UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

 

For the transition period from                      to                     

Commission File Number: 0-12798

CHIRON CORPORATION

(Exact name of registrant as specified in its charter)

 

(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)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes x    No o

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).

Yes x    No o

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Yes o    No x

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

 

CHIRON CORPORATION
TABLE OF CONTENTS

 

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Item 1.                        Financial Statements

CHIRON CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEETS
(Unaudited)
(In thousands, except share data)

 

The accompanying Notes to Condensed Consolidated Financial Statements are integral to this statement.

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CHIRON CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEETS (Continued)
(Unaudited)
(In thousands, except share data)

 

The accompanying Notes to Condensed Consolidated Financial Statements are integral to this statement.

4

CHIRON CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
(In thousands, except per share data)

 

The accompanying Notes to Condensed Consolidated Financial Statements are integral to this statement.

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CHIRON CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
(Unaudited)
(In thousands)

 

The accompanying Notes to Condensed Consolidated Financial Statements are integral to this statement.

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CHIRON CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
(In thousands)

 

The accompanying Notes to Condensed Consolidated Financial Statements are integral to this statement.

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CHIRON CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2005
(Unaudited)

Note 1—Basis of Presentation

The information presented in the Condensed Consolidated Financial Statements at September 30, 2005, and for the three and nine months ended September 30, 2005 and 2004, is unaudited but includes all adjustments, consisting only of normal recurring adjustments, which Chiron Corporation believes to be necessary for fair presentation of the periods presented.

The Condensed Consolidated Balance Sheet amounts at December 31, 2004, have been derived from audited financial statements. Historically, Chiron’s operating results have varied considerably from period to period due to the nature of Chiron’s collaborative, royalty and license arrangements and the seasonality of certain vaccine products. In addition, the mix of products sold and the introduction of new products will affect comparability from quarter to quarter. As a consequence, Chiron’s interim results in any one quarter are not necessarily indicative of results to be expected for a full year. This information should be read in conjunction with Chiron’s audited Consolidated Financial Statements as of and for the year ended December 31, 2004, which are included in the Annual Report on Form 10-K filed by Chiron with the Securities and Exchange Commission, or SEC.

Principles of Consolidation

The Condensed Consolidated Financial Statements include the accounts of Chiron and its majority-owned subsidiaries. For consolidated majority-owned subsidiaries in which Chiron owns less than 100%, Chiron records minority interest in the Condensed Consolidated Financial Statements to account for the ownership interest of the minority owner. Investments in limited partnerships and interests in which Chiron has an equity interest of 50% or less are accounted for using either the equity or cost method. All significant intercompany accounts and transactions have been eliminated in consolidation.

Restated Second-Quarter and Third-Quarter 2004 Financial Statements

During our 2004 year-end financial statement 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 restated the financial statements included in our Quarterly Reports on Form 10-Q for such quarters and filed amended Form 10-Qs for such quarters on April 6, 2005.

Use of Estimates and Reclassifications

The preparation of financial statements requires management 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, management evaluates its 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. Chiron bases its estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of

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CHIRON CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
September 30, 2005
(Unaudited)

Note 1—Basis of Presentation (Continued)

which form the 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.

Chiron, prior to filing its financial statements on Form 10-Q, publicly releases an unaudited condensed consolidated balance sheet and statement of operations. Between the date of Chiron’s earnings release and the filing of Form 10-Q, reclassifications may be required. These reclassifications, when made, have no effect on income from continuing operations, net income or earnings per share. There has been no such reclassification in the third quarter of 2005.

Chiron currently owns certain manufacturing and inspection equipment which is no longer useful and became available for sale in 2005. Chiron has committed to a plan to sell these assets and is actively marketing these assets. These assets are classified as “Assets held for sale” in the Condensed Consolidated Balance Sheet at September 30, 2005.

Certain previously reported amounts have been reclassified to conform to the current year presentation.

