simultaneous detection of HIV-1 and hepatitis C virus (HCV) in plasma, whole blood, organs and tissue donations. The global need for HIV-1 and HCV testing continues to increase. In 2004 approximately 5 million people acquired HIV, bringing the number of people in the world living with HIV to 39 million, the highest level ever. In 2004, approximately 3 million died from AIDS, the disease caused by HIV-1 or HIV-2 infection. HCV is a major cause of acute hepatitis and chronic liver disease, including cirrhosis and liver cancer. Globally, an estimated 170 million persons are chronically infected with HCV and 3 to 4 million persons are newly infected each year. The major causes of HCV infection worldwide are use of unscreened blood transfusions, and re-use of needles and syringes that have not been adequately sterilized. The PROCLEIX® HIV-1/HCV Assay received FDA approval in February 2002 and CE (Conformite Europeenne) Mark in Europe in January 2003 for use on the PROCLEIX® System. The PROCLEIX® HIV-1/HCV Assay and System is commercially available in the United States and throughout Europe, Asia, Australia and New Zealand and is under evaluation in Latin America and several Asian countries.

The PROCLEIX® ULTRIO™ Assay is the premium NAT product offering that adds the direct detection of hepatitis B virus (HBV) to the approved PROCLEIX® HIV-1/HCV Assay allowing for three results to be obtained in the same amount of time, and using the same instrumentation. Over 350 million people worldwide are chronic carriers of HBV, with over 2 billion infected. HBV is the leading cause of liver cancer in the world and is at its highest prevalence in Southeast Asia, Southern Europe, India and Africa. The PROCLEIX® ULTRIO™ Assay received CE Mark Registration in Europe on the semi-automated PROCLEIX® System in January 2004 and on the fully automated, high-throughput PROCLEIX® TIGRIS® System in December 2004. We filed a Biologics License Application (BLA) in September 2004 in the U.S. for use of the PROCLEIX® ULTRIO™ Assay on both the semi-automated PROCLEIX® System and the PROCLEIX® TIGRIS® System.

The PROCLEIX® West Nile Virus (WNV) Assay, a NAT product co-developed with Gen-Probe for the detection of WNV in plasma, whole blood, organs and tissue, is available for sale in the United States, under an Investigational New Drug, or IND, protocol and labeled For Investigational Use Only. In February 2005, Chiron and Gen-Probe filed a BLA in the U.S. for the assay. Since testing began under IND in June 2003 through December 2004, the PROCLEIX WNV Assay has detected approximately 1,200 West Nile virus contaminated units of donated blood, potentially preventing over 3,600 transfusion transmissions of the virus. The primary market for this product is the U.S., although European and Latin American medical authorities have expressed interest in conducting epidemiological studies.

In addition to assays, we also sell equipment under the Gen-Probe collaboration. Blood-testing equipment includes:

· PROCLEIX® System;

· PROCLEIX® TIGRIS® System; and

· PROCLEIX® Optiva™ System

The PROCLEIX® System is a semi-automated instrument platform which is manufactured by Gen-Probe and marketed by Chiron and which has been commercially available since receiving FDA clearance in February 2002. The PROCLEIX® OPTIVA™ System, which consists of modular components is expected to automate several of the steps performed manually with the PROCLEIX System. A portion of the PROCLEIX® OPTIVA™ System, the Front-End Pipetor (FEP), received European CE Marking in June 2004. The next generation fully automated, high-throughput instrument platform, PROCLEIX® TIGRIS® System was launched in Europe in December 2004 and is also available under IND for use with the WNV Assay in the U.S. The PROCLEIX® TIGRIS System is manufactured by Gen-Probe and marketed by Chiron. By significantly increasing throughput and automation, the TIGRIS System allows smaller pool sizes and enables individual donor testing (IDT) on a large scale, which is important for the detection of diseases with low viremic levels such as West Nile Virus and hepatitis B.

Through its joint business contractual arrangement with us, Ortho-Clinical Diagnostics sells a full line of immunodiagnostic tests for hepatitis viruses and retroviruses and provides supplemental tests and microplate and chemiluminescent instrument systems to automate test performance and data collection. We manufacture, and perform research on, viral antigens used by Ortho-Clinical Diagnostics to manufacture immunodiagnostic testing assays and supplemental hepatitis and HIV tests. Ortho-Clinical Diagnostics manufactures and sells the assays and instrument systems. Commercial products sold under the joint business contractual arrangement include RIBA® tests, which are immunodiagnostic supplemental confirmatory tests for HIV and HCV developed by us, and a line of immunodiagnostics screening tests for infectious diseases. We share equally in the pretax operating earnings generated under the contractual arrangement. The joint business contractual arrangement holds the immunodiagnostic rights to our hepatitis and retrovirus patents and receives royalties from hepatitis C virus and HIV tests sold by Abbott Laboratories, Inc. and from hepatitis C virus tests sold by Bio-Rad Laboratories, Inc. and certain other licensees.

Sales of nucleic acid testing products accounted for 14%, 11% and 10% of our consolidated total revenues in 2004, 2003 and 2002, respectively. Revenues related to our arrangement with Ortho-Clinical Diagnostics, including the joint business contractual arrangement, accounted for approximately 9%, 8% and 10% of our consolidated total revenues in 2004, 2003 and 2002, respectively.

Vaccines

Our vaccines segment offers more than 20 vaccines, including the following.

Influenza Vaccines:

· FLUVIRIN®, AGRIPPAL® S1 and BEGRIVAC™ trivalent influenza vaccines and

· FLUAD®, an innovative adjuvanted influenza vaccine.

Meningococcal Vaccine:

· MENJUGATE®, a conjugated vaccine against meningococcal meningitis caused by the bacterium N. meningitidis serogroup C.

Travel Vaccines:

· ENCEPUR™, a preservative-free vaccine against tick-borne encephalitis,

· RABIPUR®/RABAVERT®, vaccines against rabies,

· ARILVAX™, a vaccine against yellow fever and

· DUKORAL™, a vaccine for traveler’s diarrhea and cholera.

Pediatric Vaccines:

· DTP, diphtheria, tetanus and pertussis (whooping cough) vaccine,

· Morupar, measles, mumps and rubella combined vaccine,

· Oral polio vaccine and

· Vaxem Hib, glycoconjugate Haemophilus Influenzae vaccine.

In July 2003, we acquired United Kingdom based PowderJect and commenced sales of FLUVIRIN® vaccine, a trivalent influenza vaccine. In addition to its U.S. approval, FLUVIRIN® vaccine is registered for use in over 20 countries. Prior to the 2004-05 influenza season, approximately 90% of FLUVIRIN® vaccine production was supplied to the U.S. market.

Our influenza vaccine franchise includes, in addition to FLUVIRIN® vaccine, three other established brands, AGRIPPAL® S1, BEGRIVAC™, and FLUAD®, which are manufactured in our Italian and German facilities and marketed outside of the U.S., largely in Europe.

In our meningococcal franchise, we sell MENJUGATE® vaccine, a conjugate vaccine against meningococcal disease caused by the bacterium N. meningitidis serogroup C, and MENZB™, a meningococcal B vaccine developed to protect against a specific meningococcus B strain responsible for a 13-year epidemic in New Zealand. Invasive infection with the bacteria N. meningitidis can lead to meningococcal meningitis and septicemia (blood poisoning). Meningococcal meningitis can be caused by multiple serogroups (A, B, C, W, Y and others) and is associated with both high mortality and morbidity. We have sold MENJUGATE® vaccine under a tender system to national governments and health systems in a variety of countries including various European countries, Canada, Argentina and Australia. We have sold MENZB in New Zealand.

In 2000, we entered into agreements with Sanofi-Aventis (previously Aventis Pasteur MSD) for the distribution of FLUAD® vaccine and MENJUGATE® vaccine. Under the agreements, we market FLUAD® vaccine alone and we co-promote MENJUGATE® vaccine with Sanofi-Aventis in the United Kingdom and Ireland. In the rest of Europe, Sanofi-Aventis distributes, co-markets and sells FLUAD® vaccine and MENJUGATE® vaccine under its own labels, ADIUGRIP™ and MENINVACT™ respectively.

We market travel vaccines including RABIPUR® and RABAVERT® rabies vaccine, ENCEPUR™ tick-borne encephalitis vaccine, ARILVAX™ yellow fever vaccine, and DUKORAL® cholera vaccine. We also market pediatric and other vaccines.

Our primary manufacturing facilities for vaccines are located in: Siena and Rosia, Italy; Marburg, Germany; Liverpool, UK; and Ankleshwar, India. We mainly operate in India through a joint venture, Chiron Behring Vaccines Private Limited. We manufacture vaccines for the following diseases in these facilities:

Italy				Germany		United Kingdom		India
diptheria haemophilus influenza type b influenza measles meningococcal infection mumps polio (oral) rubella tetanus				diphtheria influenza meningococcal infection tetanus pertussis rabies tick-borne encephalitis		influenza cholera rabies yellow fever		rabies

The principal markets for our manufactured vaccines and vaccines that we market under license are the United States, Germany, Italy, and the United Kingdom. We have two vaccines licensed in the United States: FLUVIRIN® influenza virus vaccine and RABAVERT® rabies vaccine. We also supply diphtheria and tetanus (DT) concentrate to GlaxoSmithKline for use in its DT-containing vaccines licensed by the FDA.

In addition, we also market our vaccines in other European countries and in the Middle East, the Far East, Africa and South America, and to international health agencies such as UNICEF and the Pan American Health Organization.

In addition to revenues from the sale of the vaccines described above, we receive royalties from the sale of certain vaccines by Merck and Company, Inc. and GlaxoSmithKline, based upon technology developed by us. Merck’s hepatitis B virus vaccine, based on Chiron technology, was the first genetically engineered vaccine licensed by the FDA for human use.

Sales of our influenza vaccine franchise products accounted for approximately 9%, 19%, and 7% of our consolidated total revenues in 2004, 2003 and 2002, respectively. As a result of the prohibition imposed on us by the MHRA relating to release of FLUVIRIN® vaccine manufactured at our Liverpool facility since March 2, 2004 and the MHRA’s suspension of our license to manufacture FLUVIRIN® vaccine from October 5, 2004 through March 2, 2005, we had no sales of FLUVIRIN® vaccine in 2004 other than $2.3 million in late 2003-2004 season sales. In 2003, sales of FLUVIRIN vaccine accounted for 12% of our consolidated total revenues. Sales of pediatric and other vaccines accounted for approximately 12%, 11% and 12% of our consolidated revenues in 2004, 2003 and 2002, respectively. No other single vaccine product or class of vaccine product accounted for 10% or more of our consolidated total revenues in any of the last three fiscal years.

Biopharmaceuticals

Our biopharmaceutical segment discovers, develops, manufactures and markets a range of therapeutic products primarily for cancer and infectious and pulmonary disease. The following describes our primary marketed products.

TOBI® tobramycin solution for inhalation, USP—We manufacture and market TOBI® solution, a stable, premixed, proprietary formulation of the antibiotic tobramycin for delivery by inhalation using a nebulizer. TOBI® solution has been tested and approved for cystic fibrosis patients with Pseudomonas aeruginosa lung infections and is the first and only inhaled antibiotic solution to be approved by the FDA. Cystic fibrosis is caused by a genetic mutation that prevents cells from building a special protein required for normal movement of sodium chloride (salt) in and out of cells lining the lungs and other organs. This abnormal movement causes secretion of thick, sticky mucus in the airways. This mucus is not cleared from the airways and, as a result, bacteria begin to grow, causing infection. Pseudomonas aeruginosa is the most common bacterium causing lung infections in people with cystic fibrosis. In cystic fibrosis patients with pseudomonal lung infections, tobramycin is the most commonly used intravenous antibiotic. The advantage of inhalation is that it permits higher antibiotic concentrations in the lung and reduces side effects by limiting systemic exposure. Appropriate treatment of these chronic lung infections is a major contributor to the extended life span of patients with cystic fibrosis and to improve quality of life. The TOBI® formulation is well tolerated by patients, leading to increased patient compliance and more effective control of infection. Treatment with TOBI® solution decreases the bacterial load, reduces the associated inflammatory response, and improves overall lung function. We market the TOBI® solution in the U.S., the European Union, Canada, Switzerland, Norway, Israel, Argentina and Brazil.

PROLEUKIN® (aldesleukin) for injection—We manufacture and market PROLEUKIN®, a recombinant form of interleukin-2. Interleukin-2 is a protein produced naturally in the body in very small quantities which stimulates the immune system to increase the production and function of immune cells.

While the precise anti-tumor mechanism of PROLEUKIN® aldesleukin is unknown, research has demonstrated that PROLEUKIN® aldesleukin induces the proliferation of immune cells, including natural killer and cytotoxic T cells that can recognize and mobilize against tumor-specific antigens on the surface of malignant cells. We market PROLEUKIN® aldesleukin directly or through distributors in the U.S. and over 50 other countries in North America, Europe, Asia and South America to treat metastatic renal cell carcinoma (a type of kidney cancer), and in the U.S. and Canada to treat metastatic melanoma (a form of skin cancer). Studies have demonstrated that PROLEUKIN® aldesleukin offers the possibility of a complete and long-lasting remission in these diseases.

BETASERON® (interferon beta-1b) for SC injection—We manufacture BETASERON® (BETAFERON® in Europe) interferon beta-1b which is marketed by Schering AG and its affiliates, including Berlex Laboratories, Inc. (collectively “Schering”). Boehringer Ingelheim also supplies BETAFERON® interferon beta-1b to Schering for sale in Europe. Multiple sclerosis is an autoimmune disease in which the patient’s immune system attacks and destroys an element of the patient’s own central nervous system. The active ingredient in BETASERON® is a modified form of a beta interferon produced naturally by the human body. Interferons help to regulate the immune system, and BETASERON® interferon beta-1b is thought to help slow down the immune system’s attack on nerve tissue. While the ways in which BETASERON® interferon beta-1b actually affects multiple sclerosis are not clearly understood, it has been demonstrated clinically that BETASERON® interferon beta-1b may decrease the nerve damage associated with multiple sclerosis. It has been shown to reduce the overall frequency of multiple sclerosis relapses, which are also called exacerbations or attacks, as well as the number of moderate and severe relapses. BETASERON® interferon beta-1b is approved for relapsing/remitting multiple sclerosis in over 70 countries, including the U.S. and the nations of the European Union, and for secondary progressive multiple sclerosis in approximately 60 countries, including the nations of the European Union, Canada, Australia and New Zealand. In 2002, we and Schering AG launched a room temperature formulation of BETASERON® interferon beta-1b, which is the only beta interferon currently marketed in the U.S. that can be stored at room temperature long term up to two years. To further increase ease of use, Chiron and Schering AG introduced a diluent syringe presentation for BETASERON® interferon beta-1b in the U.S. in January 2004 and in Japan in December 2003.

In 2004, we filed for marketing approval of the following two products.

PULMINIQ™ (cyclosporine, USP) inhalation solution—In 2004, we submitted a new drug application, or NDA, to the FDA for marketing approval of PULMINIQ™ inhalation solution. We are seeking an indication for the increase in survival and prevention of chronic rejection in patients receiving allogeneic lung transplants, in combination with standard immunosuppressive therapy. We believe that PULMINIQ™ could be the first immunosuppressant approved for this indication. We acquired worldwide development and commercial rights for PULMINIQ™ from Novartis AG.

CUBICIN® (daptomycin for injection)—In 2004, we filed a Marketing Authorization Application, or MAA, with the European Medicines Agency, or EMEA, for the CUBICIN® antibiotic. The indication in the submission is for complicated skin and soft tissue infections where the presence of susceptible Gram-positive bacteria is confirmed or suspected. We acquired marketing rights to the antibiotic daptomycin for certain countries outside of the U.S. from Cubist Pharmaceuticals, Inc. The CUBICIN antibiotic has been approved by the FDA for the treatment of complicated skin and skin structure infections caused by Gram-positive bacteria.

Our biopharmaceutical products are manufactured primarily in our Emeryville, California and Vacaville, California facilities.

Sales of TOBI® formulation accounted for approximately 12%, 10% and 12% of our consolidated total revenues in 2004, 2003 and 2002, respectively. Revenues from BETASERON® interferon beta-1b, which include product sales to Schering and royalties earned on Schering’s European sales of

BETAFERON® interferon beta-1b, accounted for approximately 11% (8% product sales and 3% royalties), 11% (7% product sales and 4% royalties) and 13% (9% product sales and 4% royalties) of our consolidated total revenues in 2004, 2003 and 2002, respectively. No other biopharmaceutical product accounted for 10% or more of our consolidated total revenues in any of the last three fiscal years.

Research and Development

Our research and development focuses on the prevention and treatment of cancer and infectious and pulmonary diseases. In addition to our research and development activities, technologies that are developed in collaborations with third parties, as well as technologies licensed from outside parties, also are sources of potential products for our segments. Products or product candidates that are inappropriate for our commercial organization are out-licensed to other companies. This portfolio of intellectual property is an important part of our business model.

Blood Testing

Chiron continues to pursue research and development of assays for transfusion-transmitted diseases, such as variant Creutzfeldt-Jakob disease (vCJD). In August 2004, we supplemented our existing vCJD research and development program by acquiring Prion Solutions Inc., a privately held company focused on research into vCJD and other Prion-related diseases.

We also participate in the development of a range of hepatitis and retrovirus immunoassays for use in screening of donated blood, plasma, organs and tissue and in-vitro clinical diagnostics through our joint business contractual arrangement with Ortho-Clinical Diagnostics, Inc.

We moved beyond blood testing and into the broader realm of blood safety when we entered into collaboration with ZymeQuest in 2003 to develop and commercialize ZymeQuest’s enzyme conversion system. This system converts groups A, B and AB red blood cells to enzyme-converted universal blood group O (ECO). This technology could fill a critical need for blood and transfusion centers as between 5% and 10% of the global donated blood supply is discarded each year due to non-matches between donated blood and patients’ blood type requirements. We made an equity investment in ZymeQuest and obtained worldwide marketing and commercial rights to the technology.

Vaccines

Our vaccines segment research and development is focused on developing next generation influenza manufacturing capability, developing new vaccines for pandemic preparedness and broadening our meningococcal franchise. Next generation cell-culture production technology has the potential to increase the flexibility of our production process, while adding incremental capacity. We are developing an influenza cell culture vaccine and have currently undertaken a number of clinical studies in Europe, in which the vaccine has demonstrated satisfactory safety and immunogenicity. In the U.S. we are in discussion with the FDA to determine the clinical path for the filing of an investigational new drug application, or IND.

World health agencies are concerned about recent outbreaks of highly pathogenic avian influenza in poultry and are concerned that the present situation could give rise to another influenza pandemic in humans. In 2004, we were awarded contracts by the National Institute of Health (NIH) for production of pandemic H5N1 and H9N2 vaccines, which the National Institute of Allergy and Infectious Diseases (NIAID) expect to use in clinical studies of safety and immunogenicity.

In our meningococcal franchise, we are expanding our product line beyond MENJUGATE® vaccine, our conjugate vaccine against Meningococcus C infection, through the development of other vaccines against additional Meningococcal strains responsible for human disease. Meningococcal disease usually

affects the membranes around the brain and spinal cord or the bloodstream, and can result in brain damage, blindness, deafness, limb amputations and death. Infection may be fatal even if diagnosed early, making prevention essential. Young children and persons in close living quarters such as college dorms or military facilities are at highest risk for meningococcal disease.

In 2004, we began distributing a meningococcal B vaccine in New Zealand, MENZB™, to protect against the specific meningococcal B strain responsible for a 13-year epidemic in that country.

Serotype B, along with serotypes A, C, W and Y cause approximately 95% of the meningococcal infections worldwide. Multivalent vaccines, effective against more than one serotype offer significant advantages over monovalent vaccines. We are developing a tetravalent conjugated vaccine against serotypes A, C, W and Y and are completing Phase II studies of this ACWY vaccine in a variety of age groups including ages under two.

While our current meningococcal B product, MENZB™ is efficacious against only a single strain of meningococcal B, we are also developing a second-generation vaccine candidate utilizing our novel genomic approach against Meningococcus B, a disease for which no broadly efficacious vaccine is currently available. We completed Phase I testing of the meningococcal B vaccine in 2004.

Through collaborations, we are obtaining human safety and immunogenicity information on hepatitis C virus vaccines candidates, and our vaccine against HIV, which is in Phase I testing. We are also developing novel adjuvants, compounds that amplify the immune response generated by vaccine antigens.

Biopharmaceuticals

Research and development in the biopharmaceutical segment develops protein and small molecule therapies for cancer and infectious and pulmonary disease.

Infectious and Pulmonary Disease

Tifacogin (recombinant Tissue Factor Pathway Inhibitor)—Tifacogin, a coagulation inhibitor, was developed in collaboration with Pfizer, Inc. In October 2003 we acquired all of Pfizer, Inc.’s interest in tifacogin, in return for which Pfizer will receive royalties on sales of tifacogin. In 2004 we initiated a Phase III trial for tifacogin in patients with severe community-acquired pneumonia (CAP). CAP is a serious infection of the lungs caused by various, well-defined pathogens. Severe CAP affects approximately 300,000 patients in the United States annually requiring ICU admission, of whom approximately 30 percent die.

Tobramycin inhalation powder (TIP)—In December 2001, we entered into a collaboration with Nektar Therapeutics Inc. (Nektar) to develop and register an inhalable dry-powder formulation of the antibiotic tobramycin as an extension of our TOBI® formulation franchise. TIP is used with a new hand-held, fully portable device. We completed Phase I clinical trials in 2004, and based on an understanding with the FDA, we anticipate moving to Phase III testing of the product in 2005.

Oncology

PROLEUKIN® (aldesleukin) for injection plus rituximab—Enrollment in a Phase II study of PROLEUKIN aldesleukin plus rituximab (IL2NHL003) in patients with low-grade non-Hodgkin’s lymphoma who have failed rituximab therapy was completed in 2004. In addition, in 2004 we initiated a Phase II trial of PROLEUKIN aldesleukin in rituximab-naïve patients with non-Hodgkin’s lymphoma who have failed to respond to chemotherapy (IL2NHL006, or the PEaRL—PROLEUKIN Enhances Rituximab in Lymphoma study).

CHIR-258 (growth factor kinase inhibitor)—CHIR-258 is our first small-molecule oncology compound. In 2004, we initiated two Phase I studies of CHIR-258: one in acute myelogenous leukemia (AML) and the other in solid tumors.

CHIR-12.12—In December 2004 we filed an IND application for a monoclonal antibody oncology compound, anti-CD40. This is the first project being developed under our collaboration agreement with Xoma Ltd. for the commercialization of therapeutic antibodies for cancer.

Research and Development Expenses and Related Revenues

Research and development expenses for the years ended December 31, 2004, 2003 and 2002 for Chiron-sponsored research, including payments to collaboration partners, were $431.1 million, $409.8 million and $325.8 million, respectively. Under contracts where we recognize revenue based upon research and development work performed, the revenues amounted to $20.9 million, $16.8 million and $19.9 million in 2004, 2003 and 2002, respectively. We recorded these revenues in “Collaborative agreement revenues” and “Other revenues” in the Consolidated Statements of Operations. Generally, these revenues include fees for research services as they are performed or completed and milestone payments upon attainment of specified benchmarks.

Business Relationships

We have important business relationships with various companies, including;

Gen-Probe Incorporated

We have a collaboration with Gen-Probe relating to the development and commercialization of NAT products under the PROCLEIX brand name to screen donated blood, plasma, organs and tissue for viral infection. PROCLEIX assays and systems incorporate NAT technology to detect viral RNA and DNA in donated blood and plasma during the very early stages of infection, when those infectious agents are present but cannot be detected by immunodiagnostic tests. Gen-Probe manufactures the NAT assays and certain instruments, and Chiron sells both assays and instruments under the PROCLEIX® brand name. Effective January 1, 2004, under an amendment to the worldwide blood screening collaboration agreement with Gen-Probe, permanent, fixed revenue shares were adopted for each party. Gen-Probe’s share was set at 45.75% of net revenues for assays, which include a test for the hepatitis C virus. For commercial assays, which do not test for hepatitis C virus, such as the West Nile test, each party retains 50% of the net revenues after deduction of specified expenses.

Ortho-Clinical Diagnostics, Inc.

We have a joint business contractual arrangement with Ortho-Clinical Diagnostics relating to the development and commercialization of immunodiagnostic tests using recombinant DNA and antibody technologies to detect retroviruses and hepatitis viruses in blood. Under the terms of the arrangement, Ortho-Clinical Diagnostics manufactures and sells the assays and instrument systems, and Chiron supplies raw materials for the assays. Chiron and Ortho-Clinical Diagnostics share equally in the pretax operating earnings generated by the joint business contractual arrangement. Our joint business arrangement with Ortho-Clinical Diagnostics is operated under a contractual arrangement and is not a separate and distinct legal entity. The joint business contractual arrangement holds the immunodiagnostic rights to our hepatitis and retrovirus patents and receives royalties from the sale of hepatitis C virus and HIV tests sold by Abbott Laboratories, Inc. and from sales of hepatitis C virus tests by Bio-Rad Laboratories, Inc. and certain other licensees.

Cubist Pharmaceuticals

In October 2003, we entered into a license agreement for the development and commercialization of Cubist’s antibiotic, CUBICIN®, in Western and Eastern Europe, Australia, New Zealand, India and certain Central American, South American and Middle Eastern countries. Under the agreement, we pay upfront payments, regulatory and sales milestones, and a tiered royalty on CUBICIN® daptomycin sales in the territories.

Schering AG and Berlex Laboratories, Inc.

Chiron and Berlex, Inc., a subsidiary of Schering AG of Germany, jointly developed BETASERON® (BETAFERON® in Europe) interferon beta-1b. BETASERON product is manufactured by us and sold in the United States and Canada by Berlex. BETAFERON® interferon beta-1b is manufactured by us and Boehringer Ingelheim in Europe and is sold by Schering AG. BETAFERON® and BETASERON® product revenues recognized under this agreement contributed 11%, 11% and 13% of our consolidated total revenues in 2004, 2003 and 2002, respectively. Under the agreement, for product manufactured by us and marketed by Schering AG and its affiliates, including Berlex, we receive revenue, which is recorded as product sales. For product manufactured by Boehringer Ingelheim and marketed by Schering in Europe under the trade name BETAFERON®, we receive royalties net of Schering’s supply costs.

Nektar Therapeutics, Inc.

In December 2001, we entered into a collaboration with Nektar to develop and register an inhalable dry-powder formulation of the antibiotic tobramycin as an extension of our TOBI® formulations franchise. Under the terms of the collaboration, Nektar is responsible for development of the dry powder formulation and inhalation device, as well as supplying drug product for clinical trials and the market. Chiron is responsible for all other aspects of drug development including clinical trial conduct, regulatory submissions, preparation for product launch and sales and marketing of the final drug product. Under the agreement, we pay upfront payments and development milestones, and we will pay royalties when the product is commercialized.

XOMA Ltd.

We have a worldwide, exclusive, multi-product, collaborative agreement with XOMA for the development and commercialization of antibody products for the treatment of cancer. Under the terms of the agreement, the companies jointly research, develop, and commercialize multiple antibody product candidates. Under the agreement, the companies share development and commercialization expenses, including preclinical and clinical development, manufacturing and worldwide marketing costs, as well as revenues, generally on a 70-30 basis, with Chiron’s share being 70% and XOMA’s share being 30%. We made an initial payment of $10.0 million, and have made a loan facility of up to $50.0 million available to XOMA, starting on January 1, 2005 to fund XOMA’s share of development expenses.

Commercialization

Technologies arising out of our research and development efforts are commercialized in various ways:

· We market and distribute certain products, either directly or through distributors. See “Sales and Marketing” below;

· We develop other products in collaboration with third parties. Under collaboration agreements, marketing rights may be assigned to us or to the collaborator or shared by both parties. In the event rights are assigned to us, we generally pay royalties to or enter into revenue split agreements with

our collaborator. In the event marketing rights are assigned to the collaborator, we often retain the right to manufacture and supply key raw materials; and

· We license other technologies to third parties, with the licensee assuming responsibility for further development. We generally receive royalties on sales of the resulting product. Agreements under which we currently derive royalty revenues for technologies licensed to third parties include:

· licenses to F. Hoffmann-LaRoche Limited and Roche Molecular Systems, Inc. under our hepatitis C virus and HIV related patents for use in nucleic acid amplification in in vitro diagnostics and in blood screening,

· an agreement with Bayer Corporation relating to, among other things, use of our hepatitis C virus and HIV technologies for nucleic acid amplification in in vitro diagnostics,

· a license to the German Red Cross for use of our HIV-1 and hepatitis C virus (HCV) technology for use in molecular probe “home brew” blood screening,

· a license to LabCorp, including its subsidiary, National Genetics Institute, to use our patented HCV NAT technology in screening plasma donations in the United States and

· agreements with Novo Nordisk AS relating to technology used in the manufacture of recombinant human insulin and glucagons.

