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Form 10-K for CHIRON CORP

3-Mar-2004

Annual Report

Overview

We are a global pharmaceutical company that participates in three healthcare markets: blood testing, vaccines and biopharmaceuticals. Our revenues 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. The blood testing segment consists of an alliance with Gen-Probe Incorporated and our one-half share in the pretax operating earnings generated by the joint business contractual arrangement with Ortho-Clinical Diagnostics, Inc., a Johnson & Johnson company. 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 vaccines segment consists of flu vaccines, including Fluvirin, a product we obtained as part of our third quarter 2003 acquisition of PowderJect Pharmaceuticals (discussed below), a meningococcal vaccine, travel vaccines, which include rabies and tick-borne encephalitis vaccines and two products we obtained as part of our acquisition of PowderJect Pharmaceuticals, Arilvax™ and Dukoral™, and pediatric and other vaccines. We sell these vaccines primarily in the U.S., Germany, Italy, the United Kingdom and other international markets. Our vaccines segment is also involved in the development of other novel vaccines and vaccination technology. The biopharmaceuticals segment consists of therapeutic products and services, with an emphasis on the treatment of cancer and infectious disease. Our in-house capabilities span three types of therapeutics, including small molecules, therapeutic proteins and monoclonal antibodies. The biopharmaceuticals segment also includes collaborations with Berlex Laboratories, Inc. and its parent company, Schering AG of Germany, related to Betaseron interferon beta-1b. 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.

On July 8, 2003, we acquired PowderJect Pharmaceuticals plc, a company based in Oxford, England that develops and commercializes vaccines. We accounted for the acquisition of this business under the purchase method of accounting and included PowderJect Pharmaceuticals' operating results in our consolidated operating results beginning July 8, 2003. PowderJect Pharmaceuticals is part of our vaccines segment. 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 in 2003.

In 2003, our income from continuing operations was $220.3 million, or $1.15 per diluted share. In 2002, our income from continuing operations was $181.1 million or $0.94 per diluted share.

In 2003, total revenues were $1,766.4 million compared to $1,276.3 million in 2002. In 2003, product sales were $1,345.8 million compared to $914.1 million in 2002, reflecting our acquisition of PowderJect Pharmaceuticals during the third quarter 2003. Total revenues for PowderJect Pharmaceuticals in 2003 were $244.7 million. PowderJect Pharmaceuticals 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 Pharmaceuticals. These additional costs related to a fair value adjustment on the acquisition of PowderJect Pharmaceuticals. Excluding these additional costs, gross margins in 2003 would have been 59%. 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.

In 2003, research and development expenses totaled $409.8 million, compared to $325.8 million in 2002. Research and development expenses for PowderJect Pharmaceuticals 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.

In 2003, selling general and administrative expenses totaled $378.9 million compared to $283.7 million in 2002 with PowderJect Pharmaceuticals 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 Pharmaceuticals 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% and 27%. The 2003 effective tax rate is lower than the 2002 effective tax rate due to increased benefits associated with our research and development activities and an increase in income earned in lower tax jurisdictions.

On February 20, 2002, we acquired Matrix Pharmaceutical, Inc., 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., a Johnson & Johnson company. 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 had 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 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 relevant customer sales reports 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 in those cases where we do not supply the product. Prior to 2002, we had 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 sales became available in 2002, and as a result, we were able to recognize revenues from Betaseron product sales and Betaferon 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:

º • º 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. We 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 the PowderJect Pharmaceuticals acquisition, we initially allocated $122.7 million of the purchase price to purchased in-process research and development, which we charged to operations in the third quarter 2003. In the fourth quarter 2003, upon completion of strategic assessments of the value of certain 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. For the Matrix Pharmaceutical acquisition, we allocated $54.8 million of the purchase price to purchased in-process research and development, which we charged to operations in the first quarter 2002. We do not anticipate that there will be any alternative future use for the purchased in-process research and development. For the Matrix Pharmaceutical acquisition, we also allocated a portion of the purchase price to a liability for asset disposal and lease cancellation for the San Diego, California facility closed during the third quarter 2002. In the fourth quarter 2002, we found an assignee for the manufacturing facility lease and revised the allocation of the purchase price resulting in a $9.6 million decrease to purchased in-process research and development (as the residual amount allocated to in-process research and development was less than the estimated fair value of the in-process research and development), which we credited to operations.

º • º Investments—We invest in marketable debt and 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, 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. Our marketable debt securities consist of a

diversified portfolio of high-quality investment-grade securities. We do not hedge our marketable debt securities.

º • º 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.

º • º Product returns and rebates—In estimating returns, we analyze (i) historical returns and sales patterns, (ii) our experience with similar products, (iii) current inventory on hand at the distributors and in the distribution channel and the remaining shelf life of that inventory, (iv) current economic trends, (v) distributors practices, (vi) changes in demand, particularly due to the seasonality of certain of our products and (vii) introduction of new competing products. In arriving at 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 are greater than our estimates, additional product return and rebates accruals may be required. If actual product returns and rebates are less than our estimates, we may have to reverse certain accruals.

º • º 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; otherwise, we recognize them as revenues when collection is reasonably assured. In arrangements with multiple deliverables, there may be significant judgment in separating the different revenue generating activities and in determining whether each is a separate earnings process. 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.

º • º 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, the balance of which management believes to be adequate.

º • º 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.

º • º 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 Pharmaceuticals 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 Pharmaceuticals acquisition was adjusted to $503.0 million in the fourth quarter 2003. We are in the process of finalizing certain estimates; thus both the purchase price and the allocation of the purchase price are subject to change. The preliminary purchase price and allocation reflect management's decision to cease operations at the Madison Wisconsin facility and the Swedish facility. We have accrued approximately $28.1 million in estimated exit costs associated with these operations. In addition, we are finalizing certain estimates associated with various other direct acquisition costs. 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

        Product sales    Our blood testing segment recognized product sales of
$228.5 million, $148.0 million and $68.5 million in 2003, 2002 and 2001,
respectively.

        Procleix System    On February 27, 2002, the U.S. Food and Drug
Administration approved the Procleix HIV-1/ HCV Assay. Under a collaboration
agreement with Gen-Probe Incorporated, we market and sell the Procleix HIV-1/
HCV 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 2003 as compared with 2002 primarily related to 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. 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. Other factors contributing to the increase in 2003 were (i) the introduction of the West Nile virus assay on an investigational-use basis in the U.S. and (ii) market share gains in the U.S. and 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 additional revenue recognized in the first quarter 2002 under contracts with all our U.S. customers for increased donations exceeding contractual minimums.

The increase in product sales in 2002 as compared with 2001 related primarily to the commercial sale of the Procleix HIV-1/ HCV Assay in the U.S. following the U.S. Food and Drug Administration approval in February 2002. During 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. In addition, in 2002, we experienced continued expansion in several markets outside the U.S. In the first and second quarters of 2002, we recognized additional revenue under previously existing 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, Inc., we manufacture bulk reagents
and antigens and confirmatory test kits for immunodiagnostic products. We
recognized product sales under this arrangement of $28.4 million, $22.7 million
and $20.3 million in 2003, 2002 and 2001, respectively. The increase in 2003 as
compared with 2002 primarily related to an increase in products manufactured for
Ortho-Clinical Diagnostics. In addition, the timing of manufacturing services
under the arrangement contributed 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). The increase in 2002 as compared with 2001 primarily
related to the timing of manufacturing services rendered by Chiron.

        Revenues from joint business contractual arrangement    Revenues from
our joint business contractual arrangement with Ortho-Clinical Diagnostics, Inc.
was $108.3 million, $104.6 million and $84.5 million in 2003, 2002 and 2001,
respectively. The increase in 2003 as compared with 2002 primarily resulted from
(i) a one-time benefit in the first quarter 2003 due to a change in estimate
relating to revenues from Ortho-Clinical Diagnostics' non-U.S. affiliate sales,
(ii) the timing of Ortho-Clinical Diagnostics' shipments to third parties and
(iii) increased profitability of Ortho-Clinical Diagnostics' foreign affiliates.
Offsetting the increase were lower profits from Ortho-Clinical Diagnostics' U.S.
operations. Prior to the first quarter 2003, we had 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.

        Collaborative agreement revenues    We recognize collaborative agreement
revenues for fees received as we perform research services and achieve specified
milestones. Under the Ortho-Clinical Diagnostics, Inc. joint business
arrangement, we conduct research and development services related to
immunodiagnostic products. Our blood testing segment recognized total
collaborative agreement revenues of $9.0 million, $9.4 million and $11.3 million
in 2003, 2002 and 2001, respectively. The majority of collaborative agreement
revenues recognized by our blood testing segment related to immunodiagnostic
products. The fluctuations between 2003 and 2002, and 2002 and 2001, primarily
were due to the timing of research services.

        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
and HIV-related patents, for use in the blood screening and plasma fractionation

markets. Our blood testing segment also earns license fees related to our hepatitis C virus and HIV-related patents for technologies used by third parties to develop products for use in the blood screening and plasma fractionation markets. The blood testing segment recognized royalty and license fee revenues of $75.4 million, $53.5 million and $20.6 million in 2003, 2002 and 2001, respectively.

        Baxter A.G.    In June 2003, we entered into two license agreements with
Baxter A.G. related to our hepatitis C virus and HIV technology for use in the
plasma fractionation market for which we recognized a license fee in the second
quarter 2003. In addition, we recognized royalty revenues under one of these
agreements.

        F. Hoffmann-LaRoche settlement    In October 2000, we entered into three
license agreements with F. Hoffmann-LaRoche Limited 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
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 hepatitis C virus and HIV. Revenues under these agreements were
$61.8 million, $48.5 million and $18.1 million in 2003, 2002 and 2001,
respectively. The increase in 2003 as compared with 2002 related to (i) a
$4.0 million one-time payment estimated using an alternative methodology under
an agreement with F. Hoffmann-La Roche relating to back royalties, (ii) a
contractual increase in the royalty rates and (iii) increased donations. Under
these new agreements, royalties continue through the lives of the hepatitis C
virus and HIV-related patents covering F. Hoffmann-La Roche's nucleic acid
testing products. Currently, the applicable issued hepatitis C virus-related
patents begin to expire in 2015 for the U.S. and in 2010 for Europe. Currently,
the applicable issued HIV-related patent in Europe expires in 2005. An
HIV-related patent 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, F. Hoffmann-La Roche has decided to institute
arbitration proceedings in regard to the application of the U.S. patent. During
any pending arbitration proceedings, F. Hoffmann-La Roche remains obligated to
make all quarterly royalty payments, subject to a right to be reimbursed by us
if it is determined in the arbitration that such royalty payments were not due.

        Bayer    In June 2001, Chiron and Ortho-Clinical Diagnostics, Inc.
entered into an agreement with Bayer Corporation for the clinical diagnostic
market. Under this agreement, Bayer manufactures and sells certain of
Ortho-Clinical Diagnostics' hepatitis C virus 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.

        Gross profit    Blood testing gross profit as a percentage of net
product sales was 41%, 41% and 28% in 2003, 2002 and 2001, respectively. The
increase in blood testing gross profit in 2002 as compared to 2001 related to
the increase in nucleic acid testing product sales as a percentage of total
blood testing product sales.