Stock-Based Compensation

Chiron measures compensation expense for its stock-based employee compensation using the intrinsic value method. Compensation expense is based on the difference, if any, between the fair value of Chiron’s common stock and the exercise price of the option or share right on the measurement date, which is typically the date of grant. This amount is recorded as “Deferred stock compensation” in the Condensed Consolidated Balance Sheets and amortized as a charge to operations over the vesting period of the applicable options or share rights.

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CHIRON CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
September 30, 2005
(Unaudited)

Note 1—Basis of Presentation (Continued)

The following table illustrates the effect on net income and related net income per share, had compensation cost for stock-based employee compensation been determined based upon the fair value method:

 

Note 2—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 123(R)), 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 123(R), 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. Chiron currently measures compensation expense for its stock-based employee compensation under the intrinsic method. Chiron is currently evaluating transition methods, option valuation methodologies and assumptions in light of SFAS 123(R) and, therefore, cannot estimate the impact of its adoption at this time, although Chiron expects that its adoption will have a material impact on Chiron’s consolidated financial statements. Current option values determined using the Black-Scholes-Merton formula, used for purposes of proforma disclosure, may not be indicative of results from the valuation methodologies Chiron finally adopts. The effective date of SFAS 123(R) is the first reporting period beginning after June 15, 2005. However, on April 14, 2005, the Securities and Exchange Commission (SEC) announced the adoption of a new rule that delays the effective date of SFAS 123(R) for registrants, such as Chiron, that are not small business issuers. The

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CHIRON CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
September 30, 2005
(Unaudited)

Note 2—New Accounting Standards (Continued)

SEC’s new rule allows calendar year non-small business issuers to implement SFAS 123(R) at the beginning of 2006, which makes SFAS 123(R) effective for Chiron in the first quarter of 2006.

On October 22, 2004, the American Jobs Creation Act of 2004 (the Act) was signed into law. The Act includes a temporary incentive for U.S. multinationals to repatriate accumulated income earned outside the U.S. at an effective tax rate of 5.25%. On December 21, 2004, the FASB issued Staff Position 109-2, Accounting and Disclosure Guidance for the Foreign Earnings Repatriation Provisions within the American Jobs Creation Act of 2004 (FSP 109-2). FSP 109-2 allows companies additional time to evaluate the effect of the law on whether unrepatriated foreign earnings continue to qualify for SFAS No. 109’s exception to recognizing deferred tax liabilities and would require explanatory disclosures from those who need the additional time. Through September 30, 2005, Chiron has not provided deferred taxes on foreign earnings because such earnings were intended to be indefinitely reinvested outside the U.S. Presently Chiron does not have any plan to repatriate earnings under the Act. Accordingly, Chiron has made no change in its current intention to indefinitely reinvest accumulated earnings of its foreign subsidiaries. If Chiron repatriates these earnings, a tax charge to its consolidated results of operations could occur. Chiron will continue to evaluate the impact of this provision.

Note 3—Inventories

Inventories, net of reserves, are stated at the lower of cost or market using the moving weighted-average cost method. Chiron maintains inventory reserves primarily for product failures, expiration and obsolescence. Inventory that is obsolete (inventory that will no longer be used in the manufacturing process), expired, or in excess of forecasted usage is written down to its market value, if lower than cost.

Inventories, net of reserves, consisted of the following:

 

Note 4—Income Taxes

The effective tax rate was 21.9% and 27.3% of pretax income from continuing operations for the nine months ended September 30, 2005 and 2004, respectively. The tax rate decreased primarily due to lower expected taxable incomes, year to year, in certain high tax jurisdictions, as well as increased benefits of U.S. research credits. Such items are not expected to recur in future years. 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.

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CHIRON CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
September 30, 2005
(Unaudited)

Note 5—Comprehensive Income (Loss)

For the three and nine months ended September 30, 2005 and 2004, the foreign currency translation component of comprehensive income (loss) relates to permanent investments in non-U.S. subsidiaries and, accordingly, was not adjusted for income taxes.