Sales and Marketing

Blood Testing

Our blood testing global marketing, U.S. sales and global distribution organization for nucleic acid testing products is based in Emeryville, California and has representatives around the world. Our two primary regional offices are located in Paris, France and Hong Kong, China. We sell products to the public sector through tenders (a bid solicitation process) and to private sector blood banks directly and through distributors.

In 2002, we signed a multi-year agreement with the American Red Cross, which collects approximately 50% of the 14 to 15 million units of blood collected in the U.S. each year. Under that agreement, the American Red Cross purchases from Chiron certain products, instrumentation and services that enable the American Red Cross to perform amplified nucleic acid screening on the blood it collects. Currently we are in multi-year contracts through the tender process with the public sector blood services of many countries outside the U.S., with the most significant in terms of size being the United Kingdom, Belgium, France and Australia.

Vaccines

Our marketing and sales organization for the German market is based in Marburg, Germany, the Italian market in Siena, Italy, and the United Kingdom market in Oxford, United Kingdom. In 2004, we established a U.S. Vaccines headquarters in Philadelphia, Pennsylvania. In general, we market our influenza and rabies vaccines in the U.S. through a network of specialist distributors. In the U.S. and internationally, our direct sales efforts are focused on pediatricians and general practitioners. We also sell products to the public sector through tenders and to private sector pharmacies directly and through wholesalers and distributors.

BioPharmaceuticals

Our biopharmaceutical marketing and sales organization for the U.S. is headquartered in Emeryville, California, and European operations are headquartered in Thames Valley, England. We focus our sales efforts on specialist physicians, principally oncologists and pulmonologists, who are based in hospitals and large clinics. Generally, we sell products to wholesalers, distributors, clinics and hospital pharmacies.

Competition

We operate in a highly competitive environment, and we expect competition to increase. Competitors include large pharmaceutical and blood testing companies, and biotechnology companies. Some of these competitors, particularly large pharmaceutical and blood testing companies, have greater resources than we have. We and our competitors apply rapidly evolving technologies and new developments that frequently result in price competition and product obsolescence. Substantial consolidation is underway in the global healthcare industry and is expected to produce greater efficiencies and even more intense competition. To compete effectively, we invest heavily in research and development, maintain specialized sales forces that concentrate on individual classes of customers and spend significant amounts on advertising, promotion and selling.

Important biotechnology research is performed in universities and nonprofit research organizations. These entities are becoming more active in seeking patent protection and licensing revenues for their discoveries. The competition among large pharmaceutical companies and smaller biotechnology companies to acquire technologies from these entities also is intensifying. We actively collaborate with such entities in research, and have and will continue to license their technologies for further development. However, these institutions also compete with us to recruit scientific personnel and to establish proprietary positions in technology.

Blood Testing

The PROCLEIX® product line is based on proprietary Transcription Mediated Amplification (TMA) technology developed by Gen-Probe. The primary competition is with polymerase chain reaction (PCR) based products. PCR-based products are supplied to the market by F. Hoffmann-LaRoche, a Chiron licensee, or developed in-house by blood banks (referred to as “homebrew”). The commercial market for nucleic acid testing products in the blood banking and plasma industries has developed rapidly as regulatory agencies in developed countries began in 1999 to develop policies and mandates that require this new technology to be implemented as an additional measure to improve blood safety. In developing countries there has been a move to implement nucleic acid based tests in the private health care sector and we anticipate this expanding to the public arena over the next several years. Competition in this sector is the same as in the developed countries.

We are the sole manufacturer of hepatitis C virus antigens for use in immunodiagnostic assays of the Ortho-Clinical Diagnostics, Inc. joint business contractual arrangement. We also manufacture hepatitis C virus antigens for Abbott Laboratories, Inc.’s immunodiagnostic assays. In the immunodiagnostic blood testing market, the Ortho-Clinical Diagnostics joint business contractual arrangement competes with Abbott Laboratories. The joint business contractual arrangement has experienced increased competitive pressures from Abbott Laboratories’ ABBOTT PRISM® instrument system. The joint business contractual arrangement also develops and sells immunodiagnostic instruments and assays to detect hepatitis, retrovirus and other agents in clinical diagnostic applications. Many other companies, including F. Hoffmann-LaRoche Limited and Bayer Corporation, are significant competitors with respect to these products.

Vaccines

Four large companies hold the majority share of the worldwide vaccines business: Merck, GlaxoSmithKline, Wyeth and Sanofi-Aventis. We are the world’s fifth largest vaccines company. Sanofi-Aventis has a strategic alliance with Merck in Europe. All of these companies have substantial research and development programs. Additionally, there are a number of biotechnology companies involved in research programs, primarily involving a limited range of vaccines. We are aware of a variety of companies that are developing influenza cell culture manufacturing technology.

The competitive factors in vaccines are proven ability to supply product (particularly for influenza sales in the U.S.), price, the introduction of new products including vaccines against diseases for which no vaccine was previously available and new combination vaccines which can prevent several diseases in a single product. Public health authorities, medical practitioners and patients frequently favor combination vaccines, particularly in pediatric vaccines, because they eliminate the need for multiple injections and may increase overall compliance with recommended vaccination schedules. As new combination vaccines are introduced, older combinations and single products often become obsolete. We may be limited in our ability to develop and market certain combination vaccines if one of the vaccines, which would otherwise be included in the combination, is covered by valid and enforceable patents or other proprietary rights held by third parties.

Prior to the MHRA’s prohibition on our release of any FLUVIRIN® vaccine manufactured at our Liverpool facility since March 2, 2004 and its suspension of our Liverpool manufacturing license from October 5, 2004 through March 2, 2005, we were one of two primary suppliers of influenza vaccine to the U.S. Although the MHRA has lifted the suspension of our license to manufacture FLUVIRIN® vaccine in Liverpool, our inability to supply FLUVIRIN® vaccine during the 2004-2005 influenza season may lead to loss of market share as competitors have announced plans to introduce influenza vaccine products in the United States during the 2005-2006 season and are seeking expedited regulatory approval to do so. Our influenza vaccines sold in Europe, FLUAD®, AGRIPPAL®, and BEGRIVAC™, remain competitive there. Competition varies by region according to product license approvals. All influenza vaccines producers, including us, face an annual change in influenza strains, which can act as a barrier for new competitors.

MENJUGATE®, our meningococcal C vaccine, faces competition from vaccines produced by two other companies, Baxter International, Inc. and Sanofi-Aventis. These companies are also competing for future meningococcal vaccine business worldwide.

Biopharmaceuticals

TOBI® tobramycin solution for inhalation is the first and only inhaled antibiotic solution to be approved by the FDA for cystic fibrosis. The use of oral and intravenous antibiotics to treat pseudomonal and other bacterial infections is well established and in cystic fibrosis patients with pseudomonal lung infections, tobramycin is the most commonly used intravenous antibiotic. The advantage of inhalation is that it permits higher antibiotic concentrations in the lung and reduces side effects by limiting systemic exposure. Competitive medical therapies include generic antibiotics, anti-inflammatory drugs, pharmacist compounded generic tobramycin, oral replacement enzymes to maintain nutrition and mucolytics to clear pulmonary secretions.

PROLEUKIN® (aldesleukin) for injection is the only product approved by the FDA to treat metastatic renal cell carcinoma and one of two approved treatments for metastatic melanoma. However, there are numerous products that are used to treat both cancers on an off-label basis, including alpha interferons sold by F. Hoffmann-LaRoche Limited and Schering-Plough Corporation, and various monoclonal antibody therapies. Other competitors include Eli Lilly and Company, Bristol-Myers Squibb Company and Celgene Corporation. In addition, a number of companies are conducting large clinical trials of potential

monoclonal antibody therapies. The enrollment in these trials reduced the available new patients for PROLEUKIN aldesleukin in 2004, and these competitive pressures are expected to continue.

BETASERON® (interferon beta-1b) for SC injection, as a treatment for multiple sclerosis, competes with AVONEX®, a recombinant beta interferon, sold by Biogen Idec, Inc., REBIF®, a recombinant beta interferon, from Serono, S.A.(Serono), marketed and sold in the U.S. by Pfizer Inc., and COPAXONE® glatiramer acetate injection from Teva Pharmaceutical Industries, Ltd. NOVANTRONE® mitoxantrone for injection concentrate is marketed and sold by Serono for the treatment of secondary progressive multiple sclerosis. In addition, BETASERON® interferon beta-1b competed for a number of months with TYSABRI®, a humanized monoclonal antibody which was marketed by Biogen Idec, Inc. and Elan Pharmaceuticals until marketing was suspended by these companies in February, 2005. The multiple sclerosis market is highly competitive, and will remain so as various other companies have treatments for multiple sclerosis in clinical development.

Government Regulation

Regulation by governmental authorities in the U.S. and other important locations is a significant factor in the manufacture, marketing and sale of our products and in our research and development activities.

For all of our products, the time and expense needed to complete the required clinical studies, prepare and submit the required applications and supporting documentation and respond to inquiries generated by regulatory review can far exceed the time and expense of the research initially required to create the product. These factors largely determine the speed with which a successful research program is translated into a marketed product.

Blood Testing

In the U.S., blood-testing products, whether based upon nucleic acid testing or immunodiagnostic testing technologies, may only be commercially used pursuant to the terms of approval of specific license applications in which the product’s safety and effectiveness must be demonstrated based upon well-controlled studies. Upon approval of the license application, the product may be marketed for the specific uses, which were identified in the approval. Facilities, processes and operations used for the manufacture, testing, storage and distribution of our blood testing products in the U.S. are subject to FDA approval and periodic inspection.

In Europe, our blood testing products are regulated through the In Vitro Diagnostic Medical Devices Directive. The PROCLEIX® HIV-1/HCV Assay and PROCLEIX® ULTRIO™ Assay are in compliance with the IVD Directive. In other geographic areas, such as Australia, Canada and Mexico, local regulatory authorities regulated blood-testing products.

Vaccines and Biopharmaceuticals

In the U.S., our therapeutic and vaccine products (both commercial and investigational) are primarily regulated under federal law and are subject to rigorous FDA approval procedures. No product can be marketed in the U.S. until an appropriate application is approved by the FDA. The FDA applies the approval procedures on a product-by-product basis and typically requires, among other things, an extensive three-phase human clinical testing program. In Phase I, studies are conducted with a relatively small number of subjects to assess the safety of the product. In Phase II, the product is evaluated in a larger group of subjects to begin to assess efficacy and appropriate dosing. Phase III studies are conducted in the target population with a number of subjects that is large enough to provide sufficient data to establish statistically the safety and efficacy of the product. The FDA approves products to treat specified medical conditions or disorders. Further studies would be required to market the product for other uses. The FDA

must inspect and approve all facilities used to manufacture, fill, test and distribute biologic products. If any change in manufacturing facilities or processes occurs after FDA approval, additional regulatory review and possibly additional clinical studies may be required.

Licensing procedures in Europe are comparable to those in the U.S. In 1995, the European Union established a centralized procedure for licensing of products derived from the use of high technology/biotechnology processes. This procedure leads to the grant of a single license for the entire European Union. Effective January 1, 1998, the European Union has also adopted a decentralized procedure under which a license granted in one member state is mutually recognized by the other member states, leading to a grant of licenses in member states recognizing the original license. This procedure is replacing independent national licensing of products in the European Union. In addition, products must receive country pricing approvals in some territories before they can be marketed in that country.

Patents and Intellectual Property Rights

Patents are very important to our business. We have a policy of seeking patents on inventions arising from our research and development activities. The time and expense required to develop and obtain regulatory approval to market human healthcare products is significant. Without the protection of patents or trade secrets, competitors may be able to use our inventions to manufacture and market competitive products without being required to undertake the lengthy and expensive development efforts made by us. We also receive significant revenue through the licensing of these patents to third parties. We have a substantial number of granted patents and pending patent applications in the U.S. and other important markets. Additionally, we have licensed a number of patents and patent applications from third parties. Additional information is provided below on the certain patents held or licensed by us that relate to our key products. The existence of such patents does not mean they are valid or can be enforced against competitive products. We seek term extensions for some patents, which are available in certain countries based on delays in the grant of regulatory approvals for the sale of products covered by these patents. For these reasons the expiration dates provided below are not definitive.

We consider our trademarks and registered trademarks and those of our subsidiaries, in the aggregate, to be of material importance. All are covered by registrations or pending applications for registration in the U.S. Patent and Trademark Office and in other countries. Trademark protection continues in some countries for as long as the mark is used and, in other countries, for as long as it is registered. Registrations generally are for fixed, but renewable price terms.

Trade secrets and confidential information are also important to our commercial success. Although we seek to protect trade secrets and confidential information, others may obtain access to such information or develop the same or similar information independently. Also, third parties may obtain patent protection that precludes us from using our trade secrets or confidential information.

This report also includes trademarks, service marks and trade names of other companies.

Blood Testing

The PROCLEIX® HIV-1/HCV Assay is covered by numerous patents held by us in the U.S. and worldwide. These patents contain claims directed to methods of hybridization and methods for determining the presence of the hepatitis C virus in a sample and to probes/primers utilized in such a process. The hepatitis C virus patent family for NAT expires in the U.S. in 2015 and ex-U.S. in 2010. The HIV patent family expires in the U.S. in 2020 and ex-U.S. in 2005. The PROCLEIX® System product line is also covered by several patents held by Gen-Probe Incorporated and licensed to us.

The PROCLEIX® ULTRIO™ Assay is covered by several patents held by Gen-Probe and licensed to us.

The PROCLEIX® WNV Assay is covered by several patents and pending applications held by Gen-Probe and licensed to us.

The hepatitis C virus immunoassay diagnostic products sold by our joint business contractual arrangement with Ortho-Clinical Diagnostics, Inc. are covered by numerous patents in the U.S. and worldwide. These patents contain claims directed to hepatitis C virus immunoassay methods, kits and hepatitis C virus polypeptides. In the U.S., certain patents expire between 2011 and 2017. The corresponding European family of patents expires in 2010.

The HIV immunoassay diagnostic products sold by our joint business contractual arrangement with Ortho-Clinical Diagnostics, Inc. are covered by numerous patents in the U.S. and worldwide. The earliest patents expire in 2009 in the U.S. and 2005 in Europe.

We own additional HCV and HIV patent families and pending applications.

We hold the registered trademark PROCLEIX®, and the trademarks ULTRIO™ and OPTIVA™. TIGRIS™ is a trademark of Gen-Probe.

Vaccines

FLUAD®, our adjuvanted influenza vaccine, contains the proprietary adjuvant MF-59. The U.S. patents containing claims related to MF-59 expire in 2018. Patents in Canada, Japan, Germany, Ireland, Portugal and Hungary expire in 2010.

Widely registered trademarks of Chiron and our subsidiaries include AGRIPPAL®, FLUAD®, FLUVIRIN®, MENJUGATE®, RABAVERT®, RABIPUR®, and RIBA®. Other trademarks of Chiron and our subsidiaries include ARILVAX™, BEGRIVAC™, ENCEPUR™, POLIORAL™ and TRIACELLUVAX™.

Biopharmaceuticals

The patent family related to our first generation TOBI® tobramycin solution for inhalation product includes claims related to product formulation and methods of treating pseudomonas aeruginosa infections. The U.S. and European patents expire in 2014 and 2015, respectively.

We own or are the exclusive licensee of various patent families related to PROLEUKIN®, the serine-125 interleukin-2 mutein product, and uses thereof. The patents related to the PROLEUKIN® product will expire in the U.S. in 2012 and in Europe in 2005.

One of the earliest patent families that relate to BETASERON® and BETAFERON® interferon beta-1b in the U.S. and Europe, respectively, relate to serine-17 interferon-beta protein used in manufacturing the product. The U.S. patent in this family expires in 2007. The terms of the European patent in this family has been extended to 2008 through Supplementary Protection Certificates.

We own additional pending patent applications directed to the use of IL-2 in combination therapy in cancer or infectious disease.

We own patent applications related to the use of tifacogin in severe pneumonia. Any eventual patent in this family will expire in 2022.

We have widely registered the trademarks PROLEUKIN® and TOBI® in addition to holding the trademark CARDIOXANE™ for dexrazoxane, a cardioprotectant for doxorubicin cancer treatment. The trademarks BETASERON® and BETAFERON® are trademarks of Schering AG. CUBICIN® is a trademark of Cubist Pharmaceuticals.

Seasonality

Sales of certain of our products, particularly influenza vaccines, are seasonal, with higher sales in the third and fourth quarters of the year. ENCEPUR™, our vaccine against tick-borne encephalitis, is also seasonal with higher sales in the first half of the year.

Manufacturing and Raw Materials

Gen-Probe and Ortho-Clinical Diagnostics perform the manufacturing for the products sold by our blood testing business segment. We have engaged both Gen-Probe and Ortho-Clinical Diagnostics in extensive business continuity planning to limit any disruption to our current source of these blood safety products in the event of a loss of manufacturing capability. We maintain several months’ supply of NAT reagents in inventory. Ortho maintains similar inventories of immunodiagnostics products.

The vaccines segment primarily manufactures product in our facilities in the United Kingdom, Germany, Italy and India. In connection with the production of our flu vaccine products, we must purchase large quantities of chicken eggs. For FLUVIRIN® vaccine, we purchase those eggs and incubation services from a single supplier in the United Kingdom, and pursuant to the contract with that supplier we have agreed to make specified purchases from that supplier through 2009, subject to our right to terminate this agreement earlier upon payment of a termination fee.

Biopharmaceutical products are generally manufactured in our facilities in the United States. In addition, we perform some limited contract manufacturing for other organizations. Raw materials and supplies are generally available from various suppliers in quantities adequate to meet our needs, although we have single source suppliers for some components and value-add steps, including the pre-filled diluent syringe for BETASERON® interferon beta-1b. We purchase bulk powdered tobramycin, the primary basic raw material in TOBI® tobramycin, from two of the principal worldwide suppliers of the drug. We anticipate that either one of these suppliers alone will be able to supply sufficient quantities to meet current needs.

Our manufacturing facilities as well as those of our third-party service providers, suppliers and manufacturers are subject to continuing inspection by the FDA or comparable agencies in other jurisdictions.

We believe that our existing manufacturing facilities and outside sources will allow us to meet near-term manufacturing needs for our commercial products and our other products in clinical trials. In 2003, our Board of Directors approved $50.7 million in expenditures for a 25-year building lease and $42.2 million for capital improvements, both of which are part of a $97.0 million project for expansion and replacement of our flu vaccines manufacturing facility in Liverpool, England. The new manufacturing facility will replace a portion of the existing flu vaccines manufacturing facilities in Liverpool, England and is anticipated to be available in the middle of 2008 for the manufacture of flu vaccines, subject to regulatory approval.

Employees

Our employees are the core of Chiron and are vital to our success. As of December 31, 2004, Chiron and its subsidiaries had approximately 5,400 employees, approximately 2,500 of whom were located in the U.S. The company has experienced no work stoppages and we consider our employee relations to be good.

Relationship with Novartis AG

In January 1995, we established an alliance with Novartis, a life sciences company headquartered in Basel, Switzerland. As of January 31, 2005, Novartis owned 42% of our outstanding common stock.

We have entered into a series of agreements with Novartis, which provide, among other things and subject to certain conditions and exceptions:

· Novartis has the right to designate for nomination to our Board of Directors three individuals. The number of directors that Novartis may nominate declines if Novartis’ ownership interest in us is less than 30%.

· As long as Novartis owns at least 40% of our common stock, we may not engage in certain transactions, including significant debt or equity issuances, debt or equity repurchases, most mergers and acquisitions, the payment of cash dividends, amendments to Chiron’s Restated Certificate of Incorporation or Bylaws, without Novartis’ approval.

· Novartis will not increase its ownership interest in us above 55% unless it either acquires all of our outstanding capital stock in a “buy-out” transaction or it increases its ownership interest in us up to 79.9% in a transaction approved by a majority of the independent members of our Board of Directors.

· Novartis provided certain funding to us for research on certain adult and pediatric vaccines, Insulin-like Growth Factor-I, Factor VIII gene therapy and Herpes Simplex Virus-thymidine kinase. Funding under this agreement ended December 31, 2001. In exchange for providing this funding, Novartis has certain co-promotion rights for certain vaccines and an interest in certain royalties on sales of certain products resulting from the funded research.

· Novartis will guarantee certain indebtedness on behalf of us until January 2008.

· We may require Novartis to purchase shares of our common stock directly from us at fair market value, up to a maximum subscription amount (initially $500.0 million, subject to adjustment based on other purchases made by Novartis under related agreements, increases in amounts of certain of our indebtedness Novartis is required to guarantee or otherwise) through January 2006.

· Novartis has an option to purchase newly issued shares of our common stock directly from us at fair market value, subject to certain conditions, including the standstill restrictions described above.

· Novartis and we will cooperate and collaborate in research, development, manufacturing and marketing of biotechnology products on an arm’s-length basis while remaining independent to pursue our respective corporate strategies and opportunities.

For more information on certain of these agreements, see Note 10, “Related Party Transactions” of Notes to Consolidated Financial Statements.

Available Information

The following documents can be found free of charge on our website at http://www.chiron.com or by contacting our Investor Relations department at (510) 923-2300 or by sending an e-mail message to investor_relations@chiron.com:

· our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and all amendments to these reports as soon as reasonably practicable after such filings are electronically filed with the Securities and Exchange Commission;

· our Corporate Governance Guidelines and our Code of Conduct and Commitment to Ethical Conduct;

· our Policy on Reporting Suspected Financial Integrity Concerns; and

· the charters of the Audit Committee, Compensation Committee, Nominating and Corporate Governance Committee and Finance Committee and of our Board of Directors.

The information contained on our website, or other websites linked to our website, is not part of and is not incorporated by reference into this report.

ITEM 2. PROPERTIES

Emeryville Campus

Our principal executive offices are located in Emeryville, California. As of December 31, 2004, our campus consisted of 24 buildings, of which 14 are leased and 10 are owned. Our Emeryville facilities include research and development, manufacturing and administrative facilities and a parking structure for our biopharmaceutical, vaccine and blood-testing businesses.

Other Facilities

We also own and lease manufacturing facilities in Vacaville, California used principally for our biopharmaceutical business. The owned facility has available capacity due to lower than expected demand for certain of our products and improved production yields from other facilities. As a result, we have entered into contract manufacturing agreements to utilize this available capacity (see the Biopharmaceuticals section in Part II, Item 7. “Management’s Discussion and Analysis of Financial Condition and Results of Operations” below).

We have the following facilities for our vaccines operations:

Owned

· Manufacturing, administrative and research and development facilities in Rosia, Italy,

· Manufacturing, administrative and research and development facilities in Siena, Italy,

· Manufacturing facilities in Liverpool, England and

· Manufacturing facilities in Ankleshwar, India.

Leased

· Manufacturing facilities in Liverpool, England,

· Administrative office in Oxford, England,

· Manufacturing, research and development and administrative facilities in Marburg, Germany,

· Administrative and sales offices in Mumbai, India,

· Administrative office in Fairfax, Virginia,

· Sales office in Philadelphia, Pennsylvania,

· Sales office in Thailand,

· Sales office in China and

· Sales office in Brno-Slatina, Czech Republic.

We lease the following facilities for our biopharmaceutical operations:

· Research and development and administrative facilities in Seattle, Washington,

· Manufacturing and distribution facilities in Annandale, New Jersey,

· Administrative and sales offices in Amsterdam and Rijswijk, The Netherlands,

· Administrative and warehouse facilities in Munich, Germany,

· Sales office in Hong Kong,

· Several sales offices in Europe and Canada,

· Laboratory facility in Davis, California and

· Sales, marketing and administrative facility in Thames Valley, England.

We lease a number of other facilities in North America and Europe primarily for sales and service offices.

As described in Item 7 of this report on Form 10-K, “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” we are currently undertaking remediation efforts at our Liverpool facility. In addition, as noted above, our Board approved in 2003 a new building lease and capital improvements as part of a $97.0 million project for expansion and replacement of our flu vaccines manufacturing facility in Liverpool.

We believe that our other current facilities are in good operating condition and are adequate for our current needs. However, we are expanding to meet future requirements. We continually evaluate future requirements for our facilities.

ITEM 3. LEGAL PROCEEDINGS

Average Wholesale Price Litigation

In January 2003, the County of Suffolk filed a complaint in the United States District Court for the Eastern District of New York against numerous biotechnology and pharmaceutical companies, including Chiron, in connection with setting average wholesale prices for various products, including TOBI® solution, which are reimbursed by Medicaid. In November 2004, the County of Nassau filed an identical complaint, also in the United States District Court for the Eastern District of New York. In both cases, the plaintiff alleged that defendants violated federal racketeering laws, federal and state laws on Medicaid fraud, and state laws on unfair trade practice, breach of contract, fraud and unjust enrichment by devising and implementing a fraudulent pricing scheme against Medicaid beneficiaries, and sought declaratory relief, as well as compensatory and punitive damages. In January 2005, the County of Suffolk filed an amended complaint with the In re Pharmaceutical Industry Average Wholesale Price Litigation pre-trial proceedings that did not name Chiron as a party to the action.

In February 2005, the State of Illinois through its Attorney General filed a complaint in the Circuit Court of Cook County, Illinois, County Department, Chancery Division, against numerous biotechnology and pharmaceutical companies, including Chiron, in connection with setting average wholesale prices for various products that are reimbursed by Medicare and Illinois Medicaid. The Attorney General alleges that defendants violated the Illinois Consumer Fraud and Deceptive Business Practices Act, the Illinois Public Assistance Fraud Act, and the Illinois Whistleblower Reward and Protection Act, and seeks declaratory relief as well as damages.

It is anticipated that additional lawsuits involving the average wholesale price issues for these and other products sold by Chiron through Medicaid and/or Medicare may arise. If any such action resulted in a final judgment against Chiron, Chiron could face substantial damages exposure.

The Office of the Inspector General of the United States Department of Health and Human Services and certain State Attorneys General are investigating pharmaceutical industry practices concerning reporting of average wholesale prices for products covered by Medicare and Medicaid. It appears that the Office of the Inspector General’s investigation is connected to a pending, but as yet unserved, qui tam (whistle blower) lawsuit, in which Chiron and other companies are named defendants.

It is not known when nor on what basis these matters will be resolved.

F. Hoffmann-La Roche A.G. and Roche Diagnostics GmbH—HCV

In September 1999, F. Hoffman-LaRoche AG (“Roche”) filed an appeal with the Court of Appeals in Dusseldorf, Germany, regarding a Regional Court’s decision to enjoin Roche from the import, use, possession and sale of certain hepatitis C virus immunoassay products in Germany based on Chiron’s EP 0 318 216 (the “‘216 patent”). After withdrawing certain claims from the ‘216 patent, Chiron rescinded that injunction and substituted EP 0 450 931 (the “‘931 patent”) and Chiron’s German Patent Nos. DD 298 527, DD 298 524 and DD 287 104 (collectively, the “German Patents”) in the appellate proceeding. In October 2003, the Court of Appeals ruled that Roche’s HCV immunoassay kits containing a certain antigen infringe all three German Patents. Accordingly, the Court of Appeals granted Chiron requested injunction. Chiron has enforced the injunction. Roche is attempting to appeal this decision to the German Federal Supreme Court.

In July 2000, Chiron filed suit against Roche Diagnostics GmbH (“Roche Diagnostics”) in the German Federal Court (“Landgericht”) in Dusseldorf, Germany, asserting that Roche Diagnostics’ manufacture and sale of hepatitis C immunoassay products infringe Chiron’s German Patent No. DD 298 524 (the “‘524 patent”). In July 2003, the Landgericht decided that Roche Diagnostics’ HCV immunoassay kits containing a certain antigen infringe Chiron’s ‘524 patent. Accordingly, the Landgericht granted Chiron the right to enjoin Roche Diagnostics from the import, use, possession and sale of such kits in Germany. In August 2003, Chiron enforced the injunction against Roche Diagnostics. In November 2003, Roche Diagnostics filed an appeal with the Court of Appeals. In January 2005, the Court of Appeals denied Roche Diagnostics’ appeal and denied Roche Diagnostics leave to appeal as a matter of right to the Supreme Court.

In December 2000, Roche Diagnostics initiated nullity proceedings before the German Federal Patent Court (“Bundespatentgericht”) regarding Chiron’s ‘931 patent and the German Patents. In August 2002, the Bundespatentgericht upheld the validity of the German Patents, but nullified the German portion of the ‘931 patent. In November 2002, both Chiron and Roche Diagnostics filed appeals before the Federal Supreme Court regarding the Bundespatentgericht’s nullity decisions. Certain infringement actions related to the ‘931, ‘104 and ‘527 nullity proceedings are currently stayed pending the outcome of these appeals.