In November 2003, Chiron and Gen-Probe Incorporated agreed to amend their world-wide blood screening collaboration agreement in order to adopt permanent, fixed revenue shares for each party. Effective January 1, 2004, Gen-Probe's share will be 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 the hepatitis C virus, such as the prospective West Nile test, the agreement remains unchanged with each party retaining 50% of the net revenues after deduction of appropriate expenses.

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

        Research and development    Our blood testing segment recognized
research and development expenses of $32.5 million, $19.4 million and
$17.2 million in 2003, 2002 and 2001, respectively. The increase in research and
development spending in 2003 as compared with 2002 is primarily related to
(i) 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 (ii) 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. The remaining increase in costs
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    Our blood testing segment
recognized selling, general and administrative expenses of $40.2 million,
$30.8 million and $29.3 million in 2003, 2002 and 2001, respectively. The
increased selling, general and administrative expenses in 2003 as compared with
2002 related to the expansion of our customer base for the Procleix HIV-1/HCV
Assay in the U.S., Europe and other international markets and 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

        Product sales    We sell flu, meningococcal, travel, pediatric and other
vaccines in the U.S., Germany, Italy, the United Kingdom and other international
markets. Vaccine product sales were $678.3 million, $357.4 million and
$365.7 million in 2003, 2002 and 2001, respectively.

benefit of the movement in the Euro to U.S. Dollar exchange rate and price and volume increases in Germany and Italy.

The increase in flu vaccine sales in 2002 as compared with 2001 resulted from being first to the market in Germany, increased sales to new countries, such as China, increased sales to existing countries due to increased awareness in the overall influenza vaccines market and improved production yields.

Menjugate, our conjugate vaccine against meningococcal infection caused by the bacterium N. meningitidis serogroup C, sales were $65.5 million, $55.0 million and $105.6 million in 2003, 2002 and 2001, respectively. The increase in Menjugate sales in 2003 as compared with 2002 primarily related to the tender sales to Australia and the benefit of the movement in the Euro to U.S. Dollar exchange rate. In 2002 there were, as expected, fewer shipments to existing markets than in 2001 as a result of a universal vaccination program that occurred in the Province of Quebec, partially offset by shipments to new markets.

Sales of our travel vaccines, comprised of tick-borne encephalitis, rabies vaccines and two products we obtained as part of our third quarter 2003 acquisition of PowderJect Pharmaceuticals, Arilvax™ and Dukoral™ were $87.8 million, $64.3 million and $51.7 million in 2003, 2002 and 2001, respectively. The increase in travel vaccines sales in 2003 as compared with 2002 primarily resulted from (i) increased fourth quarter 2003 sale of tick-borne encephalitis for vaccines that are typically sold in the first half of the year, (ii) additional sales of travel vaccine products following our third quarter 2003 acquisition of PowderJect Pharmaceuticals and (iii) the benefit of the movement in the Euro to U.S. Dollar exchange rate.

The increase in travel vaccine sales in 2002 as compared with 2001 primarily resulted from increased tick-borne encephalitis vaccine sales with the 2002 launch of a new adult formulation and a pediatric formulation in Germany.

Sales of our pediatric and other vaccines were $192.5 million, $148.1 million and $133.6 million in 2003, 2002 and 2001, respectively. The increase in pediatric and other vaccines sales in 2003 as compared with 2002 was primarily due to (i) additional sales of other vaccine products following our third quarter 2003 acquisition of PowderJect Pharmaceuticals, (ii) the timing of tender sales for measles, mumps and rubella vaccines and diphtheria, tetanus and pertussis vaccines and (iii) the benefit of the movement in the Euro to U.S. Dollar exchange rate. Contributing to the increase in 2002 pediatric and other vaccines sales as compared with 2001 were increased polio vaccine sales to non-profit organizations and developing markets such as India.

Certain of our vaccine products, particularly our flu vaccines, are seasonal and typically have higher sales in the third and fourth quarters of the year. In addition, we expect Menjugate sales to continue to fluctuate as public health authorities consider adoption of broad vaccination programs.

We expect competitive pressures related to many of our vaccine products to continue into the future, primarily as a result of the introduction of competing products into the market, including, but not limited to, new combination vaccines, as listed in Part I, Item 1., "Business—Competition" above.

        Collaborative agreement revenues    We recognize collaborative agreement
revenues for fees received as we perform research services and achieve specified
milestones. Our vaccines segment recognized collaborative agreement revenues of
$4.2 million, $0.7 million and $0.01 million in 2003, 2002 and 2001,
respectively. 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, as a result of our third
quarter 2003 acquisition of PowderJect Pharmaceuticals, we recognized revenue
under an agreement with MedImmune, Inc.

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. The vaccines
segment recognized royalty and license fee revenues of $12.7 million,
$12.3 million and $16.5 million in 2003, 2002 and 2001, respectively.

        GlaxoSmithKline    An agreement with GlaxoSmithKline plc provides for
royalties on sales of certain vaccine products. Under this agreement, we
recognized $7.1 million, $7.0 million and $6.1 million of such royalties in
2003, 2002 and 2001, respectively.

        Other    In 2003, 2002 and 2001, we recognized $5.6 million,
$5.3 million and $10.4 million, respectively, of royalty revenues primarily on
third party sales of hepatitis B virus vaccine products. The decrease in 2002 as
compared with 2001 primarily related to (i) a decrease in sales of hepatitis B
virus vaccine products due to competitive multivalent hepatitis B virus vaccine
products and (ii) reduced royalties starting in the fourth quarter 2001 due to
certain terms of one of the hepatitis B virus arrangements expiring in the third
quarter 2001. Certain patents related to the production of hepatitis B vaccine
products expire beginning in 2004, which will result in reductions in royalty
revenues recognized under one arrangement.

        Other revenues    Our vaccines segment recognized other revenues of
$13.5 million, $17.9 million and $21.0 million in 2003, 2002 and 2001,
respectively.

        Grant and contract revenues    Our vaccines segment other revenues
included grant and contract revenues of $9.7 million, $14.6 million and
$15.0 million for 2003, 2002 and 2001, respectively. In the second quarter 2000,
we entered into an agreement with the U.S. National Institutes of Health to
advance our HIV vaccine program into human clinical trials. Under this
arrangement, we could receive $23.2 million over five years. Under supplemental
arrangements, we may perform other work related to the National Institutes of
Health's HIV vaccine program on a grant or contract-by-contract basis. A
majority of the grant and contract revenues, $7.3 million, $10.1 million and
$9.9 million in 2003, 2002 and 2001, respectively, were recognized under these
arrangements.

        Contract manufacturing revenues    Included in our vaccines segment
other revenues are contract manufacturing revenues of $2.2 million, $1.5 million
and $2.2 million for 2003, 2002 and 2001, respectively. The fluctuations
resulted from a change in the level of contract manufacturing activities.

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    Vaccines gross profit as a percentage of net product
sales was 53%, 58% and 63% in 2003, 2002 and 2001, respectively. The decrease in
gross profit in 2003 as compared with 2002 related to additional costs of
$24.4 million in 2003 associated with the sale of inventory acquired during the
acquisition of PowderJect Pharmaceuticals. These additional costs related to a
fair value adjustment on the acquisition of PowderJect Pharmaceuticals.
Excluding these additional costs, vaccine gross profit as a percentage of net
product sales for 2003 would have been 57%. 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 percentages may fluctuate significantly in future periods due to product and customer mix, seasonality and ordering patterns and production yields.

        Research and development    Our vaccines segment recognized research and
development expenses of $129.7 million, $70.1 million and $63.1 million in 2003,
2002 and 2001, respectively. The increase in research and development spending
in 2003 compared with 2002 resulted mainly from the advancement of several
programs in our meningococcal franchise and flu cell culture. Also, there was
$16.2 million of incremental research and development expense following our
third quarter acquisition of PowderJect Pharmaceuticals.

The increase in research and development spending in 2002 compared with 2001 primarily was due to progress in the development of our meningococcal franchise and work related to the HIV vaccine program, partially funded by the U.S. National Institutes of Health.

In April 2001, Chiron, Rhein Biotech N.V. (now a part of Berna Biotech) and GreenCross Vaccine Corporation entered into a collaboration agreement to research and develop certain pediatric combination vaccine products for sale outside of Europe and North America. Under the collaboration agreement, we have commitments for a portion of the research and development expenses, which actually began in the first quarter 2001, with Berna Biotech and GreenCross Vaccine Corporation. The collaboration agreement also requires capital commitments from Chiron, Berna Biotech and GreenCross Vaccine Corporation (see "Liquidity and Capital Resources—Sources and uses of cash" below).

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    Our vaccines segment recognized
selling, general and administrative expenses of $135.8 million, $89.9 million
and $78.2 million in 2003, 2002 and 2001, respectively. 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
Pharmaceuticals. Excluding $34.8 million of additional selling, general and
administrative expenses associated with PowderJect Pharmaceuticals, including
integration costs of $9.2 million, the remaining

increase in selling, general and administrative expenses resulted from additional costs associated with the enhancement of current business processes and headcount and the Euro to U.S. Dollar exchange rate fluctuation. These increases were partially offset by (i) 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 and (ii) increased sales and marketing costs associated with the 2002 launch of our newly formulated tick-borne encephalitis vaccine.

The increase in selling, general and administrative expenses in 2002 as compared with 2001 related to (i) a payment made in the first quarter 2002 to the German government as discussed above, (ii) increased sales and marketing costs associated with the 2002 launch of our newly formulated tick-borne encephalitis vaccine and increased flu vaccine sales and (iii) additional costs associated with the enhancement of current business processes and headcount. These increases were partially offset by the reduced commissions paid under a co-marketing and co-promotion agreement with Aventis Pasteur MSD related to sales of Menjugate vaccine.

        Amortization expense    Our vaccines segment recognized amortization
expense of $31.2 million, $5.6 million and $8.3 million in 2003, 2002 and 2001,
respectively. The increase in amortization expense in 2003 as compared with 2002
relates to the intangibles acquired following our acquisition of PowderJect
Pharmaceuticals 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

        Product sales    Biopharmaceutical product sales were $439.1 million,
$408.7 million and $337.7 million in 2003, 2002 and 2001, respectively.
Biopharmaceutical product sales in 2003, 2002 and 2001 consisted principally of
Betaseron interferon beta-1b, TOBI tobramycin and Proleukin (aldesleukin).

        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 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 supply costs, which we record in royalty and license fee revenues.
Starting in the fourth quarter 2003, the amount we recorded as product sales,
based on a percentage of sales by Schering, and Betaferon

royalties, 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, discussed in "Royalty and license fee revenues—Betaferon" below, (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. The pre-filled diluent syringe was launched in January 2004 and enhances the delivery mode and shortens preparation, helping to simplify injections of Betaseron. In the first quarter 2003, the U.S. Food and Drug Administration approved new labeling for Betaseron. The labeling expands the indication for Betaseron 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 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 2003 and 2002, we recorded charges related to process development and test runs associated with this project. See "Research and development" below.