Note 6—Treasury Stock

Treasury stock is stated at cost. Gains on reissuance of treasury stock are credited to “Additional paid-in capital.” Losses on reissuance of treasury stock are charged to “Additional paid-in capital” to the extent of available net gains on reissuance of treasury stock. Otherwise, losses are charged to “Accumulated deficit.” Chiron charged losses of $21.4 million and $45.6 million for the three and nine months ended September 30, 2005, respectively, and $9.0 million and $39.1 million for the three and nine months ended September 30, 2004, respectively, to “Accumulated deficit” in the Condensed Consolidated Balance Sheets.

Note 7—Earnings Per Share

Basic earnings per share is based upon the weighted-average number of common shares outstanding. Diluted earnings per share is based upon the weighted-average number of common shares and dilutive potential common shares outstanding. Dilutive potential common shares could result from (i) the assumed exercise of outstanding stock options and equivalents, which are included under the treasury-stock method; (ii) performance based share rights awards to the extent that dilutive shares are assumed issuable; (iii) the assumed exercise of outstanding put options, which are included under the reverse treasury-stock method; and (iv) convertible notes and debentures, which are included under the if-converted method, if applicable. Due to rounding, quarterly amounts may not sum to full year amounts.

Contingently convertible debt instruments (“CoCos”) are included in diluted earnings per share, if dilutive. For the three months ended September 30, 2005, Chiron’s $500.0 million contingently convertible debentures due 2033 (“2033 Debentures”) were included in the computation of diluted earnings per share. These debentures were not dilutive for the three months ended September 30, 2004. For the three months ended September 30, 2005 and 2004, Chiron’s $385.0 million contingently convertible debentures due 2034 (“2034 Debentures”) were excluded from the computations of diluted earnings per share as the inclusion of these debentures would be antidilutive. For the nine months ended September 30, 2005 and 2004, the 2033 Debentures and the 2034 Debentures were excluded from the computation of diluted earnings per share as the inclusion of each of these CoCos would be antidilutive.

For the three months ended September 30, 2005, the Liquid Yield Option Notes (LYONs) were included in the computation of diluted earnings per share. For the nine months ended September 30, 2005, 0.6 million shares of common stock issuable upon conversion of the LYONs were excluded from the computations of diluted earnings per share as their inclusion would be antidilutive. For the three and nine months ended September 30, 2004, 0.6 million and 4.3 million shares of common stock that would be issued upon conversion of the LYONs were excluded from the computations of diluted earnings per share, as their inclusion would be antidilutive.

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CHIRON CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
September 30, 2005
(Unaudited)

Note 7—Earnings Per Share (Continued)

The following table sets forth the computations for basic and diluted earnings per share on income from continuing operations (in thousands, except per share data):

 

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CHIRON CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
September 30, 2005
(Unaudited)

Note 7—Earnings Per Share (Continued)

The following table sets forth the computations for basic and diluted earnings per share on net income (in thousands, except per share data):

 

Stock options to purchase 17.7 million shares and 11.7 million shares with exercise prices greater than the average market prices of common stock were outstanding during the three months ended September 30, 2005 and 2004, respectively, and 19.6 million shares and 10.1 million shares, respectively, for the nine months ended September 30, 2005 and 2004. These options were excluded from the respective computations of diluted earnings per share, as their inclusion would be antidilutive.

The dilutive effect of CoCos must be included in diluted earnings per share regardless of whether the triggering contingency has been satisfied, if dilutive. For the nine months ended September 30, 2005 and the three and nine months ended September 30, 2004, 7.3 million shares of common stock issuable upon conversion of the 2033 Debentures were excluded from the computations of diluted earnings per share as their inclusion would be antidilutive.

If the 2034 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

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CHIRON CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
September 30, 2005
(Unaudited)

Note 7—Earnings Per Share (Continued)

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 that 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 dilutive, common shares to be added to the diluted shares outstanding would be determined by the net share settlement of the 2034 Debentures. For the three and nine months ended September 30, 2005 and 2004, the assumed conversion of the 2034 Debentures was not dilutive.

