**UNITEDSTATESSECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

**FORM10-K**

**FORANNUAL AND TRANSITION REPORTS PURSUANT TO SECTIONS 13 OR 15(d) OF THESECURITIES EXCHANGE ACT OF 1934**

**(Mark one)**

**x**                               ANNUAL REPORTPURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGEACT OF 1934.

**For the fiscal year ended December 31, 2004**

**OR**

**o**                                  TRANSITIONREPORT PURSUANT TO SECTION 13 OR 15(d) OF THESECURITIES EXCHANGE ACT OF 1934.

**For the transition period from                                to                                 **

**Commission File Number: 0-12798**

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CHIRON CORPORATION

(Exactname of registrant as specified in its charter)

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

**(510) 655-8730**

(Registrant’stelephone number, including area code)

**NotApplicable**

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

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Securities registeredpursuant to Section 12(b) of the Act: **None**

Securities registeredpursuant to Section 12(g) of the Act:

**Common Stock, $0.01 Par ValueWarrant to Purchase Common Stock, $0.01 Par Value**

Indicateby check mark whether the registrant (1) has filed all reports required tobe filed by Section 13 or 15(d) of the Securities Exchange Act of1934 during the preceding 12 months (or for such shorter period that theregistrant was required to file such reports), and (2) has been subject tosuch filing requirements for the past 90 days. Yes: x   No: o

Indicateby check mark if disclosure of delinquent filers pursuant to Item 405 ofRegulation S-K is not contained herein, and will not be contained, to thebest of registrant’s knowledge, in definitive proxy or information statementsincorporated by reference in Part III of this Form 10-K or anyamendment to this Form 10-K. o

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

Theaggregate market value of the voting and non-voting stock held bynon-affiliates of the registrant, based upon the closing price of Common Stockon June 30, 2004 as reported on the NASDAQ National Market, wasapproximately $3.7  billion. Shares of Common Stock held by each executiveofficer and director and by each shareholder whose beneficial ownership exceeds5% of the outstanding Common Stock at June 30, 2004 have been excluded inthat such persons may be deemed to be affiliates. This determination ofaffiliate status is not necessarily a conclusive determination for otherpurposes.

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

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

**DOCUMENTSINCORPORATED BY REFERENCE**

Portions of the Proxy Statement to be filed inconnection with the solicitation of proxies for the Annual Meeting ofStockholders to be held on May 26, 2005 are incorporated by reference intoPart III of this Report.

 

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**PART I**

**ITEM 1**.                BUSINESS

***Our Policy on Forward-Looking Statements***

This 10-K containsforward-looking statements regarding our expectations, hopes or intentionsregarding the future, including statements relating to sales growth, productdevelopment initiatives, new product marketing, acquisitions, competition, andlicensing activities that involve risks and uncertainties and are subject tochange. The forward-looking statements contained in this 10-K reflect ourcurrent expectations on the date of this 10-K. Actual results, performance oroutcomes may differ materially from current expectations. Our actualperformance may differ from current expectations due to many factors, includingadditional adverse developments resulting from the suspension from October 5,2004 through March 2, 2005 of Chiron’s UK license to manufacture FLUVIRIN®influenza virus vaccine, the announcement of such suspension and the litigationand investigations relating to these matters, the outcome of clinical trials,regulatory review and approvals, manufacturing capabilities, intellectualproperty protections and defenses, stock price and marketing effectiveness. Inparticular, there can be no assurance that we will increase sales of existingproducts, successfully develop and receive approval to market new products, orachieve market acceptance for such new products. No assurances can be giventhat additional issues with respect to FLUVIRIN® vaccine or Chiron’smanufacturing generally will not arise in the future, or that we willsuccessfully address matters raised in a warning letter from the U.S. Food andDrug Administration with respect to our FLUVIRIN vaccine manufacturingfacilities. There can be no assurance that our out-licensing activity willgenerate significant revenue, or that our in-licensing activities will fullyprotect us from claims of infringement by third parties. In addition, we mayengage in business opportunities, the successful completion of which is subjectto certain risks, including approval by Novartis, regulatory approvals and theintegration of operations. We have discussed the important factors that webelieve could cause actual results to differ from what is expressed in theforward-looking statements, in Part II, Item 7, of this 10-K, “Management’sDiscussion and Analysis of Financial Condition and Results of Operations,”under the caption “Factors That May Affect Future Results.” We do notundertake an obligation to update the forward-looking information contained inthis 10-K.

***Overview***

We are a globalbiopharmaceutical company that participates in three healthcare markets: bloodtesting, vaccines, and biopharmaceuticals. Our revenues, which totaled $1.7billion in 2004, consist of product sales, revenues from a joint businesscontractual arrangement, collaborative agreement revenues, royalty and licensefee revenues and other revenues, primarily consisting of contract manufacturingand grant revenues. Our research and development efforts are focused ondeveloping products for oncology and infectious and pulmonary disease.

*Blood Testing*

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

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

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

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

*Vaccines*

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

Our heritage in vaccines is traced to the three Europeanmanufacturers we acquired over the past two decades, all of which were founded100 or more years ago: Italy-based Sclavo was acquired in 1992, Germany-basedBehring was acquired in 1998 and United Kingdom-based PowderJect Pharmaceuticalplc, or PowderJect, was acquired in July 2003. We acquired a number ofvaccines including FLUVIRIN® influenza vaccine as part of our acquisition ofPowderJect.

As discussed in Item 7 of this report on Form 10-K,“Management’s Discussion and Analysis of Financial Condition and Results ofOperations”, on October 5, 2004 the MHRA prohibited us from releasing anyFLUVIRIN vaccine doses manufactured at our Liverpool facility since March 2,2004 and suspended our license to manufacture influenza virus vaccine in ourLiverpool facility from October 5, 2004 through March 2, 2005. Inaddition, following the MHRA’s decision and an inspection by the FDA, the FDAsent us a warning letter on December 9, 2004 citing violations of goodmanufacturing practices. We provided the FDA with a written response to thewarning letter on January 7, 2005. In a subsequent letter to us, the FDAstated that our responses appear to be adequate, but that implementation andeffectiveness of our corrective actions and overall compliance would beevaluated in a subsequent inspection. As a result of the suspension of ourlicense, we did not release any FLUVIRIN vaccine product during the 2004-2005influenza season. On March 2, 2005, the MHRA notified us that it hadlifted the suspension of our license to manufacture FLUVIRIN vaccine at ourLiverpool facility, effective March 2, 2005, giving Chiron clearance toinitiate full production of FLUVIRIN vaccine, conditioned on the understandingthat Chiron’s commitment to its remediation plan will continue. The FDA isstill expecting to conduct a full inspection to determine whether deficienciesnoted in its warning letter have been resolved. If we fail to adequatelyaddress the matters discussed in the warning letter, the FDA may modify our U.S.license in an adverse manner, take action that could result in the impositionof fines, require temporary or permanent cessation of future selling ofFLUVIRIN vaccine or take other action that could reduce our ability to marketFLUVIRIN vaccine. For additional information concerning the risks we continueto face as a result of these events relating to FLUVIRIN vaccine, see Item 7 ofthis Report on Form 10-K—”Factors That May Affect Future Results—Therecent developments with respect to FLUVIRIN vaccine will harm our business andresults of operations.” For additional information on litigation andinvestigations relating to the FLUVIRIN vaccine developments, see Part I,Item 3. “Legal Proceedings” of this Report on Form 10-K.

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Our vaccines segmentresearch and development is focused on developing next generation influenzamanufacturing capability, developing new vaccines for pandemic preparedness,and broadening our meningococcal franchise.

*Biopharmaceuticals*

Our biopharmaceuticalssegment discovers, develops, manufactures and markets a range of therapeuticproducts for cancer and infectious and pulmonary disease. The biopharmaceuticalsegment, which includes both product sales and royalties, reported net productsales and BETAFERON® interferon beta-1b royalties of $563.3 million for theyear 2004. Our marketed products include TOBI® tobramycin solution forinhalation for pseudomonal lung infections in cystic fibrosis patients; PROLEUKIN®(aldesleukin) for injection for metastatic melanoma and renal cell carcinoma;and BETASERON® (interferon beta-1b) for SC injection for multiple sclerosis. In2004, we filed for marketing approval for two additional products: PULMINIQTM(cyclosporine, USP) inhalation solution for the increase in survival andprevention of chronic rejection in patients receiving allogeneic lungtransplants, in combination with standard immunosuppressive therapy, andCUBICIN® (daptomycin for injection) for complicated skin and soft tissueinfections. Research and development efforts include advancing clinicalprograms and product improvements in oncology and pulmonary and infectiousdisease, including the use of PROLEUKIN aldesleukin to enhance the benefit ofmonoclonal antibodies in cancer treatment, the development of new formulationsof TOBI solution and the clinical advancement of tifacogin for treatment ofsevere community-acquired pneumonia, CHIR-258, a growth factor kinaseinhibitor, and CHIR-12.12, a monoclonal antibody.

*Royalties andLicense Fee Revenue*

We earn royalty and license fee revenue in all threesegments by licensing some of our key intellectual property in areas such ashepatitis C and HIV. In addition, we generate royalties through agreements withdevelopment and marketing partners, including royalties from Schering AG’ssales of BETAFERON® (interferon beta-1b) for SC injection in Europe. Someroyalties and license fees are not considered to be associated with anyparticular business segment and are recorded separately in the segment data asOther Royalty and License Fee Revenues. Financial information for thereportable segments is included in Note 18, “Segment Information” of Notes toConsolidated Financial Statements.

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

***Product Descriptions***

*Blood Testing*

Our collaboration with Gen-Probe is focused ondeveloping and commercializing NAT products using transcription-mediatedamplification, or TMA, technology to screen donated blood, plasma, organs andtissue for viral infection. Compared to immunodiagnostic testing, whereinfection is determined by the presence of antibodies, testing directly for thepresence of viral nucleic acids improves the sensitivity of testing and enablesinfection to be detected earlier than with previously approved technologies.

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

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Assaysdeveloped with Gen-Probe, and their status in the United States and the rest ofworld include:
| ** **                                              | ** ** | **U.S.**                                                       | ** ** | **Ex-U.S.** | ** ** |
|---------------------------------------------------------|------------|----------------------------------------------------------------|------------|-------------|------------|
| PROCLEIX®  HIV-1/HCV                               |       | Marketed                                                       |       | Marketed    |       |
| PROCLEIX® ULTRIOTM  (HIV-1, HCV, and HBV test) |       | Biologics  License Application filed                           |       | Marketed    |       |
| PROCLEIX® West Nile  Virus                         |       | Investigational-only  use; Biologics License Application filed |       | N/A         |       |

 

The PROCLEIX® HIV-1/HCV Assay is a NAT product thatwas co-developed with Gen-Probe for the simultaneous detection of HIV-1 andhepatitis C virus (HCV) in plasma, whole blood, organs and tissuedonations. The global need for HIV-1 and HCV testing continues to increase. In2004 approximately 5 million people acquired HIV, bringing the number of peoplein the world living with HIV to 39 million, the highest level ever. In 2004,approximately 3 million died from AIDS, the disease caused by HIV-1 or HIV-2infection. HCV is a major cause of acute hepatitis and chronic liver disease,including cirrhosis and liver cancer. Globally, an estimated 170 millionpersons are chronically infected with HCV and 3 to 4 million persons are newlyinfected each year. The major causes of HCV infection worldwide are use ofunscreened blood transfusions, and re-use of needles and syringes that have notbeen adequately sterilized. The PROCLEIX® HIV-1/HCV Assay received FDA approvalin February 2002 and CE (Conformite Europeenne) Mark in Europe in January 2003for use on the PROCLEIX® System. The PROCLEIX® HIV-1/HCV Assay and System iscommercially available in the United States and throughout Europe, Asia,Australia and New Zealand and is under evaluation in Latin America and severalAsian countries.

The PROCLEIX® ULTRIOTM Assay is the premium NAT productoffering that adds the direct detection of hepatitis B virus (HBV) to theapproved PROCLEIX® HIV-1/HCV Assay allowing for three results to be obtained inthe same amount of time, and using the same instrumentation. Over 350 millionpeople worldwide are chronic carriers of HBV, with over 2 billion infected. HBVis the leading cause of liver cancer in the world and is at its highestprevalence in Southeast Asia, Southern Europe, India and Africa. The PROCLEIX®ULTRIOTM Assay received CE Mark Registration in Europe on the semi-automatedPROCLEIX® System in January 2004 and on the fully automated,high-throughput PROCLEIX® TIGRIS® System in December 2004. We filed aBiologics License Application (BLA) in September 2004 in the U.S. for useof the PROCLEIX® ULTRIOTM Assay on both the semi-automated PROCLEIX® System andthe PROCLEIX® TIGRIS® System.

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

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

·       PROCLEIX®System;

·       PROCLEIX®TIGRIS® System; and

·       PROCLEIX®OptivaTM System

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The PROCLEIX® System is a semi-automated instrumentplatform which is manufactured by Gen-Probe and marketed by Chiron and whichhas been commercially available since receiving FDA clearance in February 2002.The PROCLEIX® OPTIVATM System, which consists of modular components is expectedto automate several of the steps performed manually with the PROCLEIX System. Aportion of the PROCLEIX® OPTIVATM System, the Front-End Pipetor (FEP), receivedEuropean CE Marking in June 2004. The next generation fully automated,high-throughput instrument platform, PROCLEIX® TIGRIS® System was launched inEurope in December 2004 and is also available under IND for use with theWNV Assay in the U.S. The PROCLEIX® TIGRIS System is manufactured by Gen-Probeand marketed by Chiron. By significantly increasing throughput and automation,the TIGRIS System allows smaller pool sizes and enables individual donortesting (IDT) on a large scale, which is important for the detection ofdiseases with low viremic levels such as West Nile Virus and hepatitis B.

Through its joint business contractual arrangementwith us, Ortho-Clinical Diagnostics sells a full line of immunodiagnostic testsfor hepatitis viruses and retroviruses and provides supplemental tests and microplateand chemiluminescent instrument systems to automate test performance and datacollection. We manufacture, and perform research on, viral antigens used byOrtho-Clinical Diagnostics to manufacture immunodiagnostic testing assays andsupplemental hepatitis and HIV tests. Ortho-Clinical Diagnostics manufacturesand sells the assays and instrument systems. Commercial products sold under thejoint business contractual arrangement include RIBA® tests, which areimmunodiagnostic supplemental confirmatory tests for HIV and HCV developed byus, and a line of immunodiagnostics screening tests for infectious diseases. Weshare equally in the pretax operating earnings generated under the contractualarrangement. The joint business contractual arrangement holds theimmunodiagnostic rights to our hepatitis and retrovirus patents and receivesroyalties from hepatitis C virus and HIV tests sold by Abbott Laboratories, Inc.and from hepatitis C virus tests sold by Bio-Rad Laboratories, Inc. andcertain other licensees.

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

*Vaccines*

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

Influenza Vaccines:

·       FLUVIRIN®,AGRIPPAL® S1 and BEGRIVACTM trivalent influenza vaccines and

·       FLUAD®,an innovative adjuvanted influenza vaccine.

MeningococcalVaccine:

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

Travel Vaccines:

·       ENCEPURTM,a preservative-free vaccine against tick-borne encephalitis,

·       RABIPUR®/RABAVERT®,vaccines against rabies,

·       ARILVAXTM,a vaccine against yellow fever and

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

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Pediatric Vaccines:

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

·       Morupar,measles, mumps and rubella combined vaccine,

·       Oralpolio vaccine and

·       VaxemHib, glycoconjugate *Haemophilus Influenzae*vaccine.

In July 2003, we acquired United Kingdom basedPowderJect and commenced sales of FLUVIRIN® vaccine, a trivalent influenzavaccine. In addition to its U.S. approval, FLUVIRIN® vaccine is registered foruse in over 20 countries. Prior to the 2004-05 influenza season, approximately90% of FLUVIRIN® vaccine production was supplied to the U.S. market.

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

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

In 2000, we entered into agreements withSanofi-Aventis (previously Aventis Pasteur MSD) for the distribution of FLUAD®vaccine and MENJUGATE® vaccine. Under the agreements, we market FLUAD® vaccinealone and we co-promote MENJUGATE® vaccine with Sanofi-Aventis in the UnitedKingdom and Ireland. In the rest of Europe, Sanofi-Aventis distributes,co-markets and sells FLUAD® vaccine and MENJUGATE® vaccine under its ownlabels, ADIUGRIPTM and MENINVACTTM respectively.

We market travel vaccines including RABIPUR® andRABAVERT® rabies vaccine, ENCEPURTM tick-borne encephalitis vaccine, ARILVAXTMyellow fever vaccine, and DUKORAL® cholera vaccine. We also market pediatricand other vaccines.

Ourprimary manufacturing facilities for vaccines are located in: Siena and Rosia,Italy; Marburg, Germany; Liverpool, UK; and Ankleshwar, India. We mainlyoperate in India through a joint venture, Chiron Behring Vaccines PrivateLimited. We manufacture vaccines for the following diseases in thesefacilities:
| Italy                                                                                                                       | ** ** | ** **                                                                                          | ** ** | **Germany**                              | ** ** | **United Kingdom** | ** ** | **India** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------|------------|-----------------------------------------------------------------------------------------------------|------------|------------------------------------------|------------|--------------------|------------|-----------|------------|
| diptheria  haemophilus influenza type b  influenza  measles  meningococcal infection  mumps  polio (oral)  rubella  tetanus |       | diphtheria  influenza  meningococcal infection  tetanus  pertussis  rabies  tick-borne encephalitis |       | influenza  cholera  rabies  yellow fever |       | rabies             |       |

 

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

In addition, we also market our vaccines in otherEuropean countries and in the Middle East, the Far East, Africa and SouthAmerica, and to international health agencies such as UNICEF and the PanAmerican Health Organization.

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

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

*Biopharmaceuticals*

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

*TOBI® tobramycin solution forinhalation, USP*—We manufacture and market TOBI® solution, astable, premixed, proprietary formulation of the antibiotic tobramycin fordelivery by inhalation using a nebulizer. TOBI® solution has been tested andapproved for cystic fibrosis patients with *Pseudomonasaeruginosa* lung infections and is the first and only inhaledantibiotic solution to be approved by the FDA. Cystic fibrosis is caused by agenetic mutation that prevents cells from building a special protein requiredfor normal movement of sodium chloride (salt) in and out of cells lining thelungs and other organs. This abnormal movement causes secretion of thick,sticky mucus in the airways. This mucus is not cleared from the airways and, asa result, bacteria begin to grow, causing infection. *Pseudomonas aeruginosa* is the most common bacterium causinglung infections in people with cystic fibrosis. In cystic fibrosis patientswith pseudomonal lung infections, tobramycin is the most commonly usedintravenous antibiotic. The advantage of inhalation is that it permits higherantibiotic concentrations in the lung and reduces side effects by limitingsystemic exposure. Appropriate treatment of these chronic lung infections is amajor contributor to the extended life span of patients with cystic fibrosisand to improve quality of life. The TOBI® formulation is well tolerated bypatients, leading to increased patient compliance and more effective control ofinfection. Treatment with TOBI® solution decreases the bacterial load, reducesthe associated inflammatory response, and improves overall lung function. Wemarket the TOBI® solution in the U.S., the European Union, Canada, Switzerland,Norway, Israel, Argentina and Brazil.

*PROLEUKIN® (aldesleukin) forinjection*—We manufacture and market PROLEUKIN®, a recombinantform of interleukin-2. Interleukin-2 is a protein producednaturally in the body in very small quantities which stimulates the immunesystem to increase the production and function of immune cells. 

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While the preciseanti-tumor mechanism of PROLEUKIN® aldesleukin is unknown, research hasdemonstrated that PROLEUKIN® aldesleukin induces the proliferation of immunecells, including natural killer and cytotoxic T cells that can recognize andmobilize against tumor-specific antigens on the surface of malignant cells. Wemarket PROLEUKIN® aldesleukin directly or through distributors in the U.S. andover 50 other countries in North America, Europe, Asia and South America totreat metastatic renal cell carcinoma (a type of kidney cancer), and in theU.S. and Canada to treat metastatic melanoma (a form of skin cancer). Studieshave demonstrated that PROLEUKIN® aldesleukin offers the possibility of acomplete and long-lasting remission in these diseases.

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

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

*PULMINIQTM (cyclosporine, USP)inhalation solution—*In 2004, we submitted a new drugapplication, or NDA, to the FDA for marketing approval of PULMINIQTM inhalationsolution. We are seeking an indication for the increase in survival andprevention of chronic rejection in patients receiving allogeneic lungtransplants, in combination with standard immunosuppressive therapy. We believethat PULMINIQTM could be the first immunosuppressant approved for thisindication. We acquired worldwide development and commercial rights forPULMINIQTM from Novartis AG.

*CUBICIN® (daptomycin for injection)*—In2004, we filed a Marketing Authorization Application, or MAA, with the EuropeanMedicines Agency, or EMEA, for the CUBICIN® antibiotic. The indication in thesubmission is for complicated skin and soft tissue infections where thepresence of susceptible Gram-positive bacteria is confirmed or suspected. Weacquired marketing rights to the antibiotic daptomycin for certain countriesoutside of the U.S. from Cubist Pharmaceuticals, Inc. The CUBICINantibiotic has been approved by the FDA for the treatment of complicated skinand skin structure infections caused by Gram-positive bacteria.

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

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

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BETAFERON®interferon beta-1b, accounted for approximately 11% (8% product sales and3% royalties), 11% (7% product sales and 4% royalties) and 13% (9% productsales and 4% royalties) of our consolidated total revenues in 2004, 2003 and2002, respectively. No other biopharmaceutical product accounted for 10% ormore of our consolidated total revenues in any of the last three fiscal years.

***Research and Development***

Our research anddevelopment focuses on the prevention and treatment of cancer and infectiousand pulmonary diseases. In addition to our research and development activities,technologies that are developed in collaborations with third parties, as wellas technologies licensed from outside parties, also are sources of potentialproducts for our segments. Products or product candidates that areinappropriate for our commercial organization are out-licensed to othercompanies. This portfolio of intellectual property is an important part of our businessmodel.

*Blood Testing*

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

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

We moved beyond bloodtesting and into the broader realm of blood safety when we entered intocollaboration with ZymeQuest in 2003 to develop and commercialize ZymeQuest’senzyme conversion system. This system converts groups A, B and AB red bloodcells to enzyme-converted universal blood group O (ECO). This technology couldfill a critical need for blood and transfusion centers as between 5% and 10% ofthe global donated blood supply is discarded each year due to non-matchesbetween donated blood and patients’ blood type requirements. We made an equityinvestment in ZymeQuest and obtained worldwide marketing and commercial rightsto the technology.

*Vaccines*

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

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

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

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affects the membranesaround the brain and spinal cord or the bloodstream, and can result in braindamage, blindness, deafness, limb amputations and death. Infection may be fataleven if diagnosed early, making prevention essential. Young children and personsin close living quarters such as college dorms or military facilities are athighest risk for meningococcal disease.

In 2004, we began distributing a meningococcal Bvaccine in New Zealand, MENZBTM, to protect against the specific meningococcal Bstrain responsible for a 13-year epidemic in that country.

Serotype B, along withserotypes A, C, W and Y cause approximately 95% of the meningococcal infectionsworldwide. Multivalent vaccines, effective against more than one serotype offersignificant advantages over monovalent vaccines. We are developing atetravalent conjugated vaccine against serotypes A, C, W and Y and are completingPhase II studies of this ACWY vaccine in a variety of age groups including agesunder two.

While our currentmeningococcal B product, MENZBTM is efficacious against only a single strain ofmeningococcal B, we are also developing a second-generation vaccine candidateutilizing our novel genomic approach against Meningococcus B, a disease forwhich no broadly efficacious vaccine is currently available. We completed PhaseI testing of the meningococcal B vaccine in 2004.

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

*Biopharmaceuticals*

Research and development in the biopharmaceuticalsegment develops protein and small molecule therapies for cancer and infectiousand pulmonary disease.

*Infectious andPulmonary Disease*

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

*Tobramycininhalation powder (TIP)—*In December 2001, we enteredinto a collaboration with Nektar Therapeutics Inc. (Nektar) to develop andregister an inhalable dry-powder formulation of the antibiotic tobramycin as anextension of our TOBI® formulation franchise. TIP is used with a new hand-held,fully portable device. We completed Phase I clinical trials in 2004, and basedon an understanding with the FDA, we anticipate moving to Phase III testing ofthe product in 2005.

*Oncology*

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

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

*CHIR-12.12—*InDecember 2004 we filed an IND application for a monoclonal antibodyoncology compound, anti-CD40. This is the first project being developed underour collaboration agreement with Xoma Ltd. for the commercialization oftherapeutic antibodies for cancer.

***Research and Development Expenses and Related Revenues***

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

***Business Relationships***

We have important businessrelationships with various companies, including;

*Gen-ProbeIncorporated*

We have a collaborationwith Gen-Probe relating to the development and commercialization of NATproducts under the PROCLEIX brand name to screen donated blood, plasma, organsand tissue for viral infection. PROCLEIX assays and systems incorporate NATtechnology to detect viral RNA and DNA in donated blood and plasma during thevery early stages of infection, when those infectious agents are present butcannot be detected by immunodiagnostic tests. Gen-Probe manufactures the NATassays and certain instruments, and Chiron sells both assays and instrumentsunder the PROCLEIX® brand name. Effective January 1, 2004, under anamendment to the worldwide blood screening collaboration agreement with Gen-Probe,permanent, fixed revenue shares were adopted for each party. Gen-Probe’s sharewas set at 45.75% of net revenues for assays, which include a test for thehepatitis C virus. For commercial assays, which do not test for hepatitis Cvirus, such as the West Nile test, each party retains 50% of the net revenuesafter deduction of specified expenses.

*Ortho-ClinicalDiagnostics, Inc.*

We have a joint businesscontractual arrangement with Ortho-Clinical Diagnostics relating to thedevelopment and commercialization of immunodiagnostic tests using recombinantDNA and antibody technologies to detect retroviruses and hepatitis viruses inblood. Under the terms of the arrangement, Ortho-Clinical Diagnosticsmanufactures and sells the assays and instrument systems, and Chiron suppliesraw materials for the assays. Chiron and Ortho-Clinical Diagnostics shareequally in the pretax operating earnings generated by the joint businesscontractual arrangement. Our joint business arrangement with Ortho-ClinicalDiagnostics is operated under a contractual arrangement and is not a separateand distinct legal entity. The joint business contractual arrangement holds theimmunodiagnostic rights to our hepatitis and retrovirus patents and receivesroyalties from the sale of hepatitis C virus and HIV tests sold by AbbottLaboratories, Inc. and from sales of hepatitis C virus tests by Bio-RadLaboratories, Inc. and certain other licensees.