Betaseron product sales were $124.9 million, $118.5 million and $96.4 million in 2003, 2002 and 2001, respectively. The increases in Betaseron product sales in 2003 as compared with 2002, primarily related to (i) price increases, (ii) the benefit of the movement in foreign exchange rates and (iii) 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) 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, (ii) fluctuations in wholesaler ordering patterns, and (iii) incremental revenues recognized in the first quarter 2002 related to the effect of recording revenue based on more current information available from Schering. 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 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 sales.

The increases in Betaseron product sales in 2002 as compared with 2001, primarily related to (i) increased underlying patient demand from end users in the U.S. and certain international markets, (ii) price increases and (iii) fluctuations in wholesaler inventory levels, following the conversion to wholesaler distribution in 2002. As discussed above, prior to 2002, we accounted for non-U.S. product sales based on information provided by Schering on a one-quarter lag. More current information of non-U.S. Betaseron sales was available in 2002, and as a result, we were able to recognize Betaseron

product sales on a current basis. As a result, there were incremental product sales revenues recognized during the first quarter 2002 of $4.3 million.

As discussed in "Royalties and license fee revenues" below, Betaferon royalties also increased in 2003 as compared with 2002, and in 2002 as compared with 2001.

        TOBI tobramycin    We sell TOBI directly in the U.S. and certain
international markets. We recognized TOBI sales of $172.0 million,
$146.9 million and $123.1 million in 2003, 2002 and 2001, respectively.
Increased TOBI sales in 2003 as compared with 2002, primarily related to
(i) greater product penetration in various European countries, (ii) price
increases, (iii) the benefit of the movement in the Euro to U.S. dollar exchange
rate and (iv) increased use and improved compliance in the U.S. by patients with
cystic fibrosis. These increases were partially offset by a change in sales
adjustments. Increased TOBI sales in 2002 as compared with 2001 primarily
related to (i) the progress of the TOBI product launch in various European
countries, (ii) increased use and compliance in the U.S. by patients with cystic
fibrosis and (iii) price increases. Fluctuations in foreign exchange rates,
principally the Euro, have also contributed slightly to the increase in 2002
TOBI sales. In 2002, these increases were partially offset by an increased level
of Medicaid rebates.

        Proleukin (aldesleukin)    Proleukin is approved in over 50 countries
for the treatment of metastatic (Stage IV) renal cell carcinoma and in Canada
and the U.S. for the treatment of metastatic (Stage IV) melanoma. Sales of
Proleukin were $115.1 million, $114.3 million and $93.3 million in 2003, 2002
and 2001, respectively. The increase in Proleukin product sales in 2003 as
compared with 2002 primarily related to (i) price increases, (ii) increase in
patient demand in the U.S. and (iii) the benefit of the movement in the Euro to
U.S. Dollar exchange rate. These increases were partially offset by wholesaler
ordering patterns and a decrease in underlying patient demand in Europe.
Proleukin product sales in 2002 as compared with 2001 increased primarily as a
result of stabilization of wholesale ordering patterns, from those experienced
in 2001, relative to demand and price increases. In 2001, wholesalers
significantly reduced inventories from quantities held at the end of 2000. In
2002, wholesalers decreased inventories only slightly. Fluctuations in foreign
exchange rates, principally the Euro, have also contributed slightly to the
increase in 2002 Proleukin sales.

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

We expect competitive pressures related to many of our biopharmaceutical products to continue into the future, primarily as a result of the introduction of competing products into the market, as listed in Part I, Item 1., "Business—Competition" above.

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

segment recognized collaborative agreement revenues of $5.3 million, $12.1 million and $25.0 million in 2003, 2002 and 2001, respectively.

        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 and
$12.1 million in 2002 and 2001, respectively, 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 $3.3 million for 2003.

        Novartis    In 1996, Chiron and Novartis entered into an agreement which
provided, among other things, for certain cross licenses between Chiron and
Novartis, and under which Novartis paid us $60.0 million over five years. In
connection with this agreement, we recognized collaborative agreement revenues
of $10.0 million in 2001. This agreement expired in the fourth quarter 2001.

The balance of collaborative agreement revenues recognized in our biopharmaceuticals segment consisted of various other agreements, 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 our achievement of performance 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 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 patents, used by third parties to develop therapeutic
products. The biopharmaceuticals segment recognized royalty and license fee
revenues of $87.7 million, $63.3 million and $59.8 million in 2003, 2002 and
2001, respectively.

        Betaferon 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 to Schering for sale in Europe. For
product manufactured by Boehringer Ingelheim, we receive royalties calculated as
a percentage of sales less the amount paid or incurred by Schering for supply
costs, including Schering's cost to purchase product from Boehringer Ingelheim.

impact of the difference between the adjustment of estimated royalty to actual royalty. These increases were partially offset by (i) a decline in our royalty rate in the fourth quarter 2003 by five percentage points, pursuant to our contractual agreement with Schering, (ii) incremental revenues recognized during the first quarter 2002 of $3.9 million related to a change in our methodology of recognizing these royalties and (iii) a shift in revenue from royalty revenue to product sales. Prior to 2002, we accounted for Betaferon 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 sales was available in 2002, and as a result, we were able to recognize Betaferon royalties on a current basis beginning in the first quarter 2002.

The increase in Betaferon royalties in 2002 compared with 2001 was due to (i) increased utilization of beta interferon therapy for multiple sclerosis, (ii) fluctuations in foreign exchange rates, principally the Euro and (iii) incremental revenues recognized during the first quarter 2002 of $3.9 million related to a change in our methodology of recognizing these royalties as discussed above. These increases were offset partially by the shift of revenue from royalties to product sales related to Switzerland as Schering began to sell product purchased in 2001 into the market.

As discussed in "Product sales—Betaseron" above, we began supplying Betaferon to Schering in the fourth quarter 2002 for certain additional European markets, which was previously supplied by Boehringer Ingelheim. 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 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. Future Betaferon royalties will be influenced by demand, price changes, decline in our royalty rate and foreign currency exchange rates.

        Novo Nordisk    We earn royalty revenues on insulin and glucagon product
sales by Novo Nordisk AS. We recognized $8.5 million, $7.5 million and
$6.9 million in 2003, 2002 and 2001, respectively, under this arrangement.
Patents related to the production of insulin and glucagons began expiring in
late 2003 and as a result, significant reductions in royalty revenue recognized
under this arrangement in future periods are expected.

        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 $4.0 million in 2003 under this arrangement.

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 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. We have no assurance that we will be able to do so or that future royalty and license fee revenues will not decline.

        Other revenues    Our biopharmaceuticals segment recognized other
revenues of $29.5 million, $17.5 million and $19.7 million in 2003, 2002 and
2001, respectively.

        Contract manufacturing revenues    Our biopharmaceuticals segment
recognized contract manufacturing revenues of $13.5 million, $14.0 million and
$16.1 million for 2003, 2002 and 2001, respectively. The fluctuations in 2003 as
compared to 2002, and in 2002 as compared to 2001, resulted from the level of
activity and the timing of contract manufacturing activities.

        Biogen and Serono settlements    A U.S. Court of Appeals partially
reversed a District Court ruling in connection with certain patents owned by
Chiron and licensed exclusively to Schering AG's U.S. subsidiary, Berlex
Laboratories. As a result of the ruling and prior agreements between Biogen and
Berlex, 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 in 2003, which represented our share of this
settlement payment. In addition, there was a similar settlement between Berlex
and Serono of which we recognized approximately $1.4 million in 2003.

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    Biopharmaceutical gross profit as a percentage of net
product sales was 72%, 73% and 71% in 2003, 2002 and 2001, respectively. The
decrease in biopharmaceutical gross profit margins in 2003 as compared to 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 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. The increase in
biopharmaceutical gross profit margins in 2002 as compared with 2001 was the
result of a more favorable mix of biopharmaceutical product sales, price
increases effective early in 2002 and a decrease in royalty expenses.

Biopharmaceutical gross profit percentages may fluctuate significantly in future periods due to production yields, increased cost to produce the Betaseron pre-filled syringe presentation, the decline in Betaseron product sales, based on a percentage of sales by Schering, by five percentage points pursuant to our contractual agreement with Schering and as the biopharmaceutical product and customer mix changes.

        Research and development    Our biopharmaceuticals segment recognized
research and development expenses of $247.2 million, $236.3 million and
$264.9 million in 2003, 2002 and 2001, respectively.

our existing manufacturing facilities to support the supply of Betaferon interferon beta-1b 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 the installed equipment. These increases were partially offset by decreases in the activities for various clinical trials, including (i) transfer of the responsibility of the SILCAAT trial to NIAID and the University of Minnesota in the fourth quarter 2002, discussed below, and (ii) termination of our development activities for HBV-MF59, an immunotherapy for patients with chronic hepatitis B infection and PA-1806, a compound for gram negative infections in cystic fibrosis patients.

In April 2003, we acquired exclusive worldwide development and commercial rights from Novartis for aerosolized cyclosporine (ACsA), a therapy under evaluation for treatment of rejection and reduction of mortality in lung transplant recipients.

In October 2003, we entered into a license agreement with Cubist Pharmaceuticals, Inc. for the development and commercialization of Cubist's antibiotic 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 daptomycin for injection made 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 sales of tifacogin. We are initiating plans for a Phase III trial for tifacogin in patients with severe community-acquired pneumonia.

In the fourth quarter 2002, we reached an agreement in principle to transfer responsibility for the SILCAAT (referred to also as Proleukin (aldesleukin) for HIV) trial, a Phase III study for recombinant human interleukin-2 (IL-2, aldeseleukin), 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 transferring responsibility for the trial. However, 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 $6.0 million has been paid in 2003.

The decrease in research and development spending in 2002 as compared with 2001 primarily related to the timing of various clinical trials, including (i) the conclusion of the clinical trial for tifacogin (recombinant Tissue Factor Pathway Inhibitor) for severe sepsis in the fourth quarter 2001, (ii) the conclusion of reimbursed manufacturing activities to our partner, Sirna Therapeutics Inc. (formerly Ribozyme Pharmaceuticals Co.), for production of Angiozyme for 2002 clinical trials in cancer and (iii) the conclusion of our Phase I trials for HIV using a non-nucleoside HIV reverse transcriptase inhibitor (NNRTI) compound. The decreases were partially offset by the progress in other development projects, including those activities related to (i) our December 2001 collaboration agreement with Nektar Therapeutics (formerly Inhale Therapeutic Systems, Inc.) for the development of a dry powder formulation of our inhaled TOBI product for the treatment of pseudomonas aeruginosa in cystic fibrosis patients, (ii) the development of tezacitabine, and (iii) the development of interleukin-2 in combination with various monoclonal antibodies. In addition, as discussed in "Product sales—Betaseron" above, we are required to make capital improvements to our existing manufacturing facilities to support the supply of Betaferon to Schering. In 2002, in connection with this project, we

incurred expenses relating to the development of new processes and the performance of test runs related to the installed equipment.

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    Our biopharmaceuticals segment
recognized selling, general and administrative expenses of $116.0 million,
$95.4 million and $79.8 million in 2003, 2002 and 2001, respectively. The
increase in selling, general and administrative expenses in 2003 as compared
with 2002 related to (i) ongoing sales and marketing programs to support TOBI
tobramycin in the U.S. and continued market penetration in Europe,
(ii) continued investment in and defense of our patents and technology,
(iii) sales and marketing costs for various biopharmaceutical post-market
approval commitments, (iv) additional costs associated with the enhancement of
current business processes and (v) the Euro to U.S. Dollar exchange rate
fluctuation. In addition, the increase in 2003 as compared with 2002 was
impacted by increased costs following the acquisition of Pulmopharm in the third
quarter 2002.