Note 8—Discontinued Operations

In a strategic effort to focus on Chiron’s core businesses of blood-testing, vaccines and biopharmaceuticals, Chiron completed the sale of Chiron Diagnostics to Bayer Corporation, or Bayer, in 1998.

In the second quarter of 2004, Chiron and the IRS entered into a settlement agreement closing the open tax years 1996 to 1998. Pursuant to this settlement, Chiron recognized a tax benefit of approximately $12.5 million for the nine months ended September 30, 2004.

Chiron and 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, Chiron 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. Chiron released previously established reserves deemed to be in excess following this settlement. This settlement resulted in a net gain of $12.8 million for the nine months ended September 30, 2004. This net gain primarily relates to a tax benefit as a result of the settlement payment to Bayer.

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CHIRON CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
September 30, 2005
(Unaudited)

Note 9—Intangible Assets

Intangible assets subject to amortization consisted of the following (in thousands):

(1)          Upon acquisition of a 100% interest in Chiron Behring by the second quarter 1998, Chiron acquired a portfolio of products that were created by Behring and are currently being sold internationally. These products embody Chiron Behring’s proprietary “know-how” consisting of unpatented technology and trade secrets. Since the unpatented technology and trade secrets meet the separability criterion, Chiron has recognized them collectively as a separate intangible asset apart from goodwill in accordance with SFAS No. 141, Business Combinations.

Aggregate future amortization expense is expected to be as follows (in thousands):

 

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CHIRON CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
September 30, 2005
(Unaudited)

Note 9—Intangible Assets (Continued)

The changes in the carrying value of goodwill by reporting unit consisted of the following (in thousands):

 

Chiron performed its annual impairment test for goodwill in the third quarter 2005, as of July 1, 2005. Based on this analysis, Chiron has no indication of an impairment loss.

Certain developed product technologies from Chiron’s acquisition of PowderJect are amortized under the estimated sales method, which considers forecasted FLUVIRIN® sales during each influenza season through the remaining period of the benefit. Related amortization was $4.1 million and $30.1 million as compared to $12.3 million and $34.9 million during the three and nine months ended September 30, 2005 and 2004, respectively, reflecting updated forecasted FLUVIRIN® sales.

In the third quarter of 2005, Chiron recognized an impairment loss of $14.5 million on acquired intangible assets from Chiron’s acquisition of PowderJect related to ARILVAX™, a yellow fever vaccine. This impairment loss was due to a focus of resources towards the influenza market, resulting in a reduction of the expected activity for ARILVAX™. ARILVAX™ remains in Chiron’s portfolio of trademarks and Chiron may re-enter the yellow fever vaccine market in the future with this product. ARILVAX™ is included in the caption “Developed product technologies” in the table above.

Note 10—Segment Information

Chiron is organized based on the products and services that it offers. Under this organizational structure, there are three reportable segments: (i) blood-testing, (ii) vaccines and (iii) biopharmaceuticals. The blood-testing segment consists of an alliance with Gen-Probe and Chiron’s one-half share in the pretax operating earnings generated by the joint business contractual arrangement with Ortho-Clinical Diagnostics. Chiron’s alliance with Gen-Probe is focused on developing and commercializing nucleic acid testing products using Transcription-Mediated Amplification technology to screen donated blood, plasma products, organs and tissues for viral infection. Chiron’s joint business arrangement with Ortho-Clinical Diagnostics is operated under a contractual arrangement and is not a separate and distinct legal entity. Through Chiron’s joint business contractual arrangement with Ortho-Clinical Diagnostics, Chiron sells a line of immunodiagnostic tests to detect hepatitis viruses and retroviruses and provides 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 Chiron’s hepatitis C virus and HIV-related patents, for use in blood screening and plasma fractionation markets. The vaccines segment consists principally of adult and pediatric vaccines for viral and bacterial infections. Chiron sells these vaccines primarily in the U.S., Germany, Italy, and the United Kingdom, as well as in other