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*CubistPharmaceuticals*

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

*Schering AG andBerlex Laboratories, Inc.*

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

*Nektar Therapeutics, Inc.*

In December 2001, weentered into a collaboration with Nektar to develop and register an inhalabledry-powder formulation of the antibiotic tobramycin as an extension of ourTOBI® formulations franchise. Under the terms of the collaboration, Nektar isresponsible for development of the dry powder formulation and inhalationdevice, as well as supplying drug product for clinical trials and the market. Chironis responsible for all other aspects of drug development including clinicaltrial conduct, regulatory submissions, preparation for product launch and salesand marketing of the final drug product. Under the agreement, we pay upfrontpayments and development milestones, and we will pay royalties when the productis commercialized.

*XOMA Ltd.*

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

***Commercialization***

Technologiesarising out of our research and development efforts are commercialized invarious ways:

·       Wemarket and distribute certain products, either directly or throughdistributors. See “Sales and Marketing” below;

·       Wedevelop other products in collaboration with third parties. Under collaborationagreements, marketing rights may be assigned to us or to the collaborator orshared by both parties. In the event rights are assigned to us, we generallypay royalties to or enter into revenue split agreements with 

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

·       Welicense other technologies to third parties, with the licensee assumingresponsibility for further development. We generally receive royalties on salesof the resulting product. Agreements under which we currently derive royaltyrevenues for technologies licensed to third parties include:

·        licensesto F. Hoffmann-LaRoche Limited and Roche Molecular Systems, Inc. under ourhepatitis C virus and HIV related patents for use in nucleic acidamplification in *in vitro*diagnostics and in blood screening,

·        anagreement with Bayer Corporation relating to, among other things, use of ourhepatitis C virus and HIV technologies for nucleic acid amplification in *in vitro* diagnostics,

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

·        alicense to LabCorp, including its subsidiary, National Genetics Institute, touse our patented HCV NAT technology in screening plasma donations in the UnitedStates and

·        agreements with NovoNordisk AS relating to technology used in the manufacture of recombinant humaninsulin and glucagons.

***Sales and Marketing***

*Blood Testing*

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

In 2002, we signed amulti-year agreement with the American Red Cross, which collects approximately50% of the 14 to 15 million units of blood collected in the U.S. each year. Underthat agreement, the American Red Cross purchases from Chiron certain products,instrumentation and services that enable the American Red Cross to perform amplifiednucleic acid screening on the blood it collects. Currently we are in multi-yearcontracts through the tender process with the public sector blood services ofmany countries outside the U.S., with the most significant in terms of sizebeing the United Kingdom, Belgium, France and Australia.

*Vaccines*

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

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*BioPharmaceuticals*

Our biopharmaceutical marketing and sales organizationfor the U.S. is headquartered in Emeryville, California, and Europeanoperations are headquartered in Thames Valley, England. We focus our salesefforts on specialist physicians, principally oncologists and pulmonologists,who are based in hospitals and large clinics. Generally, we sell products towholesalers, distributors, clinics and hospital pharmacies.

***Competition***

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

Important biotechnologyresearch is performed in universities and nonprofit research organizations.These entities are becoming more active in seeking patent protection andlicensing revenues for their discoveries. The competition among largepharmaceutical companies and smaller biotechnology companies to acquire technologiesfrom these entities also is intensifying. We actively collaborate with suchentities in research, and have and will continue to license their technologiesfor further development. However, these institutions also compete with us torecruit scientific personnel and to establish proprietary positions intechnology.

***Blood Testing***

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

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

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*Vaccines*

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

The competitive factors in vaccines are proven abilityto supply product (particularly for influenza sales in the U.S.), price, theintroduction of new products including vaccines against diseases for which novaccine was previously available and new combination vaccines which can preventseveral diseases in a single product. Public health authorities, medicalpractitioners and patients frequently favor combination vaccines, particularlyin pediatric vaccines, because they eliminate the need for multiple injectionsand may increase overall compliance with recommended vaccination schedules. Asnew combination vaccines are introduced, older combinations and single productsoften become obsolete. We may be limited in our ability to develop and marketcertain combination vaccines if one of the vaccines, which would otherwise beincluded in the combination, is covered by valid and enforceable patents orother proprietary rights held by third parties.

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

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

*Biopharmaceuticals*

*TOBI® tobramycin solution forinhalation* is the first and only inhaled antibiotic solutionto be approved by the FDA for cystic fibrosis. The use of oral and intravenousantibiotics to treat pseudomonal and other bacterial infections is wellestablished and in cystic fibrosis patients with pseudomonal lung infections,tobramycin is the most commonly used intravenous antibiotic. The advantage ofinhalation is that it permits higher antibiotic concentrations in the lung andreduces side effects by limiting systemic exposure. Competitive medicaltherapies include generic antibiotics, anti-inflammatory drugs, pharmacistcompounded generic tobramycin, oral replacement enzymes to maintain nutritionand mucolytics to clear pulmonary secretions.

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

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monoclonal antibodytherapies. The enrollment in these trials reduced the available new patientsfor PROLEUKIN aldesleukin in 2004, and these competitive pressures are expectedto continue.

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

***Government Regulation***

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

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

*Blood Testing*

In the U.S., blood-testing products, whether basedupon nucleic acid testing or immunodiagnostic testing technologies, may only be commercially used pursuant to theterms of approval of specific license applications in which the product’ssafety and effectiveness must be demonstrated based upon well-controlledstudies. Upon approval of the license application, the product may be marketedfor the specific uses, which were identified in the approval. Facilities,processes and operations used for the manufacture, testing, storage anddistribution of our blood testing products in the U.S. are subject to FDAapproval and periodic inspection.

In Europe, our bloodtesting products are regulated through the In Vitro Diagnostic Medical DevicesDirective. The PROCLEIX® HIV-1/HCV Assay and PROCLEIX® ULTRIOTM Assay arein compliance with the IVD Directive. In other geographic areas, such asAustralia, Canada and Mexico, local regulatory authorities regulatedblood-testing products.

*Vaccines andBiopharmaceuticals*

In the U.S., our therapeutic and vaccine products(both commercial and investigational) are primarily regulated under federal lawand are subject to rigorous FDA approval procedures. No product can be marketedin the U.S. until an appropriate application is approved by the FDA. The FDAapplies the approval procedures on a product-by-product basis and typicallyrequires, among other things, an extensive three-phase human clinical testingprogram. In Phase I, studies are conducted with a relatively small numberof subjects to assess the safety of the product. In Phase II, the productis evaluated in a larger group of subjects to begin to assess efficacy andappropriate dosing. Phase III studies are conducted in the targetpopulation with a number of subjects that is large enough to provide sufficientdata to establish statistically the safety and efficacy of the product. The FDAapproves products to treat specified medical conditions or disorders. Furtherstudies would be required to market the product for other uses. The FDA 

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must inspect and approveall facilities used to manufacture, fill, test and distribute biologicproducts. If any change in manufacturing facilities or processes occurs afterFDA approval, additional regulatory review and possibly additional clinicalstudies may be required.

Licensing procedures inEurope are comparable to those in the U.S. In 1995, the European Unionestablished a centralized procedure for licensing of products derived from theuse of high technology/biotechnology processes. This procedure leads to thegrant of a single license for the entire European Union. Effective January 1,1998, the European Union has also adopted a decentralized procedure under whicha license granted in one member state is mutually recognized by the othermember states, leading to a grant of licenses in member states recognizing theoriginal license. This procedure is replacing independent national licensing ofproducts in the European Union. In addition, products must receive countrypricing approvals in some territories before they can be marketed in thatcountry.

***Patents and Intellectual Property Rights***

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

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

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

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

*Blood Testing*

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

The PROCLEIX® ULTRIOTM Assay is covered by severalpatents held by Gen-Probe and licensed to us.

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

The hepatitis C virus immunoassay diagnosticproducts sold by our joint business contractual arrangement with Ortho-ClinicalDiagnostics, Inc. are covered by numerous patents in the U.S. andworldwide. These patents contain claims directed to hepatitis C virusimmunoassay methods, kits and hepatitis C virus polypeptides. In the U.S.,certain patents expire between 2011 and 2017. The corresponding European familyof patents expires in 2010.

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

We own additional HCV and HIV patent families andpending applications.

We hold the registeredtrademark PROCLEIX®, and the trademarks ULTRIOTM and OPTIVATM. TIGRISTM is atrademark of Gen-Probe.

*Vaccines*

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

Widely registeredtrademarks of Chiron and our subsidiaries include AGRIPPAL®, FLUAD®, FLUVIRIN®,MENJUGATE®, RABAVERT®, RABIPUR®, and RIBA®. Other trademarks of Chiron and oursubsidiaries include ARILVAXTM, BEGRIVACTM, ENCEPURTM, POLIORALTM andTRIACELLUVAXTM.

*Biopharmaceuticals*

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

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

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

We own additional pending patent applications directedto the use of IL-2 in combination therapy in cancer or infectiousdisease.

We own patent applications related to the use oftifacogin in severe pneumonia. Any eventual patent in this family will expirein 2022.

We have widely registeredthe trademarks PROLEUKIN® and TOBI® in addition to holding the trademarkCARDIOXANETM for dexrazoxane, a cardioprotectant for doxorubicin cancertreatment. The trademarks BETASERON® and BETAFERON® are trademarks of ScheringAG. CUBICIN® is a trademark of Cubist Pharmaceuticals.

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***Seasonality***

Sales of certain of ourproducts, particularly influenza vaccines, are seasonal, with higher sales inthe third and fourth quarters of the year. ENCEPURTM, our vaccine againsttick-borne encephalitis, is also seasonal with higher sales in the first halfof the year.

***Manufacturing and Raw Materials***

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

The vaccines segment primarily manufactures product inour facilities in the United Kingdom, Germany, Italy and India. In connectionwith the production of our flu vaccine products, we must purchase largequantities of chicken eggs. For FLUVIRIN® vaccine, we purchase those eggs andincubation services from a single supplier in the United Kingdom, and pursuantto the contract with that supplier we have agreed to make specified purchasesfrom that supplier through 2009, subject to our right to terminate thisagreement earlier upon payment of a termination fee.

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

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

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

***Employees***

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

***Relationship with Novartis AG***

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

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

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

·       Aslong as Novartis owns at least 40% of our common stock, we may not engage incertain transactions, including significant debt or equity issuances, debt orequity repurchases, most mergers and acquisitions, the payment of cashdividends, amendments to Chiron’s Restated Certificate of Incorporation orBylaws, withoutNovartis’ approval.

·       Novartiswill not increase its ownership interest in us above 55% unless it eitheracquires all of our outstanding capital stock in a “buy-out” transaction or itincreases its ownership interest in us up to 79.9% in a transaction approved bya majority of the independent members of our Board of Directors.

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

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

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

·       Novartishas an option to purchase newly issued shares of our common stock directly fromus at fair market value, subject to certain conditions, including thestandstill restrictions described above.

·       Novartisand we will cooperate and collaborate in research, development, manufacturingand marketing of biotechnology products on an arm’s-length basis whileremaining independent to pursue our respective corporate strategies andopportunities.

For more information oncertain of these agreements, see Note 10, “Related Party Transactions” of Notesto Consolidated Financial Statements.

***Available Information***

The followingdocuments can be found free of charge on our website at *http://www.chiron.com* or by contacting ourInvestor Relations department at (510) 923-2300 or by sending an e-mailmessage to *investor_relations@chiron.com*:

·       ourannual report on Form 10-K, quarterly reports on Form 10-Q,current reports on Form 8-K and all amendments to these reports assoon as reasonably practicable after such filings are electronically filed withthe Securities and Exchange Commission;

·       ourCorporate Governance Guidelines and our Code of Conduct and Commitment toEthical Conduct;

·       ourPolicy on Reporting Suspected Financial Integrity Concerns; and

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·       thecharters of the Audit Committee, Compensation Committee, Nominating andCorporate Governance Committee and Finance Committee and of our Board ofDirectors.

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

**ITEM 2.**                PROPERTIES

*Emeryville Campus*

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

*Other Facilities*

In 2003, our Board of Directors approved$50.7 million in expenditures for a 25-year building lease and$42.2 million for capital improvements, both of which are part of a$97.0 million project for expansion and replacement of our flu vaccinesmanufacturing facility in Liverpool, England. The new manufacturing facilitywill replace a portion of the existing flu vaccines manufacturing facilities inLiverpool, England and is anticipated to be available in the middle of 2008 forthe manufacture of flu vaccines, subject to regulatory approval.

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

We have the following facilities for our vaccinesoperations:

Owned

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

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

·       Manufacturingfacilities in Liverpool, England and

·       Manufacturingfacilities in Ankleshwar, India.

Leased

·       Manufacturingfacilities in Liverpool, England,

·       Administrativeoffice in Oxford, England,

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

·       Administrativeand sales offices in Mumbai, India,

·       Administrativeoffice in Fairfax, Virginia,

·       Salesoffice in Philadelphia, Pennsylvania,

·       Salesoffice in Thailand,

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·       Salesoffice in China and

·       Salesoffice in Brno-Slatina, Czech Republic.

We lease thefollowing facilities for our biopharmaceutical operations:

·       Researchand development and administrative facilities in Seattle, Washington,

·       Manufacturingand distribution facilities in Annandale, New Jersey,

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

·       Administrativeand warehouse facilities in Munich, Germany,

·       Salesoffice in Hong Kong,

·       Severalsales offices in Europe and Canada,

·       Laboratoryfacility in Davis, California and

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

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

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

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

**ITEM 3.**                LEGAL PROCEEDINGS

***Average Wholesale Price Litigation***

In January 2003, the County of Suffolk filed acomplaint in the United States District Court for the Eastern District of NewYork against numerous biotechnology and pharmaceutical companies, includingChiron, in connection with setting average wholesale prices for variousproducts, including TOBI® solution, which are reimbursed by Medicaid. In November 2004,the County of Nassau filed an identical complaint, also in the United StatesDistrict Court for the Eastern District of New York. In both cases, theplaintiff alleged that defendants violated federal racketeering laws, federaland state laws on Medicaid fraud, and state laws on unfair trade practice,breach of contract, fraud and unjust enrichment by devising and implementing afraudulent pricing scheme against Medicaid beneficiaries, and soughtdeclaratory relief, as well as compensatory and punitive damages. In January 2005,the County of Suffolk filed an amended complaint with the In re PharmaceuticalIndustry Average Wholesale Price Litigation pre-trial proceedings that did notname Chiron as a party to the action.

In February 2005, the State of Illinois throughits Attorney General filed a complaint in the Circuit Court of Cook County,Illinois, County Department, Chancery Division, against numerous biotechnologyand pharmaceutical companies, including Chiron, in connection with settingaverage wholesale prices for various products that are reimbursed by Medicareand Illinois Medicaid. The Attorney General alleges that defendants violatedthe Illinois Consumer Fraud and Deceptive Business Practices Act, the IllinoisPublic Assistance Fraud Act, and the Illinois Whistleblower Reward andProtection Act, and seeks declaratory relief as well as damages.

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

The Office of the Inspector General of the UnitedStates Department of Health and Human Services and certain State AttorneysGeneral are investigating pharmaceutical industry practices concerning reportingof average wholesale prices for products covered by Medicare and Medicaid. Itappears that the Office of the Inspector General’s investigation is connectedto a pending, but as yet unserved, qui tam (whistle blower) lawsuit, in whichChiron and other companies are named defendants.

It is not known when noron what basis these matters will be resolved.

***F. Hoffmann-La Roche A.G. and Roche DiagnosticsGmbH—HCV***

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

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

In December 2000, Roche Diagnostics initiatednullity proceedings before the German Federal Patent Court (“Bundespatentgericht”)regarding Chiron’s ‘931 patent and the German Patents. In August 2002,the Bundespatentgericht upheld the validity of the German Patents, butnullified the German portion of the ‘931 patent. In November 2002,both Chiron and Roche Diagnostics filed appeals before the Federal SupremeCourt regarding the Bundespatentgericht’s nullity decisions. Certaininfringement actions related to the ‘931, ‘104 and ‘527 nullity proceedings arecurrently stayed pending the outcome of these appeals.

It is not known when noron what basis these matters will be resolved.

***FLUVIRIN® influenza virus vaccine***

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

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

In October 2004,Chiron received a grand jury subpoena issued by the U.S. Attorney’s Office forthe United States District Court for the Southern District of New Yorkrequesting production of certain documents and materials relating to thesuspension of our license. Also, in October 2004, the U.S. Securities andExchange Commission, or SEC, notified Chiron that it would conduct an informalinquiry into the suspension with respect to potential violations of federalsecurities laws. The SEC also requested copies of related records. In February 2005,the SEC issued a formal order of investigation with respect to potentialviolations of federal securities laws. In November 2004, the U.S. House ofRepresentatives Committee on Energy and Commerce notified Chiron that it isconducting an investigation into the license suspension. The Committee alsorequested copies of related records. Chiron is cooperating with theseinvestigations, and has provided documents and information and made witnessesavailable for interviews.

**A.   FLUVIRIN® vaccineSecurities Class Actions**

Between October 2004and December 2004, five securities class action lawsuits were filedagainst Chiron and certain Chiron officers on behalf of purchasers of Chironsecurities for class periods ranging from July 23, 2003 through October 13,2004. Four of the suits were filed in the United States District Court for theNorthern District of California. One action, although originally filed in theUnited States District Court for the Eastern District of Pennsylvania, waslater transferred to the United States District Court for the Northern Districtof California. In February 2005, the Court approved the voluntarydismissal of two of the five class actions. The three remaining complaintsallege, among other things, that the defendants violated certain provisions ofthe federal securities laws by making false statements preceding the suspensionof Chiron’s license to manufacture FLUVIRIN vaccine, and seek unspecifiedmonetary damages and other relief from all defendants.

**B.   FLUVIRIN® vaccineShareholder Derivative Actions**

Between October 2004 and November 2004, sixshareholder derivative complaints were filed in the Superior Court of the Stateof California for the County of Alameda, naming Chiron as a nominal party andnaming certain current and former Chiron officers and directors and Novartis AGas defendants  in connection with thesuspension of Chiron’s license to manufacture FLUVIRIN vaccine. One complaintalso named Chiron as a defendant and sought relief from Chiron, including anequitable accounting. In December 2004, the six derivative actions wereconsolidated for discovery and trial under the caption *In re Chiron Corporation Derivative Litigation*(the “Derivative Action”)*.* TheDerivative Action alleges that defendants are liable for breach of theirfiduciary duties, abuse of control, gross mismanagement, waste of corporateassets and violation of California Business and Professions Code § 17200 andthat certain defendants are liable for violation of California CorporationsCode § 25402. The Derivative Action also alleges that Novartis AG is liable forbreach of the implied covenant of good faith and fair dealing. The DerivativeAction seeks unspecified monetary damages and other relief from all defendants.The Derivative Action does not seek any affirmative relief from Chiron.

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

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

**C.   Other FLUVIRIN® vaccineLegal Matters**

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

In December 2004 and January 2005, twocomplaints were filed, one in the United States District Court for the Districtof Connecticut and the other in the Superior Court of the State of Californiafor the County of Alameda, in which the plaintiffs claim they suffered injuriesas a result of a flu shot they received. The complaints seek unspecifiedmonetary damages.

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

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

Additional lawsuits may befiled against the Company regarding the suspension of our license tomanufacture FLUVIRIN vaccine. It is not known when nor on what basis thesematters will be concluded. For additional information concerning the risks weface as a result of these FLUVIRIN vaccine developments, see “Factors That May AffectFuture Results—The recent developments with respect to FLUVIRIN vaccine willharm our business and results of operations.”

***Institut Pasteur***

In April 2003, Institut Pasteur filed a complaintin the United States District Court for the District of Columbia against Chironseeking reversal of certain judgments entered by the Board of Patent Appealsand Interferences (the “Board”) of the United States Patent and TrademarkOffice in Patent Interference No. 103,659 (the “‘659 Interference”).The ‘659 Interference involved claims in Chiron’s U.S. Patent No. 5,156,949(the “‘949 patent”) and in certain U.S. patent applications assigned toInstitut Pasteur (the “Chang applications”), relating to HIV immunodiagnosticmethods. In the ‘659 Interference, the Board decided that the inventors ofChiron’s ‘949 patent were the first to invent the technology at issue.Chiron asserted that Institute Pasteur was barred from bringing claims per the1993 HIV Cross-License Agreement between Chiron and Institut Pasteur (the “Agreement”),and that Institut Pasteur’s standing to bring its appeal was a matter forarbitration under the terms of the Agreement. In February 2005, the Courtordered the parties to arbitrate the standing issue and the case wasadministratively dismissed. In March 2005, Chiron sent Institut Pasteur anotice of arbitration.

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

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

It is not known when noron what basis this matter will be resolved.

***Laboratory Corporation of America Holdings***

In August 2003, Chiron filed a complaint in theUnited States District Court for the Northern District of California againstLaboratory Corporation of America Holdings, Laboratory Corporation of Americaand National Genetics Institute (collectively, the “Defendants”), seekingdamages and an injunction against Defendants’ manufacture, use and sale ofcertain HIV assays for infringing Chiron’s U.S. Patent No. 6,531,276 (the “276patent”). In February 2004, Chiron voluntarily dismissed this case withoutprejudice and refiled the complaint before the United States District Court forthe Central District of California. The trial is scheduled to begin on November 7,2005.

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

In April 2003, Chironfiled a complaint in the United States District Court for the Northern Districtof California against Laboratory Corporation of America Holdings (“LabCorpHoldings”), Laboratory Corporation of America (“LabCorp”) and National GeneticsInstitute (“NGI”) (collectively, the “Defendants”), seeking damages and aninjunction against Defendants’ manufacture, use and sale of the UltraQualTM HCVRT-PCR assay and HCV SUPERQUANTTM assay for infringing Chiron’s U.S. Patent No. 6,074,816(the “816 patent”). The Defendants filed a complaint in the United StatesDistrict Court for the District of Delaware against Chiron seeking a declaratoryjudgment that Defendants infringe neither the “816 patent, nor U.S. Patent Nos.5,712,088, 5,863,719, 6,074,816, and 5,714,596 (collectively, the “ChironHepatitis C virus-related patents”), and that the Chiron Hepatitis Cvirus-related patents are invalid. In December 2004, the parties settledthe matter and the complaints in California and Delaware were dismissed.

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

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

It is not known when noron what basis these matters will be resolved.

***Sysmex Corporation***

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

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

It is not known when noron what basis these matters will be resolved.

**ITEM 4.**                SUBMISSION OFMATTERS TO A VOTE OF SECURITY HOLDERS

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

**EXECUTIVE OFFICERSOF THE REGISTRANT**

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

 

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

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**Dr. Goldstein**joined Chiron as Vice Presidentand President, Chiron Blood Testing Division in September 2002. In February 2005,Dr. Goldstein was appointed to the position of President and ChiefOperating Officer. He had served as interim Chief Operating Officer of Chironsince November 2004. From 2000 to 2002, Dr. Goldstein was GeneralPartner at Windamere Venture Partners, L.L.C., a venture fund makinginvestments in early stage biotechnology, pharmaceutical, medical device anddiagnostic companies. From 1997 to 2001, Dr. Goldstein was President andCEO of Applied Imaging Corporation, a leading supplier of instrument systemsfor prenatal and cancer genetics. From 1999 until 2002, Dr. Goldstein alsoserved as Chairman of the Board of Applied Imaging and continues to serve as adirector of one of Applied Imaging’s subsidiaries. From 1986 to 1997, Dr. Goldsteinworked for Johnson & Johnson in various executive managementpositions, including President of Ortho Diagnostic Systems and Executive VicePresident of Professional Diagnostics at Johnson & Johnson WorldHeadquarters. Dr. Goldstein holds a B.A. degree in Biology from RiderUniversity, an M.S. in Immunology and a Ph.D. in Microbiology from St. John’sUniversity.

**Mr. Green**joined Chiron as Vice President and General Counsel in October 1990,having served as Secretary or Assistant Secretary since Chiron’s inception in1981 until March 2005. In August 2004, Mr. Green was designatedSpecial Counsel to the Chief Executive Officer upon the appointment of Ursula Bartelsas Chiron’s General Counsel. He continues to serve as a Sr. Vice President. SinceNovember 2003, Mr. Green has served on a part-time basis as GeneralCounsel, Secretary and member of the Management Committee of the Gordon &Betty Moore Foundation, a private, philanthropic foundation, in which Chirondirector, Edward E. Penhoet also is employed as President and Chief ExecutiveOfficer. Mr. Green was appointed Chief Program Officer, Environment, ofthe Foundation in September 2004. From February through August 2002,Mr. Green served as President of Chiron’s Blood Testing division. From1981 to 1990, he was a partner in the San Francisco law firm of Brobeck,Phleger & Harrison.

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

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

**Ms. Leader**joined Chiron in 1992, and is the Vice President, Business Support Services andChief Information Officer. She is responsible for information technology,corporate facilities and corporate risk-mitigation services, includingenvironmental health and safety, and business continuity planning. Sincejoining Chiron, Ms. Leader has held various positions in treasury,corporate development and information management. Prior to joining Chiron, sheworked in treasury management for both Security Pacific Bank and Bank ofAmerica. Ms. Leader holds a B.A. degree in government and an M.B.A. fromSaint Mary’s College of California.