It is not known when nor on what basis these matters will be resolved.

FLUVIRIN® influenza virus vaccine

In October 2004, the U.K. regulatory body, the Medicines and Healthcare products Regulatory Agency (the “MHRA”), sent a letter prohibiting Chiron from releasing any FLUVIRIN vaccine doses manufactured at its Liverpool facility since March 2, 2004. In that letter, the MHRA asserted that Chiron’s manufacturing process did not comply with U.K. good manufacturing practices regulations. In addition to prohibiting release of existing FLUVIRIN vaccine doses, the MHRA letter also suspended Chiron’s license to manufacture influenza virus vaccine in its Liverpool facility. Chiron’s license to manufacture

influenza virus vaccine in its Liverpool facility was suspended from October 5, 2004 through March 2, 2005, when the MHRA lifted its suspension of the license. In addition, following the MHRA’s decision and an inspection by the U.S. Food and Drug Administration (the “FDA”), the FDA sent Chiron a warning letter on December 9, 2004 citing violations of good manufacturing practices. Chiron responded to the FDA’s warning letter on January 7, 2005. In a subsequent letter to Chiron, the FDA stated that Chiron’s responses appear to be adequate, but that implementation and effectiveness of Chiron’s corrective actions and overall compliance would be evaluated in a subsequent inspection. The FDA is still expected to conduct a full inspection to determine whether deficiencies noted in its warning letter have been resolved.

In October 2004, Chiron received a grand jury subpoena issued by the U.S. Attorney’s Office for the United States District Court for the Southern District of New York requesting production of certain documents and materials relating to the suspension of our license. Also, in October 2004, the U.S. Securities and Exchange Commission, or SEC, notified Chiron that it would conduct an informal inquiry into the suspension with respect to potential violations of federal securities laws. The SEC also requested copies of related records. In February 2005, the SEC issued a formal order of investigation with respect to potential violations of federal securities laws. In November 2004, the U.S. House of Representatives Committee on Energy and Commerce notified Chiron that it is conducting an investigation into the license suspension. The Committee also requested copies of related records. Chiron is cooperating with these investigations, and has provided documents and information and made witnesses available for interviews.

A. FLUVIRIN® vaccine Securities Class Actions

Between October 2004 and December 2004, five securities class action lawsuits were filed against Chiron and certain Chiron officers on behalf of purchasers of Chiron securities for class periods ranging from July 23, 2003 through October 13, 2004. Four of the suits were filed in the United States District Court for the Northern District of California. One action, although originally filed in the United States District Court for the Eastern District of Pennsylvania, was later transferred to the United States District Court for the Northern District of California. In February 2005, the Court approved the voluntary dismissal of two of the five class actions. The three remaining complaints allege, among other things, that the defendants violated certain provisions of the federal securities laws by making false statements preceding the suspension of Chiron’s license to manufacture FLUVIRIN vaccine, and seek unspecified monetary damages and other relief from all defendants.

B. FLUVIRIN® vaccine Shareholder Derivative Actions

Between October 2004 and November 2004, six shareholder derivative complaints were filed in the Superior Court of the State of California for the County of Alameda, naming Chiron as a nominal party and naming certain current and former Chiron officers and directors and Novartis AG as defendants in connection with the suspension of Chiron’s license to manufacture FLUVIRIN vaccine. One complaint also named Chiron as a defendant and sought relief from Chiron, including an equitable accounting. In December 2004, the six derivative actions were consolidated for discovery and trial under the caption In re Chiron Corporation Derivative Litigation (the “Derivative Action”). The Derivative Action alleges that defendants are liable for breach of their fiduciary duties, abuse of control, gross mismanagement, waste of corporate assets and violation of California Business and Professions Code § 17200 and that certain defendants are liable for violation of California Corporations Code § 25402. The Derivative Action also alleges that Novartis AG is liable for breach of the implied covenant of good faith and fair dealing. The Derivative Action seeks unspecified monetary damages and other relief from all defendants. The Derivative Action does not seek any affirmative relief from Chiron.

In October 2004, David Jaroslawicz filed a shareholder derivative complaint against Chiron, certain current and former officers and directors, and Novartis AG in the United States District Court for the Northern District of California in connection with the suspension of our license to manufacture

FLUVIRIN vaccine. Jaroslawicz alleged, among other things, breach of fiduciary duties, and sought unspecified monetary damages and other relief. In February 2005, the Court granted Jaroslawicz’s motion to dismiss the complaint.

C. Other FLUVIRIN® vaccine Legal Matters

In November 2004, Ruth Rosenbaum and Frosene Steevens filed a class action complaint against Chiron and ASAP Meds, Inc. in the Circuit Court of the 11th Judicial Court, in and for Miami-Dade County, Florida in connection with the suspension of our license to manufacture FLUVIRIN vaccine. With respect to Chiron, plaintiffs alleged, among other things, negligence and third party beneficiary breach of contract, and sought damages. In January 2005, Rosenbaum and Steevens voluntarily dismissed the complaint.

In December 2004 and January 2005, two complaints were filed, one in the United States District Court for the District of Connecticut and the other in the Superior Court of the State of California for the County of Alameda, in which the plaintiffs claim they suffered injuries as a result of a flu shot they received. The complaints seek unspecified monetary damages.

Chiron has received claims from several distributors of FLUVIRIN vaccine in the United States and the United Kingdom responding to Chiron’s notification that it could not supply vaccine due to conditions falling within the force majeure provisions of the respective contracts, and additional distributors may assert similar claims in the future.

In January 2005, the U.S. Centers for Disease Control and Prevention (the “CDC”) terminated two contracts for alleged failure to meet delivery dates related to Chiron’s supply of flu vaccine to the U.S. government for the 2004-2005 flu season. The CDC reserved its right to hold Chiron liable for any excess costs associated with the alleged failure to deliver and also reserved all other remedies provided by law under the contracts. The termination of the contracts for default is subject to appeal.

Additional lawsuits may be filed against the Company regarding the suspension of our license to manufacture FLUVIRIN vaccine. It is not known when nor on what basis these matters will be concluded. For additional information concerning the risks we face as a result of these FLUVIRIN vaccine developments, see “Factors That May Affect Future Results—The recent developments with respect to FLUVIRIN vaccine will harm our business and results of operations.”

Institut Pasteur

In April 2003, Institut Pasteur filed a complaint in the United States District Court for the District of Columbia against Chiron seeking reversal of certain judgments entered by the Board of Patent Appeals and Interferences (the “Board”) of the United States Patent and Trademark Office in Patent Interference No. 103,659 (the “‘659 Interference”). The ‘659 Interference involved claims in Chiron’s U.S. Patent No. 5,156,949 (the “‘949 patent”) and in certain U.S. patent applications assigned to Institut Pasteur (the “Chang applications”), relating to HIV immunodiagnostic methods. In the ‘659 Interference, the Board decided that the inventors of Chiron’s ‘949 patent were the first to invent the technology at issue. Chiron asserted that Institute Pasteur was barred from bringing claims per the 1993 HIV Cross-License Agreement between Chiron and Institut Pasteur (the “Agreement”), and that Institut Pasteur’s standing to bring its appeal was a matter for arbitration under the terms of the Agreement. In February 2005, the Court ordered the parties to arbitrate the standing issue and the case was administratively dismissed. In March 2005, Chiron sent Institut Pasteur a notice of arbitration.

In February 2005, Gen-Probe, Inc. received a letter from the Institut Pasteur regarding alleged infringement of Institut Pasteur’s European Patent EP 0 178 978 (“Cloned DNA sequences, hybridizable

with genomic RNA of lymphadenopathy-associated virus (LAV)”) (the “‘978 patent”) by the HIV-1 nucleic acid screening assays performed on Gen-Probe’s and Chiron’s PROCLEIX system.

It is not known when nor on what basis this matter will be resolved.

Laboratory Corporation of America Holdings

In August 2003, Chiron filed a complaint in the United States District Court for the Northern District of California against Laboratory Corporation of America Holdings, Laboratory Corporation of America and National Genetics Institute (collectively, the “Defendants”), seeking damages and an injunction against Defendants’ manufacture, use and sale of certain HIV assays for infringing Chiron’s U.S. Patent No. 6,531,276 (the “276 patent”). In February 2004, Chiron voluntarily dismissed this case without prejudice and refiled the complaint before the United States District Court for the Central District of California. The trial is scheduled to begin on November 7, 2005.

It is not known when nor on what basis this matter will be resolved.

In April 2003, Chiron filed a complaint in the United States District Court for the Northern District of California against Laboratory Corporation of America Holdings (“LabCorp Holdings”), Laboratory Corporation of America (“LabCorp”) and National Genetics Institute (“NGI”) (collectively, the “Defendants”), seeking damages and an injunction against Defendants’ manufacture, use and sale of the UltraQual™ HCV RT-PCR assay and HCV SUPERQUANT™ assay for infringing Chiron’s U.S. Patent No. 6,074,816 (the “816 patent”). The Defendants filed a complaint in the United States District Court for the District of Delaware against Chiron seeking a declaratory judgment that Defendants infringe neither the “816 patent, nor U.S. Patent Nos. 5,712,088, 5,863,719, 6,074,816, and 5,714,596 (collectively, the “Chiron Hepatitis C virus-related patents”), and that the Chiron Hepatitis C virus-related patents are invalid. In December 2004, the parties settled the matter and the complaints in California and Delaware were dismissed.

Luciw v. Chang; Luciw v. Alizon, et al.

In February 2005, the U.S. Patent and Trademark Office declared two interferences related to Chiron’s U.S. Patent No. 6,531,276 (“Methods For Detecting Human Immunodeficiency Virus Nucleic Acid”) (the “‘276 patent”). The first interference is between Chiron and Centocor,Inc., and pertains to Centocor’s U.S. Patent Application No. 06/693,866 (“Cloning and Expression of HTLV-III DNA”) (the “‘866 application”). The second interference is between Chiron and Institut Pasteur, and pertains to Institut Pasteur’s U.S. Patent Application No. 07/999,410 (“Cloned DNA Sequences, Hybridizable with Genomic RNA of Lymphadenopathy-Associated Virus (LAV)”) (the “‘410 application”). Chiron is the junior party in both interferences.

It is not known when nor on what basis these matters will be resolved.

Sysmex Corporation

In March 2001, Chiron filed a complaint and petition for preliminary injunction with the Osaka District Court in Japan against Sysmex Corporation (“Sysmex”) seeking damages and an injunction against Sysmex’s manufacture and sale of the Ranream HCV II Ex kit for infringing Chiron’s Japanese Patent No. 2733138 (the “‘138 patent”) claiming hepatitis C virus immunodiagnostic technology. Sysmex denied the infringement allegations and filed two invalidation appeals with the Japanese Patent Office Board of Appeals against the ‘138 patent. In February 2003, the Japanese Patent Office Board of Appeals, ruling on one of the invalidation appeals, found that the ‘138 patent was invalid. In May 2003, Chiron filed an appeal of the invalidation judgment before the Tokyo High Court. Furthermore, the second invalidation appeal was stayed pending Chiron’s appeal to the Tokyo High Court. In January 2005, the Tokyo High Court

upheld the judgment of the Japanese Patent Office Board of Appeals. Chiron has appealed this judgment to the Japanese Supreme Court.

It is not known when nor on what basis these matters will be resolved.

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

No matters were brought to a vote of Chiron’s stockholders in the quarter ended December 31, 2004.

EXECUTIVE OFFICERS OF THE REGISTRANT

The executive officers of Chiron are as follows, in alphabetical order:

Name		Age		Title
Ursula B. Bartels	47		Vice President; General Counsel; Secretary and interim Chief Compliance Officer
Jack Goldstein	57		President and Chief Operating Officer
William G. Green	60		Senior Vice President; Special Counsel
Anne Hill	45		Vice President, Human Resources
Jessica M. Hoover	47		Vice President; Head of Corporate Business Development
Meghan B. Leader	40		Vice President, Business Support Services and Chief Information Officer
Leone D. Patterson	42		Vice President and Controller
Howard H. Pien	47		Chief Executive Officer and Chairman of the Board
Rino Rappuoli	52		Vice President; Chief Scientific Officer
David V. Smith	45		Vice President; Chief Financial Officer
Daniel B. Soland	46		Vice President; President, Chiron Vaccines
Bryan L Walser	38		Vice President, Corporate Strategy
Gene W. Walther	50		Vice President; President, Chiron Blood Testing
Craig A. Wheeler	43		Vice President; President, Chiron BioPharmaceuticals

Ms. Bartels joined Chiron as Vice President and General Counsel in August 2004. In October 2004, she was designated the Company’s interim Chief Compliance Officer. In March 2005, she was designated the Company’s Secretary. Prior to joining Chiron, Ms. Bartels served as Vice President of Boehringer Ingelheim Corporation and Senior Vice President, General Counsel and Secretary of Boehringer Ingelheim Pharmaceuticals, Inc., where she was responsible for all legal functions for the corporation and its five U.S. subsidiaries. Boehringer’s primary business’ focus was branded human pharmaceuticals (primarily respiratory) and multi-source pharmaceuticals (comprised of subsidiaries, Roxane Laboratories and Ben Venue Laboratories). Prior to joining Boehringer in 1999, Ms. Bartels worked at SmithKline Beecham Corporation (now GlaxoSmithKline) from 1988 to 1999, where she progressed from Counsel, Litigation to Vice President and Associate General Counsel, responsible for the full range of legal operations in North America for its two U.S. divisions, Pharmaceuticals, and Healthcare Services (including clinical laboratory and pharmacy benefit management businesses). Ms. Bartels has been a member of the PhRMA Law Section Executive Committee since 1994, and served as Chair of the Law Section in 2001-2002. Ms. Bartels assembled and led the group that wrote the PhRMA Code. Ms. Bartels began her legal career as a litigation associate at Stradley Ronan Stevens and Young, in Philadelphia. She graduated in 1979 from Bryn Mawr College, A.B. cum laude, and attended the University of Virginia School of Law, graduating in 1983.

Dr. Goldstein joined Chiron as Vice President and President, Chiron Blood Testing Division in September 2002. In February 2005, Dr. Goldstein was appointed to the position of President and Chief Operating Officer. He had served as interim Chief Operating Officer of Chiron since November 2004. From 2000 to 2002, Dr. Goldstein was General Partner at Windamere Venture Partners, L.L.C., a venture fund making investments in early stage biotechnology, pharmaceutical, medical device and diagnostic companies. From 1997 to 2001, Dr. Goldstein was President and CEO of Applied Imaging Corporation, a leading supplier of instrument systems for prenatal and cancer genetics. From 1999 until 2002, Dr. Goldstein also served as Chairman of the Board of Applied Imaging and continues to serve as a director of one of Applied Imaging’s subsidiaries. From 1986 to 1997, Dr. Goldstein worked for Johnson & Johnson in various executive management positions, including President of Ortho Diagnostic Systems and Executive Vice President of Professional Diagnostics at Johnson & Johnson World Headquarters. Dr. Goldstein holds a B.A. degree in Biology from Rider University, an M.S. in Immunology and a Ph.D. in Microbiology from St. John’s University.

Mr. Green joined Chiron as Vice President and General Counsel in October 1990, having served as Secretary or Assistant Secretary since Chiron’s inception in 1981 until March 2005. In August 2004, Mr. Green was designated Special Counsel to the Chief Executive Officer upon the appointment of Ursula Bartels as Chiron’s General Counsel. He continues to serve as a Sr. Vice President. Since November 2003, Mr. Green has served on a part-time basis as General Counsel, Secretary and member of the Management Committee of the Gordon & Betty Moore Foundation, a private, philanthropic foundation, in which Chiron director, Edward E. Penhoet also is employed as President and Chief Executive Officer. Mr. Green was appointed Chief Program Officer, Environment, of the Foundation in September 2004. From February through August 2002, Mr. Green served as President of Chiron’s Blood Testing division. From 1981 to 1990, he was a partner in the San Francisco law firm of Brobeck, Phleger & Harrison.

Ms. Hill is responsible for human resources at Chiron. She joined Chiron in November 2004 from Baxter International Inc., where she served in a variety of executive positions of increasing responsibility from 1991 to 2004. From 1998 to 2004, she was global vice president of human resources for the Bioscience division of Baxter International in Westlake Village, California. Prior to relocating to the United States, Ms. Hill worked in human resources for the John Lewis Partnership, a large British retailer, from 1980 to 1990. Ms. Hill holds a BSc Econ degree in Industrial Relations from the University of Wales.

Ms. Hoover is responsible for corporate business development, including mergers, acquisitions, product licensing and other strategic transactions. She joined Chiron in 1994 as a member of the law department, most recently serving as vice president and assistant general counsel, where her responsibilities included strategic corporate transactions as well as business development initiatives within each of the company’s business units. Before joining Chiron, Ms. Hoover was a partner with Brobeck, Phleger & Harrison.

Ms. Leader joined Chiron in 1992, and is the Vice President, Business Support Services and Chief Information Officer. She is responsible for information technology, corporate facilities and corporate risk-mitigation services, including environmental health and safety, and business continuity planning. Since joining Chiron, Ms. Leader has held various positions in treasury, corporate development and information management. Prior to joining Chiron, she worked in treasury management for both Security Pacific Bank and Bank of America. Ms. Leader holds a B.A. degree in government and an M.B.A. from Saint Mary’s College of California.

Ms. Patterson joined Chiron as Director of special projects in the corporate Finance group in 1999. She has served as the Company’s Controller since 2001, and more recently, was promoted to Vice President, Controller in November 2003. Before joining Chiron, Ms. Patterson worked at KPMG as a senior manager in the San Francisco audit practice for two years. Prior to that, she was with KPMG Auckland in the New Zealand audit practice for eight years.

Mr. Pien joined Chiron as President and Chief Executive Officer, and a director, in April 2003. Upon the resignation of Seán P. Lance as Chiron’s Chairman of the Board following the annual meeting of stockholders in May 2004, Mr. Pien also was elected Chairman of the Board. In February 2005, Mr. Pien relinquished the title of President which was transferred to Dr. Goldstein in connection with the formalization of the role of Chief Operating Officer assumed by Dr. Goldstein. Mr. Pien joins Chiron from GlaxoSmithKline (GSK), which resulted from the merger of GlaxoWellcome and SmithKline Beecham, where he spent over twelve years in positions of international and global management responsibility, including: President of Pharmaceuticals International GSK from December 2000 to March 2003, including service as a member of the Corporate Executive Team; President, Pharmaceuticals, SmithKline Beecham (1998 to 2000); President, Pharmaceuticals-North America, SmithKline Beecham (1998); Senior Vice President and Director-North Asia (1997); Managing Director and Senior Vice President-UK (1995 to 1997); Vice President and Director, Marketing-US (1993 to 1995); Vice President and Director, Product Marketing-US, heading the arthritis, cardiovascular and vaccine groups (1992 to 1993); and Vice President and Director of New Product Development-US (1991 to 1992). Prior to joining SmithKline Beecham, Mr. Pien worked six years for Abbott Laboratories and five years for Merck & Co., in positions of sales, marketing research licensing and product management. Mr. Pien served as a director of ViroPharma Incorporated from 1998 to 2003. He currently serves as a director of several non-profit organizations: Oakland Children’s Hospital, California Healthcare Institute and Bio-Tech Industry Trade Association.

Dr. Rappuoli joined Chiron as head of European vaccines research in 1992 with the acquisition of Italian vaccines company, Sclavo SpA, where he served as head of research and development. He was responsible for Chiron Infectious Disease and Vaccine Research, serving as Vice President, Vaccine Research, Research and Development from February 2000 to January 2004. At Chiron, he led the development of MENJUGATE® conjugate vaccine against meningococcus C and the first recombinant bacterial vaccine, against pertussis. In February 2004, he was promoted to Vice President, Chief Scientific Officer of Chiron. Dr. Rappuoli earned his doctoral and bachelor’s degrees in biological sciences at the University of Siena, and also served as a visiting scientist at the Rockefeller University in New York and at the Harvard Medical School. Dr. Rappuoli is co-founder of the field of cellular microbiology, a discipline combining cell biology and microbiology, and has pioneered the genomic approach to vaccine development termed “reverse vaccinology”. He is member of numerous international associations, including the European Molecular Biology Organization and the American Society for Microbiology. Dr. Rappuoli also has served on many committees, among which the NIH Search Committee for the Director of the Vaccine Research Center (Bethesda, Maryland). He is co-chairman of the R/D Task Force of the Global Alliance for Vaccines and Immunization. He has won several prestigious international awards including the Paul Ehrlich, Ludwig Darmstaedter Prize; and IUMS Arima award. Dr. Rappuoli currently serves as a director of Fondazione Monte Dei Paschi di Siena, a private organization in Siena, Italy.

Mr. Smith joined Chiron as Vice President, Controller in February 1999 and was designated Chiron’s principal accounting officer. In February 2002, Mr. Smith was appointed Vice President, Finance. In April 2003, Mr. Smith was appointed interim Chief Financial Officer. In November 2003, Mr. Smith was appointed Chief Financial Officer. Prior to joining Chiron, Mr. Smith served as the Vice President, Finance and Chief Financial Officer of Anergen, Inc. from 1997 until he joined Chiron. From 1988 to 1997, Mr. Smith held various financial management positions with Genentech, Inc., in both the United States and Europe.

Mr. Soland joined Chiron as Vice President and President, Chiron Vaccines in late February 2005. He is responsible for the operations of Chiron’s global vaccine business. From 2003 until joining Chiron, Mr. Soland served as the President and Chief Executive Officer of Epigenesis Pharmaceuticals, a privately-held biopharmaceutical company that develops inhaled respiratory medicines for the treatment of asthma, chronic obstructive pulmonary disease and allergic rhinitis, from 2003 to 2005. From 1993 to 2003, Mr. Soland spent 10 years with GlaxoSmithKline Biologicals in a variety of executive positions, including Vice President and Director, Worldwide Marketing Operations from 1998-2003, and Vice

President and Director of SmithKline Beecham Pharmaceuticals, Vaccine Business Unit - U.S., from 1995 to 1998. Prior to joining GlaxoSmithKline, Mr. Soland spent eight years with Connaught Laboratories, a Pasteur Mérieux company with assignments in sales, sales management and product management. Mr. Soland holds a B.S. degree in Pharmacy from the University of Iowa, and was a licensed pharmacist (1981).

Dr. Walser joined Chiron as Division Vice President, Corporate Strategy in November 2001. Prior to joining Chiron, Dr. Walser was a principal in WRW, a Los-Angeles-based management consultancy working with The Rockefeller Foundation and the Boston Consulting Group on a variety of issues in biotechnology and healthcare. Before that, Dr. Walser trained in the Emergency Medicine program at UCLA, and worked for several years in Los Angeles with the healthcare practice of the Boston Consulting Group. Dr. Walser earned his undergraduate degree from Stanford, his medical degree from the University of Virginia School of Medicine and his law degree, magna cum laude, from Harvard Law School.

Mr. Walther initially joined Chiron as a consultant in August 1998, and was appointed as Vice President, Commercial Development, North America and Asia Pacific in January 2001. Mr. Walther has over two decades of experience in the health care industry in various executive management positions. From 1995 to 1998, Mr. Walther was Vice President, Global Marketing and International Sales for Gen-Probe, Incorporated. From 1991 to 1995, Mr. Walther owned and operated a Seattle-based manufacturing company involved in producing equipment for the outdoor recreational industry. He was head of sales and marketing for Seattle-based Genetic Systems from 1984 to 1991. Prior to that, Mr. Walter worked for Abbott Diagnostics and American Hospital Supply Corporation in a variety of sales, marketing and business development positions. Mr. Walther holds a B.S. degree in microbiology and immunology from Michigan State University and a Masters of Business Administration from the University of Washington.

Mr. Wheeler joined Chiron as Vice President, President of Chiron BioPharmaceuticals, responsible for the commercial operations of Chiron’s biopharmaceuticals business, in August 2001. Prior to joining Chiron, Mr. Wheeler was a senior member of The Boston Consulting Group’s health care practice and a key contributor to the firm’s practice in hospital strategy, disease management, and pharmaceutical capabilities. Based in Boston, he joined the firm in 1988. Before joining the Boston Consulting Group, Mr. Wheeler worked for Merck’s MSDRL research unit, where he served as a senior engineer in process development. He recently served as the leader of The Boston Consulting Group’s Scientist’s Network. In partnership with the Rockefeller Foundation, he has joined the Global Alliance for TB Drug Development, a public-private partnership to develop new anti-tuberculosis drugs.

PART II

ITEM 5. MARKET FOR THE REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

Our common stock is quoted on the NASDAQ National Market System under the symbol CHIR. As of December 31, 2004, there were 3,843 holders of record of Chiron common stock. We have declared no cash dividends since our inception and do not expect to pay any dividends in the foreseeable future. Pursuant to an agreement with Novartis, Novartis must approve our declaration and payment of dividends. See “Relationship with Novartis AG” above.

The quarterly high and low closing sales prices (rounded to the nearest one-hundredth) of our common stock for each quarter of 2004 and 2003 are shown below.

	2004				2003
	High		Low		High		Low
First Quarter	$	56.38	$	44.01	$	40.72	$	34.41
Second Quarter	48.59		42.25		49.00		37.68
Third Quarter	48.01		42.38		56.75		43.23
Fourth Quarter	45.42		30.76		56.98		51.75

We issued and sold $385.0 million aggregate principal amount of 2¾% convertible debentures due 2034 on June 22, 2004 in a private offering to Credit Suisse First Boston and Morgan Stanley (the “Initial Purchasers”). We have been advised by the Initial Purchasers that the debentures were resold in transactions that were exempt from the registration requirements of the Securities Act to persons reasonably believed by the initial purchasers to be “qualified institutional buyers” (as defined in Rule 144A under the Securities Act) in reliance on Rule 144A. These debentures mature on June 30, 2034 and accrue interest at a rate of 2.75% per year and interest is payable on June 30 and December 30 of each year. The debentures are senior, unsecured obligations of Chiron and rank equal in right of payment with all of Chiron’s existing and future unsecured and unsubordinated indebtedness.

The holders of the debentures may convert their debentures into Chiron common stock when certain Chiron common stock price targets have been met at certain times, if the trading price for the debentures falls below certain levels for a specified period of time, if the debentures have been called for redemption, if the credit rating assigned to Chiron’s long-term senior debt is below specified levels, upon the occurrence and continuance of specified corporate transactions or in connection with a transaction or event constituting a change in control. The initial conversion rate is 14.9254 shares of Chiron common stock per $1,000 principal amount of debentures. This is equivalent to an initial conversion price of approximately $67.00 per share of Chiron common stock.

If the debentures are tendered for conversion, the value (“Conversion Value”) of cash and shares of Chiron’s common stock, if any, to be received by a holder converting $1,000 principal amount of the debentures will be determined by multiplying the applicable conversion rate by a weighted average price. Chiron will deliver the Conversion Value to debenture holders as follows: (1) an amount in cash (“Principal Return”) equal to the lesser of (a) the aggregate Conversion Value of the debentures to be converted and (b) the aggregate principal amount of the debentures to be converted and (2) if the aggregate Conversion Value of the debentures to be converted is greater than the Principal Return, an amount in shares (“Net Shares”) equal to the aggregate Conversion Value less the Principal Return (“Net Share Amount”). The number of Net Shares to be paid will be determined by dividing the Net Share Amount by a weighted average price.

If a change in control occurs on or prior to July 5, 2010, under certain circumstances, holders of the debentures will receive a make whole premium on debentures tendered for repurchase and for debentures

converted in connection with a change in control. The amount of the make whole premium will be based on the price paid per share of Chiron common stock in a transaction constituting a change in control and is payable in Chiron common stock.

The net proceeds from this offering were approximately $377.3 million, after deducting the Initial Purchasers’ discount of $7.7 million. The proceeds from the sale of these debentures will be used for general corporate purposes, including working capital, capital expenditures, acquisitions and stock repurchases.

Our Board of Directors has, in the past, authorized the repurchase of our common stock on the open market through a stock repurchase program to offset the dilution associated with the issuance of new shares under the stock option and stock purchase plans and the granting of share rights. On December 5, 2003, the Board of Directors authorized Chiron to repurchase 5.0 million shares of Chiron common stock through December 31, 2004. Through December 31, 2004, we made purchases of 2.9 million shares, although there were no stock repurchases in the fourth quarter of 2004. On March 10, 2005, the Board of Directors authorized Chiron to repurchase 5.0 million shares of Chiron common stock through December 31, 2005.

ITEM 6. SELECTED FINANCIAL DATA

We have derived the selected consolidated financial data presented below as of December 31, 2004 and 2003 and for the years ended December 31, 2004, 2003 and 2002 from the audited Consolidated Financial Statements contained elsewhere in this Form 10-K. The selected consolidated financial data presented below as of December 31, 2002, 2001 and 2000 and for the years ended December 31, 2001 and 2000 were derived from our audited Consolidated Financial Statements not contained herein. Operating results for the periods presented below are not necessarily indicative of the results that may be expected for future years.