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CHIRON CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
September 30, 2005
(Unaudited)

Note 10—Segment Information (Continued)

international markets. The vaccines segment is also involved in the development of novel vaccines and vaccination technology. The biopharmaceuticals segment consists of therapeutic products and services, with an emphasis on the treatment of cancer and infectious and pulmonary diseases, using the development and acquisition of technologies related to therapeutic proteins, antibodies and small molecules. The biopharmaceuticals segment earns royalties on third party sales of several products, including 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.

Revenues and expenses associated with Chiron’s research and development activities specifically benefit each of the reportable segments and, as such, have been included in the results of operations of the respective reportable segment.

Chiron views certain other revenues and expenses, particularly certain royalty and license fee revenues primarily related to HIV and hepatitis C virus related patents, and unallocated corporate expenses, as not belonging to any one reportable segment. As a result, Chiron has aggregated these items into an “Other” segment.

The accounting policies of Chiron’s reportable segments are the same as those described in Chiron’s Annual Report on Form 10-K for the year ended December 31, 2004. Chiron evaluates the performance of its segments based on each segment’s income (loss) from continuing operations, excluding certain special items such as purchased in-process research and development, which is shown as a reconciling item in the table below.

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CHIRON CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
September 30, 2005
(Unaudited)

Note 10—Segment Information (Continued)

The following segment information excludes all significant intersegment transactions as these transactions are eliminated for management reporting purposes (in thousands):

 

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CHIRON CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
September 30, 2005
(Unaudited)

Note 11—Commitments and Contingencies

In October 2004, the U.K. regulatory body, the Medicines and Healthcare products Regulatory Agency, or MHRA, suspended Chiron’s license to manufacture FLUVIRIN® at our Liverpool, U.K. facility.

On March 2, 2005, the MHRA notified Chiron 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 and will be subject to further inspections by the MHRA.

On October 17, 2005 Chiron initiated delivery and release of FLUVIRIN® vaccine to customers in the United States for the 2005-2006 influenza season. As of such time, Chiron had received all necessary approvals from the U.S. Food and Drug Administration (FDA) and MHRA to start supplying FLUVIRIN® vaccine to the U.S. market. Continued shipments of FLUVIRIN® vaccine will need to undergo corresponding internal release procedures and standard FDA influenza vaccine lot release procedures.

Chiron 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 Chiron’s license. In February 2005, after having previously commenced an informal inquiry, the Securities and Exchange Commission, or SEC, notified Chiron that it would commence a formal investigation into whether Chiron or Chiron employees violated any federal securities laws in connection with these developments regarding FLUVIRIN® vaccine, and Chiron subsequently received subpoenas from the SEC requesting production of certain documents relating to our Liverpool facility and FLUVIRIN® vaccine. Chiron also received a voluntary request for information from the United States House of Representatives, Energy and Commerce Committee, Subcommittee on Oversight and Investigations 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, the SEC staff and Congressional staff. Additional investigations regarding these matters may arise.

In addition, Chiron and certain of its 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. Certain distributors and other parties with whom Chiron had contracted to supply FLUVIRIN® vaccine are considering or have communicated claims against Chiron as a result of our inability to supply FLUVIRIN® vaccine, and additional parties may do so in the future. On January 27, 2005, the U.S. Centers for Disease Control and Prevention, or CDC, terminated its contracts with Chiron for the supply of FLUVIRIN® vaccine for default on the basis of Chiron’s failure to supply such vaccine to the U.S. government for the 2004-2005 influenza season. The CDC has reserved the right to hold Chiron liable for any excess costs it may have incurred in replacing any FLUVIRIN® vaccine that Chiron failed to deliver and further has reserved all other remedies provided under the contract. 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 Chiron management and will

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CHIRON CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
September 30, 2005
(Unaudited)

Note 11—Commitments and Contingencies (Continued)

continue to do so in the future and could result in civil action and/or criminal proceedings against Chiron. The results of any such investigations, proceedings or disputes could have a material adverse effect on Chiron’s consolidated financial position and results of operations and/or cash flow.