        Amortization expense    Our biopharmaceuticals segment recognized
amortization expense of $25.1 million, $24.3 million and $38.4 million for 2003,
2002 and 2001, respectively. The increase in amortization expense in 2003
compared to 2002 related to the distribution rights acquired upon acquisition of
Pulmopharm in the third quarter 2002. We acquired PathoGenesis Corporation on
September 21, 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. Purchased technologies, which were concluded to have
alternative future uses, represented the fair value of research and development
projects, which we will develop further after the acquisition date. We are
amortizing purchased technologies on a straight-line basis over 15 years.
Acquired intangible assets included the fair value of trademarks and trade
names, patents and databases, which we are amortizing on a straight-line basis
over 13 to 16 years. On January 1, 2002, assembled workforce was reclassified to
goodwill and goodwill ceased to be amortized. This change was the primary reason
for the decrease in amortization expense in 2002 as compared with 2001. As
circumstances dictate, we evaluate the useful life and value of each intangible
asset, which may result in future adjustments to the amortization periods or
carrying values. Goodwill (including assembled workforce) amortization expense
was $14.7 million in 2001.

        Collaborative agreement revenues    We recognize collaborative agreement
revenues for fees received as we perform research services and achieve specified
milestones. Our other segment did not recognize collaborative agreement revenues
in 2003 and 2002. Our other segment recognized collaborative agreement revenues
of $9.1 million in 2001 under an agreement with Novartis AG. Under the
December 1995 Limited Liability Company Agreement as amended (see Note 9,
"Related Party Transactions," in the Notes to Consolidated Financial
Statements), Novartis agreed to provide, at our request, research funding for
certain projects. The funded projects consisted of certain adult and pediatric
vaccines, Insulin-like Growth Factor-I, Factor VIII and Herpes Simplex
Virus-thymidine kinase. This agreement as amended expired on December 31, 2001.

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. We have no assurance that new relationships will be established or that collaborative agreement revenues will be achieved.

        Royalty and license fee revenues    Our other segment earns royalties on
third party sales of, and license fees on, several products. Our other segment
recognized royalty and license fee revenues of $74.3 million, $69.6 million and
$101.4 million in 2003, 2002 and 2001, respectively.

        F. Hoffmann-LaRoche settlement    In October 2000, we entered into three
license agreements with F. Hoffmann-LaRoche Limited related to the settlement of
litigation in the U.S. and certain other countries for use of our hepatitis C
virus and HIV nucleic acid testing intellectual property for use in clinical
diagnostics.

Under the HIV agreement, we received $10.0 million in the fourth quarter 2000, which we deferred, and received $10.0 million in the first quarter 2001. These amounts included a refundable license fee and royalties for past sales related to F. Hoffmann-LaRoche's use of our HIV related patent in its in vitro diagnostic products in Europe. These amounts became nonrefundable in January 2001 when the European Patent Office Board of Technical Appeals upheld our HIV related patent. As a result, we recognized the entire $20.0 million as revenue in the first quarter 2001. The agreement also provides for royalties on future sales related to F. Hoffmann-LaRoche's use of our HIV related patent in its in vitro diagnostic products, which also 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 in 2003 were consistent with 2002.

Under these agreements, such royalties will continue through the lives of the hepatitis C virus and HIV-related patents covering F. Hoffmann-La Roche's nucleic acid testing products. Currently, the applicable issued hepatitis C virus-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. 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 Chiron of $10.0 million from F. Hoffmann-La Roche, which was received in April 2003. As permitted under the terms of its licensing agreement, F. Hoffmann-La Roche has decided to institute arbitration proceedings in regard to the application of the U.S. patent. We have deferred recognition of this $10.0 million milestone payment and interest as of December 31, 2003. During any pending arbitration proceedings, F. Hoffmann-La Roche remains obligated to make all quarterly royalty payments, subject to a right to be reimbursed by Chiron if it is determined in the arbitration that such royalty payments were not due.

See "Blood testing—Royalties and license fee revenues" above for a discussion of the third agreement entered into with F. Hoffmann-LaRoche in October 2000 and two additional agreements entered into with F. Hoffmann-LaRoche in May 2001, which superseded the October 2000 agreement.

        Bayer    In connection with the sale of Chiron Diagnostics to Bayer
Corporation, we granted Bayer rights under HIV and hepatitis C virus related
patents for use in nucleic acid diagnostic tests (excluding blood screening). In
exchange for these rights, Bayer paid us a license fee of $100.0 million, which
became nonrefundable in decreasing amounts over a period of three years,
commencing in 1999. We recognized license fee revenues in 2001, which
represented the portion of the $100.0 million payment that became nonrefundable
during that period. We recognized the final portion of revenue in the fourth
quarter 2001. In addition, the cross-license agreement provides for royalties to
us on HIV and hepatitis C virus products sold by Bayer, which increased in 2003
compared with 2002 primarily due to increased donations and a contractual
increase in the royalty rates.

        F. Hoffmann-LaRoche PCR agreement    Under a July 1991 agreement between
F. Hoffmann-LaRoche Limited and Cetus Corporation (a company acquired by
Chiron), we received royalties on sales of polymerase chain reaction products
and services sold by F. Hoffmann-LaRoche and its licensees. We did not recognize
any revenue under this agreement in 2003. In 2002 and 2001 we recognized
$0.7 million and $2.4 million, respectively, under this agreement. F.
Hoffmann-LaRoche's royalty obligations, with certain limited exceptions for
future products, expired in the fourth quarter 2000. We recorded the adjustment
of the estimate to actual for the final fourth quarter 2000 royalties in the
first quarter 2001. The amount recognized in 2002 is a back royalty relating to
2000 that resulted from a royalty audit conducted in 2002.

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. 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. We have no assurance that we will be able to do so or that future royalty and license fee revenues will not decline.

        Other revenues    Our other segment recognized other revenues of
$1.0 million in 2002 relating to Matrix Pharmaceutical contract manufacturing
projects that were not completed at the time of the acquisition.

        Selling, general and administrative    In 2003, 2002 and 2001, our other
segment recognized selling, general and administrative expenses of
$86.9 million, $67.6 million and $65.3 million, respectively. The increase in
selling, general and administrative expenses in 2003 as compared with 2002
primarily resulted from integration costs of $2.8 million incurred by the other
segment associated with our third quarter acquisition of PowderJect
Pharmaceuticals, an impairment charge associated with long-lived assets,
employee-related expenses, severance costs, additional consulting costs and a
charitable donation to the Chiron Foundation. These increases were partially
offset by lower litigation costs in 2003 related to our investment in and
defense of our patents and technology.

        Purchased in-process research and development    Purchased in-process
research and development charged to operations was $45.3 million and
$45.2 million in 2003 and 2002, respectively. There was no purchased in-process
research and development in 2001.

On July 8, 2003, we acquired PowderJect Pharmaceuticals and accounted for the acquisition using the purchase method of accounting. 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. As with all pharmaceutical products, the probability of commercial success for any research and development project is highly uncertain.

        Interest expense    In 2003, 2002 and 2001, we incurred interest expense
of $19.1 million, $12.8 million and $7.5 million, respectively. 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. In 2003, 2002 and 2001, we recognized
interest income of $23.2 million, $36.2 million and $51.6 million, 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 Pharmaceuticals and lower average interest rates.

In 2003, 2002 and 2001, we recognized gains of $9.4 million, $14.3 million and $8.7 million, respectively, related to the sale of certain equity securities.

There were no losses attributable to impairment of equity securities in 2003. In 2002 and 2001, we recognized losses attributable to the impairment of certain debt and equity securities of $7.5 million and $5.5 million, respectively.

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, for the year ended December 31, 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 $2.0 million, $5.4 million and $2.5 million in 2003, 2002 and 2001, respectively.

        Income taxes    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 Pharmaceuticals
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% and 27%. The 2003 effective
tax rate is lower than the 2002 effective tax rate due to increased benefits
associated with our research and development activities and an increase in
income earned in lower tax jurisdictions.

The effective tax rate may be affected in future period by changes in management's estimates with respect to our deferred tax assets, by the impact of acquisitions and new tax legislation, or by other items.

Management believes the acquisition of PowderJect Pharmaceuticals 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 Pharmaceutical'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 and Chiron Vision in 1998 and 1997, respectively. The
"Gain (loss) from discontinued operations, net of taxes" consisted of the
following during the years ended December 31:

                                                         2003        2002        2001  
                                                      ----------    -------    --------
                                                               (In thousands)          
 Reversal of reserves for retention and severance     $        —    $     —    $  1,600
 obligations                                                                      
 Reversal of reserves (net charge) for indemnity          (5,222 )        —       1,500
 obligations                                                                      
 Gain on the sale of real estate assets                        —          —       1,644
 Employee settlement                                           —       (438 )          
 Income tax benefit                                       12,197        118         534
                                                      ----------    -------    --------
                                                      $    6,975    $  (320 )  $  5,278
                                                      ----------    -------    --------

We reversed approximately $2.3 million related to unutilized reserves for Chiron Diagnostics and Chiron Vision, which were recorded as a "Gain from discontinued operations" for the year ended December 31, 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 during the first quarter 2003. We utilized an amount previously reserved for indemnity obligations, based upon the settlement agreement with Bayer. These amounts resulted in a net charge of $7.6 million, offset by an income tax benefit of $9.0 million, resulting in a net gain of $1.4 million, which was recorded as a "Gain from discontinued operations" for the year ended December 31, 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. This amount was recorded as a "Loss from discontinued operations" for the year ended December 31, 2002.

Under the terms of the Bayer agreement, we were responsible for retention and severance payments to specific U.S. and international employees and, accordingly, we reserved for such retention and severance obligations. In 2001, we reversed approximately $1.6 million for retention and severance obligations based upon a final reconciliation from Bayer. We recorded this amount as a "Gain from discontinued operations."

Under the terms of the Bausch & Lomb agreement related to the sale of Chiron Vision, we provided customary indemnities and, accordingly, reserved for such contractual obligations to indemnify Bausch & Lomb against certain potential claims. In 2001, we reversed the remaining reserves of $1.5 million upon the sale of the remaining real estate assets, as discussed below. We recorded this amount as a "Gain from discontinued operations."

We retained certain Chiron Vision assets, including certain Chiron Vision real estate assets, upon the completion of the sale. As of March 31, 2001, the remaining real estate assets amounted to $1.9 million. In April 2001, we sold these remaining real estate assets and recognized a net gain on the sale of these assets of $1.6 million. This gain was recorded as a "Gain from discontinued operations."

In connection with the sale of Chiron Diagnostics and Chiron Vision, we recorded cumulative net deferred tax assets of $0.1 million and $8.5 million at December 31, 2003 and 2002, respectively, principally attributable to the timing of the deduction of certain expenses associated with these sales. We also recorded corresponding valuation allowances of $0.1 million and $8.5 million at December 31, 2003 and 2002, respectively, to offset these deferred tax assets, as we believe that it is more likely than not that the deferred tax assets to which the valuation allowance relates will not be realized. We will report the future recognition of these deferred tax assets, if any, as a component of "Gain (loss) from discontinued operations."