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

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**Mr. Pien**joined Chiron as President and Chief Executive Officer, and adirector, in April 2003. Upon the resignation of Seán P. Lance as Chiron’sChairman of the Board following the annual meeting of stockholders in May 2004,Mr. Pien also was elected Chairman of the Board. In February 2005, Mr. Pienrelinquished the title of President which was transferred to Dr. Goldsteinin connection with the formalization of the role of Chief Operating Officerassumed by Dr. Goldstein. Mr. Pien joins Chiron from GlaxoSmithKline(GSK), which resulted from the merger of GlaxoWellcome and SmithKline Beecham,where he spent over twelve years in positions of international and globalmanagement responsibility, including: President of PharmaceuticalsInternational GSK from December 2000 to March 2003, including serviceas a member of the Corporate Executive Team; President, Pharmaceuticals,SmithKline Beecham (1998 to 2000); President, Pharmaceuticals-North America,SmithKline Beecham (1998); Senior Vice President and Director-North Asia(1997); Managing Director and Senior Vice President-UK (1995 to 1997); VicePresident and Director, Marketing-US (1993 to 1995); Vice President andDirector, Product Marketing-US, heading the arthritis, cardiovascular andvaccine groups (1992 to 1993); and Vice President and Director of New ProductDevelopment-US (1991 to 1992). Prior to joining SmithKline Beecham, Mr. Pienworked six years for Abbott Laboratories and five years for Merck &Co., in positions of sales, marketing research licensing and productmanagement. Mr. Pien served as a director of ViroPharma Incorporated from1998 to 2003. He currently serves as a director of several non-profitorganizations: Oakland Children’s Hospital, California Healthcare Institute andBio-Tech Industry Trade Association.

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

**Mr. Smith**joined Chiron as Vice President, Controller in February 1999 and wasdesignated Chiron’s principal accounting officer. In February 2002, Mr. Smithwas appointed Vice President, Finance. In April 2003, Mr. Smith wasappointed interim Chief Financial Officer. In November 2003, Mr. Smithwas appointed Chief Financial Officer. Prior to joining Chiron, Mr. Smithserved as the Vice President, Finance and Chief Financial Officer of Anergen, Inc.from 1997 until he joined Chiron. From 1988 to 1997, Mr. Smith heldvarious financial management positions with Genentech, Inc., in both theUnited States and Europe.

**Mr. Soland**joinedChiron as Vice President and President, Chiron Vaccines in late February 2005.He is responsible for the operations of Chiron’s global vaccine business. From2003 until joining Chiron, Mr. Soland served as the President and ChiefExecutive Officer of Epigenesis Pharmaceuticals, a privately-heldbiopharmaceutical company that develops inhaled respiratory medicines for thetreatment of asthma, chronic obstructive pulmonary disease and allergicrhinitis, from 2003 to 2005. From 1993 to 2003, Mr. Soland spent 10 yearswith GlaxoSmithKline Biologicals in a variety of executive positions, includingVice President and Director, Worldwide Marketing Operations from 1998-2003,and Vice 

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Presidentand Director of SmithKline Beecham Pharmaceuticals, Vaccine Business Unit -U.S., from 1995 to 1998. Prior to joining GlaxoSmithKline, Mr. Solandspent eight years with Connaught Laboratories, a Pasteur Mérieux company withassignments in sales, sales management and product management. Mr. Solandholds a B.S. degree in Pharmacy from the University of Iowa, and was a licensedpharmacist (1981).

**Dr. Walser**joined Chiron as Division Vice President, Corporate Strategy in November 2001.Prior to joining Chiron, Dr. Walser was a principal in WRW, aLos-Angeles-based management consultancy working with The RockefellerFoundation and the Boston Consulting Group on a variety of issues in biotechnologyand healthcare. Before that, Dr. Walser trained in the Emergency Medicineprogram at UCLA, and worked for several years in Los Angeles with thehealthcare practice of the Boston Consulting Group. Dr. Walser earned hisundergraduate degree from Stanford, his medical degree from the University ofVirginia School of Medicine and his law degree, *magna cumlaude*, from Harvard Law School.

**Mr. Walther**initially joined Chiron as a consultant in August 1998,and was appointed as Vice President, Commercial Development, North America andAsia Pacific in January 2001. Mr. Walther has over two decades ofexperience in the health care industry in various executive managementpositions. From 1995 to 1998, Mr. Walther was Vice President, GlobalMarketing and International Sales for Gen-Probe, Incorporated. From 1991to 1995, Mr. Walther owned and operated a Seattle-based manufacturingcompany involved in producing equipment for the outdoor recreational industry. Hewas head of sales and marketing for Seattle-based Genetic Systems from 1984 to1991. Prior to that, Mr. Walter worked for Abbott Diagnostics and AmericanHospital Supply Corporation in a variety of sales, marketing and businessdevelopment positions. Mr. Walther holds a B.S. degree in microbiology andimmunology from Michigan State University and a Masters of BusinessAdministration from the University of Washington.

**Mr. Wheeler**joined Chiron as Vice President, President of ChironBioPharmaceuticals, responsible for the commercial operations of Chiron’s biopharmaceuticalsbusiness, in August 2001. Prior to joining Chiron, Mr. Wheeler was asenior member of The Boston Consulting Group’s health care practice and a keycontributor to the firm’s practice in hospital strategy, disease management,and pharmaceutical capabilities. Based in Boston, he joined the firm in 1988. Beforejoining the Boston Consulting Group, Mr. Wheeler worked for Merck’s MSDRLresearch unit, where he served as a senior engineer in process development. Herecently served as the leader of The Boston Consulting Group’s Scientist’sNetwork. In partnership with the Rockefeller Foundation, he has joined theGlobal Alliance for TB Drug Development, a public-private partnership todevelop new anti-tuberculosis drugs.

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**PART II**

**ITEM 5**.                MARKETFOR THE REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUERPURCHASES OF EQUITY SECURITIES

Our common stock is quoted on the NASDAQ NationalMarket System under the symbol CHIR. As of December 31, 2004, there were3,843 holders of record of Chiron common stock. We have declared no cashdividends since our inception and do not expect to pay any dividends in theforeseeable future. Pursuant to an agreement with Novartis, Novartis mustapprove our declaration and payment of dividends. See “Relationship withNovartis AG” above.

Thequarterly high and low closing sales prices (rounded to the nearestone-hundredth) of our common stock for each quarter of 2004 and 2003 are shownbelow.
| ** **     | ** ** | **2004** | ** ** | **2003** | ** ** |
|----------------|------------|----------|------------|----------|------------|
| ** **     | ** ** | **High** | ** ** | **Low**  | ** ** | **High** | ** ** | **Low** | ** ** |
| First Quarter  |       | $        | 56.38      |     | $          | 44.01 |   | $ | 40.72 |   | $ | 34.41 |   |
| Second Quarter |       | 48.59    |       | 42.25    |       | 49.00 |   | 37.68 |   |
| Third Quarter  |       | 48.01    |       | 42.38    |       | 56.75 |   | 43.23 |   |
| Fourth Quarter |       | 45.42    |       | 30.76    |       | 56.98 |   | 51.75 |   |
|                |            |          |            |          |            |  |  |  |  |  |  |  |  |

 

We issued and sold $385.0 million aggregate principalamount of 23⁄4% convertible debentures due 2034 on June 22, 2004 in aprivate offering to Credit Suisse First Boston and Morgan Stanley (the “InitialPurchasers”). We have been advised by the Initial Purchasers that thedebentures were resold in transactions that were exempt from the registrationrequirements of the Securities Act to persons reasonably believed by theinitial purchasers to be “qualified institutional buyers” (as defined in Rule 144Aunder the Securities Act) in reliance on Rule 144A. These debentures matureon June 30, 2034 and accrue interest at a rate of 2.75% per year andinterest is payable on June 30 and December 30 of each year. Thedebentures are senior, unsecured obligations of Chiron and rank equal in rightof payment with all of Chiron’s existing and future unsecured andunsubordinated indebtedness.

The holders of the debentures may convert theirdebentures into Chiron common stock when certain Chiron common stock pricetargets have been met at certain times, if the trading price for the debenturesfalls below certain levels for a specified period of time, if the debentureshave been called for redemption, if the credit rating assigned to Chiron’slong-term senior debt is below specified levels, upon the occurrence andcontinuance of specified corporate transactions or in connection with atransaction or event constituting a change in control. The initial conversionrate is 14.9254 shares of Chiron common stock per $1,000 principal amount ofdebentures. This is equivalent to an initial conversion price of approximately$67.00 per share of Chiron common stock.

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

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

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

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

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

**ITEM 6.**                SELECTEDFINANCIAL DATA

Wehave derived the selected consolidated financial data presented below as of December 31,2004 and 2003 and for the years ended December 31, 2004, 2003 and 2002from the audited Consolidated Financial Statements contained elsewhere in this Form 10-K.The selected consolidated financial data presented below as of December 31,2002, 2001 and 2000 and for the years ended December 31, 2001 and 2000were derived from our audited Consolidated Financial Statements not containedherein. Operating results for the periods presented below are not necessarilyindicative of the results that may be expected for future years.
| ** **                                              | ** ** | **Year Ended December 31,**                         | ** ** |
|---------------------------------------------------------|------------|--------------------------------------------------------------------|------------|
| ** **                                              | ** ** | **2004**                                                           | ** ** | **2003** | ** ** | **2002** | ** ** | **2001** | ** ** | **2000** | ** ** |
| ** **                                              | ** ** | **(In thousands, except per share data)** | ** ** |
| Total revenues                                          |       | $                                                                  | 1,723,355  |   | $ | 1,766,361 |   | $ | 1,276,280 |   | $ | 1,140,667 |   | $ | 972,119 |   |
| Income from  continuing operations                      |       | 54,063                                                             |       | 220,338 |   | 181,145 |   | 174,758 |   | 16,102 |   |
| Basic earnings  per share from continuing operations    |       | 0.29                                                               |       | 1.18 |   | 0.96 |   | 0.92 |   | 0.09 |   |
| Diluted earnings  per share from continuing operations. |       | 0.28                                                               |       | 1.15 |   | 0.94 |   | 0.90 |   | 0.08 |   |
| Total assets                                            |       | 4,296,197                                                          |       | 4,195,169 |   | 2,960,344 |   | 2,866,909 |   | 2,458,076 |   |
| Long-term debt and  long-term portion of capital leases |       | 1,093,604                                                          |       | 1,084,386 |   | 416,954 |   | 408,696 |   | 3,039 |   |
|                                                         |            |                                                                    |            |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

As discussed in Item 7. “Management’s Discussion andAnalysis of Financial Condition and Results of Operations,” several factorsaffected the comparability of information between 2004 and 2003. The firstfactor relates to the effects of our acquisition of PowderJect on July 8,2003 and developments with respect to FLUVIRIN® influenza virus vaccine, whichimpacted our results of operations in 2004. Chiron did not release any FLUVIRINproduct during the 2004-2005 influenza season. Chiron had no sales ofFLUVIRIN vaccine in 2004 (other than $2.3 million in late 2003-2004season sales), while FLUVIRIN vaccine sales were $219.2 million in 2003. In2004, Chiron wrote-off the entire inventory of FLUVIRIN vaccine, resulting in a$91.3 million charge to cost of sales, which decreased diluted earnings pershare by approximately $0.36 in 2004. In 2004, Chiron incurred remediationcosts associated with our Liverpool facility of $2.6 million and incurred legalexpenses of $12.1 million related to the developments with respect to FLUVIRIN,which together decreased diluted earnings per share by approximately $0.06 in2004. In addition, we recorded a $45.3 million charge for purchased in-processresearch and development 

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for the acquisition ofPowderJect in 2003. The amortization expense for the acquired intangible assetsassociated with this acquisition was $54.7 million in 2004 and $25.3 million in2003. Second, on June 12, 2004, certain holders of our Liquid Yield OptionNotes (LYONs) tendered certain of the LYONs for purchase by Chiron. Theaggregate purchase price for all the LYONs validly surrendered for purchase was$379.7 million. Third, we issued $385.0 million aggregate principal amount ofconvertible debentures, which mature on June 30, 2034. Fourth, on September 10,2004, we reached a settlement agreement with F. Hoffman-La Roche regarding anHIV-related patent dispute. The impact on royalty and license fee revenue was$45.8 million. Fifth, on July 2, 2004, we acquired Sagres Discovery(Sagres), a privately- held company headquartered in Davis, California, whichfocuses on the discovery and validation of targets with potential applicationto the development of cancer therapeutics. We acquired Sagres for a preliminarypurchase price of $12.0 million and allocated $9.6 million of the preliminarypurchase price to purchased-in-process research and development, which wecharged to earnings in 2004.

As discussed in Item 7. “Management’s Discussion andAnalysis of Financial Condition and Results of Operations,” several factorsaffected the comparability of information between 2003 and 2002. The firstfactor relates to the effects of our acquisition of PowderJect for$938.6 million on July 8, 2003. Total revenues for PowderJect in 2003were $244.7 million. In addition, as noted above, we recorded a$45.3 million charge for purchased in-process research and development in2003. The amortization expense for the acquired intangible assets associatedwith this acquisition was $25.3 million in 2003. Second, we issued$500.0 million of convertible debentures in July 2003. Finally, in July 2003,we entered into a new six-year lease to rent a research and developmentfacility in Emeryville, California following the expiration of the existingoperating lease. We accounted for this new lease as a capital lease and, as aresult, recorded the leased facility and the corresponding liability on ourbalance sheet effective July 1, 2003. The amount recorded on the balancesheet for the leased facility was $157.5 million.

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

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

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

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**ITEM 7.**                MANAGEMENT’SDISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

***Introduction***

We are a global biopharmaceutical company, therevenues of which primarily consist of product sales, revenues from a jointbusiness contractual arrangement, collaborative agreement revenues, royalty andlicense fee revenues and other revenues, which primarily consist of contractmanufacturing and grant revenues. Our research and development efforts arefocused on developing products for oncology and infectious and pulmonarydisease. We participate in three healthcare markets: blood-testing, vaccinesand biopharmaceuticals.

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

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

The biopharmaceuticals segment consists of therapeuticproducts, with an emphasis on the treatment of cancer, infectious and pulmonarydiseases. Our in-house capabilities span three types of therapeutics, includingsmall molecules, therapeutic proteins and monoclonal antibodies. Our products includeTOBI® (tobramycin solution for inhalation) for pseudomonal lung infections incystic fibrosis patients, PROLEUKIN® (aldesleukin) for cancer (metastaticmelanoma and renal cell carcinoma), and BETASERON® (interferon beta-1b) formultiple sclerosis. The biopharmaceuticals segment also includes collaborationswith Berlex Laboratories, Inc. and its parent company, Schering AG ofGermany, related to BETASERON® interferon beta-1b. The biopharmaceuticalssegment earns royalties on third party sales of several products, primarilyBETAFERON® interferon beta-1b, and earns license fees for technologies, such ashepatitis C virus-related patents, used by third parties to develop therapeuticproducts.

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

***FLUVIRIN®Influenza Virus Vaccine Recent Events***

During the third quarter of 2004, in conducting finalinternal release procedures for our FLUVIRIN influenza virus vaccine, ourquality systems identified lots that did not meet product sterilityspecifications. As a result, we determined at that time to delay releasing anyFLUVIRIN vaccine doses pending 

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

On March 2, 2005, the MHRA notified us that ithad lifted the license suspension, giving Chiron clearance to initiate fullproduction of FLUVIRIN® vaccine, conditioned on the understanding that Chiron’scommitment to its remediation plan will continue. The FDA is still expected toconduct a full inspection to determine whether deficiencies noted in thewarning letter the FDA issued in December 2004 have been resolved. If wefail to adequately address the matters discussed in the warning letter, the FDAmay modify our U.S. license in an adverse manner, take action that could resultin imposition of fines, require temporary or permanent cessation of futureselling of FLUVIRIN vaccine or take other action that could reduce our abilityto market FLUVIRIN vaccine.

We received a grand jury subpoena issued by the U.S.Attorney’s Office for the Southern District of New York in October 2004requesting production of certain documents relating to FLUVIRIN vaccine and thesuspension by the MHRA of our license. In February 2005, the Securitiesand Exchange Commission, or SEC, notified us that it would commence a formalinvestigation into whether we or our employees have violated any federalsecurities laws in connection with these developments regarding FLUVIRINvaccine, after having previously commenced an informal inquiry. We alsoreceived a voluntary request for information from the United States House ofRepresentatives Committee on Energy and Commerce requesting production ofcertain documents. Numerous documents have been collected and produced inresponse to these requests, and several witnesses have been interviewed by theU.S. Attorney’s Office and the SEC staff and additional interviews areanticipated. Additional investigations regarding these matters may arise. Inaddition, we and certain of our officers and directors have also been named asdefendants in several putative shareholder class action and derivative lawsuitsalleging various claims arising out of or relating to these developmentsregarding FLUVIRIN vaccine, including the U.S. Centers for Disease Control andPrevention and certain distributors of FLUVIRIN vaccine who have suggested thatthey are entitled to compensation under their contracts for the 2004-2005season. It is not possible to predict whether any of these claims will bepursued and, if so, whether those claims will be upheld. Investigations,litigation and disputes have caused us to incur substantial expense and haverequired significant time and attention from our management and will continueto do so in the future and could result in civil and/or criminal penaltiesagainst Chiron. The results of any such investigations, proceedings or disputescould have a material adverse effect on our cash flow. For more information onthese lawsuits, investigations and claims, see Part I, Item 3. “LegalProceedings” above.

As a result ofthese FLUVIRIN vaccine matters, our results of operations for 2004 werematerially adversely affected. These developments had the following immediateimpact on our results of operations for the twelve months ended December 31,2004:

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

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

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vaccine. These chargesdecreased diluted earnings per share by approximately $0.42 for the twelvemonths ended December 31, 2004.

Our inability to supply FLUVIRIN vaccine during the2004-2005 influenza season may also lead to loss of market share in the2005-2006 season and future seasons. Following the announcement of our licensesuspension, competitors have announced plans to introduce influenza vaccineproducts in the United States and are seeking expedited regulatory approval todo so. Even though the license suspension has been lifted, some of ourcustomers may choose to purchase flu vaccine from other providers as theirproducts become available in the United States. Loss of market share could havea material adverse effect on our business and results of operations. We alsoexpect to incur expenses in connection with ongoing FLUVIRIN vaccine matters,which could be material, including in connection with (1) our continuingremediation efforts at our Liverpool facility; and (2) responding to theU.S. Attorney for the Southern District of New York, the SEC, the United StatesHouse of Representatives Committee on Energy and Commerce and the privatelawsuits and other claims and investigations that may arise.

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

***RestatedSecond-Quarter and Third-Quarter 2004 Financial Statements***

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

In light of the fact thatwe were already in contact with the SEC in relation to their investigationdescribed above under “FLUVIRIN® Influenza Virus Vaccine Recent Events,” weinformed the SEC of these matters, and adjustments we made after January 26,2005 to the fourth quarter and full year financial information we released on January26, 2005, and have been providing the SEC information.

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***Summary Consolidated Financial Data***

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

 

*2004 compared with2003*

As described above, there were no sales of FLUVIRINvaccine for the 2004-2005 season. Sales of FLUVIRIN influenza vaccinewere $219.2 million for the twelve months ended December 31, 2003. Acontractual decline in the BETASERON® interferon beta-1b royalty rate,described in more detail below, resulted in a $34.8 million decline intotal revenues for the twelve months ended December 31, 2004. Our totalrevenues were affected by the movement in exchange rates, in particular themovements in the Euro and British Pound against the U.S. dollar. The movementin exchange rates added approximately 3% to our total revenues for the twelvemonths ended December 31, 2004. As described above, we wrote-off ourentire FLUVIRIN product inventory, resulting in a $91.3 million charge tocost of sales, incurred remediation costs associated with our Liverpoolfacility of $2.6 million, and incurred legal expenses of $12.1 million relatedto the FLUVIRIN vaccine developments discussed above under “—FLUVIRIN® InfluenzaVirus Vaccine Recent Events”, which decreased diluted earnings per share byapproximately $0.42 for the twelve months ended December 31, 2004. Alsosince our Euro and British Pound denominated expenses have increased due to themovement in exchange rates, our earnings per share from continuing operationsdeclined $0.08 per diluted share for the twelve months ended December 31,2004, as our expenses denominated in Euros and British Pounds exceeded ourrevenues denominated in those currencies.

Product sales decreased compared to 2003 as there wereno FLUVIRIN influenza vaccine sales for the 2004-2005 season. Thedecrease in FLUVIRIN vaccine sales was partially offset by increased sales inPROCLEIX® products, TOBI® tobramycin inhalation solution, other influenzavaccines products, 

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

Royalty and licenses fees increased significantlycompared to 2003 due to the F. Hoffmann-La Roche (Roche) settlement regardingour HIV patent in the U.S. The settlement included a $78.0 million lumpsum payment, of which $14.0 million was recognized in the third quarter2004. In addition, the settlement resulted in $31.8 million of previouslydeferred royalty and license payments, being was recognized in the thirdquarter 2004. The impact of these items from the Roche settlement was anapproximate $0.18 increase in diluted earnings per share for 2004. Royaltiesand license fees also increased $7.9 million from a non-exclusive license wegranted to the German Red Cross and $6.5 million from a licensing agreementwith LabCorp.

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

In 2004, gross profitmargins decreased to 47% from 58% in 2003, primarily due to the write-off ofour entire inventory of FLUVIRIN vaccine, resulting in a $91.3 millioncharge to cost of sales in the third quarter 2004, as well as the fact thatthere were no FLUVIRIN vaccine sales for the 2004-2005 season. Inaddition, remediation costs of $2.6 million associated with our Liverpoolfacility were included in cost of sales in 2004. The effect of the FLUVIRINvaccine charge and remediation costs resulted in a 7 point decrease in ourgross profit margin percentage for 2004. Gross profit margin was alsonegatively impacted by reduced sales and margins of the MENJUGATE® product,which decreased our gross profit margin by 2 percentage points when comparing2004 with 2003.

Gross profit margins donot include amortization expense from acquired developed products, anintangible asset related to business combinations.

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

The increase in sellinggeneral and administrative expenses in 2004 as compared with 2003 mainlyreflects an $18.0 million increase due to the movement in the Euro and BritishPound exchange rates, $12.3 million from a full year of PowderJect expenses and$12.1 million in legal expenses related to the FLUVIRIN developments discussedabove under “—FLUVIRIN® Influenza Virus Vaccine Recent Events”. The remainingincrease in selling, general and administrative expenses is primarily due todefense of our patents and technology, on-going marketing and pre-launchprograms to support the continued growth of our business and investment ingeographic penetration for our products and corporate governance costs.

The effective tax rate for2004 was 28.2% of pretax income from continuing operations, including thecharge for purchased in process research and development related to the Sagresacquisition. The effective tax rate for 2003 was 28.7% of pretax income fromcontinuing operations including the charge for purchased in-process researchand development related to the PowderJect acquisition. The charges for thepurchased in-process research and development in 2004 and 2003 are not taxdeductible. The effective tax rates in 2004 and 2003 were both 25.0% of pretaxincome from continuing operations, after excluding the impact of the purchasedin-process research and development charges. The effective tax rate in 2004includes increased benefits from research tax credits and foreign income taxedat lower rates. Such benefits are a greater percentage of pretax income in 2004than in 2003. These benefits were offset by the tax cost of transferringcertain product rights through inter-company transactions as part of ourlong-term tax 

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

*2003 compared with 2002*

Total revenues forPowderJect in 2003 were $244.7 million. PowderJect flu vaccine sales were$219.2 million in 2003. In 2003, our total revenues reflected the benefitof the movement in exchange rates, in particular the movement in the Euro toU.S. dollar exchange rate. In 2003, the movement in exchange rates addedapproximately 8% to our total revenues. Our vaccines segment reflects thegreatest impact of the movement in exchange rates, which added approximately15% to our total 2003 vaccines revenues. Similarly, our total Euro-basedexpenses increased due to the movement in exchange rates.

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

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

Research and developmentexpenses for PowderJect were $16.2 million in 2003. The 2003 spendingreflects 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 variousmonoclonal antibodies. In addition, there were additional expenses related tothe in-licensing of daptomycin from Cubist Pharmaceuticals and purchasedin-process technology associated with our investment in ZymeQuest Inc. Weare collaborating with ZymeQuest, Inc. to develop and commercialize aenzymatic conversion system which converts group A, B and AB red blood cells toenzyme-converted group O (ECO®) red blood cells, and costs associated with anagreement with Infectio Diagnostics Inc. in which we licensed proprietarynucleic acid-based technology for the rapid detection of bacterialcontamination in platelets and blood products. However, we are no longerinvesting in the bacterial detection technology due to changes in the market.

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

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

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Pharmaceuticalacquisition. The effective tax rates for 2003 and 2002 after excluding theimpact of the in-process research and development charges were 25.0% and 27.0%.The 2003 effective tax rate is lower than the 2002 effective tax rate due to anincrease in income earned in lower tax jurisdictions, net of increased benefitsrecognized in 2002 with respect to our research and development activities.

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

***Critical AccountingPolicies and the Use of Estimates***

The preparation offinancial statements requires us to make estimates, assumptions and judgmentsthat affect the reported amounts of assets, liabilities, revenues and expenses,and related disclosures of contingent assets and liabilities. On an on-goingbasis, 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 andreturns; bad debts; collaborative, royalty and license arrangements;restructuring; pension and other post-retirement benefits; income taxes; andlitigation and other contingencies. We base our estimates on historicalexperience and various other assumptions that we believe to be reasonable underthe circumstances, the results of which form our basis for making judgmentsabout the carrying values of assets and liabilities that are not readilyapparent from other sources. Actual results may differ from those estimatesunder different assumptions or conditions.

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

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

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

Webelieve the following critical accounting policies incorporate our moresignificant judgments and estimates used in the preparation of our ConsolidatedFinancial Statements:

·       Purchasedin-process research and development—We allocate the purchase price ofacquisitions based on the fair value of the assets acquired and liabilitiesassumed. To assist in determining the value of the in-process research anddevelopment and certain other intangibles, a third party valuation is typicallyobtained as of the acquisition date if the acquisition is significant. Wegenerally 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 orasset is the present value of the future earning capacity that is available fordistribution to the subject investors in the security or asset. We perform adiscounted cash flow analysis, utilizing anticipated revenues, expenses and netcash flow forecasts related to the technology. Given the high risk associatedwith the development of new drugs, we probability adjust the revenue andexpense forecasts to reflect the risk of advancement through the regulatoryapproval process based on the stage of development in the regulatory process.Such a valuation requires significant estimates and assumptions. We believe thefair value assigned to the in-process research and development is based onreasonable assumptions. However, these assumptions may be incomplete orinaccurate, and unanticipated events and circumstances may occur. Additionally,estimates for the purchase price allocation may change as subsequentinformation becomes available. For example, in the fourth quarter of 2003, uponcompletion of strategic assessments of the value of certain PowderJect researchand development projects, we revised the allocation of a portion of thepurchase price resulting in a $77.4 million decrease to purchasedin-process research and development which we credited to operations and whichwas offset against goodwill.