	Year Ended December 31,
	2004		2003		2002		2001		2000
	(In thousands, except per share data)
Total revenues	$	1,723,355	$	1,766,361	$	1,276,280	$	1,140,667	$	972,119
Income from continuing operations	54,063		220,338		181,145		174,758		16,102
Basic earnings per share from continuing operations	0.29		1.18		0.96		0.92		0.09
Diluted earnings per share from continuing operations.	0.28		1.15		0.94		0.90		0.08
Total assets	4,296,197		4,195,169		2,960,344		2,866,909		2,458,076
Long-term debt and long-term portion of capital leases	1,093,604		1,084,386		416,954		408,696		3,039

As discussed in Item 7. “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” several factors affected the comparability of information between 2004 and 2003. The first factor relates to the effects of our acquisition of PowderJect on July 8, 2003 and developments with respect to FLUVIRIN® influenza virus vaccine, which impacted our results of operations in 2004. Chiron did not release any FLUVIRIN product during the 2004-2005 influenza season. Chiron had no sales of FLUVIRIN vaccine in 2004 (other than $2.3 million in late 2003-2004 season sales), while FLUVIRIN vaccine sales were $219.2 million in 2003. In 2004, Chiron wrote-off the entire inventory of FLUVIRIN vaccine, resulting in a $91.3 million charge to cost of sales, which decreased diluted earnings per share by approximately $0.36 in 2004. In 2004, Chiron incurred remediation costs associated with our Liverpool facility of $2.6 million and incurred legal expenses of $12.1 million related to the developments with respect to FLUVIRIN, which together decreased diluted earnings per share by approximately $0.06 in 2004. In addition, we recorded a $45.3 million charge for purchased in-process research and development

for the acquisition of PowderJect in 2003. The amortization expense for the acquired intangible assets associated with this acquisition was $54.7 million in 2004 and $25.3 million in 2003. Second, on June 12, 2004, certain holders of our Liquid Yield Option Notes (LYONs) tendered certain of the LYONs for purchase by Chiron. The aggregate purchase price for all the LYONs validly surrendered for purchase was $379.7 million. Third, we issued $385.0 million aggregate principal amount of convertible debentures, which mature on June 30, 2034. Fourth, on September 10, 2004, we reached a settlement agreement with F. Hoffman-La Roche regarding an HIV-related patent dispute. The impact on royalty and license fee revenue was $45.8 million. Fifth, on July 2, 2004, we acquired Sagres Discovery (Sagres), a privately- held company headquartered in Davis, California, which focuses on the discovery and validation of targets with potential application to the development of cancer therapeutics. We acquired Sagres for a preliminary purchase price of $12.0 million and allocated $9.6 million of the preliminary purchase price to purchased-in-process research and development, which we charged to earnings in 2004.

As discussed in Item 7. “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” several factors affected the comparability of information between 2003 and 2002. The first factor relates to the effects of our acquisition of PowderJect for $938.6 million on July 8, 2003. Total revenues for PowderJect in 2003 were $244.7 million. In addition, as noted above, we recorded a $45.3 million charge for purchased in-process research and development in 2003. The amortization expense for the acquired intangible assets associated with this acquisition was $25.3 million in 2003. Second, we issued $500.0 million of convertible debentures in July 2003. Finally, in July 2003, we entered into a new six-year lease to rent a research and development facility in Emeryville, California following the expiration of the existing operating lease. We accounted for this new lease as a capital lease and, as a result, recorded the leased facility and the corresponding liability on our balance sheet effective July 1, 2003. The amount recorded on the balance sheet for the leased facility was $157.5 million.

Factors that affected the comparability of information between 2002 and 2001 include (i) our implementation of Statement of Financial Accounting Standards (referred to as SFAS) No. 142 on January 1, 2002, which requires that assembled workforce be reclassified to goodwill and that goodwill (including assembled workforce) no longer be amortized, (ii) the commercial sale of the PROCLEIX® HIV-1/HCV Assay in the U.S in 2002 which was the primary contributor to an increase in worldwide product sales related to tests and instruments and the provision of services from $48.3 million in 2001 to $125.4 million in 2002 and (iii) our acquisition of Matrix Pharmaceutical, Inc. in 2002 for $67.0 million including a $45.2 million charge for purchased in-process research and development. The goodwill and assembled workforce amortization expense was $17.1 million in 2001.

Factors that affected the comparability of information between 2001 and 2000 include (i) issuance of zero coupon Liquid Yield Option Notes in June 2001 for proceeds of $401.8 million, (ii) a full-year of TOBI® tobramycin sales of $123.1 million in 2001 and (iii) a full year of amortization expense on goodwill and other acquired intangible assets of $38.4 million recognized in 2001 as a result of our acquisition of PathoGenesis Corporation in 2000. In 2000, we recognized TOBI® product sales of $27.8 million (including $2.2 million from the last seven days in September 2000) and amortization expense on goodwill and other acquired intangible assets of $9.6 million.

See Note 18, “Segment Information,” of Notes to Consolidated Financial Statements for geographic information and operating results by operating segment.

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

Introduction

We are a global biopharmaceutical company, the revenues of which primarily consist of product sales, revenues from a joint business contractual arrangement, collaborative agreement revenues, royalty and license fee revenues and other revenues, which primarily consist of contract manufacturing and grant revenues. Our research and development efforts are focused on developing products for oncology and infectious and pulmonary disease. We participate in three healthcare markets: blood-testing, vaccines and biopharmaceuticals.

The blood-testing segment consists of an alliance with Gen-Probe and our one-half share in the pretax operating earnings generated by the joint business contractual arrangement with Ortho-Clinical Diagnostics. Our alliance with Gen-Probe is focused on developing and commercializing nucleic acid testing products using transcription-mediated amplification technology to screen donated blood and plasma products for viral infection. Our joint business arrangement with Ortho-Clinical Diagnostics is operated under a contractual arrangement and is not a separate and distinct legal entity. Through our joint business contractual arrangement with Ortho-Clinical Diagnostics, we sell a line of immunodiagnostic tests to detect hepatitis viruses and retroviruses and provide supplemental tests and microplate and chemiluminescent instrument systems to automate test performance and data collection. The blood-testing segment also earns royalties from third parties based on their sales of immunodiagnostic and nucleic acid testing probe diagnostic products utilizing our hepatitis C virus and HIV-related patents, for use in blood screening and plasma fractionation markets.

The vaccines segment consists of more than 20 pediatric and adult vaccines including influenza, meningococcal, travel, and pediatric vaccines. We sell these vaccines primarily in the U.S., Germany, Italy and the United Kingdom, as well as in other international markets. Our vaccines segment is also involved in the development of other novel vaccines and vaccination technology. We acquired FLUVIRIN® influenza virus vaccine, ARILVAX™ vaccine for yellow fever and DUKORAL® vaccine for cholera as part of our July 8, 2003 acquisition of PowderJect. We accounted for that acquisition as a business combination and included PowderJect’s operating results in our consolidated operating results beginning July 8, 2003.

The biopharmaceuticals segment consists of therapeutic products, with an emphasis on the treatment of cancer, infectious and pulmonary diseases. Our in-house capabilities span three types of therapeutics, including small molecules, therapeutic proteins and monoclonal antibodies. Our products include TOBI® (tobramycin solution for inhalation) for pseudomonal lung infections in cystic fibrosis patients, PROLEUKIN® (aldesleukin) for cancer (metastatic melanoma and renal cell carcinoma), and BETASERON® (interferon beta-1b) for multiple sclerosis. The biopharmaceuticals segment also includes collaborations with Berlex Laboratories, Inc. and its parent company, Schering AG of Germany, related to BETASERON® interferon beta-1b. The biopharmaceuticals segment earns royalties on third party sales of several products, primarily BETAFERON® interferon beta-1b, and earns license fees for technologies, such as hepatitis C virus-related patents, used by third parties to develop therapeutic products.

We view certain other revenues and expenses as not belonging to any one segment. As a result, we have aggregated these items into an “Other” segment.

FLUVIRIN® Influenza Virus Vaccine Recent Events

completion of internal investigations. On October 5, 2004, the U.K. regulatory body, the Medicines and Healthcare products Regulatory Agency, or MHRA, sent us a letter prohibiting us from releasing any FLUVIRIN vaccine doses manufactured at our Liverpool facility since March 2, 2004 and suspending our license to manufacture influenza virus vaccine in our Liverpool facility for three months (later extended for an additional three months). In that letter, the MHRA asserted that our manufacturing process did not comply with U.K. good manufacturing practices regulations. Following the MHRA’s decision and an inspection by the Food and Drug Administration, or FDA, the FDA sent us a warning letter citing violations of good manufacturing practices. We provided the FDA with a written response to the warning letter on January 7, 2005. As a result of the suspension of our license, we did not release any FLUVIRIN product during the 2004-2005 influenza season.

On March 2, 2005, the MHRA notified us that it had lifted the license suspension, giving Chiron clearance to initiate full production of FLUVIRIN® vaccine, conditioned on the understanding that Chiron’s commitment to its remediation plan will continue. The FDA is still expected to conduct a full inspection to determine whether deficiencies noted in the warning letter the FDA issued in December 2004 have been resolved. If we fail to adequately address the matters discussed in the warning letter, the FDA may modify our U.S. license in an adverse manner, take action that could result in imposition of fines, require temporary or permanent cessation of future selling of FLUVIRIN vaccine or take other action that could reduce our ability to market FLUVIRIN vaccine.

We received a grand jury subpoena issued by the U.S. Attorney’s Office for the Southern District of New York in October 2004 requesting production of certain documents relating to FLUVIRIN vaccine and the suspension by the MHRA of our license. In February 2005, the Securities and Exchange Commission, or SEC, notified us that it would commence a formal investigation into whether we or our employees have violated any federal securities laws in connection with these developments regarding FLUVIRIN vaccine, after having previously commenced an informal inquiry. We also received a voluntary request for information from the United States House of Representatives Committee on Energy and Commerce requesting production of certain documents. Numerous documents have been collected and produced in response to these requests, and several witnesses have been interviewed by the U.S. Attorney’s Office and the SEC staff and additional interviews are anticipated. Additional investigations regarding these matters may arise. In addition, we and certain of our officers and directors have also been named as defendants in several putative shareholder class action and derivative lawsuits alleging various claims arising out of or relating to these developments regarding FLUVIRIN vaccine, including the U.S. Centers for Disease Control and Prevention and certain distributors of FLUVIRIN vaccine who have suggested that they are entitled to compensation under their contracts for the 2004-2005 season. It is not possible to predict whether any of these claims will be pursued and, if so, whether those claims will be upheld. Investigations, litigation and disputes have caused us to incur substantial expense and have required significant time and attention from our management and will continue to do so in the future and could result in civil and/or criminal penalties against Chiron. The results of any such investigations, proceedings or disputes could have a material adverse effect on our cash flow. For more information on these lawsuits, investigations and claims, see Part I, Item 3. “Legal Proceedings” above.

As a result of these FLUVIRIN vaccine matters, our results of operations for 2004 were materially adversely affected. These developments had the following immediate impact on our results of operations for the twelve months ended December 31, 2004:

· we had no sales of FLUVIRIN vaccine for the 2004-2005 season, while FLUVIRIN vaccine sales were $219.2 million for the twelve months ended December 31, 2003; and

· we wrote-off our entire inventory of FLUVIRIN vaccine, resulting in a $91.3 million charge to cost of sales, incurred remediation costs associated with our Liverpool facility of $2.6 million, and incurred legal expenses of $12.1 million related to the developments with respect to FLUVIRIN

vaccine. These charges decreased diluted earnings per share by approximately $0.42 for the twelve months ended December 31, 2004.

Our inability to supply FLUVIRIN vaccine during the 2004-2005 influenza season may also lead to loss of market share in the 2005-2006 season and future seasons. Following the announcement of our license suspension, competitors have announced plans to introduce influenza vaccine products in the United States and are seeking expedited regulatory approval to do so. Even though the license suspension has been lifted, some of our customers may choose to purchase flu vaccine from other providers as their products become available in the United States. Loss of market share could have a material adverse effect on our business and results of operations. We also expect to incur expenses in connection with ongoing FLUVIRIN vaccine matters, which could be material, including in connection with (1) our continuing remediation efforts at our Liverpool facility; and (2) responding to the U.S. Attorney for the Southern District of New York, the SEC, the United States House of Representatives Committee on Energy and Commerce and the private lawsuits and other claims and investigations that may arise.

For additional information concerning the risks we face as a result of these FLUVIRIN vaccine developments, see “Factors That May Affect Future Results—The recent developments with respect to FLUVIRIN vaccine will harm our business and results of operations.” For additional information on the U.S. Attorney’s investigation, SEC investigation and private lawsuits and other claims, see Part I, Item 3. “Legal Proceedings” of this report on Form 10-K.

Restated Second-Quarter and Third-Quarter 2004 Financial Statements

During our year-end financial statement review and Section 404 Sarbanes-Oxley review, we determined that certain sales of the travel vaccine recorded as revenues in the second quarter of 2004 should not have been recorded as revenue at that time, and that portions of those sales should have been recorded as revenues in the third and fourth quarters of 2004 and possibly in later quarters. As a result, we determined to restate the financial statements included in our Quarterly Reports on 10-Q for such quarters. Summary restated income statement information for the second and third quarters of 2004 is included in Note 20, “Quarterly Financial Data (Unaudited),” of Notes to Consolidated Financial Statements.

In light of the fact that we were already in contact with the SEC in relation to their investigation described above under “FLUVIRIN® Influenza Virus Vaccine Recent Events,” we informed the SEC of these matters, and adjustments we made after January 26, 2005 to the fourth quarter and full year financial information we released on January 26, 2005, and have been providing the SEC information.

Summary Consolidated Financial Data

Following is an analysis and discussion of our operating results on a consolidated basis, which is followed by a description of our most critical accounting policies and use of estimates and more detailed analysis and discussion of our operating results by segment and our liquidity and capital resources.

										$ Change					% Change
	Year Ended December 31,									2004 vs.			2003 vs.		2004 vs.			2003 vs.
	2004			2003			2002			2003			2002		2003			2002
	($ in 000’s, except per share data)
Product sales, net	$	1,268,303		$	1,345,833		$	914,121		$	(77,530	)	$	431,712		(5.8	)%		47.2	%
Royalty and license fee revenues	289,561			250,142			198,816			39,419			51,326			15.8	%		25.8	%
Other revenues	29,201			43,526			36,625			(14,325		)	6,901			(32.9	)%		18.8	%
Total revenues	1,723,355			1,766,361			1,276,280			(43,006		)	490,081			(2.4	)%		38.4	%
Cost of sales (excludes amortization expense from acquired developed products)	669,667			571,897			341,808			97,770			230,089			17.1	%		67.3	%
Research and development	431,128			409,806			325,792			21,322			84,014			5.2	%		25.8	%
Selling, general and administrative	465,779			380,388			283,712			85,391			96,676			22.4	%		34.1	%
Purchased in-process research and development	9,629			45,300			45,181			(35,671		)	119			(78.7	)%		0.3	%
Income from continuing operations	54,063			220,338			181,145			(166,275		)	39,193			(75.5	)%		21.6	%
Diluted earnings per share:
Income from continuing operations	$	0.28		$	1.15		$	0.94		$	(0.87	)	$	0.21		(75.7	)%		22.3	%
Gross profit margin	47		%	58		%	63		%

2004 compared with 2003

As described above, there were no sales of FLUVIRIN vaccine for the 2004-2005 season. Sales of FLUVIRIN influenza vaccine were $219.2 million for the twelve months ended December 31, 2003. A contractual decline in the BETASERON® interferon beta-1b royalty rate, described in more detail below, resulted in a $34.8 million decline in total revenues for the twelve months ended December 31, 2004. Our total revenues were affected by the movement in exchange rates, in particular the movements in the Euro and British Pound against the U.S. dollar. The movement in exchange rates added approximately 3% to our total revenues for the twelve months ended December 31, 2004. As described above, we wrote-off our entire FLUVIRIN product inventory, resulting in a $91.3 million charge to cost of sales, incurred remediation costs associated with our Liverpool facility of $2.6 million, and incurred legal expenses of $12.1 million related to the FLUVIRIN vaccine developments discussed above under “—FLUVIRIN® Influenza Virus Vaccine Recent Events”, which decreased diluted earnings per share by approximately $0.42 for the twelve months ended December 31, 2004. Also since our Euro and British Pound denominated expenses have increased due to the movement in exchange rates, our earnings per share from continuing operations declined $0.08 per diluted share for the twelve months ended December 31, 2004, as our expenses denominated in Euros and British Pounds exceeded our revenues denominated in those currencies.

Product sales decreased compared to 2003 as there were no FLUVIRIN influenza vaccine sales for the 2004-2005 season. The decrease in FLUVIRIN vaccine sales was partially offset by increased sales in PROCLEIX® products, TOBI® tobramycin inhalation solution, other influenza vaccines products,

PROLEUKIN® aldesleukin and travel vaccines. Sales of PROCLEIX and TOBI products increased 25% and 24%, respectively, in 2004 when compared to 2003.

Royalty and licenses fees increased significantly compared to 2003 due to the F. Hoffmann-La Roche (Roche) settlement regarding our HIV patent in the U.S. The settlement included a $78.0 million lump sum payment, of which $14.0 million was recognized in the third quarter 2004. In addition, the settlement resulted in $31.8 million of previously deferred royalty and license payments, being was recognized in the third quarter 2004. The impact of these items from the Roche settlement was an approximate $0.18 increase in diluted earnings per share for 2004. Royalties and license fees also increased $7.9 million from a non-exclusive license we granted to the German Red Cross and $6.5 million from a licensing agreement with LabCorp.

Other revenues declined due to $14.4 million of revenue in 2003 from the Biogen and Serono settlements in connection with certain patents owned by Chiron and licensed exclusively to Schering AG’s U.S. subsidiary, Berlex Laboratories.

In 2004, gross profit margins decreased to 47% from 58% in 2003, primarily due to the write-off of our entire inventory of FLUVIRIN vaccine, resulting in a $91.3 million charge to cost of sales in the third quarter 2004, as well as the fact that there were no FLUVIRIN vaccine sales for the 2004-2005 season. In addition, remediation costs of $2.6 million associated with our Liverpool facility were included in cost of sales in 2004. The effect of the FLUVIRIN vaccine charge and remediation costs resulted in a 7 point decrease in our gross profit margin percentage for 2004. Gross profit margin was also negatively impacted by reduced sales and margins of the MENJUGATE® product, which decreased our gross profit margin by 2 percentage points when comparing 2004 with 2003.

Gross profit margins do not include amortization expense from acquired developed products, an intangible asset related to business combinations.

The main components of the increase in research and development expenses in 2004 as compared with 2003 include our infectious disease franchise, primarily tifacogin, our oncology franchise, our meningococcus vaccine franchise and our flu cell-culture program. These increases were partially offset by the discontinuance of development of tezacitabine and PA-2794. In addition, 2003 included expenses related to the in-licensing of CUBICIN® (daptomycin for injection) and technology from ZymeQuest Inc. and Infectio Diagnostic Inc.

The increase in selling general and administrative expenses in 2004 as compared with 2003 mainly reflects an $18.0 million increase due to the movement in the Euro and British Pound exchange rates, $12.3 million from a full year of PowderJect expenses and $12.1 million in legal expenses related to the FLUVIRIN developments discussed above under “—FLUVIRIN® Influenza Virus Vaccine Recent Events”. The remaining increase in selling, general and administrative expenses is primarily due to defense of our patents and technology, on-going marketing and pre-launch programs to support the continued growth of our business and investment in geographic penetration for our products and corporate governance costs.

The effective tax rate for 2004 was 28.2% of pretax income from continuing operations, including the charge for purchased in process research and development related to the Sagres acquisition. The effective tax rate for 2003 was 28.7% of pretax income from continuing operations including the charge for purchased in-process research and development related to the PowderJect acquisition. The charges for the purchased in-process research and development in 2004 and 2003 are not tax deductible. The effective tax rates in 2004 and 2003 were both 25.0% of pretax income from continuing operations, after excluding the impact of the purchased in-process research and development charges. The effective tax rate in 2004 includes increased benefits from research tax credits and foreign income taxed at lower rates. Such benefits are a greater percentage of pretax income in 2004 than in 2003. These benefits were offset by the tax cost of transferring certain product rights through inter-company transactions as part of our long-term tax

planning strategy. The effective tax rate may be affected in future periods by changes in management’s estimates with respect to our deferred tax assets and other items affecting the overall tax rate.

2003 compared with 2002

Total revenues for PowderJect in 2003 were $244.7 million. PowderJect flu vaccine sales were $219.2 million in 2003. In 2003, our total revenues reflected the benefit of the movement in exchange rates, in particular the movement in the Euro to U.S. dollar exchange rate. In 2003, the movement in exchange rates added approximately 8% to our total revenues. Our vaccines segment reflects the greatest impact of the movement in exchange rates, which added approximately 15% to our total 2003 vaccines revenues. Similarly, our total Euro-based expenses increased due to the movement in exchange rates.

In 2003, increases in product sales were seen across all three of our business units, and in particular flu vaccines and PROCLEIX® products. Our share of revenues from our joint business contractual arrangement with Ortho Clinical Diagnostics was $108.3 million compared to $104.6 million in 2002, up primarily due to a one-time benefit in the first quarter 2003 from a change in estimate relating to revenues from Ortho Clinical Diagnostics’ non-U.S. affiliate sales, as discussed below. Royalty and license fees, collaborative agreement revenues and other revenues were $312.2 million in 2003 compared to $257.6 million in 2002, up primarily due to HCV/HIV product royalties and license fees from our intellectual property portfolio and BETAFERON royalties.

In 2003, gross margins decreased to 58% from 63% in 2002, largely due to (i) changes in the product mix of our three segments and (ii) additional costs of $24.4 million in 2003 associated with the sale of inventory acquired during the acquisition of PowderJect. These additional costs related to a fair value adjustment on the acquisition of PowderJect. In particular, vaccine product sales accounted for 50% of total product revenues in 2003 up from 39% in 2002, which had a significant impact on gross margins.

Research and development expenses for PowderJect were $16.2 million in 2003. The 2003 spending reflects our increased level of investment across all three of our segments. The main beneficiaries of this increase include our meningococcal vaccines franchise, flu cell culture, tifacogin and interleukin-2 in combination with various monoclonal antibodies. In addition, there were additional expenses related to the in-licensing of daptomycin from Cubist Pharmaceuticals and purchased in-process technology associated with our investment in ZymeQuest Inc. We are collaborating with ZymeQuest, Inc. to develop and commercialize a enzymatic conversion system which converts group A, B and AB red blood cells to enzyme-converted group O (ECO®) red blood cells, and costs associated with an agreement with Infectio Diagnostics Inc. in which we licensed proprietary nucleic acid-based technology for the rapid detection of bacterial contamination in platelets and blood products. However, we are no longer investing in the bacterial detection technology due to changes in the market.

In 2003, selling general and administrative expenses totaled $380.4 million compared to $283.7 million in 2002 with PowderJect contributing approximately $37.6 million in 2003. The remaining increase in selling, general and administrative expenses resulted from additional costs associated with the enhancement of current business processes and headcount, the Euro to U.S. Dollar exchange rate fluctuation, the expansion of our customer base for the PROCLEIX® HIV-1/HCV Assay in the U.S., Europe and other international markets, the preparation and roll-out of the West Nile Virus assay under IND testing, ongoing sales and marketing programs to support TOBI® tobramycin in the U.S. and continued market penetration in Europe and continued investment in and defense of our patents and technology.

The reported effective tax rate for 2003 is 28.7% of pretax income from continuing operations, including the charge for purchased in-process research and development related to the PowderJect acquisition. The reported effective tax rate for 2002 was 31.6% of pretax income from continuing operations, including the charge for purchased in-process research and development related to the Matrix

Pharmaceutical acquisition. The effective tax rates for 2003 and 2002 after excluding the impact of the in-process research and development charges were 25.0% and 27.0%. The 2003 effective tax rate is lower than the 2002 effective tax rate due to an increase in income earned in lower tax jurisdictions, net of increased benefits recognized in 2002 with respect to our research and development activities.

On February 20, 2002, we acquired Matrix Pharmaceutical, a company that was developing tezacitabine, a drug to treat cancer. We accounted for the acquisition as an asset purchase and included Matrix Pharmaceutical’s operating results in our consolidated operating results beginning on February 20, 2002. Matrix Pharmaceutical is part of our biopharmaceuticals segment. We allocated the purchase price based on the fair value of the assets acquired and liabilities assumed. We allocated $45.2 million of the purchase price to purchased in-process research and development, which we charged operations in 2002.

Critical Accounting Policies and the Use of Estimates

The preparation of financial statements requires us to make estimates, assumptions and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosures of contingent assets and liabilities. On an on-going basis, we evaluate our estimates, including those related to investments; inventories; derivatives; capital leases; intangible assets; goodwill; purchased in-process research and development; product discounts, rebates and returns; bad debts; collaborative, royalty and license arrangements; restructuring; pension and other post-retirement benefits; income taxes; and litigation and other contingencies. We base our estimates on historical experience and various other assumptions that we believe to be reasonable under the circumstances, the results of which form our basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from those estimates under different assumptions or conditions.

Our blood-testing segment includes our one-half share in the pretax operating earnings generated by the joint business contractual arrangement with Ortho-Clinical Diagnostics, Inc. Our joint business arrangement with Ortho-Clinical Diagnostics is a contractual arrangement and is not a separate and distinct legal entity. Through our joint business contractual arrangement with Ortho-Clinical Diagnostics, we sell a line of immunodiagnostic tests to detect hepatitis viruses and retroviruses and provide supplemental tests and microplate and chemiluminescent instrument systems to automate test performance and data collection. Prior to 2003, we accounted for revenues relating to non-U.S. affiliate sales on a one-quarter lag, with an adjustment of the estimate to actual in the subsequent quarter. More current information of non-U.S. affiliate sales of our joint business contractual arrangement became available in the first quarter 2003, and as a result, we are able to recognize revenues relating to non-U.S. affiliate sales on a one-month lag. The effect of this change, net of tax, was an increase to net income by $3.2 million for revenues from the joint business arrangement for the year ended December 31, 2003.

For sales of BETASERON® interferon beta-1b, we recognize revenues upon shipment to our marketing partner, Schering, and additional revenues upon Schering’s subsequent sale of BETASERON® interferon beta-1b to patients. Upon shipment to Schering, we recognize the contractually determined fixed amount of the fee to which we are entitled because at this point, there is persuasive evidence of an arrangement, delivery has occurred, the price due from Schering is fixed or determinable and collectibility is reasonably assured. Upon receiving the contractual reporting of relevant customer sales from Schering, we recognize the incremental portion of the fee related to Schering’s shipments to its customers because this portion of the fee is not determinable until receipt of the related sales reports. We also earn royalties on our marketing partner’s European sales of BETAFERON® product in those cases where we do not supply the product. Prior to 2002, we accounted for revenues from non-U.S. product sales on a one-quarter lag and royalties as a percentage of forecast received from our marketing partner, with an adjustment of the estimate to actual in the subsequent quarter. More current information of non-U.S. BETASERON® interferon beta-1b sales became available in 2002, and as a result, we were able to recognize revenues from BETASERON® product sales and BETAFERON® interferon beta-1b royalties on a current basis

beginning in the first quarter 2002. The effect of this change, net of tax, was an increase in net income for the year ended December 31, 2002 by $3.1 million for product sales and $2.8 million for royalties.

We believe the following critical accounting policies incorporate our more significant judgments and estimates used in the preparation of our Consolidated Financial Statements:

· Purchased in-process research and development—We allocate the purchase price of acquisitions based on the fair value of the assets acquired and liabilities assumed. To assist in determining the value of the in-process research and development and certain other intangibles, a third party valuation is typically obtained as of the acquisition date if the acquisition is significant. We generally use the income approach to value in-process research and development. The income approach is based on the premise that the value of a security or asset is the present value of the future earning capacity that is available for distribution to the subject investors in the security or asset. We perform a discounted cash flow analysis, utilizing anticipated revenues, expenses and net cash flow forecasts related to the technology. Given the high risk associated with the development of new drugs, we probability adjust the revenue and expense forecasts to reflect the risk of advancement through the regulatory approval process based on the stage of development in the regulatory process. Such a valuation requires significant estimates and assumptions. We believe the fair value assigned to the in-process research and development is based on reasonable assumptions. However, these assumptions may be incomplete or inaccurate, and unanticipated events and circumstances may occur. Additionally, estimates for the purchase price allocation may change as subsequent information becomes available. For example, in the fourth quarter of 2003, upon completion of strategic assessments of the value of certain PowderJect research and development projects, we revised the allocation of a portion of the purchase price resulting in a $77.4 million decrease to purchased in-process research and development which we credited to operations and which was offset against goodwill.