"Gain (loss) from discontinued operations" included an income tax benefit of $12.2 million, $0.1 million and $0.5 million in 2003, 2002 and 2001, respectively. The tax benefit in 2003 related to the settlement agreement with Bayer 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. The tax benefit in 2001 related to the reversal of reserves and valuation allowances against deferred tax assets that were established at the time of the sale.

New Accounting Standards

In January 2003, the FASB issued FASB Interpretation No. 46 ("FIN 46"), "Consolidation of Variable Interest Entities, an Interpretation of ARB No. 51," which addresses consolidation by business enterprises of variable interest entities ("VIEs") either: (1) that do not have sufficient equity investment at risk to permit the entity to finance its activities without additional subordinated financial support, or (2) in which the equity investors lack an essential characteristic of a controlling financial interest. In December 2003, the FASB completed deliberations of proposed modifications to FIN 46 ("Revised Interpretations") resulting in multiple effective dates based on the nature as well as the creation date of the VIE. VIEs created after January 31, 2003, but prior to January 1, 2004, may be accounted for either based on the original interpretation or the Revised Interpretations. However, the Revised Interpretations must be applied no later than our first quarter of fiscal 2004. VIEs created after January 1, 2004 must be accounted for under the Revised Interpretations. Special Purpose Entities (SPEs") created prior to February 1, 2003 may be accounted for under the original or revised interpretation's provision no later than our fourth quarter of fiscal 2003. Non-SPEs created prior to February 1, 2003, should be accounted for under the revised interpretation's provisions no later than

our first quarter of fiscal 2004. We have not entered into any material arrangements with VIEs created prior to or after January 31, 2003.

Liquidity and Capital Resources

Our capital requirements have generally been funded by cash flow from operations, borrowings from commercial banks and issuance of debt securities and common stock. Our cash, cash equivalents and investments in marketable debt securities, which totaled $1,098.8 million at December 31, 2003, are invested in a diversified portfolio of financial instruments, including money market funds and instruments, corporate notes and bonds, government or government agency securities and other debt 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 mature within three years.

In June 2001 we issued zero coupon convertible Liquid Yield Option Notes (LYONs). The holders of the LYONs may require us to purchase all, or a portion of, their LYONs on June 12, 2004 at a purchase price of $584.31 per LYON. The accreted value on June 12, 2004 will be $426.5 million. We may choose to pay the purchase price in cash, shares of Chiron common stock or any combination thereof. Given our ability to pay the purchase price in shares of Chiron common stock, we continue to classify the LYONs as long-term liabilities as of December 31, 2003. Additional alternatives open to us to satisfy requests to purchase the LYONs include issuing new debt or equity securities. The next dates on which the holders may require us to purchase the LYONs following June 12, 2004 are June 12, 2006, and every fifth year thereafter until maturity in 2031.

We believe that our cash, cash equivalents and marketable debt securities, together with funds provided by operations and leasing arrangements, will be sufficient to meet our foreseeable operating cash requirements over at least the next twelve months including any cash utilized under our stock repurchase program, the potential purchase of all, or a portion, of the LYONS and our contractual obligations of $312.2 million in the next twelve months as discussed in the Contractual Obligations table below. We also believe that our cash, cash equivalents and marketable debt securities, together with funds provided by operations and leasing 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. On July 30, 2003, we issued $500.0 million aggregate principal amount of convertible debentures, which mature on August 1, 2033. We are using the net proceeds from the issuance for general corporate purposes. In addition, we believe we could access additional funds from the debt and capital markets.

Sources and Uses of Cash

We had cash and cash equivalents of $364.3 million and $248.0 million at December 31, 2003 and 2002, respectively.

        Operating activities    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 system, 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 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 in connection under the Stock Purchase Agreement dated September 17, 1998.

At December 31, 2003, Chiron had foreign net operating loss carryforwards of approximately $20.8 million, of which approximately $5.3 million begins expiring over the period 2008 to 2018 and the remaining $15.5 million is available to offset future taxable income without limitation. At December 31, 2003, Chiron had foreign net operating loss carryforwards attributed to the acquisition of PowderJect Pharmaceuticals of approximately $0.7 million, all of which are available to offset future taxable income without limitation. At December 31, 2003, Chiron had federal net operating loss carryforwards, attributable to the acquisition of Matrix Pharmaceutical, Inc., of approximately $49.2 million, which are available to offset future domestic taxable income ratably through 2021. At December 31, 2003, Chiron had federal net operating loss carryforwards attributable to the acquisition of PowderJect Pharmaceuticals of approximately $13.0 million, which are available to offset future domestic taxable income ratably through 2022. At December 31, 2003, Chiron had $23.4 million of state net operating loss carryforwards, which expire between 2004 and 2021 and state net operating loss carryforwards, attributable to the acquisition of Matrix Pharmaceutical, Inc., of approximately $27.3 million, which are available to offset future state taxable income ratably through 2013. At December 31, 2003, Chiron had utilized all of the remaining federal business tax credit carryforwards attributed to the PathoGenesis Corporation acquisition. At December 31, 2003, Chiron had state business tax credit carryovers of $16.3 million, which are available to offset future state tax liabilities without limitation, and foreign business tax credit carryovers of $22.2 million.

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 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 Incorporated 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 (see "Results of Operations—Vaccines—Selling, general and administrative" above).

In 2001, net cash provided by operating activities was $262.0 million as compared with $373.4 million in 2000. The decrease in cash provided by operating activities largely was due to (i) higher tax payments, (ii) the timing of royalty and license fee payments under the F. Hoffman La-Roche Limited settlement agreements (see "Blood testing—Royalty and license fee revenues" and "Other—Royalty and license fee revenues" above) and (iii) $13.9 million of cash received upon the settlement of a cross currency interest rate swap in 2000. We made $134.8 million ($49.6 million domestic and $85.2 million foreign) in tax payments in 2001 as compared with $9.9 million in 2000. Domestic tax payments in 2001 included approximately $39.8 million related to the filing of our fiscal year 2000 tax return in September 2001. Foreign tax payments in 2001 primarily related to tax

payments made by our Italian subsidiary. Our Italian subsidiary posted profits in both 2000 and 2001, and is taxed at a substantially higher tax rate than our domestic and other foreign subsidiaries. As a result, our Italian subsidiary made significant tax payments in 2001. The decrease in cash provided by operating activities were offset partially by a $45.3 million license fee payment received from Bayer Corporation in June 2001, as discussed in "Blood testing—Royalty and license fee revenues" above.

We anticipate that research and development expenditures in 2004 will primarily be driven by (i) those activities under our December 2001 and June 2002 collaboration agreements with Nektar Therapeutics (formerly Inhale Therapeutic Systems, Inc.) related to, among other things, the development of a dry powder formulation of our inhaled TOBI product for the treatment of pseudomonas aeruginosa in cystic fibrosis patients, (ii) those activities related to the development of interleukin-2 in combination with various monoclonal antibodies, (iii) expansion of our meningococcal franchise, (iv) development of flu cell culture, (v) research activities focused on identifying several novel vaccines and therapeutics for clinical development in the areas of oncology and infectious disease and (vi) those activities related to development with tifacogin in severe community-acquired pneumonia. In addition, we are required to make capital improvements to our existing manufacturing facilities to support the supply of Betaferon 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 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 Pharmaceuticals, 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 and maturities of investments in marketable debt securities of
$1,213.6 million, proceeds from the sale of equity securities and interests in
affiliates companies of $12.6 million and proceeds from notes receivable of
$0.8 million.

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 26.4 million Euro ($33.1 million at December 31, 2003) for the expansion of Chiron's Italian manufacturing facilities, of which Chiron had incurred costs of 15.3 million Euro ($19.2 million), as of December 31, 2003. This agreement began in the fourth quarter 2001 and is expected to continue through 2008. We currently are evaluating various financing alternatives to fund this expansion.

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 2003, we became a limited partner of Burrill Life Sciences Capital Fund, L.P. We will pay $10.0 million over 6 years, of which $1 million has been paid through December 31, 2003 for a 6.92% 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 $0.5 million has been paid through December 31, 2003, for a 4.47% 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 $1.9 million has been paid through December 31, 2003, for an 8.10% 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 $9.0 million has been paid through December 31, 2003, for a 6.35% ownership. In 2000, Chiron became a limited partner of Burrill Biotechnology Capital Fund, L.P. Chiron will pay $25.0 million over five years, of which $19.7 million has been paid through December 31, 2003, for a 23.26% ownership.

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, Inc. 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 the sale and maturity of investments in marketable debt securities of $723.6 million, proceeds from the sale of equity securities and interests in affiliated companies of $18.9 million, proceeds from equity forward contracts of $6.0 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.

In 2001, net cash used in investing activities consisted of purchases of investments in marketable debt securities of $987.3 million, capital expenditures of $64.9 million, purchases of equity securities and interest in affiliated companies of $14.9 million, cash paid for acquisition costs of PathoGenesis Corporation of $9.9 million and other uses of cash of $5.5 million. Cash used in investing activities was offset by proceeds from the sale and maturity of investments in marketable debt securities of $681.6 million, proceeds from the sale of assets of $8.2 million, proceeds from the sale of equity securities and interests in affiliated companies of $15.1 million and proceeds from notes receivable of $6.4 million.

In April 2001, we sold the remaining Chiron Vision real estate assets for $3.3 million in cash, and in January 2001, we sold various assets of our San Diego facility for $4.9 million in cash. The purchases of equity securities and interests in affiliated companies consisted of a $5.3 million capital contribution under a 2001 limited partnership agreement, a $6.6 million capital contribution under a 2000 limited partnership agreement and a $3.0 million capital contribution under a joint venture agreement. Under the joint venture agreement, we invested in a Singapore-based joint venture, S*BIO, to research and develop therapeutic, diagnostic and vaccine products. We had invested $8.0 million, which we wrote off

entirely due to the early stage of the joint venture's research and development activities, for a 19.9% ownership interest and are accounting for the investment under the cost method.

The proceeds from notes receivable of $6.4 million in 2001 related to amounts collected under an April 1999 biopharmaceutical license agreement and a February 2000 agreement to sell substantially all assets of our Australian subsidiary to Mimotopes.

        Financing activities    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.

Holders of the convertible debentures may convert their securities into shares of Chiron common stock when certain Chiron common stock price targets have been met, if the debentures have been called for redemption, if the credit rating assigned to Chiron's long-term senior debt is below specified levels or upon the occurrence and continuance of specified corporate transactions. For each $1,000 principal amount of debentures surrendered for conversion, the holder will receive 14.6113 shares of Chiron common stock. This is equivalent to an initial conversion price of approximately $68.44 per share of common stock. Upon conversion, holders will not receive any cash payment for accrued and unpaid interest.

The holders of the 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. Chiron may choose to pay the repurchase price in cash or Chiron common stock or any combination of the two.

On or after August 5, 2008, we may redeem for cash all or part of the debentures at a redemption price of $1,000.00 per debenture plus accrued and unpaid interest.