·       Investments—Weinvest in marketable equity securities. The prices of some of our marketablesecurities are subject to considerable volatility. We record an impairmentcharge when we believe that an investment in a marketable security hasexperienced a decline in fair value, as measured by quoted market prices, thatis other-than-temporary. Generally, we believe that an investment in amarketable security is impaired if its quoted market price has been below itscarrying value for each trading day in a six-month period or a credit event hasoccurred, at which point we write down the investment. However, in determiningwhether 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 isexperiencing depressed and declining earnings in relation to competitors,erosion of market share, and deteriorating financial position, (ii) whetherthe issuer is experiencing financial difficulties and its market isexperiencing difficulties, (iii) ongoing activity in our collaborationswith the issuer, if any, and (iv) the issuer’s prospects for favorableclinical trial results, new product initiatives and new collaborativeagreements. Decreases in the fair value of these securities may impact ourprofitability. To reduce this risk, we hedge a portion of our equity securitiesexposure through forward sales contracts.

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

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reserve. Inaddition, we operate in a highly competitive environment, with rapidly changingtechnologies. New technology or changes in production processes may result inproduct obsolescence. As a result, we may be required to record additionalinventory reserves.

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

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

·       Incometaxes—Significant management judgment is required in developing our provisionfor income taxes, including the determination of deferred tax assets andliabilities and any valuation allowances that might be required against thedeferred tax assets. We record valuation allowances to reduce deferred taxassets to the amounts that are more likely than not to be realized. We haveconsidered future taxable income and ongoing prudent and feasible tax planningstrategies in assessing the need for valuation allowances. If we determinedthat we would be able to realize our deferred tax assets in the future inexcess of our net deferred tax assets, adjustments to the deferred tax assetswould increase income by reducing tax expense in the period that we made suchdetermination. Likewise, if we determined that we would not be able to realizeall or part of our net deferred tax assets in the future, adjustments to thedeferred tax assets would decrease income by increasing tax expense in theperiod that we made such determination. Annual tax provisions include amountsconsidered sufficient to pay assessments that may result from examination ofprior year tax returns; however, the amount ultimately paid upon resolution ofissues raised may differ materially from the amount accrued. In evaluating theexposure associated with various tax filing positions, we accrue charges forprobable exposures. We maintain an allowance for tax 

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

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

·       Goodwilland intangible assets—The valuation in connection with the initial purchaseprice allocation and the ongoing evaluation for impairment of goodwill andintangible assets requires significant management estimates and judgment. Thepurchase price allocation process requires management estimates and judgment asto expectations for various products and business strategies. If any of thesignificant assumptions differ from the estimates and judgments used in thepurchase price allocation, this could result in different valuations forgoodwill and intangible assets. For the PowderJect acquisition, we initiallyallocated $451.8 million of the purchase price to goodwill in the thirdquarter 2003. In the fourth quarter 2003, the allocation of the purchase pricechanged as we completed the strategic assessments of the value of certainresearch and development projects and adjusted the purchased in-processresearch and development, and upon finalization of certain estimates. Accordingly,goodwill associated with the PowderJect acquisition was adjusted to$503.0 million in the fourth quarter 2003. During 2004, we completed theplanned divestiture of certain research operations in Madison, Wisconsin andOxford, England and certain vaccines operations in Sweden, we adjusted thepreviously recorded obligation related to an assumed defined benefit plan,revised estimates of exit costs associated with certain contractual obligationsunder supply and research agreements related to the divested researchoperations and other direct acquisition costs, and revised estimates of certainreceivables and insurance estimates. The net impact of these items resulted inan increase to goodwill associated with the PowderJect acquisition of $17.9million and goodwill was adjusted from $503.0 million in 2003 to $520.9 millionin 2004. Once it is established, we must test goodwill annually for impairmentusing a two-step process as required by SFAS No. 142, Goodwill and OtherIntangible Assets. In addition, in certain circumstances, we must assess ifgoodwill should be tested for impairment between annual tests. Intangibleassets with definite useful lives must be tested for impairment in accordancewith SFAS No. 144, Accounting for the Impairment or Disposal of Long-LivedAssets. When we conduct our impairment tests for goodwill and intangibles,factors that are considered important in determining whether impairment mightexist include significant continued under-performance compared to peers,significant changes in the underlying business and products of our reportingunits, or other factors specific to each asset or reporting unit beingevaluated. Any changes in key assumptions about the business and its prospects,or changes in market conditions or other externalities, could result in animpairment charge and such a charge could have a material adverse effect on ourconsolidated results of operations.

The accounting policies ofour reportable segments are the same as those described in Note 1, “TheCompany and Summary of Significant Accounting Policies,” in the Notes toConsolidated Financial Statements.

Certain minor arithmeticalvariances between the following narrative and the Consolidated FinancialStatements may arise due to rounding.

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**Results ofOperations**

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

 

**Product sales**

*PROCLEIX*®*System  *On February 27, 2002,the U.S. Food and Drug Administration approved the PROCLEIX® HIV-1/ HCV Assay.We have marketed the PROCLEIX® HIV-1/HCV Assay in Europe since 1999. On January 15,2004, the PROCLEIX® UltrioTM HIV-1/HCV/HBV Assay received European CEmarking for use on the semi-automated PROCLEIX System. Under a collaborationagreement with Gen-Probe, we market and sell the PROCLEIX HIV-1/ HCV Assay, thePROCLEIX Ultrio Assay and the related instrument system. In addition to sellingdirectly in the U.S., we also sell in various European and Asia / Pacificmarkets, directly and through distributors. We record revenue based upon thereported results obtained from the customer from the use of assays to screendonations or upon sale and delivery of the assays, depending on the underlyingcontract. In the case of equipment sales or leases, we record revenue upon thesale and transfer of the title to the instrument or ratably over the life ofthe lease term, respectively. For the provision of service on the instruments,we recognize revenue ratably over the life of the service agreement.

The increase in product sales in 2004 as compared with2003 was primarily due to (i) $19.6 million for the introduction ofthe West Nile Virus Assay on an investigational-use basis in the U.S. in March 2003,which had a full year of sales in 2004, (ii) $17.0 million for thecontinued penetration into several markets abroad and (iii) $10.4 millionfor market share gains in the U.S. for the PROCLEIX® HIV-1/ HCV Assay.

The increase in product sales in 2003 as compared with2002 primarily related to $19.3 million from commercial pricing in the U.S.commencing May 1, 2002 for the PROCLEIX® HIV-1/ HCV Assay following theU.S. Food and Drug Administration approval in February 2002, while therewas a full year of commercial pricing in 2003. In addition, after the firstquarter 2002, we signed new commercial contracts including those with existingAmerica’s Blood Centers customers, the American Red Cross, the U.S. militaryand the Association of Independent Blood Centers to provide the PROCLEIX HIV-1/HCV Assay, which resulted in an increase in sales of $20.4 million in 2003 ascompared with 2002. Other factors contributing to the increase in 2003 were (i) $19.5million from the introduction of the West Nile Virus Assay on aninvestigational-use basis in the U.S. in March 2003 and (ii) $18.3million from increased sales to several markets abroad for the PROCLEIX HIV-1/HCV Assay. Slightly offsetting the increase in product sales related to tests,instruments and the provision of services in 2003 as compared with 2002, was 

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$2.9 million fromadditional revenue recognized in the first quarter 2002 under contracts withall our U.S. customers for increased donations exceeding contractual minimums.

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

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

**Revenues from joint businessarrangement  **The increase in revenue from joint businessarrangement in 2004 as compared with 2003 was primarily due to (i) $9.8 millionfor higher profits from Ortho-Clinical Diagnostics’ U.S. operations and foreignaffiliates and (ii) $5.3 million for an increase in royalties. Theseincreases were partially offset by reorganization charges from the jointbusiness arrangement of $4.5 million and a one-time benefit of$4.3 million for the three months ended March 31, 2003 due to achange in estimate from a three-month lag to a one-month lag relating tonon-U.S. affiliate sales. Prior to the first quarter of 2003, we accounted forrevenues relating to Ortho-Clinical Diagnostics’ non-U.S. affiliate sales on aone-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-monthlag, consistent with the method of how we recognize revenues relating toOrtho-Clinical Diagnostics’ sales for the U.S. portion of Ortho-ClinicalDiagnostics’ operations. For more information on this, see “Critical AccountingPolicies and the Use of Estimates.”

The increase in 2003 as compared with 2002 primarilyresulted from (i) $5.2 million from increased profitability ofOrtho-Clinical Diagnostics’ foreign affiliates and (ii) $4.3 million froma one-time benefit in the first quarter 2003 mentioned above. Partiallyoffsetting these increases was $5.8 million from lower profits fromOrtho-Clinical Diagnostics’ U.S. operations.

**Collaborative agreement revenues  **Collaborativeagreement revenues tend to fluctuate based on the amount and timing of researchservices performed, the status of projects under collaboration and theachievement of milestones. Due to the nature of our collaborative agreementrevenues, results in any one period are not necessarily indicative of resultsto be achieved in the future. Our ability to generate additional collaborativeagreement revenues may depend, in part, on our ability to initiate and maintainrelationships with potential and current collaborative partners.

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

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

The increase in royalty and license fee revenues in2003 as compared with 2002 was primarily due to (i) $13.3 million fromRoche, as discussed below and (ii) $8.6 million from Baxter, as discussedbelow.

*Roche settlement  *InOctober 2000, we entered into three license agreements with Roche andseveral of its affiliated companies related to the settlement of certainlitigation in the U.S. and certain other countries for the use of our hepatitisC virus and HIV nucleic acid testing intellectual property. Two agreementsrelate to *in vitro* diagnosticproducts. See “Other—Royalty and license fee revenues” below. The thirdagreement for blood screening was superseded in May 2001 by two newagreements, one for each of HCV and HIV.

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

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

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

*German Red Cross Settlement  *Wehave granted a non-exclusive license to the German Red Cross for use of ourHIV-1 and HCV technology for use in molecular probe “home brew” blood screeningthrough 2008, for a total license fee payment of $22.8 million. Of thislicense fee payment, $7.9 million was recognized as royalty and licensefee revenues in 2004, as discussed above, and the remaining balance is expectedto be recognized through 2008, as the cancellation privilege in the relatedagreements expires. In addition, the German Red Cross has the option to licenseour patents beyond 2008 upon payment of an additional fee. The licensing termsalso cover potential past infringements.

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

*Baxter A.G.  *InJune 2003, we entered into two license agreements with Baxter A.G. relatedto our HCV and HIV technology for use in the plasma fractionation market.Revenues under these agreements were $1.3 million and $8.6 million in2004 and 2003, respectively. We recognized a license fee of $7.0 million forthese agreements in the second quarter 2003.

*Bayer  *In June 2001,Chiron and Ortho-Clinical Diagnostics entered into an agreement with BayerCorporation (Bayer) for the clinical diagnostic market. Under this agreement,Bayer manufactures and sells certain of Ortho-Clinical Diagnostics’ HCV and HIVimmunodiagnostic products for use on Bayer’s instrument platforms. Bayer paidus a license fee of $45.3 million, which we deferred (due to ourcontinuing manufacturing obligations) and began recognizing as revenue in thethird quarter 2001. We will recognize the remaining amount ratably through2010.

Royalty and license fee revenues may fluctuate basedon the nature of the related agreements, the timing of receipt of license feesand the expiration of patents. Results in any one period are not necessarilyindicative of results to be achieved in the future. Also, the licenseagreements typically provide for certain milestone payments and variousroyalties on future product sales if the licensee commercializes a productusing our technology. However, we have no assurance that the licensee will meettheir development objectives or commercialize a product using our technology. Inaddition, our ability to generate additional royalty and license fee revenuesmay depend, in part, on our ability to market and capitalize on ourtechnologies.

**Gross profit margin  **Grossprofit margin increased in 2004 as compared with 2003 due to a positive impactby an adjustment to cost of goods sold in 2004 pursuant to our collaborationagreement with Gen-Probe. The blood-testing gross profit margin benefitedfrom an amendment in November 2003 to the worldwide blood screeningcollaboration agreement between Chiron and Gen-Probe in order to adoptpermanent, fixed revenue shares for each party. Effective January 1, 2004,Gen-Probe’s share was set at 45.75% of net revenues for assays, which include atest for HCV. For commercial assays, which do not test for HCV, such as theWest Nile Virus Assay, the agreement remains unchanged with each partyretaining 50% of the net revenues after deduction of specified expenses.

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

**Research and development  **Thedecrease in research and development expenses in 2004 as compared with 2003 wasprimarily due to (i) $6.5 million from purchased in-process technologyassociated with our investment in ZymeQuest Inc. in 2003 (we arecollaborating with ZymeQuest, Inc. to develop and commercialize aenzymatic conversion system which converts group A, B and AB red blood cells toenzyme-converted group O (ECO®) red blood cells) and (ii) $2.6 millionfrom costs associated with an agreement with Infectio Diagnostics Inc. in2003, in which we licensed proprietary nucleic acid-based technology for therapid detection of bacterial contamination in platelets and blood products.These decreases were partially offset by (i) $4.9 million due to theincreased development efforts relating to nucleic acid testing products in 2004and (ii) $1.0 million related to acquisition of in-processtechnologies in 2004, focused primarily on research into variantCreutzfeldt-Jakob disease.

The increase in research and development spending in2003 as compared with 2002 is primarily related to (i) $6.5 million frompurchased in-process technology associated with our investment inZymeQuest Inc., as discussed above and (ii) $2.6 million from costsassociated with an agreement with 

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

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

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

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

We expect continued growthin selling, general and administrative expenses related to nucleic acid testingtechnology and products as our sales opportunities expand in new marketsthrough anticipated additional nucleic acid testing adoption.

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

 

**Product sales  **Wesell influenza, meningococcal, travel, pediatric and other vaccines primarilyin the U.S., Germany, Italy, the United Kingdom, as well as in otherinternational markets.

*Influenza vaccines  *Asdescribed above under “FLUVIRIN® Influenza Virus Vaccine Recent Events,” as aresult of recent developments with respect to FLUVIRIN vaccine, we had noFLUVIRIN vaccine sales for the 2004–2005 influenza season. In 2004, we had $2.3million of FLUVIRIN sales for late 2003-2004 season. Sales of FLUVIRINinfluenza vaccine were $219.2 million in 2003. Sales of our 

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

Influenza vaccines sales increased in 2003 as comparedwith 2002, primarily as a result of additional sales of influenza vaccineproducts following our third quarter 2003 acquisition of PowderJect. PowderJectFLUVIRIN vaccine sales were $219.2 million in 2003. Excluding PowderJect,sales of our remaining influenza vaccines increased primarily as a result of$3.8 million from the benefit of the movement in the Euro to U.S. Dollarexchange rate and $19.4 million from price and volume increases in Germany andItaly.

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

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

*Travel vaccines  *Salesof our travel vaccines are comprised of tick-borne encephalitis, rabiesvaccines and two products we obtained as part of our 2003 acquisition ofPowderJect, ARILVAXTM, a yellow fever vaccine and DUKORALTM, a choleravaccine. The increase in travel vaccines sales in 2004 as compared with2003 was primarily due to $25.7 million driven by increased demand for ourrabies vaccines in the U.S., primarily due to a product recall from acompetitor and increased demand of our rabies vaccines in Europe and Asia. Theincrease was partially offset by the fact that we had $15.1 million of sales ofour tick-borne encephalitis vaccine in late 2003, which is typically sold inthe first half of the year.

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

*Pediatric and other vaccines  *Theincrease in our pediatric and other vaccines sales in 2004 as compared with2003 was primarily due to an additional $21.3 million related to thetiming of tender sales for our polio vaccines and diphtheria, tetanus andpertussis vaccines, offset partially by (i) $7.3 million due to theplanned divestiture of certain vaccines operations in Sweden in the secondquarter 2004 acquired via our acquisition of PowderJect and (ii) $6.1 milliondue to the timing of tender sales for our measles, mumps and rubella vaccines.

The increase in pediatric and other vaccines sales in2003 as compared with 2002 was primarily due to (i) $18.6 million fromadditional sales of other vaccine products following our third quarter 2003acquisition of PowderJect, (ii) $18.5 million from the timing of tendersales for measles, mumps and rubella vaccines and diphtheria, tetanus andpertussis vaccines and (iii) $7.3 million from the benefit of the movementin the Euro to U.S. Dollar exchange rate.

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

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health authoritiesconsider adoption of broad vaccination programs and competitive pressurescontinue to increase.

**Collaborative agreement revenues  **Werecognize collaborative agreement revenues for fees received as we performresearch services and achieve specified milestones. Collaborative agreementrevenues in 2004 as compared with 2003 increased primarily due to (i) $1.4 millionin higher milestone payments related to an agreement to supply MENZBTMmeningococcal B vaccine to the Ministry of Health in New Zealand and (ii) $3.0 millionin increased collaborative agreement revenues following a full year ofcollaborative revenues in 2004 from our acquisition of PowderJect.

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

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

Collaborative agreement revenues tend to fluctuatebased on the amount and timing of research services performed, the status ofprojects under collaboration and the achievement of milestones. Due to thenature of our collaborative agreement revenues, results in any one period arenot necessarily indicative of results to be achieved in the future. Inaddition, the collaboration agreements typically provide for certain milestonepayments and various royalties on future product sales if the collaborativepartners commercialize a product using our technology. Also, our ability togenerate additional collaborative agreement revenues may depend, in part, onour ability to initiate and maintain relationships with potential and currentcollaborative partners.

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

*GlaxoSmithKline  *Anagreement with GlaxoSmithKline plc provides for royalties on sales of certainvaccine products. Under this agreement, we recognized $2.9 million,$7.1 million and $7.0 million of such royalties in 2004, 2003 and2002, respectively. The decrease in royalties in 2004 compared with 2003 wasprimarily due to the expiration of various patents under this agreement.

*Other  *In2004, 2003 and 2002, we recognized $1.0 million, $5.6 million and$5.3 million, respectively, of royalty revenues primarily on third partysales of hepatitis B virus vaccine products. Certain patents related to theproduction of hepatitis B vaccine products expired beginning in 2004, whichresulted in reductions in royalty revenues recognized under one arrangement.

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

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

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**Other revenues**

*Grant and contract revenues  *Ourvaccines segment other revenues included grant and contract revenues of $13.4million, $9.7 million and $14.6 million for 2004, 2003 and 2002,respectively. We have entered into a series of agreements with the U.S.National Institutes of Health to advance our HIV vaccine program into humanclinical trials. We recognized grant and contract revenues under thesearrangements of $8.1 million, $7.3 million and $10.1 million for2004, 2003 and 2002, respectively.

*Contract manufacturing revenues  *Includedin our vaccines segment other revenues are contract manufacturing revenues of$2.2 million, $2.2 million and $1.5 million for 2004, 2003 and2002, respectively. The fluctuations resulted from a change in the level ofcontract manufacturing activities.

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

Other revenues recognized in our vaccines segment mayfluctuate due to the nature of the revenues recognized and the timing of eventsgiving rise to these revenues.

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

The decrease in gross profit margin in 2003 ascompared with 2002 related to a fair value adjustment to inventory of$24.4 million in 2003 associated with the sale of inventory acquiredduring the acquisition of PowderJect. These additional costs related to a fairvalue adjustment on the acquisition of PowderJect. In addition, the vaccinegross profit margin in 2003 was negatively impacted by the shutdown of certainfacilities, in the first quarter 2003, to ensure compliance with regulatoryrequirements.

Vaccines gross profit margin does not includeamortization expense from acquired developed products, an intangible assetrelated to business combinations. Such amortization expense is included in thecaption ‘amortization expense’ discussed below.

Vaccines gross profit margin may fluctuatesignificantly in future periods due to product and customer mix, seasonalityand ordering patterns, production yields, regulatory approvals and competitivepressures.

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

The increase in research and development spending in2003 compared with 2002 was primarily due to $22.5 million from the advancementof several programs in our meningococcal franchise and $11.2 million from flucell culture. Also, there was $16.2 million of incremental research anddevelopment expense following our third quarter acquisition of PowderJect.

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

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

**Selling, general and administrative  **Theincrease in selling, general and administrative expenses in 2004 as comparedwith 2003 was primarily related to additional expenses of $12.3 millionattributable to our third quarter 2003 PowderJect acquisition. The remainingincrease in selling, general and administrative resulted from $12.5 millionfrom the movement of the Euro and British Pound to U.S. dollar exchange ratesand $9.4 million associated with ongoing sales and marketing programs. Thesewere partially offset by savings of $4.5 million from the divestiture ofcertain PowderJect research and development operations in 2004.

The increase in selling, general and administrativeexpenses in 2003 compared with 2002 primarily relates to additional expensesfollowing our third quarter acquisition of PowderJect. Excluding$34.8 million of additional selling, general and administrative expensesassociated with PowderJect, including integration costs of $9.2 million,the remaining increase in selling, general and administrative expenses resultedprimarily from $16.5 million from the Euro to U.S. Dollar exchange ratefluctuation, offset partially by $2.0 million from a payment made in the firstquarter 2002 to the German government in lieu of statutory price reductions onprescription drugs that are reimbursed under the German government’s healthcareprogram that was expensed in the first quarter 2002.

**Amortization expense  **Theincrease in amortization expense in 2004 as compared with 2003 primarilyrelated to the intangible assets acquired following our third quarter 2003PowderJect acquisition.

The increase inamortization expense in 2003 as compared with 2002 relates to the intangiblesacquired following our acquisition of PowderJect in the third quarter 2003.Acquired intangible assets included the fair value of distribution rights, acontract manufacturing agreement and developed product technologies. Thedistribution rights and the contract manufacturing agreement are beingamortized on a straight-line basis over 1 to 4 years. Developed producttechnologies are being amortized using either the estimated sales method over10 years or on a straight-line basis over 1 to 15 years.

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

 

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

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

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

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

Pursuant to our agreement with Schering, we begansupplying BETAFERON® product to Schering in the fourth quarter 2002 for certainadditional European markets, which were previously supplied by BoehringerIngelheim. This resulted in a shift of revenue recognized under this agreementto product sales, and a decrease in royalty revenues beginning in the fourthquarter 2002. In 2003, Schering extended its supply agreement with BoehringerIngelheim through 2008. The exact shift of revenue in the future will becontingent on our production capacity, Schering’s minimum purchase commitmentunder the extended supply agreement with Boehringer Ingelheim, and marketdemand. The shift to product sales is expected to increase over the next threeyears. We expect overall, biopharmaceutical earnings to be largely unaffectedby the transition. In order to supply BETAFERON to Schering, we are required tomake capital improvements to our existing manufacturing facilities to increasecapacity. During 2004, 2003 and 2002, we recorded charges related to processdevelopment and test runs associated with this project. See “Research anddevelopment” below.

The increase in BETASERON® product sales in 2004 ascompared with 2003 primarily related to an additional (i) $7.5 million fromprice increases, (ii) $4.2 million from increased patient demand attributed tokey marketing programs, (iii) $3.2 million from the benefit of foreign exchangerates, (iv) $6.1 million from inventory ordering patterns of Schering and theirdistributors and (v) $2.9 million from increased sales of clinical materials.These increases were partially offset by an $18.5 million reduction due to adecline in the royalty rate by five percentage points pursuant to ourcontractual agreement with Schering.

The increase in BETASERON product sales in 2003 ascompared with 2002, primarily related to (i) $6.4 million from priceincreases, (ii) $5.9 million from the benefit of the movement in foreignexchange rates and (iii) $6.4 million from increased patient demandattributed to an overall increase in the market for interferon beta-1b productsfor multiple sclerosis. These increases were partially offset by (i) $5.7million from a decline in the amount we recorded as product sales, based on apercentage of sales by Schering, by five percentage points pursuant to ourcontractual agreement with Schering and (ii) $6.4 million fromfluctuations in wholesaler ordering patterns. In 2002, Schering converted towholesaler distribution from direct distribution method. Prior to the firstquarter 2002, we accounted for revenues from non-U.S. product sales based oninformation provided by Schering on a one-quarter lag. More current informationof non-U.S. BETASERON interferon beta-1b sales became available in 2002, and asa result, we were able to begin recognizing revenues from BETASERON productsales on a current basis. This change resulted in incremental revenues recognizedduring the first quarter 2002 of $4.3 million. Inventory ordering patternsas well as foreign currency exchange rates may influence future BETASERONproduct sales.

*TOBI® tobramycin solution for inhalation  *Wesell TOBI® solution directly in the U.S. and certain international markets. Theincrease in sales in 2004 as compared with 2003 was primarily due to(i)$16.0 million in increased patient demand in the U.S, (ii) $9.2 millionin price increases, (iii) $6.4 million in favorable movement in theEuro to U.S. Dollar exchange rate and (iv) $6.0 million in wholesalerordering patterns.

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

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

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

*PROLEUKIN® (aldesleukin)  *Theincrease in sales for PROLEUKIN (aldesleukin) in 2004 as compared with 2003 wasprimarily due to (i) $8.0 million from inventory ordering patterns inEurope, (ii) $5.2 million from price increases and (iii) $3.0 milliondue to favorable movement in the Euro to U.S. Dollar exchange rate. Theseincreases were partially offset by a $4.2 million reduction due to adecline in patient demand.

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

The balance of product sales recognized in ourbiopharmaceuticals segment consisted of various other products, whichindividually were not material.

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

**Collaborative agreement revenues  **Werecognize collaborative agreement revenues for fees received as we performresearch services and achieve specified milestones.

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

*GlaxoSmithKline plc  *Inthe fourth quarter 2002, we entered into a collaboration agreement and licenseagreement with GlaxoSmithKline plc related to certain of our MC-4R compoundpatents. Under this arrangement, we recognized collaborative agreement revenuesof $0.1 million and $3.3 million for 2004 and 2003, respectively.

The balance of collaborative agreement revenuesrecognized in our biopharmaceuticals segment consisted of various otheragreements, which individually were not material.

Collaborative agreement revenues tend to fluctuatebased on the amount and timing of research services performed, the status ofprojects under collaboration and the achievement of milestones. Due to thenature of our collaborative agreement revenues, results in any one period arenot necessarily indicative of results to be achieved in the future. Inaddition, the collaboration agreements typically provide for certain milestonepayments and various royalties on future product sales if the collaborativepartners commercialize a product using our technology. Also, our ability togenerate additional collaborative agreement revenues may depend, in part, onour ability to initiate and maintain relationships with potential and currentcollaborative partners.