Although the MHRA has lifted its suspension of Chiron’s license to manufacture FLUVIRIN® vaccine, Chiron expects to incur additional 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, Energy and Commerce Committee, Subcommittee on Oversight and Investigations and the private lawsuits and other claims and investigations that exist or may arise.

BEGRIVAC™ vaccine is manufactured at Chiron’s facility in Marburg, Germany. In July 2005, Chiron reported that it would be unable to supply any BEGRIVAC™ vaccine doses for the 2005-2006 influenza season due to a product sterility issue and wrote off its existing product inventory resulting in charges of $3.0 million and $18.0 million to cost of sales for the three and nine months ended September 30, 2005, respectively. Investigation of the product sterility issue has been completed and implementation of remedial measures and facility modifications is underway. Chiron’s inability to supply BEGRIVAC™ vaccine as planned to non-U.S. markets for the 2005-2006 season or, if remedial efforts are delayed or not sucessful, future seasons could have a material adverse affect on its business and results of operations. In addition, it is possible that distributors and other parties with whom Chiron had contracted to supply influenza vaccine may make claims against Chiron as a result of Chiron not supplying influenza vaccine. Any such claims may cause Chiron to incur substantial expense and require significant time and attention from Chiron management. The results of any such claims could have a material adverse effect on Chiron’s consolidated financial position and results of operations and/or cash flow.

In addition to the investigations, inquiry and lawsuits related to the recent FLUVIRIN® vaccine developments, Chiron is party to various claims, investigations and legal proceedings arising in the ordinary course of business. These claims, investigations and legal proceedings relate to intellectual property rights, contractual rights and obligations, employment matters, claims of product liability and other issues. While it is possible that an adverse determination of any of such ordinary course matters could have a material adverse impact in any future period, management does not believe, based upon information known to it, that the final resolution of any of these ordinary course matters will have a material adverse effect upon Chiron’s consolidated financial position and results of operations or cash flows.

Chiron’s tax filings are presently under examination in several domestic and international tax jurisdictions. While there is no assurance that Chiron will prevail in all tax examinations in the event the taxing authorities disagree with Chiron’s interpretation of the tax law, Chiron’s management does not believe, based upon information known to it, that the final resolution of any of these audits will have a material adverse effect upon Chiron’s consolidated financial position and results of operations or cash flows. Adequate provisions have been made for these tax examinations.

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CHIRON CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
September 30, 2005
(Unaudited)

Note 12—Subsequent events

On October 30, 2005, Chiron entered into a merger agreement with Novartis Corporation (“Novartis”), Novartis Biotech Partnership, Inc., a subsidiary of Novartis (“Merger Sub”), and Novartis AG.  Pursuant to the terms of the merger agreement, Merger Sub will merge with and into Chiron, with Chiron as the surviving corporation.  In the merger, each share of Chiron common stock, other than those held by Novartis and its affiliates, will be converted into the right to receive $45.00 per share in cash.  Completion of the merger is subject to approval of (1) the holders of a majority of the outstanding shares of Chiron common stock and (2) the holders of a majority of the outstanding shares of Chiron common stock, excluding shares owned by Novartis and its affiliates.  The merger is also subject to the satisfaction of other customary conditions, including governmental and regulatory approvals.  Chiron expects that the transaction will be completed in the first half of 2006.

Immediately prior to signing the merger agreement, Chiron gave notice to Novartis that Chiron was exercising its right under the Subscription Agreement, dated as of November 20, 1994, as amended, with Novartis (as successor to Ciba-Geigy) to require Novartis or its affiliate to purchase shares of Chiron common stock for an aggregate purchase price of $300.0 million at a per share purchase price of $43.50.

 

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