· Investments—We invest in marketable equity securities. The prices of some of our marketable securities are subject to considerable volatility. We record an impairment charge when we believe that an investment in a marketable security has experienced a decline in fair value, as measured by quoted market prices, that is other-than-temporary. Generally, we believe that an investment in a marketable security is impaired if its quoted market price has been below its carrying value for each trading day in a six-month period or a credit event has occurred, at which point we write down the investment. However, in determining whether impairment of a marketable security is considered to be other-than-temporary, we consider all available factors in the evaluation. These factors may include, but are not limited to, (i) whether the issuer of the securities is experiencing depressed and declining earnings in relation to competitors, erosion of market share, and deteriorating financial position, (ii) whether the issuer is experiencing financial difficulties and its market is experiencing difficulties, (iii) ongoing activity in our collaborations with the issuer, if any, and (iv) the issuer’s prospects for favorable clinical trial results, new product initiatives and new collaborative agreements. Decreases in the fair value of these securities may impact our profitability. To reduce this risk, we hedge a portion of our equity securities exposure through forward sales contracts.

· Inventories—We maintain inventory reserves primarily for product failures, expiration and obsolescence. The manufacturing processes for many of our products are complex. Slight deviations anywhere in the manufacturing process may result in unacceptable changes in the products that may result in failures or recalls and, therefore, additional inventory reserves. Obsolete inventory, due to the expiration of shelf life, and the seasonal nature of some of our products, may result in additional inventory reserves. In estimating inventory obsolescence reserves, we analyze on a product-by-product basis (i) the shelf life and the expiration date, (ii) sales forecasts and (iii) inventory levels compared to forecasted usage. Judgment is required in determining whether the forecasted sales and usage information is sufficiently reliable to enable us to estimate an inventory obsolescence

reserve. In addition, we operate in a highly competitive environment, with rapidly changing technologies. New technology or changes in production processes may result in product obsolescence. As a result, we may be required to record additional inventory reserves.

· Product returns and rebates—We have extensive historical information on returns and rebates for our products. Historical information with respect to actual product returns and rebates is the primary factor assessed in estimating product returns and rebates allowances. In determining the allowance for product returns, we primarily use one of the following methodologies depending on the product: (i) we match the actual returns to the actual sale on a product-by-product basis to assess the historical trend for returns, and based on an analysis of the historical trend, the appropriate return percentage for the current period is then applied to current period sales to arrive at the product returns charge against revenue for the period or (ii) for seasonal products we analyze our actual returns over the previous seasons to arrive at the average actual returns percentage, which is then applied to the current season’s sales to arrive at the charge against revenue for the current period. In estimating rebates, we use historical trends to analyze rebates against revenue on a product-by-product basis to arrive at an expected rebate percentage. This expected rebate percentage is applied to current period sales to arrive at the rebates expense for the period. If actual product returns and rebates vary, we may need to adjust our estimates and accruals accordingly.

· Collaborative, royalty and license arrangements—We recognize up-front refundable fees as revenues upon the later of when they become nonrefundable or when performance obligations are completed. In situations where continuing performance obligations exist, we defer and amortize up-front nonrefundable fees ratably over the performance period, which is typically stipulated by the contract and we may also defer further until collection is reasonably assured. In arrangements with multiple deliverables, there may be significant judgment in determining whether the different revenue generating activities are separable. Milestones, if any, related to scientific or technical achievements are recognized in income when the milestone is accomplished. The terms of such arrangements may cause our operating results to vary considerably from period to period. We estimate royalty revenues based on previous period royalties received or on product sales forecast information provided by the third party licensee. In the subsequent quarter, we record an adjustment equal to the difference between those estimated royalty revenues recorded in the previous quarter and the contractual percentage of the third party’s actual product sales for that period. We exercise judgment in determining whether the forecast information provided by licensees is sufficiently reliable for us to base our royalty revenue recognition thereon.

· Income taxes—Significant management judgment is required in developing our provision for income taxes, including the determination of deferred tax assets and liabilities and any valuation allowances that might be required against the deferred tax assets. We record valuation allowances to reduce deferred tax assets to the amounts that are more likely than not to be realized. We have considered future taxable income and ongoing prudent and feasible tax planning strategies in assessing the need for valuation allowances. If we determined that we would be able to realize our deferred tax assets in the future in excess of our net deferred tax assets, adjustments to the deferred tax assets would increase income by reducing tax expense in the period that we made such determination. Likewise, if we determined that we would not be able to realize all or part of our net deferred tax assets in the future, adjustments to the deferred tax assets would decrease income by increasing tax expense in the period that we made such determination. Annual tax provisions include amounts considered sufficient to pay assessments that may result from examination of prior year tax returns; however, the amount ultimately paid upon resolution of issues raised may differ materially from the amount accrued. In evaluating the exposure associated with various tax filing positions, we accrue charges for probable exposures. We maintain an allowance for tax

contingencies, which management believes to be adequate. As part of our long-term tax planning strategy, we transfer certain product rights through inter-company transactions. Tax expense and the effective tax rate increase in the years these transactions take place, with the expected future benefit being lower taxation of future product revenues.

· Litigation and other contingencies—We establish and maintain accruals for litigation and other contingencies when we believe a loss to be probable and reasonably estimable, as required by SFAS No. 5, Accounting for Contingencies. We base our accruals on information available internally within the company at the time of such determination and after management has consulted with and obtained advice from external professional advisors. Judgment is required in both the determination of probability and as to whether such an exposure is reasonably estimable. Information may become available to us after that time, for which adjustments to accruals may be required.

· Goodwill and intangible assets—The valuation in connection with the initial purchase price allocation and the ongoing evaluation for impairment of goodwill and intangible assets requires significant management estimates and judgment. The purchase price allocation process requires management estimates and judgment as to expectations for various products and business strategies. If any of the significant assumptions differ from the estimates and judgments used in the purchase price allocation, this could result in different valuations for goodwill and intangible assets. For the PowderJect acquisition, we initially allocated $451.8 million of the purchase price to goodwill in the third quarter 2003. In the fourth quarter 2003, the allocation of the purchase price changed as we completed the strategic assessments of the value of certain research and development projects and adjusted the purchased in-process research and development, and upon finalization of certain estimates. Accordingly, goodwill associated with the PowderJect acquisition was adjusted to $503.0 million in the fourth quarter 2003. During 2004, we completed the planned divestiture of certain research operations in Madison, Wisconsin and Oxford, England and certain vaccines operations in Sweden, we adjusted the previously recorded obligation related to an assumed defined benefit plan, revised estimates of exit costs associated with certain contractual obligations under supply and research agreements related to the divested research operations and other direct acquisition costs, and revised estimates of certain receivables and insurance estimates. The net impact of these items resulted in an increase to goodwill associated with the PowderJect acquisition of $17.9 million and goodwill was adjusted from $503.0 million in 2003 to $520.9 million in 2004. Once it is established, we must test goodwill annually for impairment using a two-step process as required by SFAS No. 142, Goodwill and Other Intangible Assets. In addition, in certain circumstances, we must assess if goodwill should be tested for impairment between annual tests. Intangible assets with definite useful lives must be tested for impairment in accordance with SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets. When we conduct our impairment tests for goodwill and intangibles, factors that are considered important in determining whether impairment might exist include significant continued under-performance compared to peers, significant changes in the underlying business and products of our reporting units, or other factors specific to each asset or reporting unit being evaluated. Any changes in key assumptions about the business and its prospects, or changes in market conditions or other externalities, could result in an impairment charge and such a charge could have a material adverse effect on our consolidated results of operations.

The accounting policies of our reportable segments are the same as those described in Note 1, “The Company and Summary of Significant Accounting Policies,” in the Notes to Consolidated Financial Statements.

Certain minor arithmetical variances between the following narrative and the Consolidated Financial Statements may arise due to rounding.

Results of Operations

Blood-testing

										$ Change						% Change
	Year Ended December 31,									2004 vs.			2003 vs.			2004 vs.			2003 vs.
	2004			2003			2002			2003			2002			2003			2002
	($ in 000’s, except percentages)
Product sales, net:
PROCLEIX® system	$	249,809		$	200,066		$	125,392		$	49,743		$	74,674			24.9	%		59.6	%
Ortho-clinical Diagnostics	27,844			28,391			22,652			(547		)	5,739				(1.9	)%		25.3	%
	277,653			228,457			148,044			49,196			80,413				21.5	%		54.3	%
Revenue from joint business arrangement	118,246			108,298			104,576			9,948			3,722				9.2	%		3.6	%
Collaborative agreement revenues	8,044			9,012			9,420			(968		)	(408		)		(10.7	)%		(4.3	)%
Royalty and license fee revenues	89,192			75,407			53,548			13,785			21,859				18.3	%		40.8	%
Other revenues	979			466			232			513			234				110.1	%		100.9	%
Total blood-testing revenues	$	494,114		$	421,640		$	315,820		$	72,474		$	105,820			17.2	%		33.5	%
Gross profit margin	42		%	41		%	41		%
Research and development	29,238			$	32,469		$	19,389		$	(3,231	)	$	13,080			(10.0	)%		67.5	%
Selling, general and administrative	$	41,885		$	40,206		$	30,750		$	1,679		$	9,456			4.2	%		30.8	%

Product sales

PROCLEIX® System On February 27, 2002, the U.S. Food and Drug Administration approved the PROCLEIX® HIV-1/ HCV Assay. We have marketed the PROCLEIX® HIV-1/HCV Assay in Europe since 1999. On January 15, 2004, the PROCLEIX® Ultrio™ HIV-1/HCV/HBV Assay received European CE marking for use on the semi-automated PROCLEIX System. Under a collaboration agreement with Gen-Probe, we market and sell the PROCLEIX HIV-1/ HCV Assay, the PROCLEIX Ultrio Assay and the related instrument system. In addition to selling directly in the U.S., we also sell in various European and Asia / Pacific markets, directly and through distributors. We record revenue based upon the reported results obtained from the customer from the use of assays to screen donations or upon sale and delivery of the assays, depending on the underlying contract. In the case of equipment sales or leases, we record revenue upon the sale and transfer of the title to the instrument or ratably over the life of the lease term, respectively. For the provision of service on the instruments, we recognize revenue ratably over the life of the service agreement.

The increase in product sales in 2004 as compared with 2003 was primarily due to (i) $19.6 million for the introduction of the West Nile Virus Assay on an investigational-use basis in the U.S. in March 2003, which had a full year of sales in 2004, (ii) $17.0 million for the continued penetration into several markets abroad and (iii) $10.4 million for market share gains in the U.S. for the PROCLEIX® HIV-1/ HCV Assay.

The increase in product sales in 2003 as compared with 2002 primarily related to $19.3 million from commercial pricing in the U.S. commencing May 1, 2002 for the PROCLEIX® HIV-1/ HCV Assay following the U.S. Food and Drug Administration approval in February 2002, while there was a full year of commercial pricing in 2003. In addition, after the first quarter 2002, we signed new commercial contracts including those with existing America’s Blood Centers customers, the American Red Cross, the U.S. military and the Association of Independent Blood Centers to provide the PROCLEIX HIV-1/ HCV Assay, which resulted in an increase in sales of $20.4 million in 2003 as compared with 2002. Other factors contributing to the increase in 2003 were (i) $19.5 million from the introduction of the West Nile Virus Assay on an investigational-use basis in the U.S. in March 2003 and (ii) $18.3 million from increased sales to several markets abroad for the PROCLEIX HIV-1/ HCV Assay. Slightly offsetting the increase in product sales related to tests, instruments and the provision of services in 2003 as compared with 2002, was

$2.9 million from additional revenue recognized in the first quarter 2002 under contracts with all our U.S. customers for increased donations exceeding contractual minimums.

Ortho-Clinical Diagnostics Under our joint business contractual arrangement with Ortho-Clinical Diagnostics, we manufacture bulk reagents and antigens and confirmatory test kits for immunodiagnostic products. Sales in 2004 as compared with 2003 remained consistent. The increase in 2003 as compared with 2002 primarily related to $4.2 million from an increase in products manufactured for Ortho-Clinical Diagnostics. In addition, the timing of manufacturing services under the arrangement contributed $1.5 million to the increase in 2003 as compared with 2002. We also supply bulk antigens for Ortho-Clinical Diagnostics to be included in products to be sold by Bayer under a June 2001 agreement with Ortho-Clinical Diagnostics and Bayer Corporation (see also “Royalty and license fee revenues—Bayer” below).

We expect competitive pressures related to our blood-testing products to continue, primarily as a result of the introduction of competing products into the market, as listed in Part I, Item 1. “Business-Competition” above.

Revenues from joint business arrangement The increase in revenue from joint business arrangement in 2004 as compared with 2003 was primarily due to (i) $9.8 million for higher profits from Ortho-Clinical Diagnostics’ U.S. operations and foreign affiliates and (ii) $5.3 million for an increase in royalties. These increases were partially offset by reorganization charges from the joint business arrangement of $4.5 million and a one-time benefit of $4.3 million for the three months ended March 31, 2003 due to a change in estimate from a three-month lag to a one-month lag relating to non-U.S. affiliate sales. Prior to the first quarter of 2003, we accounted for revenues relating to Ortho-Clinical Diagnostics’ non-U.S. affiliate sales on a one-quarter lag. More current information is now available to us and as such, we now recognize revenues relating to non-U.S. affiliate sales on a one-month lag, consistent with the method of how we recognize revenues relating to Ortho-Clinical Diagnostics’ sales for the U.S. portion of Ortho-Clinical Diagnostics’ operations. For more information on this, see “Critical Accounting Policies and the Use of Estimates.”

The increase in 2003 as compared with 2002 primarily resulted from (i) $5.2 million from increased profitability of Ortho-Clinical Diagnostics’ foreign affiliates and (ii) $4.3 million from a one-time benefit in the first quarter 2003 mentioned above. Partially offsetting these increases was $5.8 million from lower profits from Ortho-Clinical Diagnostics’ U.S. operations.

Collaborative agreement revenues Collaborative agreement revenues tend to fluctuate based on the amount and timing of research services performed, the status of projects under collaboration and the achievement of milestones. Due to the nature of our collaborative agreement revenues, results in any one period are not necessarily indicative of results to be achieved in the future. Our ability to generate additional collaborative agreement revenues may depend, in part, on our ability to initiate and maintain relationships with potential and current collaborative partners.

Royalty and license fee revenues Our blood-testing segment earns royalties from third parties based on their sales of immunodiagnostic and nucleic acid testing probe diagnostic products utilizing our hepatitis C virus (HCV) and HIV-related (HIV) patents, for use in the blood screening and plasma fractionation markets. Our blood-testing segment also earns license fees related to our HCV and HIV patents for technologies used by third parties to develop products for use in the blood screening and plasma fractionation markets. The increase in royalty and license fee revenues in 2004 as compared with 2003 was primarily due to (i) $10.1 million for the settlement with Roche, as described below, (ii) $7.9 million due to recognition of a portion of the license fee under our license agreements with the German Red Cross for the use of our HIV-1 and HCV technology for use in molecular probe “home brew” blood screening and (iii) $6.5 million under our licensing agreement with Laboratory Corporation of America Holdings (LabCorp) for our HCV intellectual property for nucleic acid testing (NAT). These

increases were partially offset by a $7.0 million license fee from Baxter A.G. related to our HCV and HIV technology for use in the plasma fractionation market in 2003 and a $4.0 million one-time payment relating to back royalties, which was recognized in 2003.

The increase in royalty and license fee revenues in 2003 as compared with 2002 was primarily due to (i) $13.3 million from Roche, as discussed below and (ii) $8.6 million from Baxter, as discussed below.

Roche settlement In October 2000, we entered into three license agreements with Roche and several of its affiliated companies related to the settlement of certain litigation in the U.S. and certain other countries for the use of our hepatitis C virus and HIV nucleic acid testing intellectual property. Two agreements relate to in vitro diagnostic products. See “Other—Royalty and license fee revenues” below. The third agreement for blood screening was superseded in May 2001 by two new agreements, one for each of HCV and HIV.

An HIV-related patent directed to nucleic acid testing methods for HIV-1 was issued in the U.S. on March 13, 2003. This patent will expire seventeen years from the date of issuance. As permitted under the terms of its licensing agreement, Roche decided to institute arbitration proceedings in regard to the application of the U.S. patent. Our blood-testing segment had deferred recognition of royalties received and royalties accrued under the patent until the resolution of this dispute. On September 10, 2004, we reached a settlement agreement with Roche. Under the terms of the settlement agreement, royalties received prior to March 31, 2004 became non-refundable. For discussion regarding the impact of this settlement on our in vitro diagnostics products, see “Other—Royalty and license fee revenue” below. Accordingly, in 2004, our blood-testing segment recognized revenue of $5.5 million for royalties up until June 30, 2004, which had previously been deferred. Also under the settlement agreement, in the first quarter of 2005, we are entitled to receive a lump-sum payment of $78.0 million in lieu of royalties beyond January 1, 2005. Roche may elect under the terms of the agreement to obtain a partial refund and revert to paying royalties on the sales of its products in North America. The amount of such potential refund ranges between $64.0 million and $0.0. The amount of the refund available decreases in increments over the quarters of 2005 and 2006. As such, we expect to recognize $64.0 million of the payment as revenue over 2005 and 2006. This revenue will be split between our blood-testing segment and our other segment. The remaining $14.0 million is nonrefundable and was recognized as revenue in 2004, of which, $9.3 million has been recognized as revenue in our other segment and $4.7 million has been recognized as revenue in our blood-testing segment.

Revenues under these blood screening agreements were $69.0 million, $61.8 million and $48.5 million in 2004, 2003 and 2002, respectively. The $69.0 million for 2004 includes the $5.5 million of previously deferred revenue recognized in 2004 and the $4.7 million (for an aggregate of $10.1 million) of nonrefundable revenue recognized in 2004. The impact on revenues in 2004 from these items from the September 10, 2004 settlement with Roche is summarized under “Other—Royalty and license fee revenues” below.

The increase in 2003 as compared with 2002 related to (i) $5.3 million from a contractual increase in the royalty rates, (ii) a $4.0 million one-time payment estimated using an alternative methodology under an agreement with Roche relating to back royalties, and (iii) $4.0 million from increased blood donations.

German Red Cross Settlement We have granted a non-exclusive license to the German Red Cross for use of our HIV-1 and HCV technology for use in molecular probe “home brew” blood screening through 2008, for a total license fee payment of $22.8 million. Of this license fee payment, $7.9 million was recognized as royalty and license fee revenues in 2004, as discussed above, and the remaining balance is expected to be recognized through 2008, as the cancellation privilege in the related agreements expires. In addition, the German Red Cross has the option to license our patents beyond 2008 upon payment of an additional fee. The licensing terms also cover potential past infringements.

LabCorp We have entered into a licensing agreement for our hepatitis C virus intellectual property for nucleic acid testing. The agreement gives LabCorp, including its subsidiary, National Genetics Institute, a semi-exclusive license to use our patented HCV NAT technology in screening plasma donations in the United States, subject to existing licenses and certain conditions. In 2004, we recognized a $6.5 million fee associated with this agreement.

Baxter A.G. In June 2003, we entered into two license agreements with Baxter A.G. related to our HCV and HIV technology for use in the plasma fractionation market. Revenues under these agreements were $1.3 million and $8.6 million in 2004 and 2003, respectively. We recognized a license fee of $7.0 million for these agreements in the second quarter 2003.

Bayer In June 2001, Chiron and Ortho-Clinical Diagnostics entered into an agreement with Bayer Corporation (Bayer) for the clinical diagnostic market. Under this agreement, Bayer manufactures and sells certain of Ortho-Clinical Diagnostics’ HCV and HIV immunodiagnostic products for use on Bayer’s instrument platforms. Bayer paid us a license fee of $45.3 million, which we deferred (due to our continuing manufacturing obligations) and began recognizing as revenue in the third quarter 2001. We will recognize the remaining amount ratably through 2010.

Royalty and license fee revenues may fluctuate based on the nature of the related agreements, the timing of receipt of license fees and the expiration of patents. Results in any one period are not necessarily indicative of results to be achieved in the future. Also, the license agreements typically provide for certain milestone payments and various royalties on future product sales if the licensee commercializes a product using our technology. However, we have no assurance that the licensee will meet their development objectives or commercialize a product using our technology. In addition, our ability to generate additional royalty and license fee revenues may depend, in part, on our ability to market and capitalize on our technologies.

Gross profit margin Gross profit margin increased in 2004 as compared with 2003 due to a positive impact by an adjustment to cost of goods sold in 2004 pursuant to our collaboration agreement with Gen-Probe. The blood-testing gross profit margin benefited from an amendment in November 2003 to the worldwide blood screening collaboration agreement between Chiron and Gen-Probe in order to adopt permanent, fixed revenue shares for each party. Effective January 1, 2004, Gen-Probe’s share was set at 45.75% of net revenues for assays, which include a test for HCV. For commercial assays, which do not test for HCV, such as the West Nile Virus Assay, the agreement remains unchanged with each party retaining 50% of the net revenues after deduction of specified expenses.

Blood-testing gross profit margin may fluctuate in future periods as the blood-testing product and customer mix changes.

Research and development The decrease in research and development expenses in 2004 as compared with 2003 was primarily due to (i) $6.5 million from purchased in-process technology associated with our investment in ZymeQuest Inc. in 2003 (we are collaborating with ZymeQuest, Inc. to develop and commercialize a enzymatic conversion system which converts group A, B and AB red blood cells to enzyme-converted group O (ECO®) red blood cells) and (ii) $2.6 million from costs associated with an agreement with Infectio Diagnostics Inc. in 2003, in which we licensed proprietary nucleic acid-based technology for the rapid detection of bacterial contamination in platelets and blood products. These decreases were partially offset by (i) $4.9 million due to the increased development efforts relating to nucleic acid testing products in 2004 and (ii) $1.0 million related to acquisition of in-process technologies in 2004, focused primarily on research into variant Creutzfeldt-Jakob disease.

The increase in research and development spending in 2003 as compared with 2002 is primarily related to (i) $6.5 million from purchased in-process technology associated with our investment in ZymeQuest Inc., as discussed above and (ii) $2.6 million from costs associated with an agreement with

Infectio Diagnostics Inc., as discussed above. The remaining increase of $4.0 million is due to the continued development of nucleic acid testing products.

Research and development expenses may fluctuate from period to period depending upon the stage of certain projects and the level of pre-clinical and clinical trial-related activities.

Selling, general and administrative The increase in selling, general and administrative expenses in 2004 as compared with 2003 was primarily due to (i) $2.1 million from the support and pre-launch costs associated with TIGRIS, a fully automated testing system and (ii) $1.6 million from the geographic expansion of our customer base for the PROCLEIX® HIV-1/HCV Assay particularly in Latin America and Asia markets. These increases were partially offset by a decrease in other costs of $2.1 million.

The increase in selling, general and administrative expenses in 2003 as compared with 2002 related to $7.9 million from the expansion of our customer base for the PROCLEIX® HIV-1/HCV Assay in the U.S., Europe and other international markets and $1.5 million from the preparation and roll-out of the West Nile virus assay under IND testing.

We expect continued growth in selling, general and administrative expenses related to nucleic acid testing technology and products as our sales opportunities expand in new markets through anticipated additional nucleic acid testing adoption.

Vaccines

										$ Change						% Change
	Year Ended December 31,									2004 vs.			2003 vs.			2004 vs.			2003 vs.
	2004			2003			2002			2003			2002			2003			2002
	($ in 000’s, except percentages)
Product sales, net:
Influenza vaccines:
Other Influenza vaccines	$	151,158		$	113,188		$	89,995		$	37,970		$	23,193			33.5	%		25.8	%
FLUVIRIN vaccine	2,255			219,240			—			(216,985		)	219,240				(99.0	)%		100.0	%
Influenza vaccines	153,413			332,428			89,995			(179,015		)	242,433				(53.9	)%		269.4	%
Meningococcus vaccines	27,739			65,548			54,971			(37,809		)	10,577				(57.7	)%		19.2	%
Travel vaccines	96,864			87,831			64,335			9,033			23,496				10.3	%		36.5	%
Pediatric and other vaccines	200,948			192,511			148,108			8,437			44,403				4.4	%		30.0	%
	478,964			678,318			357,409			(199,354		)	320,909				(29.4	)%		89.8	%
Collaborative agreement revenues	8,646			4,222			655			4,424			3,567				104.8	%		544.6	%
Royalty and license fee revenues	5,234			12,747			12,309			(7,513		)	438				(58.9	)%		3.6	%
Other revenues	17,282			13,522			17,890			3,760			(4,368		)		27.8	%		(24.4	)%
Total vaccines revenues	$	510,126		$	708,809		$	388,263		$	(198,683	)	$	320,546			(28.0	)%		82.6	%
Gross profit margin	24		%	53		%	58		%
Research and development	$	135,380		$	129,719		$	70,136		$	5,661		$	59,583			4.4	%		85.0	%
Selling, general and administrative	$	164,846		$	135,808		$	90,011		$	29,038		$	45,797			21.4	%		50.9	%
Amortization expense	$	59,519		$	31,248		$	5,623		$	28,271		$	25,625			90.5	%		455.7	%

Product sales We sell influenza, meningococcal, travel, pediatric and other vaccines primarily in the U.S., Germany, Italy, the United Kingdom, as well as in other international markets.

Influenza vaccines As described above under “FLUVIRIN® Influenza Virus Vaccine Recent Events,” as a result of recent developments with respect to FLUVIRIN vaccine, we had no FLUVIRIN vaccine sales for the 2004–2005 influenza season. In 2004, we had $2.3 million of FLUVIRIN sales for late 2003-2004 season. Sales of FLUVIRIN influenza vaccine were $219.2 million in 2003. Sales of our

remaining influenza vaccines increased in 2004 as compared with 2003 primarily due to approximately $19.3 million for price increases and $11.2 million for the favorable movement in the Euro to U.S. Dollar exchange rate.

Influenza vaccines sales increased in 2003 as compared with 2002, primarily as a result of additional sales of influenza vaccine products following our third quarter 2003 acquisition of PowderJect. PowderJect FLUVIRIN vaccine sales were $219.2 million in 2003. Excluding PowderJect, sales of our remaining influenza vaccines increased primarily as a result of $3.8 million from the benefit of the movement in the Euro to U.S. Dollar exchange rate and $19.4 million from price and volume increases in Germany and Italy.

Meningococcus vaccines The decrease in meningococcus vaccines sales in 2004 as compared with 2003 was primarily due to a reduction of $51.1 million in sales of MENJUGATE® product due to significant price erosion and reduced volume due to competition. This decrease was partially offset by sales in 2004 of $13.3 million of MENZB™ meningococcal B vaccine to the Ministry of Health in New Zealand.

The increase in meningococcus vaccines sales in 2003 as compared with 2002 primarily related to $8.8 million from the tender sales to Australia and $1.7 million from the benefit of the movement in the Euro to U.S. Dollar exchange rate.

Travel vaccines Sales of our travel vaccines are comprised of tick-borne encephalitis, rabies vaccines and two products we obtained as part of our 2003 acquisition of PowderJect, ARILVAX™, a yellow fever vaccine and DUKORAL™, a cholera vaccine. The increase in travel vaccines sales in 2004 as compared with 2003 was primarily due to $25.7 million driven by increased demand for our rabies vaccines in the U.S., primarily due to a product recall from a competitor and increased demand of our rabies vaccines in Europe and Asia. The increase was partially offset by the fact that we had $15.1 million of sales of our tick-borne encephalitis vaccine in late 2003, which is typically sold in the first half of the year.

The increase in travel vaccines sales in 2003 as compared with 2002 primarily resulted from (i) $15.1 million from fourth quarter 2003 sales of tick-borne encephalitis vaccine, which is typically sold in the first half of the year, (ii) $5.1 million from additional sales of travel vaccine products following our third quarter 2003 acquisition of PowderJect and (iii) $3.3 million from the benefit of the movement in the Euro to U.S. Dollar exchange rate.

Pediatric and other vaccines The increase in our pediatric and other vaccines sales in 2004 as compared with 2003 was primarily due to an additional $21.3 million related to the timing of tender sales for our polio vaccines and diphtheria, tetanus and pertussis vaccines, offset partially by (i) $7.3 million due to the planned divestiture of certain vaccines operations in Sweden in the second quarter 2004 acquired via our acquisition of PowderJect and (ii) $6.1 million due to the timing of tender sales for our measles, mumps and rubella vaccines.