**Royalty and license fee revenues  **Ourbiopharmaceuticals segment earns royalties on third party sales of severalproducts, including BETAFERON® interferon beta-1b and recombinant insulin andglucagon products. Our biopharmaceuticals segment also earns license fees fortechnologies, such as hepatitis C virus-related patents, used by third partiesto develop therapeutic products.

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

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

The increase in BETAFERON product royalties in 2003compared with 2002 was primarily due to (i) $8.6 million from benefit inthe movement of the Euro to U.S. dollar exchange rate, (ii) $7.4 millionfrom the benefit of a reduction of the allocated cost under a three-yearlimited cost sharing arrangement under the transitional supply agreement withSchering and (iii) $4.9 million from increase in demand. These increaseswere partially offset by $4.0 million from a decline in our royalty rate in thefourth quarter 2003 by five percentage points, pursuant to our contractualagreement with Schering. Incremental revenues recognized during the firstquarter 2002 of $3.9 million related to a change in our methodology ofrecognizing these royalties. Prior to 2002, we accounted for BETAFERON® productroyalties as a percentage of forecast received from Schering, with anadjustment of the estimate to actual in the subsequent quarter. More current informationof European BETASERON® product sales was available in 2002, and as a result, wewere able to recognize BETAFERON product royalties on a current basis beginningin the first quarter 2002.

As discussed in “Product sales—BETASERON®” above, webegan supplying BETAFERON® product, which was previously supplied by BoehringerIngelheim, to Schering in the fourth quarter 2002 for certain additionalEuropean markets. This resulted in a shift of revenue recognized under thisagreement to product sales, with a decrease in royalty revenues, beginning inthe fourth quarter 2002. In 2003, Schering extended its supply agreement withBoehringer Ingelheim through 2008. The magnitude of the shift of revenue in thefuture will be contingent on our production capacity, Schering’s minimumpurchase commitment under the extended supply agreement with BoehringerIngelheim and market demand. The shift to product sales is expected to increaseover the next three years. Future BETAFERON® product royalties will be influencedby demand, price changes and foreign currency exchange rates.

*Novo Nordisk  *Weearn royalty revenues on insulin and glucagon product sales by Novo Nordisk AS.We recognized $4.4 million, $8.5 million and $7.5 million in2004, 2003 and 2002, respectively, under this arrangement. Patents related tothe production of insulin and glucagons began expiring in late 2003 and as aresult, there were significant reductions in royalty revenue in 2004 recognizedunder this arrangement.

*Boehringer Ingelheim  *InDecember 2003, we granted Boehringer Ingelheim a nonexclusive license forthe research, development and commercialization of small molecule therapeuticsagainst hepatitis C virus drug targets. We recognized $0.8 million and$4.0 million in 2004 and 2003 under this arrangement. The decrease isprimarily due to initial license fees recognized in 2003.

*GlaxoSmithKline plc  *In2002, we granted GlaxoSmithKline plc rights to certain of our MC-4R compoundpatents. Under this arrangement, we recognized royalty revenues $0.2 millionand $4.8 million in 2004 and 2003, respectively. The project associatedwith our MC-4R compound was completed early in 2004.

The balance of royalty and license fee revenuesrecognized in our biopharmaceuticals segment consisted of various otheragreements, which individually were not material.

Royalty and license feerevenues may fluctuate based on the nature of the related agreements, thetiming of receipt of license fees and the expiration of patents. Results in anyone period are not necessarily indicative of results to be achieved in thefuture. Also, the license agreements typically provide for certain milestonepayments and various royalties on future product sales if the licenseescommercialize a product 

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

**Other revenues**

*Contract manufacturing revenues  *Ourbiopharmaceuticals segment recognized contract manufacturing revenues of$10.3 million, $13.5 million and $14.0 million in 2004, 2003 and2002, respectively. The fluctuations in 2004 as compared with 2003 and in 2003as compared with 2002, resulted from the level of activity and the timing ofcontract manufacturing activities.

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

The balance of other revenues recognized in ourbiopharmaceuticals segment consisted of various other arrangements, whichindividually were not material.

Other revenues recognized in our biopharmaceuticalssegment may fluctuate due to the nature of the revenues recognized and thetiming of events giving rise to these revenues. We cannot guarantee that wewill be successful in obtaining additional revenues or that these revenues willnot decline.

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

The decrease in biopharmaceutical gross profit marginin 2003 as compared with 2002 was the result of higher annual facilitymaintenance costs, non-recurring expenses related to production, less favorablemix of biopharmaceutical product sales, the increased cost of producing theBETASERON ®interferon beta-1b pre-filled syringe presentation and a decline inBETASERON product sales, based on a percentage of sales by Schering, by fivepercentage points pursuant to our contractual agreement with Schering, offsetby price increases.

Biopharmaceutical gross profit margin does not includeamortization expense from acquired developed products, an intangible assetrelated to business combinations. Such amortization expense is included in thecaption “amortization expense.”

Biopharmaceutical gross profit margin may fluctuatesignificantly in future periods due to production yields, increased cost toproduce the BETASERON® interferon beta-1b pre-filled diluent syringe, thedecline in BETASERON® product sales, based on a percentage of sales bySchering, which decreased by five percentage points pursuant to our contractualagreement with Schering and as the biopharmaceutical product and customer mixchanges.

**Research and development  **Theincrease in research and development spending in 2004 as compared with 2003 wasprimarily the result of (i) $30.7 million from activities related to thedevelopment of tifacogin, as discussed below, (ii) $15.2 million fromdevelopment of our early-stage oncology compounds CHIR-258 (small molecule) andCHIR 12.12 (an antibody) and (iii) $7.1 million from pre-registrationactivities for PULMINIQTM (cyclosporine, USP) inhalation solution for theincrease in survival and prevention of chronic rejection in patients receivingallogenic lung transplants, in combination with 

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

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

The increase in research and development spending in2003 as compared with 2002 primarily related to (i) $10.6 million fromcosts associated with a license agreement with Cubist Pharmaceuticals, Inc.for the development and commercialization of Cubist’s antibiotic daptomycin, asdiscussed below, (ii) $8.8 million from those activities related to thedevelopment of tezacitabine, obtained as a part of the acquisition of MatrixPharmaceutical in the first quarter 2002 and (iii) $6.3 million frominterleukin-2 in oncology trials in combination with various monoclonalantibodies. These increases were partially offset by decreases in theactivities for various clinical trials, including (i) $6.8 million fromtransfer of the responsibility of the SILCAAT trial to NIAID and the Universityof Minnesota in the fourth quarter 2002, discussed below, and (ii) $6.4million from termination of our development activities for HBV-MF59, animmunotherapy for patients with chronic hepatitis B infection.

In March 2004, Chiron entered into a worldwide,exclusive, multi-product, collaborative arrangement with XOMA Ltd. for thedevelopment and commercialization of antibody products for the treatment ofcancer. Under the terms of the arrangement, the parties agreed to jointlyresearch, develop, and commercialize multiple antibody product candidates.Under the arrangement, the parties agreed to share development andcommercialization expenses, including preclinical and clinical development,manufacturing and worldwide marketing costs, as well as revenues, generally ona 70-30 basis, with Chiron’s share being 70% and XOMA’s share being 30%. Chironagreed to make an initial payment of $10.0 million, which has been paid asof December 31, 2004, and to make a loan facility of up to$50.0 million available to XOMA, starting on January 1, 2005 to fund75% of XOMA’s share of development expenses.

In October 2003, we entered into a licenseagreement with Cubist Pharmaceuticals, Inc. for the development andcommercialization of Cubist’s antibiotic CUBICIN® (daptomycin for injection) inWestern and Eastern Europe, Australia, New Zealand, India and certain CentralAmerican, South American and Middle Eastern countries. In exchange for thesedevelopment and commercialization rights, we have agreed to pay Cubist up to$50.0 million. This $50.0 million includes $18.0 million, whichwas paid by Chiron up front in the fourth quarter 2003, $10.0 million ofwhich was used to purchase restricted Cubist common stock at a 50 percentpremium over market price and up to $32.0 million of additional paymentsto Cubist upon the achievement of certain regulatory and sales milestones. Wewill also pay Cubist a tiered royalty on CUBICIN marketed by Chiron. Werecorded $10.6 million of the up front payment, related to the purchase ofin-process research and development as research and development expense in thefourth quarter 2003.

In October 2003, we acquired all of Pfizer, Inc.’s,formerly Pharmacia Corp.’s, interest in tifacogin, in return for which Pfizerwill receive royalties on future sales of tifacogin. In the second quarter2004, we 

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began enrolling patientsin our Phase III trial for tifacogin as a treatment for patients with severecommunity-acquired pneumonia.

In April 2003, we acquired exclusive worldwidedevelopment and commercial rights from Novartis for PULMINIQTM (cyclosporine, USP) inhalation solution, atherapy under evaluation for treatment of rejection and reduction of mortalityin lung transplant recipients for $0.5 million, which was expensed as researchand development costs in 2003. In 2004, we submitted a new drug application tothe FDA for marketing approval of PULMINIQTM.

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

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

**Selling, general and administrative  **Theincrease in selling, general and administrative expenses in 2004 as comparedwith 2003 was primarily due to (i) $ 5.5 million for increasedexpenses for new product support, (ii) $5.5 million for the Euro toU.S. Dollar exchange rate fluctuation and (iii) $4.5 million forincreased expenses for programs and headcount in support of TOBI® tobramycinand international marketing, (iv) $4.2 million related to increased costsof our facilities, (v) $1.7 million increase for support to enhancebusiness processes and (vi) $1.2 for increased sales and medical affairssupport.

The increase in selling, general and administrativeexpenses in 2003 as compared with 2002 related to (i) $8.8 million fromongoing sales and marketing programs to support TOBI® in the U.S. and continuedmarket penetration in Europe, (ii) $3.0 investment in marketing capabilities tosupport clinical programs, (iii) $2.3 million from additional costsassociated with the enhancement of current business processes and (iv) $4.0million from the Euro to U.S. Dollar exchange rate fluctuation. In addition,the increase in 2003 as compared with 2002 was impacted by $5.1 million fromincreased costs following the acquisition of Pulmopharm in the third quarter2002.

**Amortizationexpense  **The increase in amortization expense in 2003compared with 2002 related to the distribution rights acquired upon acquisitionof Pulmopharm in the third quarter 2002. We acquired PathoGenesis Corporationin 2000 and accounted for the acquisition under the purchase method ofaccounting. We allocated a portion of the purchase price to purchasedtechnologies, acquired intangible assets and goodwill, which related to thebiopharmaceuticals segment.

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***Other***

Weview certain other revenues and expenses, particularly certain royalty andlicense fee revenues primarily related to HIV and HCV related patents, andunallocated corporate expenses, as not belonging to any one reportable segment.As a result, we have aggregated these items into an “Other’ segment.
| ** **                           | ** ** | **Twelve Months Ended**                             | ** ** | **$ Change** | ** ** | **% Change** | ** ** |
|--------------------------------------|------------|---------------------------------------------------------------|------------|-------------------|------------|-------------------|------------|
| ** **                           | ** ** | **December 31,**                                         | ** ** | **2004 vs.** | ** ** | **2003 vs.** | ** ** | **2004 vs.** | ** ** | **2003 vs.** | ** ** |
| ** **                           | ** ** | **2004**                                                      | ** ** | **2003**          | ** ** | **2002**          | ** ** | **2003** | ** ** | **2002** | ** ** | **2003** | ** ** | **2002** | ** ** |
| ** **                           | ** ** | **($ in 000’s, except percentages)** | ** ** |
| Royalty and license fee  revenues    |       | $                                                             | 123,608    |              | $          | 74,290            |       | $ | 69,645 |   | $ | 49,318 |   | $ | 4,645 |   |   | 66.4 | % |   |   | 6.7 | % |   |
| Selling, general and  administrative |       | $                                                             | 116,933    |              | $          | 86,867            |       | $ | 67,639 |   | $ | 30,066 |   | $ | 19,228 |   |   | 34.6 | % |   |   | 28.4 | % |   |
| Interest expense                     |       | $                                                             | 26,093     |              | $          | 19,104            |       | $ | 12,821 |   | $ | 6,989 |   | $ | 6,283 |   |   | 36.6 | % |   |   | 49.0 | % |   |
| Interest and other income, net       |       | $                                                             | 56,797     |              | $          | 38,892            |       | $ | 46,616 |   | $ | 17,905 |   | $ | (7,724 | ) |   | 46.0 | % |   |   | (16.6 | )% |   |

 

**Royalty and license fee revenues  **Ourother segment earns royalties on third party sales of, and license fees on,several products. The majority of royalty and license fee revenues related to theuse of our hepatitis C virus and HIV-related patents for diagnostic testingpurposes by various third parties.

*Roche settlement  *InOctober 2000, we entered into three license agreements with Roche andseveral of its affiliated companies related to the settlement of certainlitigation in the U.S. and certain other countries for use of our HCV and HIVnucleic acid testing intellectual property. Two agreements relate to *in vitro* diagnostics products. The thirdagreement relates to blood screening. See “Blood Testing—Royalty and licensefee revenues” above for more information on these agreements.

Under the hepatitis C virus agreement, wereceived $85.0 million, of which we recognized $40.0 million in thefourth quarter 2000. We deferred the remaining $45.0 million, whichbecomes nonrefundable through 2005. In the first quarter 2001, we beganrecognizing portions of the $45.0 million based upon the greater of (i) thescheduled quarterly minimum non-refundable amount or (ii) the actualearned credits as royalties on future sales related to Roche’s use of ourHCV-related patent in its *in vitro*diagnostic products. The agreement also provides for royalties on future salesrelated to Roche’s use of our HCV-related patent in its *in vitro* diagnostic products, which commencedin the first quarter 2001. Royalty revenues increased in 2004 as compared with2003, by $4.4 million or 9.5%. Royalty revenues decreased $7.5 million or13.8% in 2003 as compared with 2002 as the annual minimum royalty under thisagreement expired at the end of 2002.

The HIV agreement also provides for royalties onfuture sales related to Roche’s use of our HIV-related patent in its *in vitro* diagnostic products, whichcommenced in the first quarter 2001 when the European Patent Office Board ofTechnical Appeals upheld our HIV-related patent. Royalty revenues recognizedunder this agreement increased by $40.0 million in 2004 as compared with2003. This increase is mainly due to a settlement agreement with Roche,described in more detail below, in which we recognized revenues for a licensefee, deferred royalties and a portion of a nonrefundable royalty payment.Royalty revenues recognized under this agreement in 2003 were consistent with2002.

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

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Under the terms of thesettlement agreement, the milestone payment along with any royalties receivedprior to March 31, 2004 became non-refundable. Accordingly, in 2004, wehave recognized $10.0 million in license fees and $21.8 million inroyalties up until June 30, 2004, which had previously been deferred, ofwhich $16.3 million has been recognized as revenue in our other segmentand $5.5 million has been recognized as revenue in our blood testingsegment. We also recognized $0.8 million in interest on the license fee.Also under the settlement agreement, in the first quarter of 2005, we areentitled to receive a lump-sum payment of $78.0 million in lieu ofroyalties beyond January 1, 2005. Roche may elect under the terms of theagreement to obtain a partial refund and revert to paying royalties on thesales of its products in North America. The amount of such potential refundranges between $64.0 million and $0.0 million. The amount of therefund available decreases in increments over the quarters of 2005 and 2006. Assuch, Chiron expects to recognize $64.0 million of the payment as revenueover 2005 and 2006. The remaining $14.0 million is nonrefundable and wasrecognized as revenue in 2004, of which $9.3 million has been recognizedas revenue in our other segment and $4.7 million has been recognized asrevenue in our blood-testing segment. Revenues earned from diagnostic productsare included in our other segment and revenues earned from blood screening areincluded in our blood-testing segment.

Theimpact on revenues in 2004 from these items from the September 10, 2004settlement with Roche is summarized below (in thousands).
| ** **                                  | ** ** | **Other  Segment** | ** ** | **Blood-testing  Segment** | ** ** | **Total** | ** ** |
|---------------------------------------------|------------|--------------------|------------|----------------------------|------------|-----------|------------|
| Deferred revenues  recognized               |       | $                  | 16,313     |                       |       | $         | 5,453      |   |   | $ | 21,766 |   |
| Deferred license  fee recognized            |       | 10,000             |       |                       | —     |      |       | 10,000 |   |
| Non-refundable  portion of Roche settlement |       | 9,333              |       |                       | 4,667      |      |       | 14,000 |   |
| Total royalty and  license fee revenue      |       | $                  | 35,646     |                       |       | $         | 10,120     |   |   | $ | 45,766 |   |

 

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

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

*Bayer  *Across-license agreement provides for royalties to us on HIV and hepatitis Cvirus products sold by Bayer Corporation. Royalties were consistent in 2004 ascompared with 2003. Royalties increased $10.9 million in 2003 compared with2002 primarily due to increased donations and a contractual increase in theroyalty rates.

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

Royalty and license fee revenues may fluctuate basedon the nature of the related agreements, the timing of receipt of license feesand the expiration of patents. Results in any one period are not necessarilyindicative of results to be achieved in the future. In addition, our ability togenerate additional royalty and license fee revenues may depend, in part, onour ability to market and capitalize on our technologies.

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**Selling, general and administrative  **Theincrease in selling, general and administrative expenses in 2004 as comparedwith 2003 was primarily due to $12.1 million in legal costs related to theFLUVIRIN vaccine developments discussed above under “—FLUVIRIN® Influenza VirusVaccine Recent Events”, $12.9 million in legal costs related to thedefense of our patents and technology and $5.4 million from corporategovernance costs. These increases were partially offset by $4.0 million from a2003 donation to Chiron Foundation and $1.2 million from lower employee relatedexpenses.

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

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

On July 2, 2004, we acquired Sagres Discovery andaccounted for the acquisition as an asset purchase. We allocated the purchaseprice based on fair value of the assets acquired and liabilities assumed. Weallocated $9.6 million of the purchase price to purchased in-processresearch and development, which we charged to operations in the third quarter2004. We do not anticipate that there will be any alternative future use forthe purchased in-process research and development.

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

On February 20, 2002, we acquired MatrixPharmaceutical, Inc. and accounted for the acquisition as an assetpurchase. We allocated the purchase price based on the fair value of the assetsacquired and liabilities assumed. We allocated $45.2 million of thepurchase price to purchased in-process research and development, which wecharged to operations in 2002. We do not anticipate that there will be anyalternative future use for the in-process research and development. In valuingthe purchased in-process research and development, we usedprobability-of-success-adjusted cash flows and a 20% discount rate. We assumedrevenue from tezacitabine to commence after 2005. Development of tezacitabinewas discontinued in the first quarter of 2004 based on the analysis of the datafrom a Phase II trial in patients with gastroesophageal cancer. As with allpharmaceutical products, the probability of commercial success for any researchand development project is highly uncertain.

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

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

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**Interest and other income, net  **Interestand other income, net, primarily consisted of interest income on our cash andinvestment balances and other non-operating gains and losses. We recognizedinterest income of $23.4 million, $23.2 million and $36.2 million in2004, 2003 and 2002, respectively.

The decrease in interest income in 2003 as comparedwith 2002 primarily was due to lower average cash and investment balancesfollowing the acquisition of PowderJect and lower average interest rates.

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

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

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

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

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

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

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

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

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**Discontinued operations  **In astrategic effort to focus on our core businesses of blood-testing, vaccines andbiopharmaceuticals, we completed the sale of Chiron Diagnostics to Bayer andChiron Vision to Bausch & Lomb in 1998 and 1997, respectively. The “Gain(loss) from discontinued operations, net of taxes” consisted of the followingfor the years ended December 31:
| ** **                                                   | ** ** | **2004**                | ** ** | **2003** | ** ** | **2002** | ** ** |
|--------------------------------------------------------------|------------|-------------------------|------------|----------|------------|----------|------------|
| ** **                                                   | ** ** | **(In thousands)** | ** ** |
| Reversal of  reserves (net charge) for indemnity obligations |       | $                       | —     |     | $          | (5,222   | )          | $ | — |   |
| Gain resulting  from IRS settlement                          |       | 12,459                  |       | —   |       | —   |       |
| Employee  settlement                                         |       | —                  |       | —   |       | (438     | )          |
| Reversal of income  tax reserves from Bayer settlement       |       | 12,395                  |       | —   |       | —   |       |
| Income tax  benefit                                          |       | —                  |       | 12,197   |       | 118      |       |
|                                                         |       | $                       | 24,854     |     | $          | 6,975    |       | $ | (320 | ) |

 

Chiron and Bayer Corporation, or Bayer, were involvedin a dispute with respect to their respective rights to certain royalty refundsreceivable for which a settlement was reached in 2004. Under this settlementagreement, we made a settlement payment to Bayer in 2004. This settlementincludes an agreement that all outstanding items with Bayer related to the saleof Chiron Diagnostics are resolved and no future indemnity obligations arerequired. We released previously established reserves deemed to be excessfollowing this settlement. This settlement resulted in a net gain of$12.4 million in 2004. This net gain primarily relates to a tax benefit asa result of the settlement payment to Bayer.

In 2004, Chiron and the IRS entered into a settlementagreement closing the open tax years 1996 to 1998. Pursuant to this settlementagreement we recognized a tax benefit of approximately $12.5 million in2004.

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

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

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

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

**New AccountingStandards**

In December 2004, theFinancial Accounting Standards Board (FASB) issued Statement of FinancialAccounting Standards No. 123 (Revised 2004), *Share-Based Payment* (SFAS 123R), which requires the costresulting from all share-based payment transactions to be recognized in theconsolidated financial statements. That cost will be measured based on the fairvalue of the equity instruments issued or on the fair value of liabilitiesincurred. Under SFAS 123R, the fair-value-based method for recognition ordisclosure of compensation expense will be applied using the modifiedprospective application transition 

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methodor the modified retrospective application transition method. We currentlymeasure compensation expense for our stock-based employee compensation underthe intrinsic method. The adoption of SFAS 123R will have a material impact onour consolidated financial statements. Current option values of using theBlack-Scholes formula, as discussed in Note 1 of Notes to ConsolidatedFinancial Statements, may not be indicative of results from the valuationmethodologies we finally adopt. The adoption of SFAS 123R is effective forChiron commencing the beginning of the third quarter 2005.

**Liquidity andCapital Resources**

Our capital requirements have generally been funded bycash flow from operations, borrowings from commercial banks and issuance ofconvertible debt securities and common stock. Our cash, cash equivalents andinvestments in marketable debt securities, which totaled $1,013.0 millionat December 31, 2004, are invested in a diversified portfolio of fixedincome securities, including money market instruments, corporate notes andbonds, and government agency securities issued by financial institutions andother issuers with strong credit ratings. By policy, the amount of creditexposure to any one institution is limited. Investments are generally notcollateralized and primarily mature within three years.

The recent events regarding FLUVIRIN vaccine, asdiscussed above, will continue to impact our cash flow going forward. As wecontinue to implement our remediation plan, our efforts will entail additionalcash payments, which will be material. The MHRA’s lifting of our licensesuspension is conditioned upon theunderstanding that our commitment to remediation will continue.

In addition, we have incurred and expect to continueto incur substantial expense relating to the investigation by the U.S. Attorney’sOffice for the Southern District of New York, the Securities and ExchangeCommission formal investigation and the shareholder class action and derivativeprivate lawsuits and other claims arising out of or related to thesedevelopments regarding FLUVIRIN vaccine.

In addition, our inability to supply FLUVIRIN vaccinefor the 2004-2005 season may also lead to loss of market share becausecompetitors have announced plans to introduce influenza vaccine products in theUnited States during the 2005-2006 season and are seeking expeditedregulatory approval to do so. Even though the license suspension has beenlifted, some of our customers may choose to purchase flu vaccine from otherproviders as their products become available in the United States. Loss ofmarket share could have a material adverse effect on cash flow.

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

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

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

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

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

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

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

**Sources and Uses ofCash**

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

**Operating activities**   In 2004, netcash provided by operating activities was $170.7 million as compared with$413.9 million in 2003. The decrease in cash provided by operatingactivities was primarily due to lower income from continuing operations beforedepreciation, amortization and other non-cash charges, which decreased mainlydue to the suspension of our license to manufacture FLUVIRIN® influenza virusvaccine in our Liverpool facility which prevented the release of any of theproduct during the 2004-2005 influenza season. Cash provided by operatingactivities also decreased due to (i) increased selling, general andadministration expenses in 2004 primarily due to the movement of the Euro andBritish Pound exchange rates, twelve months of selling, general andadministrative expenses from PowderJect in 2004 compared to approximately six monthsin 2003 and increased legal costs, (ii) lower royalty payments ofBETASERON® and BETAFERON® interferon beta-1b due to a decline in theroyalty rate by five percentage points pursuant to our contractual arrangementwith Schering, and lower royalty payments received under the Roche royaltyarrangements in 2004 compared with 2003 and (iii) $14.4 million ofcash received as a result of the Biogen and Serono settlements in connectionwith the McCormick patents in 2003. These decreases were offset by (i) lowertax payments in 2004 as compared with 2003, (ii) a payment to BayerCorporation in 2003 from a settlement agreement relating to certain claimsraised by Bayer in connection with the Stock Purchase Agreement dated September 17,1998 and (iii) increased product sales of PROCLEIX® assays and TOBI®tobramycin in 2004.

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

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combination with variousmonoclonal antibodies, expansion of our meningococcal franchise and developmentof flu cell culture. We also incurred costs associated with our collaborationwith ZymeQuest Inc. to develop and commercialize an enzymatic conversionsystem, our license agreement with Infectio Diagnostics, and the in-licensingof daptomycin, (ii) higher royalty payments received under the BETAFERON®interferon beta-1b  and Rocheroyalty arrangements, (iii) $14.4 million of cash received as a resultof the Biogen and Serono settlements in connection with the McCormick patents(see “Biopharmaceuticals—Other revenues” above), (iv) an increase inaccounts payable and accrued liabilities at December 31, 2003 as comparedto a decrease at December 31, 2002 driven by the timing of payments andour acquisition of PowderJect and (v) excluding the effect ofacquisitions, a decrease in inventories at December 31, 2003 as comparedto an increase in inventories at December 31, 2002. Partially offsettingthese increases was a payment made to Bayer Corporation as a result of asettlement agreement relating to certain claims raised by Bayer under the StockPurchase Agreement dated September 17, 1998.