Our Board of Directors authorized the repurchase of our common stock on the open market to offset the dilution associated with the issuance of new shares under the stock option and employee stock purchase plans and the granting of share rights. In 2001, the Board of Directors granted authority to purchase up to 10.0 million shares. On December 6, 2002, the Board of Directors granted authority to buy an additional 5.0 million shares through December 31, 2003. On December 5, 2003, the Board of Directors granted authority to buy an additional 5.0 million shares and authorized such repurchases through December 31, 2004. As of December 31, 2003, Chiron is authorized to repurchase up to an additional 5.0 million shares of its common stock.

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, 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.

In 2001, net cash provided by financing activities consisted of $401.8 million in proceeds from the issuance of the Liquid Yield Option Notes (LYONs), $65.7 million in proceeds from the reissuance of treasury stock (primarily related to stock option exercises) and $8.2 million in proceeds from put options. Cash provided by financing activities was offset by $9.9 million for the payment of issuance costs on the LYONs, $201.0 million for the acquisition of treasury stock, $1.4 million for the repayment of debt and $0.6 million for the repayment of short-term borrowings.

We issued zero coupon LYONs in June 2001 for proceeds of $401.8 million. The LYONs mature on June 12, 2031. At the option of the holder, we may be required to purchase all, or a portion, of the LYONs on June 12, 2004 and 2006, and every five years thereafter. In addition, upon a change in control of Chiron occurring on or before June 12, 2006, each holder may require us to purchase all or a portion of such holder's LYONs for cash at a price equal to 100% of the issue price for such LYONs plus any accrued original issue discount and contingent additional principal (and accrued original issue discount thereon) to the date of purchase. Beginning on June 12, 2004 and continuing through June 12, 2006, the holder may receive contingent additional principal if Chiron's stock price falls below the threshold specified in the indenture. The contingent additional principal will replace the original issue discount and bear an effective yield of 2.0 to 9.0% per year for the two-year period. Based on market conditions as of December 31, 2003, contingent additional principal would have been zero, and the original issue discount of 2% per year would apply. After June 12, 2006, the original issue discount will continue to accrue at 2.0% per year.

In the event that the holders of the LYONs require us to purchase all, or a portion, of the LYONs on June 12, 2004, funding for such purchases may be provided by cash from operations, cash and investments on hand, borrowings or issuance of debt or common stock.

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 have agreed to make an initial payment of $10.0 million and make a loan facility of up to $50.0 million available to Xoma to fund Xoma's share of development expenses. The collaboration will initially focus on preclinical, process development and scale up work, with a potential Investigative New Drug (IND) filing anticipated early on in the collaboration.

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, 2003 were as follows:

                                                      Obligations by period                      
                                 ----------------------------------------------------------------
                                               Less than                               More than 
Contractual Obligations             Total        1 year     1-3 years    3-5 years      5 years  
------------------------------   -----------   ----------   ----------   ----------   -----------
                                                          (in thousands)                         
Long-term debt(1)                $   926,709   $        —   $      683   $      574   $   925,452
Capital lease obligations(2)         172,589        3,546        5,601        5,375       158,067
Other non-current                                                                       
liabilities(3)                        69,448            —       19,975          155        49,318
Operating leases(4)                  268,831       33,597       54,300       38,855       142,079
Purchase obligations:                                                                            
      Technology services                                                               
      agreement(5)                    59,100        5,910       11,820       11,820        29,550
      Purchase orders(6)              59,864       58,211        1,653            —             —
Supply agreement(7)                  100,000       25,000       50,000       25,000             —
Plant expansion(8)                    40,700       40,700            —            —             —
Berna biotech(9)                      13,900        2,780        5,560        5,560             —
Capital commitments(10)               30,700       30,700            —            —             —
Infonet(11)                            4,500        1,200        2,400          900             —
Letters of credit(12)                 12,700       12,700            —            —             —
Research and development                                                                
arrangements(13)                      49,400       30,400       19,000            —             —
Insurance-related items(14)           12,900       12,900            —            —             —
Manufacturing and supply                                                                
agreement(15)                         33,100        8,300       16,600        8,200             —
Supply agreement(16)                  28,740        5,099       11,213       12,428             —
Burrill Life Sciences Capital                                                           
Fund, L.P.(17).                        9,000        9,000            —            —             —
Forward Venture V L.P(18)              4,500        4,500            —            —             —
TPG Biotechnology Partners,                                                             
L.P(19)                                3,100        3,100            —            —             —
Forward Ventures IV L.P(20)            6,000        6,000            —            —             —
Burrill Biotechnology Capital                                                           
Fund L.P(21)                           5,300        5,300            —            —             —
Contract manufacturing                                                                  
agreement(22)                         33,789        5,332       11,242        8,608         8,607
FDA compliance agreement(23)           5,400        5,400            —            —             —
Revolving credit agreement(24)         2,500        2,500            —            —             —
                                 -----------   ----------   ----------   ----------   -----------
Total                            $ 1,952,770   $  312,175   $  210,047   $  117,475   $ 1,313,073
                                 -----------   ----------   ----------   ----------   -----------

º (1) º 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 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 Chiron's existing and future unsecured and unsubordinated indebtedness.

º º 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 are carried net of an original issue discount of $328.2 million, which is being accreted to interest expense over the life of the LYONs using the effective interest method. The LYONs mature on June 12, 2031, at a face value of

$1,000 per note. The LYONs are uncollateralized and unsubordinated, and rank equal in right of payment to Chiron's existing and future uncollateralized and unsubordinated indebtedness.

º º We had various other notes payable totaling $4.0 million at December 31, 2003.

º (2) º 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 effective July 1, 2003 and, as a result, recorded the leased facility and the corresponding liability on our balance sheet. The amount recorded on the balance sheet for the leased facility is $157.5 million. The amount of the leased facility less the expected value of the facility at the end of the lease term is being amortized on a straight-line basis over the lease term. We expect the value of the facility at the end of the lease term will be approximately $151.6 million. 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 interest payments represent variable-rate interest payments indexed to a three-month London interbank offered rate plus 40 basis points. The lease provides a $156.0 million residual value guarantee from us to the lessors in the event of property value declines. Consequently, our maximum payment obligation is $156.0 million upon termination of the lease on or before July 1, 2009. 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. This option accelerates if we default on our lease payments or in the event of other defined events. As of July 1, 2003, Novartis AG had 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.

º (3) º Other non-current liabilities as recorded in the Consolidated Balance Sheet as of December 31, 2003.

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

º (5) º 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 terminate this agreement at any time beginning April 1, 2004, subject to certain termination charges. If we do not terminate this agreement, future payments to IBM are expected to be approximately $59.1 million. Payments to IBM are subject to adjustment depending upon the levels of services and infrastructure equipment provided by IBM, as well as inflation.

º (6) º We had noncancelable purchase orders for ongoing operations of $59.9 million at December 31, 2003.

º (7) º 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 are required to make specified minimum purchases of 14.0 million British Pounds ($25.0 million at December 31, 2003) each year from that supplier through 2007.

º (8) º In 2003, our Board of Directors approved $50.7 million in expenditures for a 25-year lease for buildings and $42.2 million for capital improvements, both of which are part of a $97.0 million project for a new flu vaccines manufacturing facility in Liverpool, England. The new manufacturing facility will replace existing flu vaccines manufacturing facilities in Liverpool, England. As of December 31, 2003, we have incurred $1.5 million for capital improvements.

º (9) º 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 26.4 million Euro ($33.1 million at December 31, 2003) for the expansion of our Italian manufacturing facilities, of which we have incurred costs of 15.3 million Euro ($19.2 million), as of December 31, 2003. This agreement began in the fourth quarter 2001 and is expected to continue through 2008. The amount of the commitment remaining at December 31, 2003 is $13.9 million. The remaining commitment is allocated on a straight-line basis until 2008.

º (10) º We had various other firm purchase and capital project commitments totaling approximately $30.7 million at December 31, 2003.

º (11) º 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, 2003, totaled $4.5 million.

º (12) º At December 31, 2003, we had $12.7 million available under letters of credit, which is required by German law, related to ongoing legal proceedings in Germany.

º (13) º 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, 2003, aggregate annual noncancelable funding commitments under collaborative arrangements are as follows: 2004—$8.5 million and 2005—$18.9 million. We may also be required to make payments to certain collaborative partners upon the achievement of specified milestones. At December 31, 2003, aggregate milestone payments that may become due under these noncancelable collaborative arrangements totaled $5.3 million. These milestone payments are due upon the achievement of various technical milestones, completion of trials and regulatory filings.

º º 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, 2003, aggregate annual noncancelable commitments under these contracts are as follows: 2004—$3.0 million and 2005—$0.1 million. At December 31, 2003, aggregate milestone payments that may become due under these noncancelable arrangements totaled $13.6 million. These milestone payments are due upon the achievement of various technical milestones, completion of trials and regulatory filings.

º (14) º We had various performance bonds and insurance-related letters of credit in the amount of $12.9 million available at December 31, 2003. There are no amounts outstanding under these letters of credit at December 31, 2003.

º (15) º 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 $36.4 million over four years from regulatory approval, which occurred in 2003. We have paid $3.3 million towards the minimum purchase obligation as of December 31, 2003. As of December 31, 2003, the remaining minimum purchase obligation of $33.1 million is allocated ratably over four years.

º (16) º 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 five

years is approximately $28.7 million. We can terminate the agreement at any time beginning January 1, 2005 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.

º (17) º In 2003, we became a limited partner of Burrill Life Sciences Capital Fund, L.P. We will pay $10.0 million over 6 years, of which $1.0 million has been paid through December 31, 2003 for a 6.92% 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.

º (18) º In 2003, we became a limited partner of Forward Venture V, L.P. We will pay $5.0 million over five years, of which $0.5 million has been paid through December 31, 2003, for a 4.47% 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.

º (19) º In 2002, we became a limited partner of TPG Biotechnology Partners, L.P. We will pay $5.0 million over 10 years, of which $1.9 million has been paid through December 31, 2003, for an 8.10% 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.

º (20) º In 2001, we became a limited partner of Forward Venture IV, L.P. We will pay $15.0 million over ten years, of which $9.0 million has been paid through December 31, 2003, 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.

º (21) º 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 $19.7 million has been paid through December 31, 2003, 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.

º (22) º 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. We have a firm binding order for products to be delivered by SynCo in 2004, 2005 and 2006 under this agreement. Our minimum purchase obligation under this agreement, subject to adjustment depending 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 $33.8 million over the term of the agreement.

º (23) º In June 2003, Chiron and SynCo B.V. executed an FDA compliance agreement. Under this agreement, we will fund certain costs required to bring SynCo's Amsterdam manufacturing facility into compliance to support approval by the U.S. Food and Drug Administration to manufacture certain vaccine products for the U.S. market. Our funding commitment under this agreement is expected to be approximately $10.9 million through the first quarter 2005, of which we have paid 4.7 million Euro ($5.5 million) as of December 31, 2003.

º (24) º 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, 2003, Nektar Therapeutics has not drawn from the revolving line of credit.

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, 2003 and December 31, 2002. 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.