The increase in pediatric and other vaccines sales in 2003 as compared with 2002 was primarily due to (i) $18.6 million from additional sales of other vaccine products following our third quarter 2003 acquisition of PowderJect, (ii) $18.5 million from the timing of tender sales for measles, mumps and rubella vaccines and diphtheria, tetanus and pertussis vaccines and (iii) $7.3 million from the benefit of the movement in the Euro to U.S. Dollar exchange rate.

Certain of our vaccine products are seasonal, particularly our influenza vaccines, which have higher sales primarily in the second half of the year. Our tick-borne encephalitis vaccine is also seasonal with higher sales in the first half of the year. Certain of our vaccines require regulatory approval for production or sale of the product and sales may fluctuate depending on these regulatory approvals. We expect increased competition for our influenza vaccines business in the future as a result of the recent FLUVIRIN developments. For more information on this, see “—FLUVIRIN® Influenza Virus Vaccine Recent Events” above. In addition, we expect MENJUGATE® vaccine sales to continue to fluctuate as public

health authorities consider adoption of broad vaccination programs and competitive pressures continue to increase.

Collaborative agreement revenues We recognize collaborative agreement revenues for fees received as we perform research services and achieve specified milestones. Collaborative agreement revenues in 2004 as compared with 2003 increased primarily due to (i) $1.4 million in higher milestone payments related to an agreement to supply MENZB™ meningococcal B vaccine to the Ministry of Health in New Zealand and (ii) $3.0 million in increased collaborative agreement revenues following a full year of collaborative revenues in 2004 from our acquisition of PowderJect.

In the first quarter 2002, we entered into an agreement to supply a vaccine for meningococcal meningitis caused by the bacterium N. meningitidis serogroup B to the Ministry of Health in New Zealand. We recognized $2.3 million of revenue under this arrangement in 2003. In addition, in 2003 we recognized collaborative agreement revenues of $1.7 million as a result of our third quarter acquisition of PowderJect.

The balance of collaborative agreement revenues recognized in our vaccines segment consisted of various other arrangements, which individually were not material.

Collaborative agreement revenues tend to fluctuate based on the amount and timing of research services performed, the status of projects under collaboration and the achievement of milestones. Due to the nature of our collaborative agreement revenues, results in any one period are not necessarily indicative of results to be achieved in the future. In addition, the collaboration agreements typically provide for certain milestone payments and various royalties on future product sales if the collaborative partners commercialize a product using our technology. Also, our ability to generate additional collaborative agreement revenues may depend, in part, on our ability to initiate and maintain relationships with potential and current collaborative partners.

Royalty and license fee revenues Our vaccines segment earns royalties on third party sales of, and license fees on, several products.

GlaxoSmithKline An agreement with GlaxoSmithKline plc provides for royalties on sales of certain vaccine products. Under this agreement, we recognized $2.9 million, $7.1 million and $7.0 million of such royalties in 2004, 2003 and 2002, respectively. The decrease in royalties in 2004 compared with 2003 was primarily due to the expiration of various patents under this agreement.

Other In 2004, 2003 and 2002, we recognized $1.0 million, $5.6 million and $5.3 million, respectively, of royalty revenues primarily on third party sales of hepatitis B virus vaccine products. Certain patents related to the production of hepatitis B vaccine products expired beginning in 2004, which resulted in reductions in royalty revenues recognized under one arrangement.

The balance of royalty and license fee revenues recognized in our vaccines segment consisted of various other arrangements, which individually were not material.

Royalty and license fee revenues may fluctuate based on the nature of the related agreements, the timing of receipt of license fees and the expiration of patents. Results in any one period are not necessarily indicative of results to be achieved in the future. Also, the license agreements typically provide for certain milestone payments and various royalties on future product sales if the licensees commercialize a product using our technology. However, we have no assurance that the licensee will meet their development objectives or commercialize a product using our technology. In addition, our ability to generate additional royalty and license fee revenues may depend, in part, on our ability to market and capitalize on our technologies.

Other revenues

Grant and contract revenues Our vaccines segment other revenues included grant and contract revenues of $13.4 million, $9.7 million and $14.6 million for 2004, 2003 and 2002, respectively. We have entered into a series of agreements with the U.S. National Institutes of Health to advance our HIV vaccine program into human clinical trials. We recognized grant and contract revenues under these arrangements of $8.1 million, $7.3 million and $10.1 million for 2004, 2003 and 2002, respectively.

Contract manufacturing revenues Included in our vaccines segment other revenues are contract manufacturing revenues of $2.2 million, $2.2 million and $1.5 million for 2004, 2003 and 2002, respectively. The fluctuations resulted from a change in the level of contract manufacturing activities.

The balance of other revenues consisted of various other agreements, which individually were not material.

Other revenues recognized in our vaccines segment may fluctuate due to the nature of the revenues recognized and the timing of events giving rise to these revenues.

Gross profit Gross profit margin declined in 2004 as compared with 2003 primarily due to (i) the fact that there were no FLUVIRIN vaccine sales for the 2004-2005 influenza season and (ii) a $91.3 million charge to cost of sales resulting from the write-off of our entire inventory of FLUVIRIN vaccine. In addition, 2004 included approximately $2.6 million in FLUVIRIN vaccine remediation costs, which were charged to cost of sales. Gross profit margin was also negatively impacted by reduced sales and margins of the MENJUGATE® product. These decreases were offset by higher prices of our other influenza vaccines products and increased sales of our rabies vaccine in the U.S. market.

The decrease in gross profit margin in 2003 as compared with 2002 related to a fair value adjustment to inventory of $24.4 million in 2003 associated with the sale of inventory acquired during the acquisition of PowderJect. These additional costs related to a fair value adjustment on the acquisition of PowderJect. In addition, the vaccine gross profit margin in 2003 was negatively impacted by the shutdown of certain facilities, in the first quarter 2003, to ensure compliance with regulatory requirements.

Vaccines gross profit margin does not include amortization expense from acquired developed products, an intangible asset related to business combinations. Such amortization expense is included in the caption ‘amortization expense’ discussed below.

Vaccines gross profit margin may fluctuate significantly in future periods due to product and customer mix, seasonality and ordering patterns, production yields, regulatory approvals and competitive pressures.

Research and development The increase in research and development expenses in 2004 as compared with 2003 was primarily due to (i) $7.3 million from flu cell culture and (ii) $7.1 million from the advancement of several programs in our meningococcal franchise. These increases were mainly offset by the effects of the planned divestiture of certain research operations, associated with our acquisition of PowderJect, in Madison, Wisconsin and Oxford, England during the second quarter of 2004. Research and development expense associated with these operations in 2004 as compared with 2003 decreased $8.8 million.

The increase in research and development spending in 2003 compared with 2002 was primarily due to $22.5 million from the advancement of several programs in our meningococcal franchise and $11.2 million from flu cell culture. Also, there was $16.2 million of incremental research and development expense following our third quarter acquisition of PowderJect.

In 2004, we successfully concluded our Phase III trial for MENJUGATE® meningococcus C vaccine in the United States. We will not be filing a Biologics License Application for the vaccine and instead focus our resources on advancing our quadrivalent meningococcus vaccine candidate for serogroups A,C,W and Y.

Research and development expenses may fluctuate from period to period depending upon the stage of certain projects and the level of pre-clinical and clinical trial-related activities.

Selling, general and administrative The increase in selling, general and administrative expenses in 2004 as compared with 2003 was primarily related to additional expenses of $12.3 million attributable to our third quarter 2003 PowderJect acquisition. The remaining increase in selling, general and administrative resulted from $12.5 million from the movement of the Euro and British Pound to U.S. dollar exchange rates and $9.4 million associated with ongoing sales and marketing programs. These were partially offset by savings of $4.5 million from the divestiture of certain PowderJect research and development operations in 2004.

The increase in selling, general and administrative expenses in 2003 compared with 2002 primarily relates to additional expenses following our third quarter acquisition of PowderJect. Excluding $34.8 million of additional selling, general and administrative expenses associated with PowderJect, including integration costs of $9.2 million, the remaining increase in selling, general and administrative expenses resulted primarily from $16.5 million from the Euro to U.S. Dollar exchange rate fluctuation, offset partially by $2.0 million from a payment made in the first quarter 2002 to the German government in lieu of statutory price reductions on prescription drugs that are reimbursed under the German government’s healthcare program that was expensed in the first quarter 2002.

Amortization expense The increase in amortization expense in 2004 as compared with 2003 primarily related to the intangible assets acquired following our third quarter 2003 PowderJect acquisition.

The increase in amortization expense in 2003 as compared with 2002 relates to the intangibles acquired following our acquisition of PowderJect in the third quarter 2003. Acquired intangible assets included the fair value of distribution rights, a contract manufacturing agreement and developed product technologies. The distribution rights and the contract manufacturing agreement are being amortized on a straight-line basis over 1 to 4 years. Developed product technologies are being amortized using either the estimated sales method over 10 years or on a straight-line basis over 1 to 15 years.

Biopharmaceuticals

										$ Change						% Change
	Year Ended December 31,									2004 vs.			2003 vs.			2004 vs.			2003 vs.
	2004			2003			2002			2003			2002			2003			2002
	($ in 000’s, except percentages)
Product sales, net:
BETASERON® interferon beta-1b	$	130,572		$	124,936		$	118,513		$	5,636		$	6,423			4.5	%		5.4	%
TOBI® tobramycin	212,876			172,047			146,874			40,829			25,173				23.7	%		17.1	%
PROLEUKIN® aldesleukin	129,377			115,075			114,281			14,302			794				12.4	%		0.7	%
Other	38,861			27,000			29,000			11,861			(2,000		)		43.9	%		(6.9	)%
	511,686			439,058			408,668			72,628			30,390				16.5	%		7.4	%
Collaborative agreement revenues	1,354			5,328			12,067			(3,974		)	(6,739		)		(74.6	)%		(55.8	)%
Royalty and license fee revenues	71,527			87,698			63,314			(16,171		)	24,384				(18.4	)%		38.5	%
Other revenues	10,940			29,538			17,464			(18,598		)	12,074				(63.0	)%		69.1	%
Total biopharmaceuticals revenues	$	595,507		$	561,622		$	501,513		$	33,885		$	60,109			6.0	%		12.0	%
Gross profit margin	72		%	72		%	73		%
Research and development	$	266,511		$	247,618		$	236,267		$	18,893		$	11,351			7.6	%		4.8	%
Selling, general and administrative	$	142,114		$	117,505		$	95,312		$	24,609		$	22,193			20.9	%		23.3	%
Amortization expense	$	24,984		$	25,117		$	24,234		$	(133	)	$	883			(0.5	)%		3.6	%

Product sales Biopharmaceutical product sales in 2004, 2003 and 2002 consisted principally of BETASERON® interferon beta-1b, TOBI® tobramycin and PROLEUKIN® products.

BETASERON® interferon beta-1b We manufacture interferon beta-1b which is marketed by Schering AG and its affiliates, including Berlex Laboratories, Inc. (collectively Schering), under the trade names BETASERON® (in the U.S and other non-European markets) and BETAFERON® (in Europe). Boehringer Ingelheim also supplies BETAFERON® interferon beta-1b to Schering for sale in Europe. For product manufactured by us, we recognize a portion of revenue for product sales upon shipment to Schering and the remainder based on a contractual percentage of sales by Schering, both of which we record as product sales. For product manufactured by Boehringer Ingelheim and marketed by Schering in Europe under the trade name BETAFERON®, we receive royalties calculated at the same percentage of sales less the amount paid or incurred by Schering for supply costs, which we record in royalty and license fee revenues. Starting in the fourth quarter 2003, the amount we record as product sales and BETAFERON royalties, based on a percentage of sales by Schering, declined by five percentage points pursuant to our contractual agreement with Schering. As a result, we estimate that the percentage of sales per unit on which our payments are based will decrease, reducing our per unit revenue by approximately 18% (for sales of Chiron product) and approximately 34% (for royalties from sales of Boehringer Ingelheim product) from that received prior to the decline. However, there are a number of mitigating considerations, including (i) the transitional supply agreement, (ii) the volume mix of Chiron product and Boehringer Ingelheim product and (iii) the launch of product upgrades with ease-of-use features. We believe these considerations will partially offset this contractual change.

In October 2003, the U.S. Food and Drug Administration approved a new pre-filled diluent syringe for BETASERON® interferon beta-1b. The pre-filled diluent syringe was launched in January 2004 and enhances the delivery mode and shortens preparation, helping to simplify injections of BETASERON interferon beta-1b. In the first quarter 2003, the U.S. Food and Drug Administration approved new labeling for BETASERON interferon beta-1b. The labeling expands the indication for BETASERON interferon beta-1b to treat all relapsing forms of multiple sclerosis to reduce the frequency of clinical

exacerbations. Relapsing forms of multiple sclerosis include relapsing-remitting, the most common form, and secondary progressive multiple sclerosis with relapses.

Pursuant to our agreement with Schering, we began supplying BETAFERON® product to Schering in the fourth quarter 2002 for certain additional European markets, which were previously supplied by Boehringer Ingelheim. This resulted in a shift of revenue recognized under this agreement to product sales, and a decrease in royalty revenues beginning in the fourth quarter 2002. In 2003, Schering extended its supply agreement with Boehringer Ingelheim through 2008. The exact shift of revenue in the future will be contingent on our production capacity, Schering’s minimum purchase commitment under the extended supply agreement with Boehringer Ingelheim, and market demand. The shift to product sales is expected to increase over the next three years. We expect overall, biopharmaceutical earnings to be largely unaffected by the transition. In order to supply BETAFERON to Schering, we are required to make capital improvements to our existing manufacturing facilities to increase capacity. During 2004, 2003 and 2002, we recorded charges related to process development and test runs associated with this project. See “Research and development” below.

The increase in BETASERON® product sales in 2004 as compared with 2003 primarily related to an additional (i) $7.5 million from price increases, (ii) $4.2 million from increased patient demand attributed to key marketing programs, (iii) $3.2 million from the benefit of foreign exchange rates, (iv) $6.1 million from inventory ordering patterns of Schering and their distributors and (v) $2.9 million from increased sales of clinical materials. These increases were partially offset by an $18.5 million reduction due to a decline in the royalty rate by five percentage points pursuant to our contractual agreement with Schering.

The increase in BETASERON product sales in 2003 as compared with 2002, primarily related to (i) $6.4 million from price increases, (ii) $5.9 million from the benefit of the movement in foreign exchange rates and (iii) $6.4 million from increased patient demand attributed to an overall increase in the market for interferon beta-1b products for multiple sclerosis. These increases were partially offset by (i) $5.7 million from a decline in the amount we recorded as product sales, based on a percentage of sales by Schering, by five percentage points pursuant to our contractual agreement with Schering and (ii) $6.4 million from fluctuations in wholesaler ordering patterns. In 2002, Schering converted to wholesaler distribution from direct distribution method. Prior to the first quarter 2002, we accounted for revenues from non-U.S. product sales based on information provided by Schering on a one-quarter lag. More current information of non-U.S. BETASERON interferon beta-1b sales became available in 2002, and as a result, we were able to begin recognizing revenues from BETASERON product sales on a current basis. This change resulted in incremental revenues recognized during the first quarter 2002 of $4.3 million. Inventory ordering patterns as well as foreign currency exchange rates may influence future BETASERON product sales.

TOBI® tobramycin solution for inhalation We sell TOBI® solution directly in the U.S. and certain international markets. The increase in sales in 2004 as compared with 2003 was primarily due to (i)$16.0 million in increased patient demand in the U.S, (ii) $9.2 million in price increases, (iii) $6.4 million in favorable movement in the Euro to U.S. Dollar exchange rate and (iv) $6.0 million in wholesaler ordering patterns.

The increase in TOBI® product sales in 2003 as compared with 2002, primarily related to (i) $9.1 million from greater product penetration in various European countries, (ii) $8.3 million from the benefit of the movement in the Euro to U.S. dollar exchange rate (iii) $4.0 million from price increases, and (iv) $1.9 million from increased use and improved compliance in the U.S. by patients with cystic fibrosis.

We continue to seek approval of TOBI® solution in other countries. Wholesaler ordering patterns as well as reimbursement and government pressures, competition, foreign currency exchange rates and the level of rebates may influence future TOBI product sales. In December 2002, the U.S. Food and Drug Administration tentatively approved an abbreviated new drug application for an inhaled tobramycin for

sale in the U.S. following expiration of the orphan drug status of the TOBI solution in December 2004. Subsequently, the application was withdrawn and under terms of a settlement agreement reached in October 2003, approval will not be sought to market this generic product until the 2014 expiration of our patent in the U.S. covering the formulation of TOBI solution for inhalation.

PROLEUKIN® (aldesleukin) The increase in sales for PROLEUKIN (aldesleukin) in 2004 as compared with 2003 was primarily due to (i) $8.0 million from inventory ordering patterns in Europe, (ii) $5.2 million from price increases and (iii) $3.0 million due to favorable movement in the Euro to U.S. Dollar exchange rate. These increases were partially offset by a $4.2 million reduction due to a decline in patient demand.

The increase in PROLEUKIN product sales in 2003 as compared with 2002 primarily related to (iii) $5.1 million from the benefit of the movement in the Euro to U.S. Dollar exchange rate, (ii) $4.8 million from price increases, (ii) $2.2 million from increase in patient demand in the U.S. These increases were partially offset by $7.5 million from inventory ordering patterns and $3.7 million from a decrease in underlying patient demand in Europe.

The balance of product sales recognized in our biopharmaceuticals segment consisted of various other products, which individually were not material.

Wholesale ordering patterns, reimbursement and government pressures, competition, foreign currency exchange rates and the level of rebates may influence future biopharmaceutical sales.

Collaborative agreement revenues We recognize collaborative agreement revenues for fees received as we perform research services and achieve specified milestones.

S*BIO In the second quarter 2000, we invested in a Singapore-based venture, S*BIO Pte Ltd, to research and develop therapeutic, diagnostic, vaccine and antibody products. We also granted S*BIO certain rights to our gene expression and combinatorial chemistry technology. Under this arrangement, we received approximately $23.7 million for technology transfer and research services. We recognized collaborative agreement revenues of $8.8 million in 2002, under this arrangement. The technology transfer period and the related revenue recognition period ended in the third quarter 2002.

GlaxoSmithKline plc In the fourth quarter 2002, we entered into a collaboration agreement and license agreement with GlaxoSmithKline plc related to certain of our MC-4R compound patents. Under this arrangement, we recognized collaborative agreement revenues of $0.1 million and $3.3 million for 2004 and 2003, respectively.

The balance of collaborative agreement revenues recognized in our biopharmaceuticals segment consisted of various other agreements, which individually were not material.

Royalty and license fee revenues Our biopharmaceuticals segment earns royalties on third party sales of several products, including BETAFERON® interferon beta-1b and recombinant insulin and glucagon products. Our biopharmaceuticals segment also earns license fees for technologies, such as hepatitis C virus-related patents, used by third parties to develop therapeutic products.

BETAFERON® interferon beta-1b BETAFERON product royalties were $51.6 million, $63.8 million and $46.9 million in 2004, 2003 and 2002, respectively.

The decrease in 2004 as compared with 2003 was primarily due to $16.6 from the reduction in the royalty rate of five percentage points, pursuant to our contractual agreement with Schering, partially offset by (i) $5.2 million due to favorable movement in the Euro to U.S. Dollar exchange rate and (ii) $4.6 million due to an increase in demand.

The increase in BETAFERON product royalties in 2003 compared with 2002 was primarily due to (i) $8.6 million from benefit in the movement of the Euro to U.S. dollar exchange rate, (ii) $7.4 million from the benefit of a reduction of the allocated cost under a three-year limited cost sharing arrangement under the transitional supply agreement with Schering and (iii) $4.9 million from increase in demand. These increases were partially offset by $4.0 million from a decline in our royalty rate in the fourth quarter 2003 by five percentage points, pursuant to our contractual agreement with Schering. Incremental revenues recognized during the first quarter 2002 of $3.9 million related to a change in our methodology of recognizing these royalties. Prior to 2002, we accounted for BETAFERON® product royalties as a percentage of forecast received from Schering, with an adjustment of the estimate to actual in the subsequent quarter. More current information of European BETASERON® product sales was available in 2002, and as a result, we were able to recognize BETAFERON product royalties on a current basis beginning in the first quarter 2002.

As discussed in “Product sales—BETASERON®” above, we began supplying BETAFERON® product, which was previously supplied by Boehringer Ingelheim, to Schering in the fourth quarter 2002 for certain additional European markets. This resulted in a shift of revenue recognized under this agreement to product sales, with a decrease in royalty revenues, beginning in the fourth quarter 2002. In 2003, Schering extended its supply agreement with Boehringer Ingelheim through 2008. The magnitude of the shift of revenue in the future will be contingent on our production capacity, Schering’s minimum purchase commitment under the extended supply agreement with Boehringer Ingelheim and market demand. The shift to product sales is expected to increase over the next three years. Future BETAFERON® product royalties will be influenced by demand, price changes and foreign currency exchange rates.

Novo Nordisk We earn royalty revenues on insulin and glucagon product sales by Novo Nordisk AS. We recognized $4.4 million, $8.5 million and $7.5 million in 2004, 2003 and 2002, respectively, under this arrangement. Patents related to the production of insulin and glucagons began expiring in late 2003 and as a result, there were significant reductions in royalty revenue in 2004 recognized under this arrangement.

Boehringer Ingelheim In December 2003, we granted Boehringer Ingelheim a nonexclusive license for the research, development and commercialization of small molecule therapeutics against hepatitis C virus drug targets. We recognized $0.8 million and $4.0 million in 2004 and 2003 under this arrangement. The decrease is primarily due to initial license fees recognized in 2003.

GlaxoSmithKline plc In 2002, we granted GlaxoSmithKline plc rights to certain of our MC-4R compound patents. Under this arrangement, we recognized royalty revenues $0.2 million and $4.8 million in 2004 and 2003, respectively. The project associated with our MC-4R compound was completed early in 2004.

The balance of royalty and license fee revenues recognized in our biopharmaceuticals segment consisted of various other agreements, which individually were not material.

using our technology. However, we have no assurance that the licensees will meet their development objectives or commercialize a product using our technology. In addition, our ability to generate additional royalty and license fee revenues may depend, in part, on our ability to market and capitalize on our technologies.

Other revenues

Contract manufacturing revenues Our biopharmaceuticals segment recognized contract manufacturing revenues of $10.3 million, $13.5 million and $14.0 million in 2004, 2003 and 2002, respectively. The fluctuations in 2004 as compared with 2003 and in 2003 as compared with 2002, resulted from the level of activity and the timing of contract manufacturing activities.

Biogen and Serono settlements As a result of a favorable federal court decision and prior agreements between Chiron and Schering’s U.S. subsidiary, Berlex Laboratories, and Berlex and Biogen, Biogen was required to make a settlement payment to Schering. In accordance with an earlier contract between Chiron and Berlex, we recognized approximately $13.0 million as revenue in 2003, which represented our share of this settlement payment. In addition, there was a similar settlement between Berlex and Serono, S.A. of which we recognized approximately $1.4 million in 2003.

The balance of other revenues recognized in our biopharmaceuticals segment consisted of various other arrangements, which individually were not material.

Other revenues recognized in our biopharmaceuticals segment may fluctuate due to the nature of the revenues recognized and the timing of events giving rise to these revenues. We cannot guarantee that we will be successful in obtaining additional revenues or that these revenues will not decline.

Gross profit The biopharmaceutical gross profit margin in 2004 was consistent with the gross profit margin in 2003. Price increases were offset by the contractual change in the royalty rate related to the sale of BETASERON® product and the increased costs associated with the pre-filled diluent syringe for BETASERON® product.

The decrease in biopharmaceutical gross profit margin in 2003 as compared with 2002 was the result of higher annual facility maintenance costs, non-recurring expenses related to production, less favorable mix of biopharmaceutical product sales, the increased cost of producing the BETASERON ®interferon beta-1b pre-filled syringe presentation and a decline in BETASERON product sales, based on a percentage of sales by Schering, by five percentage points pursuant to our contractual agreement with Schering, offset by price increases.

Biopharmaceutical gross profit margin does not include amortization expense from acquired developed products, an intangible asset related to business combinations. Such amortization expense is included in the caption “amortization expense.”

Biopharmaceutical gross profit margin may fluctuate significantly in future periods due to production yields, increased cost to produce the BETASERON® interferon beta-1b pre-filled diluent syringe, the decline in BETASERON® product sales, based on a percentage of sales by Schering, which decreased by five percentage points pursuant to our contractual agreement with Schering and as the biopharmaceutical product and customer mix changes.

Research and development The increase in research and development spending in 2004 as compared with 2003 was primarily the result of (i) $30.7 million from activities related to the development of tifacogin, as discussed below, (ii) $15.2 million from development of our early-stage oncology compounds CHIR-258 (small molecule) and CHIR 12.12 (an antibody) and (iii) $7.1 million from pre-registration activities for PULMINIQ™ (cyclosporine, USP) inhalation solution for the increase in survival and prevention of chronic rejection in patients receiving allogenic lung transplants, in combination with

standard immunosuppressive therapy. These increases were partially offset by (i) a reduction of $13.5 million due to the discontinued development of tezacitabine in the first quarter of 2004 based on an analysis of the data from a Phase II trial in patients with gastroesophageal cancer, (ii) a decline of $9.2 million in spending due to discontinuance of development of PA-2794, (iii) a decline of $7.8 million due to a decline in expenses related to the development of new processes and the performance of test runs related to installed equipment of our existing manufacturing facilities to support the supply of BETAFERON® interferon beta-1b to Schering and (iv) a net decline of $5.2 million in spending related to the pre-registration activities of CUBICIN (daptomycin for injection) for treatment of complicated skin and soft tissue infections. During 2003 we recorded $10.6 million of expense associated with a fee paid under a license agreement with Cubist Pharmaceuticals, Inc. for the development and commercialization of Cubist’s antibiotic daptomycin, as discussed below.

In 2004, we expensed $6.0 million to fund the remaining obligations of the SILCAAT trial due to assessment of no future benefit from the trial.

The increase in research and development spending in 2003 as compared with 2002 primarily related to (i) $10.6 million from costs associated with a license agreement with Cubist Pharmaceuticals, Inc. for the development and commercialization of Cubist’s antibiotic daptomycin, as discussed below, (ii) $8.8 million from those activities related to the development of tezacitabine, obtained as a part of the acquisition of Matrix Pharmaceutical in the first quarter 2002 and (iii) $6.3 million from interleukin-2 in oncology trials in combination with various monoclonal antibodies. These increases were partially offset by decreases in the activities for various clinical trials, including (i) $6.8 million from transfer of the responsibility of the SILCAAT trial to NIAID and the University of Minnesota in the fourth quarter 2002, discussed below, and (ii) $6.4 million from termination of our development activities for HBV-MF59, an immunotherapy for patients with chronic hepatitis B infection.

In March 2004, Chiron entered into a worldwide, exclusive, multi-product, collaborative arrangement with XOMA Ltd. for the development and commercialization of antibody products for the treatment of cancer. Under the terms of the arrangement, the parties agreed to jointly research, develop, and commercialize multiple antibody product candidates. Under the arrangement, the parties agreed to share development and commercialization expenses, including preclinical and clinical development, manufacturing and worldwide marketing costs, as well as revenues, generally on a 70-30 basis, with Chiron’s share being 70% and XOMA’s share being 30%. Chiron agreed to make an initial payment of $10.0 million, which has been paid as of December 31, 2004, and to make a loan facility of up to $50.0 million available to XOMA, starting on January 1, 2005 to fund 75% of XOMA’s share of development expenses.

In October 2003, we entered into a license agreement with Cubist Pharmaceuticals, Inc. for the development and commercialization of Cubist’s antibiotic CUBICIN® (daptomycin for injection) in Western and Eastern Europe, Australia, New Zealand, India and certain Central American, South American and Middle Eastern countries. In exchange for these development and commercialization rights, we have agreed to pay Cubist up to $50.0 million. This $50.0 million includes $18.0 million, which was paid by Chiron up front in the fourth quarter 2003, $10.0 million of which was used to purchase restricted Cubist common stock at a 50 percent premium over market price and up to $32.0 million of additional payments to Cubist upon the achievement of certain regulatory and sales milestones. We will also pay Cubist a tiered royalty on CUBICIN marketed by Chiron. We recorded $10.6 million of the up front payment, related to the purchase of in-process research and development as research and development expense in the fourth quarter 2003.

In October 2003, we acquired all of Pfizer, Inc.’s, formerly Pharmacia Corp.’s, interest in tifacogin, in return for which Pfizer will receive royalties on future sales of tifacogin. In the second quarter 2004, we

began enrolling patients in our Phase III trial for tifacogin as a treatment for patients with severe community-acquired pneumonia.