In 2002, net cash provided by operating activities was$268.2 million as compared with $262.0 million in 2001. The increasein cash provided by operating activities largely was due to (i) higherincome from operations before the charge for in-process research anddevelopment, depreciation and amortization and other non-cash charges and (ii) increasedcash due to the timing of payments received under the BETAFERON® interferonbeta-1b and Roche royalty arrangements. These increases were partiallyoffset by (i) the $45.3 million license fee payment received fromBayer in June 2001, (ii) increased accounts receivable primarily drivenby increases in product sales and royalty receivables due to an increase inBETAFERON® product sales and increased blood screening royalties due tocontractual price increases and increased blood-testing volume, (iii) loweraccrued liabilities and other payables due to the timing of payments and (iv) increasedpayments in 2002. Increased payments in 2002 as compared with 2001, includedpayments to (i) Gen-Probe upon resolution of certain contractual disputeswhich were accrued for in the fourth quarter 2001 and (ii) the Germangovernment in lieu of statutory price reductions on prescription drugs that arereimbursed under the German government’s healthcare program.

We anticipate that research and developmentexpenditures in 2005 will primarily be driven by (i) the furtherance ofour Phase III study and other development activities for tifacogin as atreatment for patients with severe community-acquired pneumonia (ii) initiationof a Phase III study and production of a dry powder formulation of our inhaledTOBI product for the treatment of pseudomonas aeruginosa in cystic fibrosispatients under our December 2001 collaboration agreement with NektarTherapeutics, (iii) early-stage oncology studies and other developmentactivities for Chiron compounds CHIR-258 and CHIR-12.12 (iv) expansionof our meningococcal franchise, (v) development of flu cell culture, (vi) researchactivities focused on identifying several novel vaccines and therapeutics forclinical development in the areas of oncology and infectious disease. Inaddition, we are required to make capital improvements to our existingmanufacturing facilities to support the supply of BETAFERON® product toSchering. In connection with this project, we are continuing to incur expensesrelating to the development of new processes and the performance of test runsrelated to installed equipment. Net cash from operating activities are expectedto fund these research and development activities.

**Investing activities  **In2004, net cash used in investing activities consisted of purchases ofinvestments in marketable debt securities of $796.9 million, capitalexpenditures of $183.7 million, cash paid for acquisitions net of cashacquired of $34.9 million, other uses of cash of $10.7 million andpurchases of equity securities and interests in affiliated companies of$6.6 million. Included in net cash paid for acquisitions was $8.2 millionfor previously accrued costs in connection with the acquisition of PowderJect,$15.5 million of cash delivered on the divestiture of certain operationsin Wisconsin, the U.K., and Sweden and $11.2 million of cash paid for theacquisition of Sagres. Cash used in investing activities was offset by proceedsfrom sales of investments in marketable debt securities of $431.1 million, proceedsfrom maturities of investments in marketable debt securities of $286.5 million,proceeds from the sale of 

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

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

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

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

In 2003, we became a limited partner of Burrill LifeSciences Capital Fund, L.P. We will pay $10.0 million over six years,of which $3.5 million has been paid through December 31, 2004 for a5.14% ownership. In 2003, we became a limited partner of Forward Venture V,L.P. We will pay $5.0 million over five years, of which $0.6 million hasbeen paid through December 31, 2004, for a 3.45% ownership. In 2002, webecame a limited partner of TPG Biotechnology Partners, L.P. We will pay$5.0 million over ten years, of which $2.2 million has been paidthrough December 31, 2004, for a 2.83% ownership. In 2001, we became alimited partner of Forward Venture IV, L.P. We will pay $15.0 million overten years, of which $11.0 million has been paid through December 31,2004, for a 6.35% ownership. In 2000, we became a limited partner of BurrillBiotechnology Capital Fund, L.P. We will pay $25.0 million over fiveyears, of which $21.1 million has been paid through December 31,2004, for a 23.26% ownership.

In 2003, net cash used in investing activitiesconsisted 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 ofequity securities and interests in affiliated companies of $14.2 millionand other uses of cash of $0.9 million. In 2003, cash paid foracquisitions, net of cash acquired, consisted of cash paid to acquirePowderJect, net of cash acquired, of $814.7 million and cash paid foracquisition costs related to the acquisitions of PathoGenesis Corporation andMatrix Pharmaceutical of $0.7 million. Cash used in investing activities wasoffset by proceeds from sales of investments in marketable debt securities of$793.2 million, proceeds from maturities of investments in marketable debtsecurities of $420.5 million, proceeds from the sale of equity securitiesand interests in affiliated companies of $12.6 million and proceeds fromnotes receivable of $0.8 million.

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

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total purchase price ofapproximately $938.6 million. As part of the acquisition of PowderJect, weassumed the debt of PowderJect including convertible notes with a face value of35.0 million British pounds (fair value of $57.0 million at July 8, 2003).We repaid the convertible notes during the third quarter 2003 and the paymentis included in “Repayment of debt and capital leases” in the ConsolidatedStatement of Cash Flows for the year ended December 31, 2003.

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

In 2002, net cash used in investing activitiesconsisted of purchases of investments in marketable debt securities of$796.5 million, capital expenditures of $105.7 million, net cash paidto acquire Matrix Pharmaceutical of $55.5 million, purchases of equitysecurities and interests in affiliated companies of $6.8 million, cashpaid to acquire Pulmopharm of $2.4 million, cash paid for acquisitioncosts related to the acquisition of PathoGenesis of $0.5 million and otheruses of cash of $6.1 million. Cash used in investing activities was offsetby proceeds from sales of investments in marketable debt securities of $ 252.0million and proceeds from maturities of investments in marketable debtsecurities of $471.6 million, proceeds from the sale of equity securitiesand interests in affiliated companies of $24.9 million, proceeds fromnotes receivable of $6.4 million and proceeds from sales of assets of$0.5 million.

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

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

**Financing activities  **In2004, net cash used in financing activities consisted of $383.0 millionfor the repayment of debt and capital leases, $135.0 million for theacquisition of treasury stock and $8.4 million for the payment of debt issuancecosts. Cash used in financing activities was offset by $385.0 million ofproceeds from issuance of convertible debentures (discussed above), $69.1million of proceeds from the reissuance of treasury stock and $5.6 million ofborrowings from a government agency.

In 2003, net cash provided by financing activitiesconsisted of $500.0 million of proceeds from the issuance of convertibledebentures (discussed below), $123.6 million of proceeds from thereissuance of treasury stock (related to stock option exercises), $2.1 millionof proceeds from put options sold to reduce the costs of our share repurchaseprogram, and $1.2 million from borrowings from a government agency inItaly. Cash provided by financing activities was offset by $207.7 millionfor the acquisition of treasury stock, $62.5 million for the repayment ofdebt and capital leases, $10.7 million for the payment of issuance costson the convertible debentures and $2.4 million for the net repayment ofshort-term borrowings.

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

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

In January 2001, we initiated a put optionprogram to reduce the effective cost of repurchasing our common stock. Underthis program, we entered into contracts with third parties to sell put optionson Chiron stock, entitling the holders to sell to us a specified number ofshares 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 wereexercised, we purchased 0.2 million shares. At December 31, 2004 and2003, Chiron had no outstanding put option contracts.

In 2002, net cash used in financing activitiesconsisted 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 wasoffset by proceeds from the reissuance of treasury stock (related to stockoption exercises) of $27.5 million and proceeds from put options of$5.4 million.

For the year ended December 31, 2002, wecollected 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 athird party entitling the holder to sell us 0.5 million shares. The optionexpired 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 theoutstanding put options, totaling $19.1 million, was reclassified from “Additionalpaid-in capital” to “Put options” in temporary equity in the ConsolidatedBalance Sheets at December 31, 2002. On January 29, 2003, our closingstock 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, thetemporary equity of $19.1 million was reclassified to permanent equity inthe first quarter 2003.

In March 2004, Chiron entered into a worldwide,exclusive, multi-product, collaborative arrangement with XOMA Ltd. for thedevelopment and commercialization of antibody products for the treatment ofcancer. Under the terms of the arrangement, the parties agreed to jointlyresearch, develop, and commercialize multiple antibody product candidates.Under the arrangement, the parties agreed to share development andcommercialization expenses, including preclinical and clinical development,manufacturing and worldwide marketing costs, as well as revenues, generally ona 70-30 basis, with Chiron’s share being 70% and XOMA’s share being 30%.Chiron agreed to make an initial payment of $10.0 million, which has beenpaid as of December 31, 2004, and to make a loan facility of up to$50.0 million available to XOMA, starting on January 1, 2005 to fundXOMA’s share of development expenses. The collaboration will initially focus onpreclinical, process development and scale up work. In December 2004,Chiron filed an IND application for a monoclonal antibody oncology compound,CHIR 12.12. This is the first project being developed under the collaborationagreement with XOMA for the commercialization of therapeutic antibodies forcancer.

From time to time, we evaluate a number of businessdevelopment opportunities. To the extent that we are successful in reachingagreements with third parties, these transactions may involve selling asignificant portion of our current investment portfolio, incurring additionaldebt or issuing additional Chiron shares.

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***Contractual Obligations***

Ourcontractual obligations as of December 31, 2004 were as follows: 
| ** **                                     | ** ** | **Obligations by period** | ** ** |
|------------------------------------------------|------------|--------------------------------|------------|
| **Contractual Obligations**               | ** ** | ** **                     | ** ** | **Total** | ** ** | **Less than  1 year** | ** ** | **1-3 years** | ** ** | **3-5 years** | ** ** | **More than  5 years** | ** ** |
| ** **                                     | ** ** | **(in thousands)**        | ** ** |
| Long-term debt  (includes current  portion)(1) |       | $                              | 939,093    |   | $ | 2,441 |   | $ | 1,726 |   | $ | 2,254 |   | $ | 932,672 |   |
| Capital lease  obligations(2)                  |       | 168,461                        |       | 2,624 |   | 5,248 |   | 160,589 |   | — |   |
| Other non-current  liabilities(3)              |       | 79,643                         |       | — |   | 9,969 |   | 1,839 |   | 67,835 |   |
| Operating leases(4)                            |       | 262,124                        |       | 32,705 |   | 56,587 |   | 39,074 |   | 133,758 |   |
| Purchase obligations:                          |       |                           |       |   |   |   |   |   |   |   |   |
| Technology services agreement(5)               |       | 50,400                         |       | 9,600 |   | 19,200 |   | 19,200 |   | 2,400 |   |
| Purchase orders(6)                             |       | 56,023                         |       | 53,486 |   | 2,006 |   | 481 |   | 50 |   |
| Supply agreement(7)                            |       | 119,500                        |       | 23,900 |   | 47,800 |   | 47,800 |   | — |   |
| Plant expansion(8)                             |       | 28,600                         |       | 28,600 |   | — |   | — |   | — |   |
| Berna biotech(9)                               |       | 6,360                          |       | 3,180 |   | 3,180 |   | — |   | — |   |
| Capital  commitments(10)                       |       | 19,800                         |       | 19,800 |   | — |   | — |   | — |   |
| Infonet(11)                                    |       | 3,300                          |       | 1,200 |   | 2,100 |   | — |   | — |   |
| Letters of  credit(12)                         |       | 13,721                         |       | 13,721 |   | — |   | — |   | — |   |
| Research and  development  arrangements(13)    |       | 71,500                         |       | 68,400 |   | 3,100 |   | — |   | — |   |
| Insurance-related  items(14)                   |       | 20,000                         |       | 20,000 |   | — |   | — |   | — |   |
| Manufacturing and  supply  agreement(15)       |       | 19,700                         |       | 6,566 |   | 13,134 |   | — |   | — |   |
| Supply  agreement(16)                          |       | 19,136                         |       | 6,222 |   | 12,914 |   | — |   |   |   |
| Burrill Life  Sciences Capital Fund,  L.P.(17) |       | 6,500                          |       | 6,500 |   | — |   | — |   | — |   |
| Forward Venture V  L.P(18)                     |       | 4,400                          |       | 4,400 |   | — |   | — |   | — |   |
| TPG Biotechnology  Partners, L.P(19)           |       | 2,800                          |       | 2,800 |   | — |   | — |   | — |   |
| Forward Ventures  IV L.P(20)                   |       | 4,000                          |       | 4,000 |   | — |   | — |   | — |   |
| Burrill  Biotechnology Capital Fund  L.P(21)   |       | 3,900                          |       | 3,900 |   | — |   | — |   | — |   |
| Contract  manufacturing agreement(22)          |       | 33,735                         |       | 6,791 |   | 11,759 |   | 10,124 |   | 5,061 |   |
| Revolving credit  agreement(23)                |       | 2,500                          |       | 2,500 |   | — |   | — |   | — |   |
| Loan facility(24)                              |       | 50,000                         |       | 50,000 |   | — |   | — |   | — |   |
| Managed services  agreement(25)                |       | 400                            |       | 400 |   | — |   | — |   | — |   |
| Total                                          |       | $                              | 1,985,596  |   | $ | 373,736 |   | $ | 188,723 |   | $281,361 |   | $ | 1,141,776 |   |
|                                                |            |                                |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

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

Theholders of the 2034 Debentures may require us to repurchase for cash all orpart of the debentures on June 30, 2010, June 30, 2014, June 30,2019, June 30, 2024 and June 30, 2029. The repurchase price will beequal to 100% of the principal amount of the Debentures to be repurchased, plusaccrued and unpaid interest, if any, up to the repurchase date.

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

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

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

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

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

Long-termdebt has been reflected in the table above at its stated maturity dates forpresentation purposes only. On specified dates, our repayment obligation couldoccur earlier than the maturity dates presented above because holders of thedebentures have the right to require us to repurchase the debt.

(2)          In July 2003, weentered into a new six-year lease to rent a research and development facilityin Emeryville, California (R&D Property) following the expiration of theexisting lease accounted for as an operating lease. We accounted for this new leaseas a capital lease and, as a result, recorded the leased asset and thecorresponding liability of $157.5 million on our balance sheet. This amountrepresents the present value of minimum lease payments, including the residualvalue guarantee. The lease provides a $156.0 million residual value guaranteefrom us to the lessors in the event fair value of the R&D Property declinesbelow the total investment of $173.3 million made by the lessors in the R&DProperty. Consequently, our maximum payment obligation is $156.0 million upontermination of the lease on or before July 1, 2009. The leased asset isamortized, using a straight-line method, to an amount such that the capitallease liability, net of the book value of the leased asset at the end of thelease term equals an amount that may become payable to the lessor due to an estimateddecline in fair value of the leased asset below the lessors’ total investmentof $173.3 million. We estimated the fair value of the R&D Property at theend of the lease term will be approximately $168.9 million. The fair valueat the end of the lease term was estimated using the cost approach in whichappraised value at lease inception is modified by estimates for building costappreciation and building component depreciation through the six-year leaseterm. This valuation requires significant estimates and assumptions. We believethe fair value assigned is based on reasonable assumptions. Aggregateamortization of the leased asset over the term of the lease is estimated to beapproximately $6.0 million. For the years ended December 31, 2004 and2003, $1.0 million and $0.5 million were recorded as amortization expense forthe capital lease.

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

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

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

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

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

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

(8)          In 2003, our Board ofDirectors approved $50.7 million in expenditures for a 25-yearbuilding lease and $42.2 million for capital improvements, both of whichare part of a $97.0 million project for expansion and replacement of ourflu vaccines manufacturing facility in Liverpool, England. The newmanufacturing facility will replace a portion of the existing flu vaccinesmanufacturing facilities in Liverpool, England and is anticipated to beavailable in the middle of 2008 for the manufacture of flu vaccines, subject toregulatory approval. In December 2003, we entered into a 25-yearlease for the building. As of December 31, 2004, we have incurred$13.6 million for the capital improvements portion of the project.

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

(10)   Wehad various other firm purchase and capital project commitments totalingapproximately $19.8 million at December 31, 2004.

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(11)   In2003, we entered into a four year Communication Services Agreement with InfonetUSA Corporation. The contract requires a minimum monthly payment of$0.1 million and our commitment at December 31, 2004, totaled$3.3 million.

(12)   AtDecember 31, 2004, we had $13.7 million committed under letters ofcredit, which are required by German law, related to ongoing legal proceedingsin Germany.

(13)   Weparticipate in a number of research and development arrangements with otherpharmaceutical and biotechnology companies to research, develop and marketcertain technologies and products. Chiron and its collaborative partnersgenerally contribute certain technologies and research efforts and commit,subject to certain limitations and cancellation clauses, to share costs relatedto certain research and development activities, including those related toclinical trials. At December 31, 2004, aggregate noncancelable fundingcommitments for 2005 under collaborative arrangements are $37.2 million.There are no noncancelable funding commitments under collaborative arrangementsthereafter. We may also be required to make payments to certain collaborativepartners upon the achievement of specified milestones. At December 31,2004, aggregate milestone payments that may become due under thesenoncancelable collaborative arrangements totaled $5.4 million. Thesemilestone payments are due upon the achievement of various technicalmilestones, completion of trials and regulatory filings.

In addition to thesecollaboration arrangements, we have entered into contracts where we areresponsible for all the costs related to research and development activities.At December 31, 2004, aggregate annual noncancelable commitments underthese contracts are as follows: 2005—$3.7 million and2006—$3.1 million. At December 31, 2004, aggregate milestone paymentsthat may become due under these noncancelable arrangements totaled$22.1 million. These milestone payments are due upon the achievement ofvarious technical milestones, completion of trials and regulatory filings.

The timing of paymentsrequired for the achievement of milestones in the future is not determinabletherefore we have included future milestone payments in “less than 1 year” forpresentation purposes.

(14)   Wehad various performance bonds and insurance-related letters of credit in theamount of $20.0 million available at December 31, 2004. There are noamounts outstanding under these letters of credit at December 31, 2004.

(15)   EffectiveFebruary 2003, Chiron and Baxter Pharmaceutical Solutions LLC executed aneight-year manufacturing and supply agreement. Under this agreement, Baxteragreed to perform certain manufacturing procedures and supply us with a keycomponent for a certain biopharmaceutical product. We have certain minimumpurchase obligations under this agreement and are required to pay thedifference, if any, between the actual quantity purchased and the minimumpurchase obligation. We can terminate this agreement in the fifth year withprior notice. Our minimum purchase obligation under this agreement is expectedto be approximately $38.2 million over four years from regulatoryapproval, which occurred in 2003. We have paid $18.5 million towards theminimum purchase obligation as of December 31, 2004. As of December 31,2004, the remaining minimum purchase obligation of $19.7 million isallocated ratably over three years.

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

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(17)   In2003, we became a limited partner of Burrill Life Sciences Capital Fund, L.P.We will pay $10.0 million over six years, of which $3.5 millionhas been paid through December 31, 2004 for a 5.14% ownership. Thepartnership agreement does not allocate the contribution across future years,therefore we have included the remaining contributions in ‘less than1 year’ for presentation purposes.

(18)   In2003, we became a limited partner of Forward Venture V, L.P. We will pay $5.0 millionover five years, of which $0.6 million has been paid through December 31,2004, for a 3.45% ownership. The partnership agreement does not allocate thecontribution across future years; therefore, we have included the remainingcontributions in ‘less than 1 year’ for presentation purposes.

(19)   In2002, we became a limited partner of TPG Biotechnology Partners, L.P. We willpay $5.0 million over ten years, of which $2.2 million has beenpaid through December 31, 2004, for an 2.83% ownership. The partnershipagreement does not allocate the contribution across future years; therefore, wehave included the remaining contributions in ‘less than 1 year’ forpresentation purposes.

(20)   In2001, we became a limited partner of Forward Venture IV, L.P. We will pay$15.0 million over ten years, of which $11.0 million has been paidthrough December 31, 2004, for a 6.35% ownership. The partnershipagreement does not allocate the contribution across future years; therefore, wehave included the remaining contributions in ‘less than 1 year’ forpresentation purposes.

(21)   In2000, we became a limited partner of Burrill Biotechnology Capital Fund, L.P.We will pay $25.0 million over five years, of which $21.1 million hasbeen paid through December 31, 2004, for a 23.26% ownership. Thepartnership agreement does not allocate the contribution across future years;therefore, we have included the remaining contributions in ‘less than1 year’ for presentation purposes.

(22)   EffectiveJune 2003, Chiron and SynCo B.V. executed a seven and a half-year contractmanufacturing agreement. Under this agreement, SynCo agreed to provide servicesrelated to the production of certain of our vaccine products for the Europeanand U.S. markets commencing in 2004. We have a firm binding order for productsto be delivered by SynCo in 2005 and 2006 under this agreement. Our minimumpurchase obligation under this agreement, which depends on the quantitiespurchased by us in years 2007 through 2010, inflation and movement in the Euroto U.S. Dollar exchange rate, is expected to be approximately$33.7 million over the remaining term of the agreement.

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

(24)   InMarch 2004, we entered into a worldwide, exclusive, multi-product,collaborative arrangement with XOMA Ltd. for the development andcommercialization of antibody products for the treatment of cancer. Under theterms of the arrangement, the parties agreed to jointly research, develop, andcommercialize multiple antibody product candidates. Under the arrangement, theparties agreed to share development and commercialization expenses, includingpreclinical and clinical development, manufacturing and worldwide marketingcosts, as well as revenues, generally on a 70-30 basis, with our share being70% and XOMA’s share being 30%. We agreed to make an initial payment of$10.0 million, which has been paid as of December 31, 2004, and tomake a loan facility of up to $50.0 million available to XOMA, starting onJanuary 1, 2005 to fund 75% of XOMA’s share of development expenses. Thefunding of the loan facility in the future is not determinable therefore wehave included the entire amount available under the loan facility in “less than1 year” for presentation purposes.

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(25)   EffectiveJune 2002, Chiron and VWR international, Inc. executed a seven-yearmanaged services agreement. Under this agreement, VWR agreed to provide uspurchasing and delivery services. We can terminate this agreement any time withsix-month notice and a minimum payment obligation of $0.4 million. If we do notterminate this agreement, payments to VWR are expected to be approximately $6.5million, of which approximately $0.9 million has been paid as of December 31,2004. At the end of the initial term, we have the option to renew the agreementfor an additional three years.

***BorrowingArrangements***

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

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

**Off-Balance Sheet Arrangements**

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

**Market RiskManagement**

Our cash flow fromoperations and earnings are subject to fluctuations due to changes in foreigncurrency exchange rates, interest rates, the fair value of equity securitiesheld and the realized value of investment securities sold. We attempt to limitour exposure to some or all of these market risks through the use of variousfinancial instruments. These activities are discussed in further detail in Item7A. “Quantitative and Qualitative Disclosures About Market Risk.”

**Factors That May Affect Future Results**

As a globalbiopharmaceutical company, we are engaged in a rapidly evolving and oftenunpredictable business. The forward-looking statements contained in this 10-Kand in other periodic reports, press releases and other statements issued by usfrom time to time reflect our current beliefs and expectations concerningobjectives, plans, strategies, future performance and other future events. Thefollowing discussion highlights some of the factors, many of which are beyondour control, which could cause actual results to differ.

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*The recent developmentswith respect to FLUVIRIN® vaccine will harm our business and results ofoperations.*

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

On March 2, 2005, the MHRA notified us that ithad lifted the license suspension, giving Chiron clearance to initiate fullproduction of FLUVIRIN vaccine, conditioned on the understanding that Chiron’scommitment to its remediation plan will continue. The FDA is still expected toconduct a full inspection to determine whether deficiencies noted in itswarning letter have been resolved. If we fail to adequately address the mattersdiscussed in the warning letter, the FDA may modify our U.S. license in anadverse manner, take action that could result in imposition of fines, requiretemporary or permanent cessation of future selling of FLUVIRIN vaccine or takeother action that could reduce our ability to market FLUVIRIN vaccine.

We received a grand jury subpoena issued by the U.S.Attorney’s Office for the Southern District of New York in October 2004requesting production of certain documents relating to FLUVIRIN vaccine and thesuspension by the MHRA of our license. In February 2005, the Securitiesand Exchange Commission, or SEC, notified us that it would commence a formalinvestigation into whether we or our employees have violated any federalsecurities laws in connection with these developments regarding FLUVIRIN, afterhaving previously commenced an informal inquiry. We also received a voluntaryrequest for information from the United States House of RepresentativesCommittee on Energy and Commerce requesting production of certain documents. Numerousdocuments have been collected and produced in response to these requests, andseveral witnesses have been interviewed by the U.S. Attorney’s Office and theSEC staff and additional interviews are anticipated. Additional investigationsregarding these matters may arise. In addition, we and certain of our officersand directors have also been named as defendants in several putative shareholderclass action and derivative lawsuits alleging various claims arising out of orrelating to these developments regarding FLUVIRIN, which are described above inPart I, Item 3, “Legal Proceedings”. Certain parties with which we havecontracted to supply FLUVIRIN are considering claims against us as a result ofour inability to supply FLUVIRIN vaccine, and additional parties may do so inthe future. On January 27, 2005, the U.S. Centers for Disease Control andPrevention terminated its contracts with Chiron for the supply of flu vaccinefor default on the basis of Chiron’s failure to supply such vaccine to the U.S.government for the 2004-2005 flu season. The CDC has reserved the rightto hold Chiron liable for any excess costs it may incur if it chooses to replacethe flu vaccine that Chiron failed to deliver and further has reserved allother remedies provided under the contract. Chiron maintains that its failureto deliver does not constitute default, because its reasons for non-performancefall within the “excusable delay” provisions of contracts with the CDC. We havealso received communications from certain distributors of FLUVIRIN vaccinesuggesting that they are entitled to compensation under their contracts for the2004-2005 season. It is not possible to predict whether any of theseclaims will be pursued and, if so, 

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whether those claims willbe upheld. Investigations, litigation and disputes have caused us to incursubstantial expense and have required significant time and attention from ourmanagement and will continue to do so in the future and could result in civilaction and/or criminal penalties against Chiron. The results of any suchinvestigations, proceedings or disputes could have a material adverse effect onour cash flow. From more information on these lawsuits, investigations andclaims, see Part I, Item 3. “Legal Proceedings” above.