We also have various credit facilities available outside the U.S. There were no outstanding borrowings under these facilities at December 31, 2003. Borrowings under these facilities totaled $0.1 million at December 31, 2002. One facility is maintained for our 51%-owned Indian subsidiary, and allows for total borrowings of 200 million Indian Rupee ($4.4 million at December 31, 2003). There were no outstanding borrowings under this facility at December 31, 2003. At December 31, 2002, $0.1 million was outstanding under this facility. Our Italian subsidiary also has various facilities, related to its receivables, which allow for total borrowings of 10.9 million Euro ($13.6 million at December 31, 2003). There were no outstanding borrowings under these facilities at December 31, 2003 and December 31, 2002.

Off-Balance Sheet Arrangements

As of December 31, 2003, 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 pharmaceutical 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.

If our focus on the research and development of emerging technologies does not result in the creation of commercial products, our business could be harmed.

We focus our research and development activities on areas in which we have particular strengths and on technologies that appear promising. These technologies often are on the "cutting edge" of modern science. As a result, the outcome of any research or development program is highly uncertain. Only a very small fraction of these programs ultimately result in commercial products or even product candidates. Product candidates that initially appear promising often fail to yield successful products. In many cases, preclinical or clinical studies will show that a product candidate is not efficacious (that is, it lacks the intended therapeutic or prophylactic effect), or that it raises safety concerns or has other side effects, which outweigh the intended benefit. Success in preclinical or early clinical trials (which generally focus on safety issues) may not translate into success in large-scale clinical trials (which are designed to show efficacy), often for reasons that are not fully understood. Further, success in clinical

trials will likely lead to increased investment, adversely affecting short-term profitability, to bring such products to market. And even after a product is approved and launched, general usage or post-marketing studies may identify safety or other previously unknown problems with the product which may result in regulatory approvals being suspended, limited to narrow indications or revoked, or which may otherwise prevent successful commercialization.

Conflicts with or decisions by third parties we collaborate with could harm our business.

An important part of our business strategy depends upon collaborations with third parties, including research collaborations and joint efforts to develop and commercialize new products. As circumstances change, Chiron and our strategic partners may develop conflicting priorities or other conflicts of interest. We may experience significant delays and incur significant expenses in resolving these conflicts and may not be able to resolve these matters on acceptable terms. Even without conflicts of interest, we may disagree with our strategic partners as to how best to realize the value associated with a current product or a product in development. In some cases, the strategic partner may have responsibility for formulating and implementing key strategic or operational plans. In addition, merger and acquisition activity within the pharmaceutical and biotechnology industries may affect our strategic partners, causing them to reprioritize their efforts related to the research collaborations and other joint efforts with us. Decisions by corporate partners on key clinical, regulatory, marketing (including pricing), inventory management and other issues may prevent successful commercialization of the product or otherwise impact our profitability.

If we fail to obtain or maintain the regulatory approvals we need to market our products, our business will suffer.

We must obtain and maintain regulatory approval in order to market most of our products. Generally, these approvals are on a product-by-product and country-by-country basis. In the case of therapeutic products, a separate approval is required for each therapeutic indication. Product candidates that appear promising based on early, and even large-scale, clinical trials may not receive regulatory approval. The results of clinical trials often are susceptible to varying interpretations that may delay, limit or prevent approval or result in the need for post-marketing studies. In addition, regulations may be amended from time to time. Revised regulations may require us to reformulate products on a country or regional basis, obtain additional regulatory approvals, or accept additional risks that our products will not maintain market acceptance or be eligible for third party insurance coverage. Increased regulatory scrutiny and restrictions regarding marketing practices for products that are subject to government reimbursement may impact the sales of such products. There is no guarantee that we will be able to satisfy these new regulatory requirements and may suffer a loss of revenue as a result.

Our products are complex and difficult to manufacture on a large-scale basis, which could cause us to delay product launches, experience shortages of products or prevent us from offering products on a volume basis.

Most of our products are biologics. Manufacturing biologic products is complex. Unlike chemical pharmaceuticals, a biologic product generally cannot be sufficiently characterized (in terms of its physical and chemical properties) to rely on assaying of the finished product alone to ensure that the product will perform in the intended manner. Accordingly, it is essential to be able to both validate and control the manufacturing process, that is, to show that the process works and that the product is made strictly and consistently in compliance with that process. Slight deviations anywhere in the manufacturing process, including quality control, labeling and packaging, may result in unacceptable changes in the products that may result in lot failures or product recalls, or liability to a third party to the extent we are contract manufacturing products in our facilities for such third party. Manufacturing processes which are used to produce the smaller quantities of material needed for research and

development purposes may not be successfully scaled up to allow production of commercial quantities at reasonable cost or at all. All of these difficulties are compounded when dealing with novel biologic products that require novel manufacturing processes. Additionally, manufacturing is subject to extensive government regulation. Even minor changes in the manufacturing process require regulatory approval, which, in turn, may require further clinical studies. For some of our products, we rely on others to supply raw materials and to manufacture those products according to regulatory requirements.

In addition, any prolonged interruption in our operations or those of our partners could result in our inability to satisfy the product demands of our customers. A number of factors could cause interruptions, including equipment malfunctions or failures, interruptions due to labor action, damage to a facility due to natural disasters, such as an earthquake, suspension of power supplied to these facilities arising out of regional power shortages or terrorist activities and armed conflict, including as a result of the disruption of operations of our subsidiaries and our customers, suppliers, distributors, couriers, collaborative partners, licensees and clinical trial sites.

Our mishandling of hazardous materials could result in substantial costs and harm to our business.

In connection with our research and manufacturing activities, we utilize some hazardous materials. We believe we take great care to ensure we have appropriate procedures and permits in place for storing and handling such hazardous materials. We could be subject to loss of our permits, government fines or penalties and/or other adverse governmental action if such hazardous materials are stored, handled or released into the environment in violation of law or any permit. A substantial fine or penalty, the payment of significant environmental remediation costs or the loss of a permit or other authorization to operate or engage in our ordinary course of business could result in material, unanticipated expenses and the possible inability to satisfy customer demand.

If any of our third party suppliers or manufacturers cannot adequately meet our needs, our business could be harmed.

We use raw materials and other supplies that generally are available from multiple commercial sources. Certain manufacturing processes, however, use materials that are available from sole sources, or that are in short supply, or are difficult for the supplier to produce and certify in accordance with our specifications. From time to time, concerns are raised with respect to potential contamination of biological materials that are supplied to us. These concerns can further tighten market conditions for materials that may be in short supply or available from limited sources. Moreover, regulatory approvals to market our products may be conditioned upon obtaining certain materials from specified sources. Our ability to substitute material from an alternate source may be delayed pending regulatory approval of such alternate source. Although we work to mitigate the risks associated with relying on sole suppliers, there is a possibility that material shortages could impact production.

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; however, there can be no assurance that these suppliers will be able to meet future demand in a timely and cost-effective manner. As a result, our operations could be adversely affected by an interruption or reduction in the supply of bulk-powdered tobramycin.

We have entered into contracts with third parties for the production and packaging of TOBI. Over time, we can use alternative production and packaging sources. However, if the contracted third parties become unable to produce or package sufficient quantities of TOBI due to work stoppages or other factors, our operations could be disrupted until alternative sources are secured.

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 are required to make specified minimum purchases from that supplier through 2007. If our supplier were to fail to supply eggs in sufficient quantities or quality, including as a result of any health or other issues related to the chickens, our business would be materially adversely affected.

We are a key provider for the blood screening field of nucleic acid testing and immunodiagnostics. In nucleic acid testing, we rely on our collaborative partner, Gen-Probe, to manufacture the West Nile virus assay, currently in use on an investigational-use basis in the U.S. and the Procleix HIV-1/ HCV Assay. We currently source the related instrument system from third party suppliers. Currently, Gen-Probe is the only manufacturer of nucleic acid testing products using Transcription-Mediated Amplification technology. In immunodiagnostics, under the Ortho-Clinical Diagnostics, Inc. contract, we manufacture bulk reagents and antigens and confirmatory test kits sold in the clinical diagnostics and blood screening fields. While we and our partners work to mitigate the risks associated with being a key provider, there can be no assurance that our partner, Gen-Probe, will be able to provide sufficient quantities of the Procleix HIV-1/ HCV Assay or that we will be able to manufacture sufficient bulk reagents and antigens and confirmatory test kits for immunodiagnostic products. Our difficulties or delays or those of our partners' could cause a public health concern for the blood supply, as well as increase costs and cause loss of revenue or market share.

If we cannot obtain necessary licenses to third party patents for the manufacture or sale of our products, we may have to withdraw from the market or delay the introduction of the affected product.

Third parties, including competitors, have patents and patent applications in the U.S. and other significant markets that may be useful or necessary for the manufacture, use or sale of certain products and products in development by us and our strategic partners. It is likely that third parties will obtain these patents in the future. Certain of these patents may be broad enough to prevent or delay us and our strategic partners from manufacturing or marketing products important to our current and future business. We cannot accurately predict the scope, validity and enforceability of these patents, if granted, the extent to which we may wish or need to obtain licenses to these patents, and the cost and availability of these licenses. If we do not or cannot obtain these licenses, products may be withdrawn from the market or delays could be encountered in market introduction while an attempt is made to design around these patents, or we could find that the development, manufacture or sale of such products is foreclosed. We could also incur substantial costs in licensing or challenging the validity and scope of these patents.

Because most of our products are based on technologies that are unfamiliar to the healthcare community, they may not be accepted by healthcare providers and patients, which could harm our business.

We may experience difficulties in launching new products, many of which are novel products based on technologies that are unfamiliar to the healthcare community. We have no assurance that healthcare providers and patients will accept such products. In addition, government agencies, as well as private organizations involved in healthcare, from time to time publish guidelines or recommendations to healthcare providers and patients. Such guidelines or recommendations can be very influential and may adversely affect the usage of our products directly (for example, by recommending a decreased dosage of our product in conjunction with a concomitant therapy or a government entity withdrawing its recommendation to screen blood donations for certain viruses) or indirectly (for example, by recommending a competitive product over our product).

If we are unable to avoid significant exposure to product liability claims, our business could be harmed.

We are exposed to product liability and other claims in the event that the use of our products is alleged to have resulted in adverse effects. While we will continue to take precautions, we may not avoid significant product liability exposure. Although we maintain product liability insurance, there is

no guarantee that this coverage will be sufficient. It is not feasible to obtain adequate insurance coverage for certain products and we are self-insured in relation to these products. If we are sued for any injury caused by our products, we could suffer a significant financial loss.

As we are a key provider for the blood screening field of nucleic acid testing and immunodiagnostics, we may have product liability in addition to contract exposure, in the event that our difficulties or delays or those of our partners could cause a public health concern for the blood supply.

If we are unable to successfully compete in the highly competitive healthcare industry, our business could be harmed.

We operate in a highly competitive environment, and the competition is expected to increase. Competitors include large pharmaceutical, chemical and blood testing companies, and biotechnology companies. Some of these competitors, particularly large pharmaceutical and blood testing companies, have greater resources than us. Accordingly, even if we are successful in launching a product, we may find that a competitive product dominates the market for any number of reasons, including:

º • º The possibility that the competitor may have launched its product first;

º • º The competitor may have greater access to certain raw materials;

º • º The competitor may have more efficient manufacturing processes;

º • º The competitor may adapt more quickly to technological change;

º • º The competitor may have greater marketing capabilities;

º • º The competitive product may have therapeutic or other advantages; or

º • º New competitors may enter into markets where we currently have significant competitive advantage.