In April 2003, we acquired exclusive worldwide development and commercial rights from Novartis for PULMINIQ™ (cyclosporine, USP) inhalation solution, a therapy under evaluation for treatment of rejection and reduction of mortality in lung transplant recipients for $0.5 million, which was expensed as research and development costs in 2003. In 2004, we submitted a new drug application to the FDA for marketing approval of PULMINIQ™.

In the fourth quarter 2002, we reached an agreement in principle to transfer responsibility for the SILCAAT trial, a Phase III study for recombinant human interleukin-2 (IL-2, aldesleukin), to the National Institutes Allergy and Infectious Disease (NIAID) and the University of Minnesota. Responsibility for the SILCAAT study was transferred to NIAID and University of Minnesota effective February 14, 2003. Our research and development expenses related to the SILCAAT trial decreased in 2003 as a result of the transfer. Under the agreement, we are obligated to fund a maximum of $18.0 million over the lifetime of the trial and to supply clinical materials and certain other support services of which $18.0 million has been paid through December 31,2004.

Research and development expenses may fluctuate from period to period depending upon the stage of certain projects and the level of pre-clinical and clinical trial-related activities.

Selling, general and administrative The increase in selling, general and administrative expenses in 2004 as compared with 2003 was primarily due to (i) $ 5.5 million for increased expenses for new product support, (ii) $5.5 million for the Euro to U.S. Dollar exchange rate fluctuation and (iii) $4.5 million for increased expenses for programs and headcount in support of TOBI® tobramycin and international marketing, (iv) $4.2 million related to increased costs of our facilities, (v) $1.7 million increase for support to enhance business processes and (vi) $1.2 for increased sales and medical affairs support.

The increase in selling, general and administrative expenses in 2003 as compared with 2002 related to (i) $8.8 million from ongoing sales and marketing programs to support TOBI® in the U.S. and continued market penetration in Europe, (ii) $3.0 investment in marketing capabilities to support clinical programs, (iii) $2.3 million from additional costs associated with the enhancement of current business processes and (iv) $4.0 million from the Euro to U.S. Dollar exchange rate fluctuation. In addition, the increase in 2003 as compared with 2002 was impacted by $5.1 million from increased costs following the acquisition of Pulmopharm in the third quarter 2002.

Amortization expense The increase in amortization expense in 2003 compared with 2002 related to the distribution rights acquired upon acquisition of Pulmopharm in the third quarter 2002. We acquired PathoGenesis Corporation in 2000 and accounted for the acquisition under the purchase method of accounting. We allocated a portion of the purchase price to purchased technologies, acquired intangible assets and goodwill, which related to the biopharmaceuticals segment.

Other

We view certain other revenues and expenses, particularly certain royalty and license fee revenues primarily related to HIV and HCV related patents, and unallocated corporate expenses, as not belonging to any one reportable segment. As a result, we have aggregated these items into an “Other’ segment.

	Twelve Months Ended						$ Change					% Change
	December 31,						2004 vs.		2003 vs.			2004 vs.			2003 vs.
	2004		2003		2002		2003		2002			2003			2002
	($ in 000’s, except percentages)
Royalty and license fee revenues	$	123,608	$	74,290	$	69,645	$	49,318	$	4,645			66.4	%		6.7	%
Selling, general and administrative	$	116,933	$	86,867	$	67,639	$	30,066	$	19,228			34.6	%		28.4	%
Interest expense	$	26,093	$	19,104	$	12,821	$	6,989	$	6,283			36.6	%		49.0	%
Interest and other income, net	$	56,797	$	38,892	$	46,616	$	17,905	$	(7,724	)		46.0	%		(16.6	)%

Royalty and license fee revenues Our other segment earns royalties on third party sales of, and license fees on, several products. The majority of royalty and license fee revenues related to the use of our hepatitis C virus and HIV-related patents for diagnostic testing purposes by various third parties.

Roche settlement In October 2000, we entered into three license agreements with Roche and several of its affiliated companies related to the settlement of certain litigation in the U.S. and certain other countries for use of our HCV and HIV nucleic acid testing intellectual property. Two agreements relate to in vitro diagnostics products. The third agreement relates to blood screening. See “Blood Testing—Royalty and license fee revenues” above for more information on these agreements.

Under the hepatitis C virus agreement, we received $85.0 million, of which we recognized $40.0 million in the fourth quarter 2000. We deferred the remaining $45.0 million, which becomes nonrefundable through 2005. In the first quarter 2001, we began recognizing portions of the $45.0 million based upon the greater of (i) the scheduled quarterly minimum non-refundable amount or (ii) the actual earned credits as royalties on future sales related to Roche’s use of our HCV-related patent in its in vitro diagnostic products. The agreement also provides for royalties on future sales related to Roche’s use of our HCV-related patent in its in vitro diagnostic products, which commenced in the first quarter 2001. Royalty revenues increased in 2004 as compared with 2003, by $4.4 million or 9.5%. Royalty revenues decreased $7.5 million or 13.8% in 2003 as compared with 2002 as the annual minimum royalty under this agreement expired at the end of 2002.

The HIV agreement also provides for royalties on future sales related to Roche’s use of our HIV-related patent in its in vitro diagnostic products, which commenced in the first quarter 2001 when the European Patent Office Board of Technical Appeals upheld our HIV-related patent. Royalty revenues recognized under this agreement increased by $40.0 million in 2004 as compared with 2003. This increase is mainly due to a settlement agreement with Roche, described in more detail below, in which we recognized revenues for a license fee, deferred royalties and a portion of a nonrefundable royalty payment. Royalty revenues recognized under this agreement in 2003 were consistent with 2002.

An HIV-related patent directed to nucleic acid testing methods for HIV-1 was issued in the U.S. on March 13, 2003. This patent will expire seventeen years from the date of issuance. The issuance of the patent triggered a milestone payment to us of $10.0 million from Roche, which was received in April 2003. As permitted under the terms of its licensing agreement, Roche decided to institute arbitration proceedings in regard to the application of the U.S. patent. We had deferred recognition of the $10.0 million milestone payment, interest, royalties received and royalties accrued under the patent until the resolution of this dispute. On September 10, 2004, we reached a settlement agreement with Roche.

Under the terms of the settlement agreement, the milestone payment along with any royalties received prior to March 31, 2004 became non-refundable. Accordingly, in 2004, we have recognized $10.0 million in license fees and $21.8 million in royalties up until June 30, 2004, which had previously been deferred, of which $16.3 million has been recognized as revenue in our other segment and $5.5 million has been recognized as revenue in our blood testing segment. We also recognized $0.8 million in interest on the license fee. Also under the settlement agreement, in the first quarter of 2005, we are entitled to receive a lump-sum payment of $78.0 million in lieu of royalties beyond January 1, 2005. Roche may elect under the terms of the agreement to obtain a partial refund and revert to paying royalties on the sales of its products in North America. The amount of such potential refund ranges between $64.0 million and $0.0 million. The amount of the refund available decreases in increments over the quarters of 2005 and 2006. As such, Chiron expects to recognize $64.0 million of the payment as revenue over 2005 and 2006. The remaining $14.0 million is nonrefundable and was recognized as revenue in 2004, of which $9.3 million has been recognized as revenue in our other segment and $4.7 million has been recognized as revenue in our blood-testing segment. Revenues earned from diagnostic products are included in our other segment and revenues earned from blood screening are included in our blood-testing segment.

The impact on revenues in 2004 from these items from the September 10, 2004 settlement with Roche is summarized below (in thousands).

	Other Segment		Blood-testing Segment			Total
Deferred revenues recognized	$	16,313		$	5,453	$	21,766
Deferred license fee recognized	10,000			—		10,000
Non-refundable portion of Roche settlement	9,333			4,667		14,000
Total royalty and license fee revenue	$	35,646		$	10,120	$	45,766

Currently, the applicable issued HCV-related patents expire in 2015 for the U.S. and in 2010 for Europe. Currently, the applicable issued HIV-related patent in Europe expires in 2005.

Roche PCR agreement Under a July 1991 agreement between Roche Limited and Cetus Corporation (a company acquired by Chiron), we received royalties on sales of polymerase chain reaction products and services sold by Roche and its licensees. In 2004, we recognized a $3.0 million settlement with Roche regarding this agreement. We did not recognize any revenue under this agreement in 2003 and recognized $0.7 million in 2002. Roche’s royalty obligations, with certain limited exceptions for future products, expired in the fourth quarter 2000.

Bayer A cross-license agreement provides for royalties to us on HIV and hepatitis C virus products sold by Bayer Corporation. Royalties were consistent in 2004 as compared with 2003. Royalties increased $10.9 million in 2003 compared with 2002 primarily due to increased donations and a contractual increase in the royalty rates.

The balance of royalty and license fee revenues consisted of various other agreements, which individually were not material.

Selling, general and administrative The increase in selling, general and administrative expenses in 2004 as compared with 2003 was primarily due to $12.1 million in legal costs related to the FLUVIRIN vaccine developments discussed above under “—FLUVIRIN® Influenza Virus Vaccine Recent Events”, $12.9 million in legal costs related to the defense of our patents and technology and $5.4 million from corporate governance costs. These increases were partially offset by $4.0 million from a 2003 donation to Chiron Foundation and $1.2 million from lower employee related expenses.

The increase in selling, general and administrative expenses in 2003 as compared with 2002 was primarily due to $12.5 million from an increase in employee related expenses, $4.0 million from a donation to Chiron Foundation, $2.8 million from integration costs incurred by the other segment associated with our third quarter acquisition of PowderJect and $1.6 million from an impairment charge associated with long-lived assets. These increases were partially offset by a $9.3 million reduction in spending related to the defense of our patents and technology.

Purchased in-process research and development Purchased in-process research and development charged to operations was $9.6 million, $45.3 million and $45.2 million in 2004, 2003 and 2002, respectively.

On July 2, 2004, we acquired Sagres Discovery and accounted for the acquisition as an asset purchase. We allocated the purchase price based on fair value of the assets acquired and liabilities assumed. We allocated $9.6 million of the purchase price to purchased in-process research and development, which we charged to operations in the third quarter 2004. We do not anticipate that there will be any alternative future use for the purchased in-process research and development.

On July 8, 2003, we acquired PowderJect and accounted for the acquisition as a business combination. We allocated the purchase price based on the fair value of the assets acquired and liabilities assumed. We allocated $45.3 million of the purchase price to purchased in-process research and development, which we charged to operations in 2003. We do not anticipate that there will be any alternative future use for the in-process research and development. In valuing the purchased in-process research and development, we used probability-of-success-adjusted cash flows and a 14% discount rate. Cash flows from projects including those relating to (i) certain travel vaccines and (ii) vaccines for allergies were assumed to commence between 2004 and 2012.

On February 20, 2002, we acquired Matrix Pharmaceutical, Inc. and accounted for the acquisition as an asset purchase. We allocated the purchase price based on the fair value of the assets acquired and liabilities assumed. We allocated $45.2 million of the purchase price to purchased in-process research and development, which we charged to operations in 2002. We do not anticipate that there will be any alternative future use for the in-process research and development. In valuing the purchased in-process research and development, we used probability-of-success-adjusted cash flows and a 20% discount rate. We assumed revenue from tezacitabine to commence after 2005. Development of tezacitabine was discontinued in the first quarter of 2004 based on the analysis of the data from a Phase II trial in patients with gastroesophageal cancer. As with all pharmaceutical products, the probability of commercial success for any research and development project is highly uncertain.

Interest expense The increase in interest expense in 2004 as compared with 2003 primarily related to the effect of twelve months versus five months of interest expense recognized on the $500.0 million convertible debentures that we issued on July 30, 2003. Also, interest expense increased due to interest on the $385.0 million convertible debentures that we issued on June 22, 2004. These increases were partially offset by lower interest expense from certain of our Liquid Yield Options Notes (LYONs), which were put to us on June 12, 2004.

The increase in 2003 as compared with 2002 primarily related to interest expense recognized on the $500.0 million convertible debentures that were issued on July 30, 2003.

Interest and other income, net Interest and other income, net, primarily consisted of interest income on our cash and investment balances and other non-operating gains and losses. We recognized interest income of $23.4 million, $23.2 million and $36.2 million in 2004, 2003 and 2002, respectively.

The decrease in interest income in 2003 as compared with 2002 primarily was due to lower average cash and investment balances following the acquisition of PowderJect and lower average interest rates.

In 2004, 2003 and 2002, we recognized gains of $34.3 million, $9.4 million and $14.3 million, respectively, related to the sale of certain equity securities. The increase in 2004 is primarily due to the termination of certain equity forward contracts.

In 2004, we recognized losses attributable to the impairment of equity securities of $1.4 million. There were no losses attributable to impairment of equity securities in 2003. In 2002, we recognized losses attributable to the impairment of certain equity securities of $7.5 million.

In the second quarter 2001, we recorded a charge of $1.5 million to write-down debt securities with a face value of $5.0 million due to the decline in the credit rating of the issuer. On March 1, 2002, the issuer paid us $5.1 million—the full principal plus interest. We recorded $1.5 million in interest and other income, net, in 2002.

On December 31, 1998, we completed the sale of our 30% interest in General Injectibles & Vaccines, Inc., a distribution business, to Henry Schein, Inc. and received payment in full of certain advances we made to General Injectibles & Vaccines. The agreement also provided for us to receive additional payments, calculated as a pre-determined percentage of Henry Schein’s gross profit, through 2003. We received $4.2 million, $2.0 million and $5.4 million in 2004, 2003 and 2002, respectively.

Income taxes The effective tax rate in 2004 was 28.2%, of pretax income from continuing operations, including the charge for purchased in-process research and development related to the Sagres acquisition. The effective tax rate in 2003 was 28.7% of pretax income from continuing operations, including the charge for purchased in-process research and development related to the PowderJect acquisition. The charges for the purchased in-process research and development in 2004 and 2003 are not tax deductible. The effective tax rate in 2004 and 2003 were both 25.0% of pretax income from continuing operations, after excluding the impact of the purchased in-process research and development charges. The effective tax rate in 2004 includes increased benefits from research tax credits and foreign income taxed at lower rates. Such benefits are a greater percentage of pretax income in 2004 than in 2003. These benefits were offset by the tax cost of transferring certain product rights through inter-company transactions as part of our long-term tax planning strategy.

The reported effective tax rate in 2002 was 31.6% of pretax income from continuing operations, including the charge for purchased in-process research and development related to the Matrix Pharmaceutical acquisition. The effective tax rate in 2002 was 27.0% of pretax income from continuing operations, after excluding the impact of the in-process research and development charge. The 2003 effective tax rate is lower than the 2002 effective tax rate due to an increase in income earned in lower tax jurisdictions, net of increased benefits recognized in 2002 with respect to our research and development activities.

The effective tax rate may be affected in future periods by changes in management’s estimates with respect to our deferred tax assets and other items affecting the overall tax rate.

Management believes the acquisition of PowderJect may cause an increase in the future effective tax rate and is in the process of evaluating certain options that may mitigate any potential increase. Specifically, most of PowderJect’s profits earned are in the United Kingdom, subject to a 30% marginal tax rate.

Discontinued operations In a strategic effort to focus on our core businesses of blood-testing, vaccines and biopharmaceuticals, we completed the sale of Chiron Diagnostics to Bayer and Chiron Vision to Bausch & Lomb in 1998 and 1997, respectively. The “Gain (loss) from discontinued operations, net of taxes” consisted of the following for the years ended December 31:

	2004		2003			2002
	(In thousands)
Reversal of reserves (net charge) for indemnity obligations	$	—	$	(5,222	)	$	—
Gain resulting from IRS settlement	12,459		—			—
Employee settlement	—		—			(438		)
Reversal of income tax reserves from Bayer settlement	12,395		—			—
Income tax benefit	—		12,197			118
	$	24,854	$	6,975		$	(320	)

Chiron and Bayer Corporation, or Bayer, were involved in a dispute with respect to their respective rights to certain royalty refunds receivable for which a settlement was reached in 2004. Under this settlement agreement, we made a settlement payment to Bayer in 2004. This settlement includes an agreement that all outstanding items with Bayer related to the sale of Chiron Diagnostics are resolved and no future indemnity obligations are required. We released previously established reserves deemed to be excess following this settlement. This settlement resulted in a net gain of $12.4 million in 2004. This net gain primarily relates to a tax benefit as a result of the settlement payment to Bayer.

In 2004, Chiron and the IRS entered into a settlement agreement closing the open tax years 1996 to 1998. Pursuant to this settlement agreement we recognized a tax benefit of approximately $12.5 million in 2004.

We reversed approximately $2.3 million related to unutilized reserves for Chiron Diagnostics and Chiron Vision in 2003.

In 2003, Chiron and Bayer Corporation reached a settlement agreement relating to certain claims raised by Bayer under the Stock Purchase Agreement dated September 17, 1998, between Chiron and Bayer for Chiron Diagnostics. Under this settlement agreement, we made a payment to Bayer in 2003. Pursuant to this settlement, we recorded a charge, net of adjustment to our previously provided reserve for indemnity obligations of $7.6 million, offset by an income tax benefit of $9.0 million, resulting in a net gain of $1.4 million in 2003.

In 2002, we recognized a charge of $0.4 million related to a settlement with a former employee arising out of the sale of Chiron Diagnostics.

We recognized an income tax benefit of $12.2 million and $0.1 million in 2003 and 2002, respectively. The tax benefit in 2003 related to the settlement agreement between Bayer, as discussed above and the reversal of valuation allowances against deferred tax assets that were established at the time of the sale of Chiron Diagnostics. The tax benefit in 2002 related to the charge for a settlement with a former employee arising out of the sale, as discussed above.

New Accounting Standards

In December 2004, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards No. 123 (Revised 2004), Share-Based Payment (SFAS 123R), which requires the cost resulting from all share-based payment transactions to be recognized in the consolidated financial statements. That cost will be measured based on the fair value of the equity instruments issued or on the fair value of liabilities incurred. Under SFAS 123R, the fair-value-based method for recognition or disclosure of compensation expense will be applied using the modified prospective application transition

method or the modified retrospective application transition method. We currently measure compensation expense for our stock-based employee compensation under the intrinsic method. The adoption of SFAS 123R will have a material impact on our consolidated financial statements. Current option values of using the Black-Scholes formula, as discussed in Note 1 of Notes to Consolidated Financial Statements, may not be indicative of results from the valuation methodologies we finally adopt. The adoption of SFAS 123R is effective for Chiron commencing the beginning of the third quarter 2005.

Liquidity and Capital Resources

Our capital requirements have generally been funded by cash flow from operations, borrowings from commercial banks and issuance of convertible debt securities and common stock. Our cash, cash equivalents and investments in marketable debt securities, which totaled $1,013.0 million at December 31, 2004, are invested in a diversified portfolio of fixed income securities, including money market instruments, corporate notes and bonds, and government agency securities issued by financial institutions and other issuers with strong credit ratings. By policy, the amount of credit exposure to any one institution is limited. Investments are generally not collateralized and primarily mature within three years.

The recent events regarding FLUVIRIN vaccine, as discussed above, will continue to impact our cash flow going forward. As we continue to implement our remediation plan, our efforts will entail additional cash payments, which will be material. The MHRA’s lifting of our license suspension is conditioned upon the understanding that our commitment to remediation will continue.

In addition, we have incurred and expect to continue to incur substantial expense relating to the investigation by the U.S. Attorney’s Office for the Southern District of New York, the Securities and Exchange Commission formal investigation and the shareholder class action and derivative private lawsuits and other claims arising out of or related to these developments regarding FLUVIRIN vaccine.

In addition, our inability to supply FLUVIRIN vaccine for the 2004-2005 season may also lead to loss of market share because competitors have announced plans to introduce influenza vaccine products in the United States during the 2005-2006 season and are seeking expedited regulatory approval to do so. Even though the license suspension has been lifted, some of our customers may choose to purchase flu vaccine from other providers as their products become available in the United States. Loss of market share could have a material adverse effect on cash flow.

We are subject to investigations, litigation and disputes in connection with the FLUVIRIN developments. The results of any such investigations, proceedings or disputes could have a material adverse effect on our cash flow.

For additional information concerning the risks we face as a result of these FLUVIRIN vaccine developments, see “Factors That May Affect Future Results—The recent developments with respect to FLUVIRIN vaccine will harm our business and results of operations.” For additional information on the U.S. Attorney’s investigation, SEC investigation, private lawsuits and other claims arising out of or relating to the developments regarding FLUVIRIN, see Part I, Item 3 of this Report on Form 10-K.

On June 12, 2004, certain holders of our Liquid Yield Option Notes (LYONs), at their option, tendered LYONs with $649.9 million in aggregate principal amount at maturity, which we were required to purchase. The purchase price for the tendered LYONs was $584.31 in cash per $1,000 in principal amount at maturity. The aggregate purchase price for all the LYONs validly surrendered for purchase was $379.7 million. At December 31, 2004, there remains $80.1 million outstanding in aggregate principal amount at maturity with a current accreted balance of $47.3 million.

On June 22, 2004, we issued $385.0 million aggregate principal amount of new convertible debentures, which mature on June 30, 2034. The convertible debentures accrue interest at a rate of 2.75% per year with interest payable each June 30 and December 30 commencing December 30, 2004. The debentures are

senior, unsecured obligations and rank equal in right of payment with all of our existing and future unsecured and unsubordinated indebtedness.

Under the terms of the Investment Agreement between Novartis and Chiron, Novartis agreed to guarantee certain Chiron obligations up to a maximum of $702.5 million. Under this agreement, Novartis has guaranteed $100.0 million under a U.S. credit facility in which there were no borrowings outstanding at December 31, 2004 and $173.3 million from a lease commitment for a research and development facility in Emeryville, California.

We believe that our cash, cash equivalents and marketable debt securities, together with funds provided by operations and borrowing and leasing arrangements, will be sufficient to meet our foreseeable operating cash requirements over at least the next twelve months including any cash needed for remediation efforts for our Liverpool plant, cash utilized for our stock repurchase program and our contractual obligations of $373.7 million in the next twelve months as discussed in the contractual obligation table below. We also believe that our cash, cash equivalents and marketable debt securities, together with funds provided by operations and lease arrangements, will be sufficient to meet our contractual obligations of $1.6 billion arising after twelve months as discussed in the Contractual Obligations table below. In addition, we believe we could access additional funds from the debt and capital markets should the need arise. As noted above, if we suffer a permanent loss of FLUVIRIN influenza vaccine sales, whether through loss of regulatory approvals, market share or otherwise, it would have a material adverse effect on our cash flow.

Sources and Uses of Cash

We had cash and cash equivalents of $209.5 million and $364.3 million at December 31, 2004 and 2003, respectively.

Operating activities In 2004, net cash provided by operating activities was $170.7 million as compared with $413.9 million in 2003. The decrease in cash provided by operating activities was primarily due to lower income from continuing operations before depreciation, amortization and other non-cash charges, which decreased mainly due to the suspension of our license to manufacture FLUVIRIN® influenza virus vaccine in our Liverpool facility which prevented the release of any of the product during the 2004-2005 influenza season. Cash provided by operating activities also decreased due to (i) increased selling, general and administration expenses in 2004 primarily due to the movement of the Euro and British Pound exchange rates, twelve months of selling, general and administrative expenses from PowderJect in 2004 compared to approximately six months in 2003 and increased legal costs, (ii) lower royalty payments of BETASERON® and BETAFERON® interferon beta-1b due to a decline in the royalty rate by five percentage points pursuant to our contractual arrangement with Schering, and lower royalty payments received under the Roche royalty arrangements in 2004 compared with 2003 and (iii) $14.4 million of cash received as a result of the Biogen and Serono settlements in connection with the McCormick patents in 2003. These decreases were offset by (i) lower tax payments in 2004 as compared with 2003, (ii) a payment to Bayer Corporation in 2003 from a settlement agreement relating to certain claims raised by Bayer in connection with the Stock Purchase Agreement dated September 17, 1998 and (iii) increased product sales of PROCLEIX® assays and TOBI® tobramycin in 2004.

In 2003, net cash provided by operating activities was $413.9 million as compared with $268.2 million in 2002. The increase in cash provided by operating activities was primarily due to (i) higher income from continuing operations before depreciation and amortization and other non-cash charges, which increased mainly due to flu vaccine sales following the acquisition of PowderJect and higher product sales of PROCLEIX® assays, partially offset by increases in research and development costs. Increases in research and development costs were primarily due to the development of a dry powder formulation of our inhaled TOBI® tobramycin product, the development of tezacitabine, the development of interleukin-2 in

combination with various monoclonal antibodies, expansion of our meningococcal franchise and development of flu cell culture. We also incurred costs associated with our collaboration with ZymeQuest Inc. to develop and commercialize an enzymatic conversion system, our license agreement with Infectio Diagnostics, and the in-licensing of daptomycin, (ii) higher royalty payments received under the BETAFERON® interferon beta-1b and Roche royalty arrangements, (iii) $14.4 million of cash received as a result of the Biogen and Serono settlements in connection with the McCormick patents (see “Biopharmaceuticals—Other revenues” above), (iv) an increase in accounts payable and accrued liabilities at December 31, 2003 as compared to a decrease at December 31, 2002 driven by the timing of payments and our acquisition of PowderJect and (v) excluding the effect of acquisitions, a decrease in inventories at December 31, 2003 as compared to an increase in inventories at December 31, 2002. Partially offsetting these increases was a payment made to Bayer Corporation as a result of a settlement agreement relating to certain claims raised by Bayer under the Stock Purchase Agreement dated September 17, 1998.

In 2002, net cash provided by operating activities was $268.2 million as compared with $262.0 million in 2001. The increase in cash provided by operating activities largely was due to (i) higher income from operations before the charge for in-process research and development, depreciation and amortization and other non-cash charges and (ii) increased cash due to the timing of payments received under the BETAFERON® interferon beta-1b and Roche royalty arrangements. These increases were partially offset by (i) the $45.3 million license fee payment received from Bayer in June 2001, (ii) increased accounts receivable primarily driven by increases in product sales and royalty receivables due to an increase in BETAFERON® product sales and increased blood screening royalties due to contractual price increases and increased blood-testing volume, (iii) lower accrued liabilities and other payables due to the timing of payments and (iv) increased payments in 2002. Increased payments in 2002 as compared with 2001, included payments to (i) Gen-Probe upon resolution of certain contractual disputes which were accrued for in the fourth quarter 2001 and (ii) the German government in lieu of statutory price reductions on prescription drugs that are reimbursed under the German government’s healthcare program.

We anticipate that research and development expenditures in 2005 will primarily be driven by (i) the furtherance of our Phase III study and other development activities for tifacogin as a treatment for patients with severe community-acquired pneumonia (ii) initiation of a Phase III study and production of a dry powder formulation of our inhaled TOBI product for the treatment of pseudomonas aeruginosa in cystic fibrosis patients under our December 2001 collaboration agreement with Nektar Therapeutics, (iii) early-stage oncology studies and other development activities for Chiron compounds CHIR-258 and CHIR-12.12 (iv) expansion of our meningococcal franchise, (v) development of flu cell culture, (vi) research activities focused on identifying several novel vaccines and therapeutics for clinical development in the areas of oncology and infectious disease. In addition, we are required to make capital improvements to our existing manufacturing facilities to support the supply of BETAFERON® product to Schering. In connection with this project, we are continuing to incur expenses relating to the development of new processes and the performance of test runs related to installed equipment. Net cash from operating activities are expected to fund these research and development activities.

Investing activities In 2004, net cash used in investing activities consisted of purchases of investments in marketable debt securities of $796.9 million, capital expenditures of $183.7 million, cash paid for acquisitions net of cash acquired of $34.9 million, other uses of cash of $10.7 million and purchases of equity securities and interests in affiliated companies of $6.6 million. Included in net cash paid for acquisitions was $8.2 million for previously accrued costs in connection with the acquisition of PowderJect, $15.5 million of cash delivered on the divestiture of certain operations in Wisconsin, the U.K., and Sweden and $11.2 million of cash paid for the acquisition of Sagres. Cash used in investing activities was offset by proceeds from sales of investments in marketable debt securities of $431.1 million, proceeds from maturities of investments in marketable debt securities of $286.5 million, proceeds from the sale of

equity securities and interests in affiliated companies of $38.7 million, proceeds from the sale of assets of $3.0 million and proceeds from notes receivable of $1.5 million.

In 2003, our Board of Directors approved $50.7 million in expenditures for a 25-year building lease and $42.2 million for capital improvements, both of which are part of a $97.0 million project for expansion and replacement of our flu vaccines manufacturing facility in Liverpool, England. The new manufacturing facility will replace a portion of the existing flu vaccines manufacturing facilities in Liverpool, England and is anticipated to be available in the middle of 2008 for the manufacture of flu vaccines, subject to regulatory approval. In December 2003, we entered into a 25-year lease for the building; as of December 31, 2004, we have incurred $13.6 million for the capital improvements portion of the project. Management does not currently expect the recent FLUVIRIN vaccine developments to impact the timing of this project.