We did not release any FLUVIRIN vaccine during the 2004-2005influenza season. As a result, our results of operations for 2004 werematerially adversely affected by these matters. Additional issues with respectto FLUVIRIN vaccine could cause us to have to recognize an impairment chargewith respect to the goodwill, certain other intangible assets and the Liverpoolplant resulting from the PowderJect acquisition and the new flu vaccinesmanufacturing facility under construction in Liverpool, which could have amaterial adverse effect on our results of operations.

Our inability to supply FLUVIRIN vaccine during the2004-2005 influenza season may also lead to loss of market share in the2005-2006 season and future seasons. Following the announcement of ourlicense suspension, competitors have announced plans to introduce influenzavaccine products in the United States and are seeking expedited regulatoryapproval to do so. Even though the license suspension has been lifted, some ofour customers may choose to purchase flu vaccine from other providers as theirproducts become available in the United States. Loss of market share could havea material adverse effect on our business and results of operations.

Although the MHRA has lifted its suspension of ourlicense to manufacture FLUVIRIN vaccine, we expect to incur additional expensesin connection with ongoing FLUVIRIN vaccine matters, which could be material,including in connection with (1) our continuing remediation efforts at ourLiverpool facility; and (2) responding to the U.S. Attorney for theSouthern District of New York, the SEC, the United States House ofRepresentatives Committee on Energy and Commerce and the private lawsuits andother claims and investigations that may arise.

For additional information on the U.S. Attorney’sinvestigation, SEC investigation, private lawsuits and other claims, see Part I,Item 3. “Legal Proceedings” of this report on Form 10-K.

*If we fail to obtain or maintain the regulatoryapprovals we need to market our products or substantial changes in theregulatory environment occur, our business may suffer.*

We must obtain and maintain regulatory approval inorder to market most of our products. Generally, these approvals are on aproduct-by-product and country-by-country basis. In the case of FLUVIRIN, thefailure to obtain or maintain our licenses, or delays imposed by regulatoryactions, could lead to the loss of our entire inventory during any given seasonsince each year’s vaccines are manufactured to meet specific strains of flu. Inthe case of therapeutic products, a separate approval is required for eachtherapeutic indication. Product candidates that appear promising based onearly, and even large-scale, clinical trials may not receive regulatoryapproval. The results of clinical trials often are susceptible to varyinginterpretations that may delay, limit or prevent approval or result in the needfor post-marketing studies. In addition, regulations may be amended from timeto time. Revised regulations may require us to reformulate products on acountry or regional basis, obtain additional regulatory approvals, or acceptadditional risks that our products will not maintain market acceptance or beeligible for third party insurance coverage. Increased regulatory scrutiny andrestrictions regarding marketing practices for products that are subject togovernment reimbursement may impact the sales of such products. There is noguarantee that we will be able to satisfy these new regulatory requirements andmay suffer a loss of revenue as a result.

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

We focus our research anddevelopment activities on areas in which we have particular strengths and ontechnologies that appear promising. These technologies often are on the cuttingedge of modern science. As a result, the outcome of any research or developmentprogram is highly uncertain. Only a very small fraction of these programsultimately result in commercial products or even product candidates. Productcandidates that initially appear promising often fail to yield successfulproducts. In many cases, preclinical or clinical studies will show that aproduct candidate is not efficacious (that is, it lacks the intendedtherapeutic or prophylactic effect), or that it raises safety concerns or hasother side effects, which outweigh the intended benefit. Success in preclinicalor early clinical trials (which generally focus on safety issues) may not translateinto success in large-scale clinical trials (which are designed to showefficacy), often for reasons that are not fully understood. Further, success inclinical trials will likely lead to increased investment, adversely affectingshort-term profitability, to bring such products to market. And even after aproduct is approved and launched, general usage or post-marketing studies mayidentify safety or other previously unknown problems with the product which mayresult in regulatory approvals being suspended, limited to narrow indicationsor revoked, or which may otherwise prevent successful commercialization.

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

Most of our products arebiologics. Manufacturing biologic products is complex. Unlike chemicalpharmaceuticals, a biologic product generally cannot be sufficientlycharacterized (in terms of its physical and chemical properties) to rely onassaying of the finished product alone to ensure that the product will performin the intended manner. Accordingly, it is essential to be able to bothvalidate and control the manufacturing process, that is, to show that theprocess works and that the product is made strictly and consistently incompliance with that process. Slight deviations anywhere in the manufacturingprocess, including quality control, labeling and packaging, may result inunacceptable changes in the products that may result in lot failures or productrecalls, or liability to a third party to the extent we are contractmanufacturing products in our facilities for such third party. Manufacturingprocesses which are used to produce the smaller quantities of material neededfor research and development purposes may not be successfully scaled up toallow production of commercial quantities at reasonable cost or at all. All ofthese difficulties are compounded when dealing with novel biologic productsthat require novel manufacturing processes. Additionally, manufacturing issubject to extensive government regulation. Even minor changes in themanufacturing process require regulatory approval, which, in turn, may requirefurther clinical studies. For some of our products, we rely on others to supplyraw materials and to manufacture those products according to regulatoryrequirements.

In addition, any prolongedinterruption in our operations or those of our partners could result in ourinability to satisfy the product demands of our customers. A number of factorscould cause interruptions, including equipment malfunctions or failures,interruptions due to labor action, damage to a facility due to naturaldisasters, such as an earthquake, suspension of power supplied to thesefacilities arising out of regional power shortages or terrorist activities andarmed conflict, including as a result of the disruption of operations of oursubsidiaries and our customers, suppliers, distributors, couriers, collaborativepartners, licensees and clinical trial sites.

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

We operate in a highlycompetitive environment, and the competition is expected to increase.Competitors include large pharmaceutical, chemical and blood testing companies,compounding 

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pharmacies,and biotechnology companies. Some of these competitors, particularly largepharmaceutical and blood testing companies, have greater resources than us.Accordingly, even if we are successful in launching a product, we may find thata competitive product dominates the market for any number of reasons,including:

·       Thepossibility that the competitor may have launched its product first;

·       Thecompetitor may have greater access to certain raw materials;

·       Thecompetitor may have more efficient manufacturing processes;

·       Thecompetitor may adapt more quickly to technological change;

·       Thecompetitor may have greater marketing capabilities;

·       Thecompetitive product may have therapeutic or other advantages; or

·       Newcompetitors may enter into markets where we currently have significantcompetitive advantage.

The technologies appliedby our competitors and us are rapidly evolving, and new developments frequentlyresult in price competition and product obsolescence. In addition, we may beimpacted by competition from generic forms of our products, substitute productsor imports of products from lower priced markets.

*Conflicts with or decisions by third parties wecollaborate with could harm our business.*

An important part of ourbusiness strategy depends upon collaborations with third parties, includingresearch collaborations and joint efforts to develop and commercialize newproducts. As circumstances change, Chiron and our strategic partners maydevelop conflicting priorities or other conflicts of interest. We mayexperience significant delays and incur significant expenses in resolving theseconflicts and may not be able to resolve these matters on acceptable terms.Even without conflicts of interest, we may disagree with our strategic partnersas to how best to realize the value associated with a current product or aproduct in development. In some cases, the strategic partner may haveresponsibility for formulating and implementing key strategic or operationalplans. In addition, merger and acquisition activity within the pharmaceuticaland biotechnology industries may affect our strategic partners, causing them toreprioritize their efforts related to the research collaborations and otherjoint efforts with us. Decisions by corporate partners on key clinical,regulatory, marketing (including pricing), inventory management and otherissues may prevent successful commercialization of the product or otherwiseimpact our profitability.

*If any of our third party suppliers or manufacturerscannot adequately meet our needs, our business could be harmed.*

We use raw materials andother supplies that generally are available from multiple commercial sources.Certain manufacturing processes, however, use materials that are available fromsole sources, or that are in short supply, or are difficult for the supplier toproduce and certify in accordance with our specifications. From time to time,concerns are raised with respect to potential contamination of biologicalmaterials that are supplied to us. These concerns can further tighten marketconditions for materials that may be in short supply or available from limitedsources. Moreover, regulatory approvals to market our products may beconditioned upon obtaining certain materials from specified sources. Ourability to substitute material from an alternate source may be delayed pendingregulatory approval of such alternate source. Although we work to mitigate the risksassociated with relying on sole suppliers, there is a possibility that materialshortages could impact production.

We purchase bulk powderedtobramycin, the primary basic raw material in TOBI® tobramycin, from two of theprincipal worldwide suppliers of the drug. We anticipate that either one ofthese suppliers alone 

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will beable to supply sufficient quantities to meet current needs; however, there canbe no assurance that these suppliers will be able to meet future demand in atimely and cost-effective manner. As a result, our operations could beadversely affected by an interruption or reduction in the supply of bulkpowdered tobramycin.

We have entered intocontracts with third parties for the production and packaging of TOBI®tobramycin. Over time, we can use alternative production and packaging sources.However, if the contracted third parties become unable to produce or packagesufficient quantities of TOBI solution due to work stoppages or otherfactors, our operations could be disrupted until alternative sources aresecured.

We have entered intocontracts with third parties for the packaging of the pre-filled diluentsyringe for BETASERON® interferon beta-1b. Over time, we can usealternative packaging sources. However, if the contracted third parties becomeunable to produce or package sufficient quantities of the pre-filled diluentsyringe for BETASERON® interferon beta-1b due to work stoppages orother factors, our operations could be disrupted until alternative sources aresecured.

In connection with theproduction of our flu vaccine products, we must purchase large quantities ofchicken eggs. For FLUVIRIN® vaccine, we purchase those eggs and incubationservices from a single supplier in the United Kingdom and, pursuant to thecontract with that supplier, we have agreed to make specified purchases fromthat supplier through 2009, subject to our right to terminate this agreementearlier upon payment of a termination fee. If our supplier were to fail tosupply eggs in sufficient quantities or quality, including as a result of anyhealth or other issues related to the chickens, our business would bematerially adversely affected.

We are a key provider forthe blood screening field of nucleic acid testing and immunodiagnostics. Innucleic acid testing, we rely on our collaborative partner, Gen-Probe, tomanufacture the West Nile virus assay, currently in use on aninvestigational-use basis in the U.S. and the PROCLEIX® HIV-1/ HCV andPROCLEIX® ULTRIOTM Assays. We currently source the related instrument systemfrom third party suppliers. Currently, Gen-Probe is the only manufacturer ofnucleic acid testing products using Transcription-Mediated Amplificationtechnology. In immunodiagnostics, under the Ortho-Clinical Diagnostics, Inc.contract, we manufacture bulk reagents and antigens and confirmatory test kitssold in the clinical diagnostics and blood screening fields. While we and ourpartners work to mitigate the risks associated with being a key provider, therecan be no assurance that our partner, Gen-Probe, will be able to providesufficient quantities of the PROCLEIX® HIV-1/HCV and PROCLEIX® ULTRIOTMAssays or that we will be able to manufacture sufficient bulk reagents andantigens and confirmatory test kits for immunodiagnostic products. Ourdifficulties or delays or those of our partners’ could cause a public healthconcern for the blood supply, as well as increase costs and cause loss ofrevenue or market share.

*If we cannot obtain necessary licenses to third partypatents for the manufacture or sale of our products, we may have to withdrawfrom the market or delay the introduction of the affected product.*

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

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

We may experiencedifficulties in launching new products, many of which are novel products basedon technologies that are unfamiliar to the healthcare community. We have noassurance that healthcare providers and patients will accept such products. Inaddition, government agencies, as well as private organizations involved inhealthcare, from time to time publish guidelines or recommendations tohealthcare providers and patients. Such guidelines or recommendations can bevery influential and may adversely affect the usage of our products directly(for example, by recommending a decreased dosage of our product in conjunctionwith a concomitant therapy or a government entity withdrawing itsrecommendation 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 toproduct liability claims, our business could be harmed.*

We are exposed to productliability and other claims in the event that the use of our products is allegedto have resulted in adverse effects. While we will continue to takeprecautions, we may not avoid significant product liability exposure. Althoughwe maintain product liability insurance, there is no guarantee that thiscoverage will be sufficient. It is not feasible to obtain adequate insurancecoverage for certain products and we are self-insured in relation to theseproducts. If we are sued for any injury caused by our products, we could suffera significant financial loss.

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

*Our mishandling of hazardous materials could result insubstantial costs and harm to our business.*

In connection with ourresearch and manufacturing activities, we utilize some hazardous materials. Webelieve we take great care to ensure we have appropriate procedures and permitsin place for storing and handling such hazardous materials. We could be subjectto loss of our permits, government fines or penalties and/or other adversegovernmental action if such hazardous materials are stored, handled or releasedinto the environment in violation of law or any permit. A substantial fine orpenalty, the payment of significant environmental remediation costs or the lossof a permit or other authorization to operate or engage in our ordinary courseof business could result in material, unanticipated expenses and the possibleinability to satisfy customer demand.

*Our patents may not prevent competition or generaterevenues.*

We seek to obtain patentson many of our inventions. Without the protection of patents, competitors maybe able to use our inventions to manufacture and market competing productswithout being required to undertake the lengthy and expensive developmentefforts made by us and without having to pay royalties or otherwise compensateus for the use of the invention. We have no assurance that patents and patentapplications owned or licensed to us will provide substantial protection.Important legal questions remain to be resolved as to the extent and scope ofavailable patent protection for biotechnology products and processes in theU.S. and other important markets. We do not know how many of our pending patentapplications will be granted, or the effective coverage of those that aregranted. In the U.S. and other important markets, the issuance of a patent isneither conclusive as to its validity nor the enforceable scope of its claims.We have engaged in significant litigation to determine the scope and validityof certain of our patents and expect to continue to do so. An adverse outcomeof litigation could result in the reduction or loss of royalty revenues.Engaging in patent litigation against one party may place significant royaltyrevenues received or to be received from other parties at risk. Even if we aresuccessful in obtaining and defending patents, there can be no assurance thatthese patents will provide substantial protection. The 

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lengthof time necessary to resolve patent litigation successfully may allowinfringers to gain significant market advantage. Third parties may be able todesign around the patents and develop competitive products that do not use theinventions covered by our patents. Many countries, including certain countriesin Europe, have compulsory licensing laws under which a patent owner may becompelled to grant licenses to third parties (for example, the third party’sproduct 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 thethird party has patented improvements). In addition, most countries limit theenforceability of patents against government agencies or governmentcontractors. In these countries, the patent owner may be limited to monetaryrelief and may be unable to enjoin infringement, which could materiallydiminish the value of the patent. In addition, royalty revenues may decline aspatents expire.

*Sales of our products may be adversely affected by theavailability and amount of reimbursement to the user of our products from thirdparties, such as the government and insurance companies.*

In the U.S. and othersignificant markets, sales of our products may be affected by the availabilityof reimbursement from the government or other third parties, such as insurancecompanies. It is difficult to predict the reimbursement status of newly approved,novel biotechnology products, and current reimbursement policies for existingproducts may change. In certain foreign markets, governments have issuedregulations relating to the pricing and profitability of pharmaceuticalcompanies. There have been proposals in the U.S. (at both the federal and statelevel) to implement such controls. If the United States Congress enactslegislative proposals addressing parallel importation currently beingdeliberated, revenues from certain products may be affected by this change inU.S. policy. The growth of managed care in the U.S. also has placed pressure onthe pricing of healthcare products. These pressures can be expected tocontinue.

*If our efforts to integrate acquired or licensedbusinesses or technologies into our business are not successful, our businesscould be harmed.*

Aspart of our business strategy, we expect to continue to grow our businessthrough in-licensing, collaborations or acquisitions of products or companies.The failure to adequately address the financial, operational or legal risksraised by such transactions could harm our business. Financial aspects relatedto these transactions may alter our financial position, reported operatingresults or stock price, and include:

·       Useof cash resources;

·       Potentiallydilutive issuances of equity securities;

·       Theincurrence of debt and contingent liabilities, impairment losses orrestructuring charges;

·       Largewrite-offs and difficulties in assessment of the relative percentages ofin-process research and development expense that can be immediately written offas compared to the amount which must be amortized over the appropriate life ofthe asset; and

·       Amortizationexpenses related to other intangible assets.

Operationalrisks that could harm our existing operations or prevent realization ofanticipated benefits from such transactions include:

·       Challengesassociated with managing an increasingly diversified business;

·       Difficultiesin assimilating the operations, products, technology, information systems orpersonnel of the acquired company;

·       Diversionof management’s attention from other business concerns;

·       Inabilityto maintain uniform standards, controls, procedures and policies;

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·       Theassumption of known and unknown liabilities of the acquired company, includingintellectual property claims; and

·       Subsequentloss of key personnel.

Legal risks may includerequirements to obtain the consent of our stockholders or a third party, or theapproval of various regulatory authorities.

If such efforts to integrateacquired or licensed businesses or technologies into our business are notsuccessful, our business could be harmed.

*If we cannot initiate and maintain revenue-generatingrelationships with third parties, we may not be able to grow our revenues inthe near to medium term.*

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

*Fluctuations in interest rates and foreign currencyexchange rates could harm our business.*

We have significant cashbalances and investments. Our financial results, therefore, are sensitive tointerest rate fluctuations. In addition, we sell products in many countriesthroughout the world, and our financial results could be significantly affectedby fluctuations in foreign currency exchange rates or by weak economicconditions in foreign markets.

*Our level of debt could limit cash flow available forour operations and could adversely affect our ability to service our debt orobtain additional financing, if necessary.*

As of December 31,2004, our total debt including current portion, was $939.1 million. Ourlevel of debt could restrict our operations and make it more difficult for usto satisfy our obligations under the 2033 and the 2034 convertible debentures(the “debentures”). Among other things, our level of debt may:

·       Limitour ability to obtain additional financing for working capital, capitalexpenditures, strategic acquisitions and general corporate purposes;

·       Requireus to dedicate all or a substantial portion of our cash flow to service ourdebt, which will reduce funds available for other business purposes, such ascapital expenditures or acquisitions;

·       Limitour flexibility in planning for or reacting to changes in the markets in whichwe compete;

·       Placeus at a competitive disadvantage relative to our competitors with lessleverage;

·       Renderus more vulnerable to general adverse economic and industry conditions; and

·       Makeit more difficult for us to satisfy our financial obligations, including thoserelating to the debentures and our other debt obligations.

We and our subsidiariesmay still be able to incur substantially more debt. The terms of our creditfacility, the indenture governing the debentures and the agreements governingour other debt permit additional borrowings. Our incurrence of additional debtcould further exacerbate the risks described above.

Our ability to satisfy ourobligations under the debentures and our other debt agreements will depend onour future operating performance, which will be subject, in part, to factorsbeyond our control, including general economic and business conditions. If weare unable to generate sufficient cash flow to service our debt, we may berequired to refinance all or a portion of our debt, including the debentures, 

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obtainadditional financing, sell some of our assets or operations, reduce or delaycapital expenditures, or revise or delay our strategic plans. If we arerequired to take any of these actions, it could have a material adverse effecton our business, financial condition and results of operations. In addition, wecannot assure you that we would be able to take any of these actions, thatthese actions would enable us to continue to satisfy our capital requirementsor that these actions would be permitted under the terms of our various debtinstruments, including the indenture governing the debentures.

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

We have an alliance withNovartis AG, a life sciences company headquartered in Basel, Switzerland. Undera series of agreements between Chiron and Novartis, and as a result ofsubsequent stock issuances by Chiron, Novartis’ ownership interest in Chironwas approximately 42.4% as of December 31, 2004. The governance agreementbetween Chiron and Novartis contains provisions that require the approval ofNovartis before we enter into certain corporate transactions. Thesetransactions generally include significant debt or equity issuances, debt orequity repurchases, most mergers and acquisitions, the payment of cash dividends,amendments to Chiron’s certificate of incorporation or by-laws, and othertransactions that would adversely impact the rights of Novartis, ordiscriminate against Novartis, as a Chiron stockholder. In addition, a majorityof the independent directors must approve any material transactions betweenChiron and Novartis. These provisions may limit our ability to enter intotransactions with third parties otherwise viewed as beneficial to Chiron. Allof our shares owned by Novartis are eligible for sale in the public marketsubject to compliance with the applicable securities laws. We have agreed that,upon Novartis’ request, we will file one or more registration statements underthe Securities Act in order to permit Novartis to offer and sell shares of ourcommon stock. Sales of a substantial number of shares of our common stock byNovartis in the public market could adversely affect the market price of ourcommon stock.

*Our stock price could be volatile.*

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

·       Fluctuationsin earnings from period to period;

·       Resultsof clinical trials conducted by us or by our competitors;

·       Announcementsby us or our competitors regarding product development efforts, including thestatus of regulatory approval applications;

·       Impactfrom the recent FLUVIRIN vaccine developments;

·       Theoutcome of legal proceedings, including claims filed by us against thirdparties to enforce our patents and claims filed by third parties against usrelating to patents held by the third parties;

·       Thelaunch of competing products;

·       Theresolution of (or failure to resolve) disputes with strategic partners;

·       Corporaterestructuring by us;

·       Thesale of a substantial number of shares held by our existing stockholders;

·       Licensingactivities by us; and

·       Theacquisition or sale by us of products, products in development or businesses.

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In connection with ourresearch and development collaborations, from time to time we may invest inequity securities of our strategic partners. The price of these securities alsois subject to significant volatility and may be affected by, among otherthings, the types of events that affect our stock. Changes in the market priceof these securities may impact our profitability.

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

We pay taxes principallyin the U.S., Germany, Italy, The Netherlands and the United Kingdom. All ofthese jurisdictions have in the past and may in the future make changes totheir corporate tax rates and other tax laws, which could increase our futuretax provision. Specifically, on October 22, 2004, the American JobsCreation Act of 2004 (the Act) was signed into law. The Act includes anelimination of the tax benefit of the Extraterritorial Income Exclusion over2005 and 2006.

We have negotiated anumber of rulings regarding income and other taxes that are subject to periodicreview and renewal. If such rulings are not renewed or are substantiallymodified, income taxes payable in particular jurisdictions could increase.While we believe that all material tax liabilities are reflected properly inour balance sheet, we are presently under audit in several jurisdictions andmay be subject to further audits in the future, and we have no assurance thatwe will prevail in all cases in the event the taxing authorities disagree withour interpretations of the tax law. In addition, we have assumed liabilitiesfor all income taxes incurred prior to the sales of our former subsidiaries,including PowderJect Vaccines, Inc., SBL Vaccin AB, and PowderJectResearch Limited. Future levels of research and development spending, capitalinvestment and export sales will impact our entitlement to related tax creditsand benefits which have the effect of lowering our effective tax rate.

*Our earnings results may be inconsistent and causevolatility in our stock price.*

Ouroperating results may vary considerably from quarter to quarter. Any number offactors may affect our quarterly operating results. These factors include, butare not limited to the following:

·       Inventorymanagement practices, including wholesale ordering patterns;

·       Thelevel of pre-clinical and clinical trial-related activities;

·       Seasonalityof certain vaccine products;

·       Thetender driven nature of certain vaccine products;

·       Thenature of our collaborative, royalty and license arrangements and other revenuesources;

·       Foreigncurrency exchange rate fluctuations; and

·       Thelevel of product reserves due to various issues, including seasonality patterns,excess and obsolete inventory, and production yields.

Our results in any onequarter are not necessarily indicative of results to be expected for a fullyear.

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

We must follow accountingstandards, financial reporting and corporate governance requirements and taxlaws set by the governing bodies and lawmakers in the U.S. and other countrieswhere we do business. From time to time, these governing bodies and lawmakersimplement new and revised rules and laws. These new and revised accountingstandards, financial reporting and corporate governance requirements and taxlaws may require changes to our financial statements, the composition of ourboard of directors, the composition, the responsibility and manner of operationof various board-level committees, the 

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informationfiled by us with the governing bodies and enforcement of tax laws against us.Implementing changes required by such new standards, requirements or lawslikely will require a significant expenditure of time, attention and resources,especially by our senior management. It is impossible to completely predict theimpact, if any, on Chiron of future changes to accounting standards, financialreporting and corporate governance requirements and tax laws.

It is possible that theapplication of certain current accounting standards may change due toenvironmental factors, which may necessitate a change in our standard practicerelated to these accounting standards. In particular, effective July 1,2005 we will be required to adopt SFAS No. 123R requiring us to apply afair-value based method to account for costs related to share-based paymentsincluding stock options and employee stock purchase plans. We expect theadoption of SFAS 123R to materially impact our results of operations.

**ITEM 7A.**        QUANTITATIVEAND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

**Foreign CurrencyRisk**

A significant portion of our operations consists ofmanufacturing and sales activities in western European countries. As a result,our financial results may be affected by changes in the foreign currencyexchange rates of those countries. Our primary exposures to foreign exchangerates are associated with the value of the Euro and the value of the BritishPound. A decrease in the value of the U.S. Dollar vis-à-vis the Euro and/orBritish Pound will result in a higher U.S. Dollar translated value of ournon-U.S. Dollar based revenues and expenses. Similarly, a decrease in the valueof the U.S. Dollar vis-à-vis the Euro and/or British Pound will result in ahigher U.S. Dollar translated value of our Pound-denominated revenue andexpenditures. To mitigate foreign currency exchange risks, we enter intoforeign currency forward contracts and purchase foreign currency optioncontracts. We do not use any of these derivative instruments for trading orspeculative purposes. The total notional amount of these derivative financialinstruments at December 31, 2004 and 2003 was $131.3 million and$113.6 million, respectively.

We use foreign currency forward contracts to hedge thegains and losses generated by the remeasurement of certain assets andliabilities denominated in foreign currencies. Typically, these contracts havematurities of three months or less. At December 31, 2004, our transactionexposures amounted to $138.8 million and were offset by foreign currencyforward contracts with a notional amount of $131.3 million (fair value of$120.9 million). The notional amount of the foreign currency forwardcontracts was $80.2 million (fair value of $85.6 million) at December 31,2003. Based on exposures at December 31, 2004, a 10% movement against ourportfolio of transaction exposures and hedge contracts would result in a gainor loss of approximately $0.75 million. A 10% movement in the value of theU.S. Dollar versus our portfolio of transaction exposures has occurred onlyonce in the last 12 quarters (in the second quarter of 2002). Foreign currencygains (losses) from continuing operations, including the impact of hedging,were $(0.4) million, $5.5 million and $0.7 million in 2004, 2003 and2002, respectively.