The technologies applied by our competitors and us are rapidly evolving, and new developments frequently result in price competition and product obsolescence. In addition, we may be impacted by competition from generic forms of our products or substitute products. Specific to one product, TOBI, a generic form of this product may be available from our competitors, which may cause loss of revenue or market share. 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 TOBI 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.

Our patents may not prevent competition or generate revenues.

We seek to obtain patents on many of our inventions. Without the protection of patents, competitors may be able to use our inventions to manufacture and market competing products without being required to undertake the lengthy and expensive development efforts made by us and without having to pay royalties or otherwise compensate us for the use of the invention. We have no assurance that patents and patent applications owned or licensed to us will provide substantial protection. Important legal questions remain to be resolved as to the extent and scope of available patent protection for biotechnology products and processes in the U.S. and other important markets. We do not know how many of our pending patent applications will be granted, or the effective coverage of those that are granted. In the U.S. and other important markets, the issuance of a patent is neither conclusive as to its validity nor the enforceable scope of its claims. We have engaged in significant

litigation to determine the scope and validity of certain of our patents and expect to continue to do so. An adverse outcome of litigation could result in the reduction or loss of royalty revenues. Engaging in patent litigation against one party may place significant royalty revenues received or to be received from other parties at risk. Even if we are successful in obtaining and defending patents, there can be no assurance that these patents will provide substantial protection. The length of time necessary to resolve patent litigation successfully may allow infringers to gain significant market advantage. Third parties may be able to design around the patents and develop competitive products that do not use the inventions covered by our patents. Many countries, including certain countries in Europe, have compulsory licensing laws under which a patent owner may be compelled to grant licenses to third parties (for example, the third party's product is needed to meet a threat to public health or safety in that country, or the patent owner has failed to "work" the invention in that country, or the third party has patented improvements). In addition, most countries limit the enforceability of patents against government agencies or government contractors. In these countries, the patent owner may be limited to monetary relief and may be unable to enjoin infringement, which could materially diminish the value of the patent. In addition, royalty revenues may decline as patents expire.

Sales of our products may be adversely affected by the availability and amount of reimbursement to the user of our products from third parties, such as the government and insurance companies.

In the U.S. and other significant markets, sales of our products may be affected by the availability of reimbursement from the government or other third parties, such as insurance companies. It is difficult to predict the reimbursement status of newly approved, novel biotechnology products, and current reimbursement policies for existing products may change. In certain foreign markets, governments have issued regulations relating to the pricing and profitability of pharmaceutical companies. There have been proposals in the U.S. (at both the federal and state level) to implement such controls. If the United States Congress enacts legislative proposals addressing parallel importation currently being deliberated, revenues from certain products may be affected by this change in U.S. policy. The growth of managed care in the U.S. also has placed pressure on the pricing of healthcare products. These pressures can be expected to continue.

If our efforts to integrate acquired or licensed businesses or technologies into our business are not successful, our business could be harmed.

As part of our business strategy, we expect to continue to grow our business through in-licensing, collaborations or acquisitions of products or companies. For example, we are currently in the process of completing the integration of PowderJect Pharmaceuticals. The failure to adequately address the financial, operational or legal risks raised by such transactions, including our integration of PowderJect, could harm our business. Financial aspects related to these transactions may alter our financial position, reported operating results or stock price, and include:

º • º Use of cash resources;

º • º Potentially dilutive issuances of equity securities;

º • º The incurrence of debt and contingent liabilities, impairment losses or restructuring charges;

º • º Large write-offs and difficulties in assessment of the relative percentages of in-process research and development expense that can be immediately written off as compared to the amount which must be amortized over the appropriate life of the asset; and

º • º Amortization expenses related to other intangible assets.

Operational risks that could harm our existing operations or prevent realization of anticipated benefits from such transactions include:

º • º Challenges associated with managing an increasingly diversified business;

º • º Difficulties in assimilating the operations, products, technology, information systems or personnel of the acquired company;

º • º Diversion of management's attention from other business concerns;

º • º Inability to maintain uniform standards, controls, procedures and policies;

º • º The assumption of known and unknown liabilities of the acquired company, including intellectual property claims; and

º • º Subsequent loss of key personnel.

Legal risks may include requirements to obtain the consent of our stockholders or a third party, or the approval of various regulatory authorities.

If such efforts to integrate acquired or licensed businesses or technologies into our business are not successful, our business could be harmed.

If we cannot initiate and maintain revenue-generating relationships with third parties, we may not be able to grow our revenues in the near to medium term.

Many products in our current pipeline are in relatively early stages of research or development. Our ability to grow earnings in the near- to medium-term may depend, in part, on our ability to initiate and maintain other revenue generating relationships with third parties, such as licenses to certain of our technologies, and on our ability to identify and successfully acquire rights to later-stage products from third parties. We may fail to establish such other sources of revenue.

Fluctuations in interest rates, foreign currency exchange rates and levels of indebtedness could harm our business.

We have significant cash balances and investments. Our financial results, therefore, are sensitive to interest rate fluctuations. In addition, we sell products in many countries throughout the world, and our financial results could be significantly affected by fluctuations in foreign currency exchange rates or by weak economic conditions in foreign markets.

We have significant debt balances following the issuance of our most recent convertible debt offerings. Therefore, our financial results will reflect increased interest expense and we could be harmed by a negative change to our credit rating by the debt rating agencies.

The holders of the Liquid Yield Option Notes (LYONs) due 2031 may require us to purchase all, or a portion, of the LYONs on June 12, 2004. We may choose to pay the purchase price in cash or in shares of Chiron common stock. To the extent we elect to purchase the LYONs for cash, our inability to replace the LYONs with new debt securities could adversely affect our cash balances and our business. To the extent we elect to pay for the LYONs in shares of Chiron common stock, the existing common stockholders would experience dilution as a result of the newly issued shares of Chiron common stock.

Our relationship with Novartis AG could limit our ability to enter into transactions, pursue opportunities in conflict with Novartis and cause the price of our common stock to decline.

We have an alliance with Novartis AG, a life sciences company headquartered in Basel, Switzerland. Under a series of agreements between Chiron and Novartis, and as a result of subsequent

stock issuances by Chiron, Novartis' ownership interest in Chiron was approximately 42.4% as of December 31, 2003. The governance agreement between Chiron and Novartis contains provisions that require the approval of Novartis before we enter into certain corporate transactions. These transactions generally include significant debt or equity issuances, debt or equity repurchases, most mergers and acquisitions, the payment of cash dividends, amendments to Chiron's certificate of incorporation or by-laws, and other transactions that would adversely impact the rights of Novartis, or discriminate against Novartis, as a Chiron stockholder. In addition, a majority of the independent directors must approve any material transactions between Chiron and Novartis. These provisions may limit our ability to enter into transactions with third parties otherwise viewed as beneficial to Chiron. All of our shares owned by Novartis are eligible for sale in the public market subject to compliance with the applicable securities laws. We have agreed that, upon Novartis' request, we will file one or more registration statements under the Securities Act in order to permit Novartis to offer and sell shares of our common stock. Sales of a substantial number of shares of our common stock by Novartis in the public market could adversely affect the market price of our common stock.

Volatility of our stock price could negatively impact our profitability.

The price of our stock, like that of other pharmaceutical companies, is subject to significant volatility. Any number of events, both internal and external to us, may affect our stock price. These include, without limitation:

º • º Fluctuations in earnings from period to period;

º • º Results of clinical trials conducted by us or by our competitors;

º • º Announcements by us or our competitors regarding product development efforts, including the status of regulatory approval applications;

º • º The outcome of legal proceedings, including claims filed by us against third parties to enforce our patents and claims filed by third parties against us relating to patents held by the third parties;

º • º The launch of competing products;

º • º The resolution of (or failure to resolve) disputes with strategic partners;

º • º Corporate restructuring by us;

º • º The sale of a substantial number of shares held by our existing stockholders;

º • º Licensing activities by us; and

º • º The acquisition or sale by us of products, products in development or businesses.

In connection with our research and development collaborations, from time to time we may invest in equity securities of our strategic partners. The price of these securities also is subject to significant volatility and may be affected by, among other things, the types of events that affect our stock. Changes in the market price of these securities may impact our profitability.

We are subject to taxation in a number of jurisdictions and changes to the corporate tax rate and laws of any of these jurisdictions could increase the amount of corporate taxes we have to pay.

We pay taxes principally in the U.S., Germany, Italy, The Netherlands and, with the acquisition of PowderJect, the United Kingdom. All of these jurisdictions have in the past and may in the future make changes to their corporate tax rates and other tax laws, which could increase our future tax provision. We have negotiated a number of rulings regarding income and other taxes that are subject to periodic review and renewal. If such rulings are not renewed or are substantially modified, income

taxes payable in particular jurisdictions could increase. While we believe that all material tax liabilities are reflected properly in our balance sheet, we are presently under audit in several jurisdictions and may be subject to further audits in the future, and we have no assurance that we will prevail in all cases in the event the taxing authorities disagree with our interpretations of the tax law. In addition, we have assumed liabilities for all income taxes incurred prior to the sales of our former subsidiaries, Chiron Vision (subject to certain limitations) and Chiron Diagnostics. Future levels of research and development spending, capital investment and export sales will impact our entitlement to related tax credits and benefits which have the effect of lowering our effective tax rate.

Volatility of earnings could negatively impact our business.

Our operating results may vary considerably from quarter to quarter. Any number of factors may affect our quarterly operating results. These factors include, but are not limited to the following:

º • º Inventory management practices, including wholesale ordering patterns;

º • º The level of pre-clinical and clinical trial-related activities;

º • º Seasonality of certain vaccine products;

º • º The tender driven nature of certain vaccine products;

º • º The nature of our collaborative, royalty and license arrangements and other revenue sources;

º • º Foreign currency exchange rate fluctuations; and

º • º The level of product reserves due to various issues, including seasonality patterns, excess and obsolete inventory, and production yields.

Our results in any one quarter are not necessarily indicative of results to be expected for a full year.

Revisions to accounting standards, financial reporting and corporate governance requirements and tax laws could result in changes to our standard practices and could require a significant expenditure of time, attention and resources, especially by senior management.

We must follow accounting standards, financial reporting and corporate governance requirements and tax laws set by the governing bodies and lawmakers in the U.S. and other countries where we do business. From time to time, these governing bodies and lawmakers implement new and revised rules and laws. These new and revised accounting standards, financial reporting and corporate governance requirements and tax laws may require changes to our financial statements, the composition of our board of directors, the composition, the responsibility and manner of operation of various board-level committees, the information filed by us with the governing bodies and enforcement of tax laws against us. Implementing changes required by such new standards, requirements or laws likely will require a significant expenditure of time, attention and resources, especially by our senior management. It is impossible to predict the impact, if any, on Chiron of future changes to accounting standards, financial reporting and corporate governance requirements and tax laws. In addition, it is possible that the application of certain current accounting standards may change due to environmental factors, which may necessitate a change in our standard practice related to these accounting standards.

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