In April 2001, we entered into a collaboration with Rhein Biotech N.V. (now part of Berna Biotech) and GreenCross Vaccine Corporation to research and develop certain pediatric combination vaccine products for sale outside of Europe and North America. The collaboration agreement requires capital commitments from Chiron, Berna Biotech and GreenCross Vaccine. Our commitment is approximately 31.6 million Euro ($42.9 million at December 31, 2004) for the expansion of Chiron’s Italian manufacturing facilities, of which Chiron had incurred costs of 26.9 million Euro ($36.5 million), as of December 31, 2004. This agreement began in the fourth quarter 2001 and is expected to continue through 2006.

The purchases of equity securities and interests in affiliated companies in 2004 consisted of equity contributions under several venture capital funds including a $2.6 million capital contribution under two 2003 limited partnership agreements, a $0.3 million capital contribution under a 2002 limited partnership agreement, a $2.0 million capital contribution under a 2001 limited partnership agreement and a $1.4 million capital contribution under a 2000 limited partnership agreement. In addition, we contributed $0.3 million to our 51%-owned joint venture Indian subsidiary in 2004.

In 2003, we became a limited partner of Burrill Life Sciences Capital Fund, L.P. We will pay $10.0 million over six years, of which $3.5 million has been paid through December 31, 2004 for a 5.14% ownership. In 2003, we became a limited partner of Forward Venture V, L.P. We will pay $5.0 million over five years, of which $0.6 million has been paid through December 31, 2004, for a 3.45% ownership. In 2002, we became a limited partner of TPG Biotechnology Partners, L.P. We will pay $5.0 million over ten years, of which $2.2 million has been paid through December 31, 2004, for a 2.83% ownership. In 2001, we became a limited partner of Forward Venture IV, L.P. We will pay $15.0 million over ten years, of which $11.0 million has been paid through December 31, 2004, for a 6.35% ownership. In 2000, we became a limited partner of Burrill Biotechnology Capital Fund, L.P. We will pay $25.0 million over five years, of which $21.1 million has been paid through December 31, 2004, for a 23.26% ownership.

In 2003, net cash used in investing activities consisted of purchases of investments in marketable debt securities of $920.8 million, cash paid for acquisitions, net of cash acquired of $815.4 million, capital expenditures of $139.4 million, purchases of equity securities and interests in affiliated companies of $14.2 million and other uses of cash of $0.9 million. In 2003, cash paid for acquisitions, net of cash acquired, consisted of cash paid to acquire PowderJect, net of cash acquired, of $814.7 million and cash paid for acquisition costs related to the acquisitions of PathoGenesis Corporation and Matrix Pharmaceutical of $0.7 million. Cash used in investing activities was offset by proceeds from sales of investments in marketable debt securities of $793.2 million, proceeds from maturities of investments in marketable debt securities of $420.5 million, proceeds from the sale of equity securities and interests in affiliated companies of $12.6 million and proceeds from notes receivable of $0.8 million.

On July 8, 2003, we acquired PowderJect, a company based in Oxford, England that develops and commercializes vaccines. We acquired all of the outstanding shares of common stock of PowderJect for a

total purchase price of approximately $938.6 million. As part of the acquisition of PowderJect, we assumed the debt of PowderJect including convertible notes with a face value of 35.0 million British pounds (fair value of $57.0 million at July 8, 2003). We repaid the convertible notes during the third quarter 2003 and the payment is included in “Repayment of debt and capital leases” in the Consolidated Statement of Cash Flows for the year ended December 31, 2003.

The purchases of equity securities and interests in affiliated companies in 2003 consisted of (i) a payment of $6.7 million for the purchase of restricted Cubist common stock, (ii) a payment of $1.0 million for an equity investment in ZymeQuest and (iii) equity contributions under several venture capital funds including a $1.3 million capital contribution under two 2003 limited partnership agreements, a $0.6 million capital contribution under a 2002 limited partnership agreement, a $2.0 million capital contribution under a 2001 limited partnership agreement and a $2.7 million capital contribution under a 2000 limited partnership agreement.

In 2002, net cash used in investing activities consisted of purchases of investments in marketable debt securities of $796.5 million, capital expenditures of $105.7 million, net cash paid to acquire Matrix Pharmaceutical of $55.5 million, purchases of equity securities and interests in affiliated companies of $6.8 million, cash paid to acquire Pulmopharm of $2.4 million, cash paid for acquisition costs related to the acquisition of PathoGenesis of $0.5 million and other uses of cash of $6.1 million. Cash used in investing activities was offset by proceeds from sales of investments in marketable debt securities of $ 252.0 million and proceeds from maturities of investments in marketable debt securities of $471.6 million, proceeds from the sale of equity securities and interests in affiliated companies of $24.9 million, proceeds from notes receivable of $6.4 million and proceeds from sales of assets of $0.5 million.

The purchases of equity securities and interests in affiliated companies consisted of a $1.9 million capital contribution under a 2001 limited partnership agreement, a $3.6 million capital contribution under a 2000 limited partnership agreement and a $1.3 million capital contribution under a 2002 limited partnership agreement.

The proceeds from notes receivable of $6.4 million in 2002 related to amounts collected under promissory notes received in consideration for payment under biopharmaceutical license agreements with SkyePharma plc and Bristol-Myers Squibb Company.

Financing activities In 2004, net cash used in financing activities consisted of $383.0 million for the repayment of debt and capital leases, $135.0 million for the acquisition of treasury stock and $8.4 million for the payment of debt issuance costs. Cash used in financing activities was offset by $385.0 million of proceeds from issuance of convertible debentures (discussed above), $69.1 million of proceeds from the reissuance of treasury stock and $5.6 million of borrowings from a government agency.

In 2003, net cash provided by financing activities consisted of $500.0 million of proceeds from the issuance of convertible debentures (discussed below), $123.6 million of proceeds from the reissuance of treasury stock (related to stock option exercises), $2.1 million of proceeds from put options sold to reduce the costs of our share repurchase program, and $1.2 million from borrowings from a government agency in Italy. Cash provided by financing activities was offset by $207.7 million for the acquisition of treasury stock, $62.5 million for the repayment of debt and capital leases, $10.7 million for the payment of issuance costs on the convertible debentures and $2.4 million for the net repayment of short-term borrowings.

On July 30, 2003, we issued $500.0 million aggregate principal amount of convertible debentures, which mature on August 1, 2033. The debentures accrue interest at a rate of 1.625% per year. Interest is payable on February 1 and August 1 each year, commencing February 1, 2004. The debentures are senior, unsecured obligations of Chiron and rank equal in right of payment with all of our existing and future unsecured and unsubordinated indebtedness.

Our Board of Directors has, in the past, authorized the repurchase of our common stock on the open market. On December 5, 2003, the Board of Directors authorized Chiron to repurchase 5.0 million shares of Chiron common stock through December 31, 2004. Through December 31, 2004, we made purchases of 2.9 million shares at a cost of $126.5 million and the authorization to purchase the remaining 2.1 million shares expired unutilized. On March 10, 2005, the Board of Directors authorized Chiron to repurchase 5.0 million shares of Chiron common stock through December 31, 2005.

In January 2001, we initiated a put option program to reduce the effective cost of repurchasing our common stock. Under this program, we entered into contracts with third parties to sell put options on Chiron stock, entitling the holders to sell to us a specified number of shares at a specified price per share on a specified date. For the year ended December 31, 2003, we collected premiums of $2.1 million and for contracts that were exercised, we purchased 0.2 million shares. At December 31, 2004 and 2003, Chiron had no outstanding put option contracts.

In 2002, net cash used in financing activities consisted of $155.0 million for the acquisition of treasury stock, $0.5 million for the repayment of short-term borrowings and $0.2 million for the repayment of debt. Cash used in financing activities was offset by proceeds from the reissuance of treasury stock (related to stock option exercises) of $27.5 million and proceeds from put options of $5.4 million.

For the year ended December 31, 2002, we collected premiums of $4.3 million and, for contracts that were exercised, we purchased 0.3 million shares in connection with the put option program. As of December 31, 2002, we had an outstanding put option contract with a third party entitling the holder to sell us 0.5 million shares. The option expired on January 29, 2003 and had an exercise price of $38.11 per share. The amount of our obligation to repurchase such shares upon exercise of the outstanding put options, totaling $19.1 million, was reclassified from “Additional paid-in capital” to “Put options” in temporary equity in the Consolidated Balance Sheets at December 31, 2002. On January 29, 2003, our closing stock price was $37.94. Although the closing stock price was below the stipulated $38.11, the third party elected not to exercise the options. As a result, the temporary equity of $19.1 million was reclassified to permanent equity in the first quarter 2003.

From time to time, we evaluate a number of business development opportunities. To the extent that we are successful in reaching agreements with third parties, these transactions may involve selling a significant portion of our current investment portfolio, incurring additional debt or issuing additional Chiron shares.

Contractual Obligations

Our contractual obligations as of December 31, 2004 were as follows:

	Obligations by period
Contractual Obligations	Total		Less than 1 year		1-3 years		3-5 years		More than 5 years
	(in thousands)
Long-term debt (includes current portion)(1)	$	939,093	$	2,441	$	1,726	$	2,254	$	932,672
Capital lease obligations(2)	168,461		2,624		5,248		160,589		—
Other non-current liabilities(3)	79,643		—		9,969		1,839		67,835
Operating leases(4)	262,124		32,705		56,587		39,074		133,758
Purchase obligations:
Technology services agreement(5)	50,400		9,600		19,200		19,200		2,400
Purchase orders(6)	56,023		53,486		2,006		481		50
Supply agreement(7)	119,500		23,900		47,800		47,800		—
Plant expansion(8)	28,600		28,600		—		—		—
Berna biotech(9)	6,360		3,180		3,180		—		—
Capital commitments(10)	19,800		19,800		—		—		—
Infonet(11)	3,300		1,200		2,100		—		—
Letters of credit(12)	13,721		13,721		—		—		—
Research and development arrangements(13)	71,500		68,400		3,100		—		—
Insurance-related items(14)	20,000		20,000		—		—		—
Manufacturing and supply agreement(15)	19,700		6,566		13,134		—		—
Supply agreement(16)	19,136		6,222		12,914		—
Burrill Life Sciences Capital Fund, L.P.(17)	6,500		6,500		—		—		—
Forward Venture V L.P(18)	4,400		4,400		—		—		—
TPG Biotechnology Partners, L.P(19)	2,800		2,800		—		—		—
Forward Ventures IV L.P(20)	4,000		4,000		—		—		—
Burrill Biotechnology Capital Fund L.P(21)	3,900		3,900		—		—		—
Contract manufacturing agreement(22)	33,735		6,791		11,759		10,124		5,061
Revolving credit agreement(23)	2,500		2,500		—		—		—
Loan facility(24)	50,000		50,000		—		—		—
Managed services agreement(25)	400		400		—		—		—
Total	$	1,985,596	$	373,736	$	188,723	$281,361		$	1,141,776

(1) On June 22, 2004, we issued $385.0 million aggregate principal amount of convertible debentures, which mature on June 30, 2034 (2034 Debentures). The convertible debentures accrue interest at a rate of 2.75% per year and interest is payable on each June 30 and December 30 commencing on December 30, 2004. The debentures are senior, unsecured obligations of Chiron and rank equal in right of payment with all of our existing and future unsecured and unsubordinated indebtedness.

The holders of the 2034 Debentures may require us to repurchase for cash all or part of the debentures on June 30, 2010, June 30, 2014, June 30, 2019, June 30, 2024 and June 30, 2029. The repurchase price will be equal to 100% of the principal amount of the Debentures to be repurchased, plus accrued and unpaid interest, if any, up to the repurchase date.

On July 30, 2003, we issued $500.0 million aggregate principal amount of convertible debentures, which mature on August 1, 2033 (2033 Debentures). The convertible debentures accrue interest at a rate of 1.625% per year and interest is payable on February 1 and August 1 commencing February 1, 2004. The debentures are senior, unsecured obligations of Chiron and rank equal in right of payment with all of our existing and future unsecured and unsubordinated indebtedness.

The holders of the 2033 Debentures may require us to repurchase the debentures on August 1, 2008, August 1, 2013, August 1, 2018, August 1, 2023 and August 1, 2028. The repurchase price will be equal to the principal and accrued and unpaid interest. Payments for repurchases shall be made in the form of cash.

In June 2001, we issued zero coupon Liquid Yield Option Notes (LYONs) with a face value of $730.0 million and a yield to maturity of 2.0%. The LYONs were carried net of an original issue discount of $328.2 million, which was being accreted to interest expense over the life of the LYONs using the effective interest method. On June 12, 2004, certain LYONs holders, at their option, tendered $649.9 million in aggregate principal amount at maturity for purchase by us. The purchase price for the LYONs was $584.31 in cash per $1,000 in principal amount at maturity. The aggregate purchase price for all the LYONs validly surrendered for purchase was $379.7 million. At December 31, 2004, there remains outstanding $80.1 million in aggregate principal amount at maturity and an accreted balance of $47.3 million for the LYONs. The LYONs are uncollateralized and unsubordinated, and rank equal in right of payment to our existing and future uncollateralized and unsubordinated indebtedness.

At the option of the holder, Chiron may be required to purchase all, or a portion, of the remaining LYONs on June 12, 2006 at $608.04 for each note with face value of $1,000.

We had various other notes payable totaling $4.3 million at December 31, 2004.

Long-term debt has been reflected in the table above at its stated maturity dates for presentation purposes only. On specified dates, our repayment obligation could occur earlier than the maturity dates presented above because holders of the debentures have the right to require us to repurchase the debt.

(2) In July 2003, we entered into a new six-year lease to rent a research and development facility in Emeryville, California (R&D Property) following the expiration of the existing lease accounted for as an operating lease. We accounted for this new lease as a capital lease and, as a result, recorded the leased asset and the corresponding liability of $157.5 million on our balance sheet. This amount represents the present value of minimum lease payments, including the residual value guarantee. The lease provides a $156.0 million residual value guarantee from us to the lessors in the event fair value of the R&D Property declines below the total investment of $173.3 million made by the lessors in the R&D Property. Consequently, our maximum payment obligation is $156.0 million upon termination of the lease on or before July 1, 2009. The leased asset is amortized, using a straight-line method, to an amount such that the capital lease liability, net of the book value of the leased asset at the end of the lease term equals an amount that may become payable to the lessor due to an estimated decline in fair value of the leased asset below the lessors’ total investment of $173.3 million. We estimated the fair value of the R&D Property at the end of the lease term will be approximately $168.9 million. The fair value at the end of the lease term was estimated using the cost approach in which appraised value at lease inception is modified by estimates for building cost appreciation and building component depreciation through the six-year lease term. This valuation requires significant estimates and assumptions. We believe the fair value assigned is based on reasonable assumptions. Aggregate amortization of the leased asset over the term of the lease is estimated to be approximately $6.0 million. For the years ended December 31, 2004 and 2003, $1.0 million and $0.5 million were recorded as amortization expense for the capital lease.

At the inception of the lease, the future minimum lease payments, exclusive of a residual value guarantee, are approximately $15.7 million over the lease term. The lease payments represent variable-rate interest payments indexed to a three-month London interbank offered rate plus 40 basis points. Under the lease, on or before July 1, 2009, we can choose to either purchase the facility from the lessors or sell the facility to a third party. If we choose to purchase this property the specified purchase consideration under the lease agreement is $173.3 million. This option accelerates if we default on our lease payments or in the event of other defined events. Novartis has guaranteed (under provisions of the Investment Agreement) payments on this lease commitment, including payment of the residual value guarantee, to a maximum of $173.3 million.

(3) Other non-current liabilities as recorded in the Consolidated Balance Sheet as of December 31, 2004.

(4) We lease laboratory, office and manufacturing facilities, land and equipment under noncancelable operating leases, which expire through 2021.

(5) Effective August 1, 2003, Chiron and IBM Corporation amended and restated the previous ten-year information technology services agreement which was effective on July 1, 1998. Under this revised agreement, IBM agreed to provide us with a full range of information services until March 31, 2010. We can now terminate this agreement subject to certain termination charges. Minimum future payments to IBM are expected to be approximately $50.4 million. Payments to IBM are subject to adjustment depending upon the levels of services and infrastructure equipment provided by IBM, as well as inflation.

(6) We had noncancelable purchase orders for ongoing operations of $56.0 million at December 31, 2004.

(7) In connection with the production of our flu vaccine products, we must purchase large quantities of chicken eggs. Currently, for FLUVIRIN® vaccine, we purchase those eggs and incubation services from a single supplier in the United Kingdom and, pursuant to the contract with that supplier, we have agreed to make specified purchases of 12.5 million British Pounds ($23.9 million at December 31, 2004) each year from that supplier through 2009, subject to our right to terminate this agreement earlier upon payment of a termination fee.

(8) In 2003, our Board of Directors approved $50.7 million in expenditures for a 25-year building lease and $42.2 million for capital improvements, both of which are part of a $97.0 million project for expansion and replacement of our flu vaccines manufacturing facility in Liverpool, England. The new manufacturing facility will replace a portion of the existing flu vaccines manufacturing facilities in Liverpool, England and is anticipated to be available in the middle of 2008 for the manufacture of flu vaccines, subject to regulatory approval. In December 2003, we entered into a 25-year lease for the building. As of December 31, 2004, we have incurred $13.6 million for the capital improvements portion of the project.

(9) In April 2001, Chiron, Rhein Biotech N.V. (now part of Berna Biotech) and GreenCross Vaccine Corporation entered into a collaboration to research and develop certain pediatric combination vaccine products for sale outside of Europe and North America. The collaboration agreement requires capital commitments from Chiron, Berna Biotech and GreenCross Vaccine. Our commitment is approximately 31.6 million Euro ($42.9 million at December 31, 2004) for the expansion of our Italian manufacturing facilities, of which we have incurred costs of 26.9 million Euro ($36.5 million), as of December 31, 2004. This agreement began in the fourth quarter 2001 and is expected to continue through 2006. The amount of the commitment remaining at December 31, 2004 is $6.4 million. The remaining commitment is allocated on a straight-line basis until 2006.

(10) We had various other firm purchase and capital project commitments totaling approximately $19.8 million at December 31, 2004.

(11) In 2003, we entered into a four year Communication Services Agreement with Infonet USA Corporation. The contract requires a minimum monthly payment of $0.1 million and our commitment at December 31, 2004, totaled $3.3 million.

(12) At December 31, 2004, we had $13.7 million committed under letters of credit, which are required by German law, related to ongoing legal proceedings in Germany.

(13) We participate in a number of research and development arrangements with other pharmaceutical and biotechnology companies to research, develop and market certain technologies and products. Chiron and its collaborative partners generally contribute certain technologies and research efforts and commit, subject to certain limitations and cancellation clauses, to share costs related to certain research and development activities, including those related to clinical trials. At December 31, 2004, aggregate noncancelable funding commitments for 2005 under collaborative arrangements are $37.2 million. There are no noncancelable funding commitments under collaborative arrangements thereafter. We may also be required to make payments to certain collaborative partners upon the achievement of specified milestones. At December 31, 2004, aggregate milestone payments that may become due under these noncancelable collaborative arrangements totaled $5.4 million. These milestone payments are due upon the achievement of various technical milestones, completion of trials and regulatory filings.

In addition to these collaboration arrangements, we have entered into contracts where we are responsible for all the costs related to research and development activities. At December 31, 2004, aggregate annual noncancelable commitments under these contracts are as follows: 2005—$3.7 million and 2006—$3.1 million. At December 31, 2004, aggregate milestone payments that may become due under these noncancelable arrangements totaled $22.1 million. These milestone payments are due upon the achievement of various technical milestones, completion of trials and regulatory filings.

The timing of payments required for the achievement of milestones in the future is not determinable therefore we have included future milestone payments in “less than 1 year” for presentation purposes.

(14) We had various performance bonds and insurance-related letters of credit in the amount of $20.0 million available at December 31, 2004. There are no amounts outstanding under these letters of credit at December 31, 2004.

(15) Effective February 2003, Chiron and Baxter Pharmaceutical Solutions LLC executed an eight-year manufacturing and supply agreement. Under this agreement, Baxter agreed to perform certain manufacturing procedures and supply us with a key component for a certain biopharmaceutical product. We have certain minimum purchase obligations under this agreement and are required to pay the difference, if any, between the actual quantity purchased and the minimum purchase obligation. We can terminate this agreement in the fifth year with prior notice. Our minimum purchase obligation under this agreement is expected to be approximately $38.2 million over four years from regulatory approval, which occurred in 2003. We have paid $18.5 million towards the minimum purchase obligation as of December 31, 2004. As of December 31, 2004, the remaining minimum purchase obligation of $19.7 million is allocated ratably over three years.

(16) Effective October 2002, Chiron and Medical Associates Network, Inc., Medimop Medical Projects, Ltd. and Medimop Medical Projects North, Ltd. (referred to as Med Parties in this section) executed a five-year supply agreement. Under this agreement, the Med Parties agreed to provide us with a presentation device for certain pharmaceutical products. Under this agreement, we have minimum purchase requirements. Our minimum purchase obligation for the next three years is approximately $19.1 million. We can now terminate the agreement subject to twelve-months notification. If we do not terminate the agreement by December 31, 2007, the agreement will be automatically renewed for an additional twelve months.

(17) In 2003, we became a limited partner of Burrill Life Sciences Capital Fund, L.P. We will pay $10.0 million over six years, of which $3.5 million has been paid through December 31, 2004 for a 5.14% ownership. The partnership agreement does not allocate the contribution across future years, therefore we have included the remaining contributions in ‘less than 1 year’ for presentation purposes.

(18) In 2003, we became a limited partner of Forward Venture V, L.P. We will pay $5.0 million over five years, of which $0.6 million has been paid through December 31, 2004, for a 3.45% ownership. The partnership agreement does not allocate the contribution across future years; therefore, we have included the remaining contributions in ‘less than 1 year’ for presentation purposes.

(19) In 2002, we became a limited partner of TPG Biotechnology Partners, L.P. We will pay $5.0 million over ten years, of which $2.2 million has been paid through December 31, 2004, for an 2.83% ownership. The partnership agreement does not allocate the contribution across future years; therefore, we have included the remaining contributions in ‘less than 1 year’ for presentation purposes.

(20) In 2001, we became a limited partner of Forward Venture IV, L.P. We will pay $15.0 million over ten years, of which $11.0 million has been paid through December 31, 2004, for a 6.35% ownership. The partnership agreement does not allocate the contribution across future years; therefore, we have included the remaining contributions in ‘less than 1 year’ for presentation purposes.

(21) In 2000, we became a limited partner of Burrill Biotechnology Capital Fund, L.P. We will pay $25.0 million over five years, of which $21.1 million has been paid through December 31, 2004, for a 23.26% ownership. The partnership agreement does not allocate the contribution across future years; therefore, we have included the remaining contributions in ‘less than 1 year’ for presentation purposes.

(22) Effective June 2003, Chiron and SynCo B.V. executed a seven and a half-year contract manufacturing agreement. Under this agreement, SynCo agreed to provide services related to the production of certain of our vaccine products for the European and U.S. markets commencing in 2004. We have a firm binding order for products to be delivered by SynCo in 2005 and 2006 under this agreement. Our minimum purchase obligation under this agreement, which depends on the quantities purchased by us in years 2007 through 2010, inflation and movement in the Euro to U.S. Dollar exchange rate, is expected to be approximately $33.7 million over the remaining term of the agreement.

(23) In August 2003, we entered into a $2.5 million revolving credit agreement with Nektar Therapeutics to support the financing of equipment, facility improvements and other capital expenditures related to the manufacture of clinical supplies in support of a program to develop a dry powder formulation of TOBI® tobramycin. Each advance made under this revolving line of credit matures on the sixth anniversary of the initial advance. As of December 31, 2004, Nektar Therapeutics has not drawn from the revolving line of credit.

(24) In March 2004, we entered into a worldwide, exclusive, multi-product, collaborative arrangement with XOMA Ltd. for the development and commercialization of antibody products for the treatment of cancer. Under the terms of the arrangement, the parties agreed to jointly research, develop, and commercialize multiple antibody product candidates. Under the arrangement, the parties agreed to share development and commercialization expenses, including preclinical and clinical development, manufacturing and worldwide marketing costs, as well as revenues, generally on a 70-30 basis, with our share being 70% and XOMA’s share being 30%. We agreed to make an initial payment of $10.0 million, which has been paid as of December 31, 2004, and to make a loan facility of up to $50.0 million available to XOMA, starting on January 1, 2005 to fund 75% of XOMA’s share of development expenses. The funding of the loan facility in the future is not determinable therefore we have included the entire amount available under the loan facility in “less than 1 year” for presentation purposes.

(25) Effective June 2002, Chiron and VWR international, Inc. executed a seven-year managed services agreement. Under this agreement, VWR agreed to provide us purchasing and delivery services. We can terminate this agreement any time with six-month notice and a minimum payment obligation of $0.4 million. If we do not terminate this agreement, payments to VWR are expected to be approximately $6.5 million, of which approximately $0.9 million has been paid as of December 31, 2004. At the end of the initial term, we have the option to renew the agreement for an additional three years.

Borrowing Arrangements

Under a revolving, committed, uncollateralized credit agreement with a major financial institution, we can borrow up to $100.0 million in the U.S. This credit facility is guaranteed by Novartis AG under a November 1994 Investment Agreement, provides various interest rate options and matures in February 2006. There were no borrowings outstanding under this credit facility at December 31, 2004 and 2003. In July 2003, we entered into a new six-year lease to rent a research and development facility in Emeryville, California. Under provisions of the November 1994 Investment Agreement, Novartis AG guaranteed payments on this lease commitment to a maximum of $173.3 million. In December 1999, Chiron and Novartis amended the November 1994 Investment Agreement to reduce the maximum amount of our obligations that Novartis would guarantee from $725.0 million to $702.5 million. Out of the maximum guarantee of $702.5 million, the credit agreement and lease discussed above have reduced the amount of our debt Novartis would be required to guarantee by $273.3 million. There remains $429.2 million of the guarantee available at December 31, 2004. The Novartis loan guarantee will expire on January 1, 2008 unless certain debt ratings are triggered which would extend the guarantee on a declining basis ratably over the subsequent three year period.

We also have various credit facilities available outside the U.S. There were no outstanding borrowings under these facilities at December 31, 2004 and 2003. One facility is maintained for our 51%-owned Indian subsidiary, and allows for total borrowings of 200 million Indian Rupee ($4.6 million at December 31, 2004). There were no outstanding borrowings under this facility at December 31, 2004 and 2003.

Off-Balance Sheet Arrangements

As of December 31, 2004, we do not have any off-balance sheet debt arrangements.

Market Risk Management

Our cash flow from operations and earnings are subject to fluctuations due to changes in foreign currency exchange rates, interest rates, the fair value of equity securities held and the realized value of investment securities sold. We attempt to limit our exposure to some or all of these market risks through the use of various financial instruments. These activities are discussed in further detail in Item 7A. “Quantitative and Qualitative Disclosures About Market Risk.”

Factors That May Affect Future Results

As a global biopharmaceutical company, we are engaged in a rapidly evolving and often unpredictable business. The forward-looking statements contained in this 10-K and in other periodic reports, press releases and other statements issued by us from time to time reflect our current beliefs and expectations concerning objectives, plans, strategies, future performance and other future events. The following discussion highlights some of the factors, many of which are beyond our control, which could cause actual results to differ.

The recent developments with respect to FLUVIRIN® vaccine will harm our business and results of operations.

During the third quarter of 2004, in conducting final internal release procedures for our FLUVIRIN influenza virus vaccine, our quality systems identified lots that did not meet product sterility specifications. As a result, we determined at the time to delay releasing any FLUVIRIN vaccine doses pending completion of internal investigations. On October 5, 2004, the U.K. regulatory body, the Medicines and Healthcare products Regulatory Agency, or MHRA, sent us a letter prohibiting us from releasing any FLUVIRIN vaccine doses manufactured at our Liverpool facility since March 2, 2004 and suspending our license to manufacture influenza virus vaccine in our Liverpool facility for three months (later extended for an additional three months). In that letter, the MHRA asserted that our manufacturing process did not comply with U.K. good manufacturing practices regulations. Following the MHRA’s decision and an inspection by the Food and Drug Administration, or FDA, the FDA sent us a warning letter on December 9, 2004 citing violations of good manufacturing practices. We provided the FDA with a written response to the warning letter on January 7, 2005. In a subsequent letter to us, the FDA stated that our responses appear to be adequate, but that implementation and effectiveness of our corrective actions and overall compliance would be evaluated in a subsequent inspection. As a result of the license suspension, we did not release any FLUVIRIN product during the 2004-2005 influenza season.

On March 2, 2005, the MHRA notified us that it had lifted the license suspension, giving Chiron clearance to initiate full production of FLUVIRIN vaccine, conditioned on the unde