Our primary anticipatedexposures result from non-U.S. Dollar denominated revenues and expendituresrelated to our Western European operations. Our risk is that the value of theBritish Pound increases (i.e., we have a “short” British Pound exposure) andthat the value of the Euro decreases (i.e., we have a “long” Euro exposure). Ourshort British Pound exposure is currently larger than our long Euro exposure. Hence,a further decrease in the value of the U.S. Dollar vis-à-vis both thesecurrencies will likely have a negative impact on our financial results. We mayselectively hedge anticipated currency exposures by purchasing foreign currencyoption contracts and forward contracts. To limit hedging costs, we usuallypurchase out-of-the-money foreign currency option contracts. At December 31,2004, we had no outstanding option contracts. The notional amount of foreigncurrency option contracts was $33.4 million (fair value of$0.07 million) at December 31, 2003. Based on exposures estimated at December 31,2004 and based on historical patterns of exchange rate movements, avalue-at-risk analysis estimates that there 

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is a 95%probability that our unhedged portfolio of anticipated currency exposures willresult in a loss of $14.8 million or less over the next 12 months. In otherwords, there is a 5% chance that the loss will be greater than $14.8 million. Wemay enter into foreign currency forwards or options to hedge these exposures.

**Interest Rate Risk**

We have exposure to changes in interest rates in bothour investment portfolio and certain floating rate liabilities and leasecommitments where interest rates are tied to the London Inter-Bank OfferedRate. Our investment portfolio consists of a diversified selection of fixedincome securities, including money market funds and instruments, corporatenotes and bonds, government agency securities and other debt securities issuedby financial institutions and other issuers with strong credit ratings. Changesin interest rates do not affect interest expense incurred on our convertibledebentures because the debentures bear interest at fixed rates.

Our investment portfolio amounted to approximately$1,013.0 million at December 31, 2004. As of that date, we also had$173.3 million of floating rate obligations tied to the London Inter-BankOffered Rate (LIBOR). We had a “natural hedge” against this exposure as aresult of our portfolio holdings in floating rate fixed income securities tiedto LIBOR. The analysis below describes the impact of changes in interest ratesto us and is based on a net investment portfolio of $839.7 million.

The analysis assumes an immediate parallel increase ordecrease in interest rates of 100-basis points and examines the impact tous over the next twelve months. An immediate increase in interest rates of 100-basispoints results in higher interest income of $6.0 million over thesubsequent 12-month period. Similarly, a 100-basis point decreaseresults in a decrease in reported income of $3.2 million. Also, an immediateincrease in interest rates of 100-basis points results in a decrease inthe portfolio market value of $4.5 million. Fluctuations in the value of ourinvestment securities caused by changes in interest rates (gains or losses onthe carrying value) are recorded in other comprehensive income, and arerealized only if we sell the underlying securities.

A larger than 150-basispoint movement in short-term interest rates has occurred once in the last tenyears, a 100-150 basis point movement has occurred once in the last tenyears, a 50-100 basis point movement has occurred in four of the last tenyears, and a 0-50 basis point movement has occurred in four of the lastten years.

**Equity SecuritiesRisk**

We have exposure to equityprice risk because of our investments in equity securities. Typically, weobtain these securities through our collaboration agreements with otherpharmaceutical and biotechnology partners. We classify a majority of thesesecurities as available-for-sale and, consequently, record them on the balancesheet at fair value with unrealized gains or losses reported as a component ofcomprehensive income or loss. We periodically review the carrying values ofthese securities. We recognize impairment losses against earnings in the sameperiod the loss was deemed to have occurred. Changes in share prices affect thevalue of our equity portfolio. To reduce this risk, we hedge a portion of ourexposure through forward sales contracts. The forward sales contractssubstantially offset the value of the securities held and, in effect,neutralize the impact of market valuation shifts on the hedged portfolio. Thenotional amount of our forward sales contracts at December 31, 2004 was$41.5 million (versus a fair value of $36.7 million). A lower fair valueindicates a gain on forward sales contracts since we sold the shares forward athigher prices. The notional amount of our forward sales contracts at December 31,2003 was $64.8 million (fair value of $54.2 million). In the future,we may use additional hedging strategies in order to mitigate the potentialadverse impact from changes in the market value of stock prices. We have noassurance that impairment losses will not have a material adverse impact on ourfuture results of operations. We recorded 

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chargesof $1.4 million and $7.5 million in 2004 and 2002, respectively, towrite down certain available-for-sale equity securities that we deemed to havebeen impaired. There was no such charge in 2003. At December 31, 2004, ifthe market price of our equity investments, including warrants, decreased by10%, the market value of the equity portfolio would decrease by$3.6 million.

**Counterparty Risk**

We manage the risk ofcounterparty default on our debt securities and derivative financialinstruments through the use of credit standards, counterparty diversificationand monitoring of counterparty financial condition. We execute debt securitiesand derivative financial instrument transactions with financial institutionsand other issuers with strong credit ratings, which reduce the risk of loss dueto nonpayment or deterioration in credit rating. In 2001, we recorded a chargeof $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 the full principal plus interest, thus offsetting theprior loss. We have not experienced any realized losses due to counterpartydefault.

**ITEM 8.**                FINANCIALSTATEMENTS AND SUPPLEMENTARY DATA

We incorporate theinformation required for this item by reference to the financial statementslisted in Item 15(a) of Part IV of this Form 10-K.

**ITEM 9.**                CHANGESIN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE

Not applicable.

**ITEM 9A.**        CONTROLSAND PROCEDURES

**(a) Evaluation of disclosurecontrols and procedures**   As of the end of the periodcovered by this Annual Report, Chiron carried out an evaluation under thesupervision and with the participation of Chiron’s management, including Chiron’sCEO and CFO, of the effectiveness of the design and operation of Chiron’sdisclosure controls and procedures. Based on that evaluation, Chiron’smanagement, including the CEO and CFO, concluded that as of December 31,2004 Chiron’s disclosure controls and procedures were ineffective to ensurethat information required to be disclosed by the Company in reports that itfiles or submits under the Exchange Act is recorded, processed, summarized andreported within the time periods specified in SEC rules and forms. For adiscussion of the reasons and matters on which this conclusion was based, see “Management’sannual report on internal control over financial reporting”, below.

**(b) Management’s annual report on internalcontrol over financial reporting**

The management of Chiron Corporation is responsiblefor establishing and maintaining adequate internal control over financialreporting. Chiron’s internal control system was designed to provide reasonableassurance to the Company’s management and board of directors regarding thepreparation and fair presentation of published financial statements.

The management of Chiron assessed the effectiveness ofthe Company’s internal control over financial reporting as of December 31,2004. In making its assessment of internal control over financial reportingmanagement used the criteria issued by the Committee of SponsoringOrganizations of the Treadway Commission (COSO) in *Internal Control—Integrated Framework.*

In performing the assessment management has identifiedthree material weaknesses in internal control over financial reporting as of December 31,2004.

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The first material weakness pertains to both thedesign and operating effectiveness of controls relating to revenue recognitionat our vaccines subsidiary in Germany. Specifically, controls pertaining to thecommunication and evaluation of any special terms and other actions of thesales organization that may affect revenue recognition were not effective. As aresult, on March 8, 2005, the Audit Committee of the Board of Directors,following discussion with and upon the recommendation of management andfollowing discussion with Chiron’s independent auditors, concluded that thepreviously issued financial statements for the second and third quarters of2004 should be restated to correct certain errors contained therein and shouldnot be relied upon. The identified errors affected product revenue, cost ofgoods sold, accounts receivable, and unearned revenue for the Company’svaccines segment. In addition to the restatement of the financial statementsfor the second and third quarters of 2004, adjustments were recorded in theconsolidated financial statements for year ended December 31, 2004 to correctthe identified errors.

The second material weakness pertains to both thedesign and operating effectiveness of controls relating to the annual incometax provision. Specifically, there were errors in the annual tax provision forthe year ended December 31, 2004 as a result of ineffective controlsrelating to the design and use of analytical tools to analyze and calculate thetax provision, the reconciliation of certain tax accounts, and the review ofthose reconciliations. These errors affected income tax expense and income taxasset and liability accounts. Adjustments were recorded in the consolidatedfinancial statements for year ended December 31, 2004 to correct theidentified errors.

The third material weakness pertains to both thedesign and operating effectiveness of controls relating to the timelydetermination of the appropriate accrual for legal services. Specifically,procedures to estimate the accrual for unbilled services and controls over thetimely recording of invoices payable were not effective. Errors resulting fromthese deficiencies affected operating expenses, intangible assets and accruedliabilities. Adjustments were recorded in the consolidated financial statementsfor year ended December 31, 2004 to correct the identified errors.

Management has concluded that each of the abovecontrol deficiencies represents a material weakness in internal control overfinancial reporting. A material weakness is a control deficiency, orcombination of control deficiencies, that results in a more than remotelikelihood that a material misstatement of the annual or interim financialstatements will not be prevented or detected. As a result of the materialweaknesses described above, management believes that, as of December 31,2004, the Company’s system of internal control over financial reporting was noteffective based on the criteria in *InternalControl—Integrated Framework*.

Management’sassessment of the effectiveness of our internal control over financialreporting as of December 31, 2004 has been audited by Ernst &Young LLP, an independent registered public accounting firm, as stated in theirreport which is included below.

**(c) Attestation report of the independentregistered public accounting firm**

The Board of Directors andStockholders of Chiron Corporation

We have audited management’s assessment, in “Management’sannual report on internal control over financial reporting” included above,that Chiron Corporation did not maintain effective internal control overfinancial reporting as of December 31, 2004, because of the effect of thematerial weaknesses identified in management’s assessment and described below,based on criteria established in Internal Control—Integrated Framework issuedby the Committee of Sponsoring Organizations of the Treadway Commission (theCOSO criteria). Chiron Corporation’s management is responsible for maintainingeffective internal control over financial reporting and for its assessment ofthe effectiveness of internal control over financial reporting. Our responsibilityis to express an opinion on management’s assessment and an opinion on theeffectiveness of the Company’s internal control over financial reporting basedon our audit.

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We conducted our audit in accordance with thestandards of the Public Company Accounting Oversight Board (United States).Those standards require that we plan and perform the audit to obtain reasonableassurance about whether effective internal control over financial reporting wasmaintained in all material respects. Our audit included obtaining anunderstanding of internal control over financial reporting, evaluatingmanagement’s assessment, testing and evaluating the design and operatingeffectiveness of internal control, and performing such other procedures as weconsidered necessary in the circumstances. We believe that our audit provides areasonable basis for our opinion.

A company’s internal control over financial reportingis a process designed to provide reasonable assurance regarding the reliabilityof financial reporting and the preparation of financial statements for externalpurposes in accordance with generally accepted accounting principles. A company’sinternal control over financial reporting includes those policies andprocedures that (1) pertain to the maintenance of records that, inreasonable detail, accurately and fairly reflect the transactions anddispositions of the assets of the company; (2) provide reasonableassurance that transactions are recorded as necessary to permit preparation offinancial statements in accordance with generally accepted accountingprinciples, and that receipts and expenditures of the company are being madeonly in accordance with authorizations of management and directors of thecompany; and (3) provide reasonable assurance regarding prevention ortimely detection of unauthorized acquisition, use, or disposition of thecompany’s assets that could have a material effect on the financial statements.

Because of its inherent limitations, internal controlover financial reporting may not prevent or detect misstatements. Also,projections of any evaluation of effectiveness to future periods are subject tothe risk that controls may become inadequate because of changes in conditions,or that the degree of compliance with the policies or procedures maydeteriorate.

A material weakness is a control deficiency, orcombination of control deficiencies, that results in more than a remotelikelihood that a material misstatement of the annual or interim financialstatements will not be prevented or detected. The following material weaknesseshave been identified and included in management’s assessment:

The first material weakness pertains to both thedesign and operating effectiveness of controls relating to revenue recognitionat the Company’s vaccines subsidiary in Germany. Specifically, the controlspertaining to the communication and evaluation of special terms and otheractions of the sales organization that may affect revenue recognition were noteffective. As a result, Chiron Corporation concluded that the Company’spreviously issued financial statements for the second and third quarters of2004 should be restated to correct certain errors contained therein. Theidentified errors affected product revenue, cost of goods sold, accountsreceivable, and unearned revenue in the Company’s vaccines segment. In additionto the restatement of the financial statements for the second and thirdquarters of 2004, adjustments were recorded in the consolidated financialstatements for year ended December 31, 2004 to correct the identifiederrors.

The second material weakness pertains to both thedesign and operating effectiveness of controls relating to the annual incometax provision. Specifically, there were errors in the annual tax provision forthe year ended December 31, 2004 as result of ineffective controlsrelating to the design and use of analytical tools to analyze and calculate thetax provision, the reconciliation of certain tax accounts, and the review ofthose reconciliations. These errors affected income tax expense and income taxasset and liability accounts. Adjustments were recorded in the consolidatedfinancial statements for year ended December 31, 2004 to correct theidentified errors.

The third material weakness pertains to both thedesign and operating effectiveness of controls relating to the timelydetermination of the appropriate accrual for legal services. Specifically,procedures to estimate the accrual for unbilled services and controls over thetimely recording of invoices payable were not effective. Errors resulting fromthese deficiencies affected operating expenses, intangible assets and 

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accrued liabilities.Adjustments were recorded in the consolidated financial statements for yearended December 31, 2004 to correct the identified errors.

These material weaknesses were considered indetermining the nature, timing, and extent of audit tests applied in our auditof the 2004 financial statements, and this report does not affect our reportdated March 11, 2005****on thosefinancial statements.

In our opinion, management’sassessment that Chiron Corporation did not maintain effective internal controlover financial reporting as of December 31, 2004, is fairly stated, in allmaterial respects, based on the COSO criteria. Also, in our opinion, because ofthe effect of the material weaknesses described above on the achievement of theobjectives of the control criteria, Chiron Corporation has not maintainedeffective internal control over financial reporting as of December 31,2004, based on****the COSO criteria**.**
|                       | /s/ Ernst & Young LLP |
|-----------------------|--------------------------------|
| Palo Alto, California |                           |
| March 11, 2005   |                           |

 

**(d) ****Remediation steps to address material weaknesses**

We have an ongoingprocess of analyzing and attempting to improve our internal controls, includingthose related to the matters identified above. With regard to the revenuerecognition material weakness, the Company is taking steps designed to provideits sales force with the necessary training with respect to applicableaccounting principles so that the sales force understands the impact of itsactivities on the Company’s financial reporting. In addition, we intend to takesteps to implement processes to provide that changes to our standard terms ofsale will need specified levels of approval prior to being made, such asapproval from finance and legal departments or personnel. Additionally, theCompany is in the process of establishing a remediation plan to address theineffective controls related to the annual tax provision process. Theremediation plan is expected to include consideration and identification ofadditional controls and reconciliations and the consideration andimplementation of different analytical tools in order to enhance the analysisand calculation of the tax provision. With regard to the legal services accrualmaterial weakness, we are taking steps to increase awareness and understandingof the accruals process by providing training to the legal department andredesigning the processes related to estimating the accrual and the timely recordingof legal invoices, and we are also working to improve communication between thefinance and legal departments.

**(e) Changesin internal controls  **There have been no significantchanges in Chiron’s internal controls over financial reporting that havematerially affected, or are reasonably likely to materially affect internalcontrols over financial reporting during the fiscal quarter ended December 31,2004. Refer to Item 9A(d) for a discussion of remediation activitiesin connection with the material weaknesses in internal control over financialreporting identified above.

**ITEM 9B.**       OTHERINFORMATION

Not applicable.

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**PART III**

**ITEM10.**         DIRECTORSAND EXECUTIVE OFFICERS OF THE REGISTRANT

We incorporate theinformation required for this item by reference to our definitive ProxyStatement for our 2005 Annual Meeting. We intend to file our Proxy Statementwith the Securities and Exchange Commission within 120 days of December 31,2004. See the sections entitled “Election of Directors”, “Section 16(a) BeneficialOwnership Reporting Compliance” and “Corporate Governance Matters” in the ProxyStatement. For information on our executive officers, refer to the sectionentitled  “Executive Officers of theRegistrant” which appears at the end of Part I of this 10-K.

**ITEM 11.**         EXECUTIVECOMPENSATION

We incorporate theinformation required for this item by reference to our Proxy Statement. See thesections entitled “Compensation of Directors” and “Executive Compensation andRelated Information” in the Proxy Statement.

**ITEM 12.**         SECURITYOWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDERMATTERS

We incorporate the stockownership information required for this item by reference to our ProxyStatement. See section entitled “Stock Ownership” in the Proxy Statement.

**Equity CompensationPlan Information**

Thetable below shows the securities authorized for issuance under Chiron’s equitycompensation plans in effect at December 31, 2004. Chiron does not maintainany equity compensation plans that have not been approved by its stockholders.
| ** **                                                  | ** ** | **(a)**                                                                                                                                  | ** ** | **(b)**                                                                                                                    | ** ** | **(c)**                                                                                                                                                                                                      | ** ** |
|-------------------------------------------------------------|------------|------------------------------------------------------------------------------------------------------------------------------------------|------------|----------------------------------------------------------------------------------------------------------------------------|------------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|
| ** **                                                  | ** ** | **Number securities to  be issued upon  exercise of  outstanding options,  warrants and rights** | ** ** | **Weighted average exercise  price of outstanding   options, warrants and rights** | ** ** | **Number of securities  remaining available for  future issuance under  equity compensation  plans (excluding  securities reflected in  column (a))** | ** ** |
| Equity compensation  plans approved by security holders     |       |                                                                                                                                     | 27,257,292 | (1)(2)(3)                                                                                                                  |       |                                                                                                                                                                                                         | $          | 40.85 |   |   |   | 27,327,145 | (4) |   |
| Equity  compensation plans not approved by security holders |       |                                                                                                                                     | —     |                                                                                                                       |       |                                                                                                                                                                                                         | —     |   |   |   | — |   |   |
| Total                                                       |       |                                                                                                                                     | 27,257,292 |                                                                                                                       |       |                                                                                                                                                                                                         |       |   |   |   | 27,327,145 |   |   |

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(1)   Excludespurchase rights accruing under the Purchase Program component of the 2004 StockCompensation Plan (the “Stock Plan”); the Stock Plan has a shareholder approvedreserve of 79.2 million shares of which up to 6,400,000 shares may be issuedunder the Purchase Program. Under the Purchase Program as in effect on December 31,2004,each eligible employee may purchase up to 10,667 shares of common stockduring a 12 month offering period; shares are purchased during the offeringperiod at quarterly intervals on the last business day of January, April, July andOctober each year at a purchase price per share equal to eighty-fivepercent (85%) of the lower of (i) the fair market value per share of ourcommon stock on the date that the employee becomes a participant in theoffering period or (ii) the fair market value per share of our commonstock on the purchase date.

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(2)          Includes 624,411 sharesreserved for issuance under outstanding share right awards issued under theStock Plan. The outstanding share right awards will vest upon the completion ofa designated service period or attainment of specified performance goals. Asthe award vests, shares will be issued to the holder with no cash payment to usrequired. The weighted average exercise price indicated in column (b) doesnot take the share right awards into account.

(3)          Includes 59,831 sharessubject to outstanding options granted in substitution of options held byemployees of Pathogenesis Corporation at the time of its acquisition by Chironin September 2000. The weighted average exercise price of these options is$31.42. At the time of the acquisition, Chiron granted substitute options for207,293 shares with a weighted average exercise price of $30.12.

(4)          Consists of sharesavailable for future issuance under the Stock Plan. As of December 31,2004, 21,197,098 shares of our common stock were available for issuance underthe Stock Plan. In accordance with the current terms of the Stock Plan, thenumber of shares of our common stock available for issuance under that planautomatically increases on the first trading day of January each calendar yearby an amount equal to the lesser of (i) one percent (1.0%) of the numberof Chiron Common Equivalent Shares outstanding as of the end of the precedingfiscal year or (ii) 3 million shares.  “Chiron Common Equivalent Shares” are thetotal number of shares of common stock outstanding plus the total number ofshares of common stock issuable upon conversion or exercise of outstandingwarrants, options and convertible securities.

We incorporate the otherinformation required for this item by reference to our Proxy Statement. See thesection entitled “Stock Ownership” in the Proxy Statement.

**ITEM 13.**         CERTAINRELATIONSHIPS AND RELATED TRANSACTIONS

We incorporate the informationrequired for this item by reference to our Proxy Statement. See the sectionentitled “Certain Relationships and Related Transactions” in the ProxyStatement.

**ITEM 14.**         PRINCIPALACCOUNTANT FEES AND SERVICES

We incorporate the information required by this itemby reference to our Proxy Statement. See section entitled “Ratification ofAppointment of Independent Auditors—Independent Auditor Fee Information” in theProxy Statement.

Except for the information incorporated by referencesin Items 10, 11, 12, 13 and 14 of this Form 10-K, our definitiveProxy Statement is not deemed filed as part of this Form 10-K.

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**PART IV**

**ITEM 15.**         EXHIBITSAND FINANCIAL STATEMENT SCHEDULES

(a)           The following documentsare filed as part of this report:

1.                Indexto Consolidated Financial Statements
|                                                                                                                                              | ** ** | **Page  Number** |
|----------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------|
|                                                                                                                                         |       |             |
| Report of Independent  Registered Public Accounting Firm                                                                                     |       | F-1              |
| Consolidated  Balance Sheets at December 31, 2004 and 2003                                                                              |       | F-2  – F-3  |
| Consolidated Statements of  Operations for each of the three years in the period ended  December 31, 2004                          |       | F-4              |
| Consolidated Statements of  Comprehensive Income for each of the three years in the period ended  December 31, 2004           |       | F-5              |
| Consolidated  Statements of Stockholders’ Equity for each of the three years in the  period ended December 31, 2004 |       | F-6              |
| Consolidated  Statements of Cash Flows for each of the three years in the period ended  December 31, 2004                          |       | F-7  – F-8  |
| Notes to Consolidated  Financial Statements                                                                                                  |       | F-9  – F-83 |

 

2.                Indexto Financial Statement Schedules
|                                                               | ** ** | **Page  Number** |
|---------------------------------------------------------------|------------|------------------|
| II  Valuation and Qualifying Accounts and  Reserves |       | F-84             |

 

We omitted all other schedules because those schedulesare not applicable, not required or because the required information isincluded in the Consolidated Financial Statements or accompanying notes.

(b)          Exhibits.   TheExhibits listed below are filed as part of this report.
| Exhibit Number | ** ** | ** **                                                                                                                                                                                                                                                                                                        | ** ** | **Exhibit** |
|----------------|------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------|
| 3.01           |       | Restated Certificate of Incorporation of Chiron, as  filed with the Office of the Secretary of State of Delaware on  August 17, 1987, incorporated by reference to Exhibit 3.01 of  Chiron’s report on Form 10-K for fiscal year 1996.                                                        |
| 3.02           |       | Certificate of Amendment  of Restated Certificate of Incorporation of Chiron, as filed with the Office  of the Secretary of State of Delaware on December 12, 1991, incorporated  by reference to Exhibit 3.02 of the Chiron’s report on Form 10-K  for fiscal year 1996.                     |
| 3.03           |       | Certificate of Amendment  of Restated Certificate of Incorporation of Chiron, as filed with the Office  of the Secretary of State of Delaware on May 22, 1996, incorporated by  reference to Exhibit 3.04 of Chiron’s report on Form 10-Q for the  quarterly period ended June 30, 1996. |
| 3.04           |       | Bylaws of Chiron, as  amended and restated, incorporated by reference to Exhibit 99.1 of  Chiron’s current report on Form 8-K dated March 10, 2005.                                                                                                                                           |
| 4.01           |       | Indenture between Chiron  and State Street Bank and Trust Company, dated as of June 12, 2001,  incorporated by reference to Exhibit 4.01 of Chiron’s report on  Form 10-Q for the quarterly period ended June 30, 2001.                                                                  |

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| 4.02   |   | Registration Rights  Agreement between Chiron and Merrill Lynch & Co., Inc., and  Merrill Lynch, Pierce, Fenner & Smith, Incorporated, incorporated by  reference to Exhibit 4.02 of Chiron’s report on Form 10-Q for the  quarterly period ended June 30, 2001.                                                                                                 |
|--------|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 4.03   |   | Form of Liquid  Yield Option NoteTM due 2031 (Zero Coupon—Senior) (included as exhibits A-1  and A-2 to the Indenture filed as Exhibit 4.01 to Chiron’s report on  Form 10-Q for the quarterly period ended June 30, 2001),  incorporated by reference to Exhibit 4.03 of Chiron’s report on  Form 10-Q for the quarterly period ended June 30, 2001. |
| 4.04   |   | Indenture between Chiron  and U.S. Bank National Association, as trustee, dated as of July 30,  2003, incorporated by reference to Exhibit 4.1 of Chiron’s registration  statement on Form S-3 filed with the Commission on September 23,  2003.                                                                                                                                   |
| 4.05   |   | Registration Rights  Agreement dated as of July 30, 2003, between Chiron and Morgan  Stanley & Co., Goldman, Sachs & Co., Banc of America  Securities LLC and BNP Paribas Securities Corp., incorporated by reference to  Exhibit 4.3 of Chiron’s registration statement on Form S-3 filed  with the Commission on September 23, 2003.                           |
| 4.06   |   | Form of Convertible  Debentures (included in Exhibit 4.04), incorporated by reference to  Exhibit 4.2 of Chiron’s registration statement on Form S-3 filed  with the Commission on September 23, 2003.                                                                                                                                                                        |
| 4.07   |   | Indenture between Chiron  and U.S. Bank National Association, as trustee, dated as of June 22,  2004, incorporated by reference to Exhibit 4.07 of Chiron’s report on  Form 10-Q for the quarterly period ended June 30, 2004.                                                                                                                                                     |
| 4.08   |   | Registration Rights  Agreement dated as of June 22, 2004, between Chiron, Credit Suisse First  Boston, LLC and Morgan Stanley & Co., Goldman, Sachs & Co.,  Incorporated, incorporated by reference to Exhibit 4.08 of Chiron’s  report on Form 10-Q for the quarterly period ended June 30, 2004.                                                               |
| 4.09   |   | Specimen of Convertible  Debentures (included as Exhibit A to the Indenture referenced as  Exhibit 4.07 of Chiron’s report on Form 10-Q for June 30,  2004) issued on June 22, 2004, incorporated by reference to  Exhibit 4.09 of Chiron’s report on Form 10-Q for the quarterly  period ended June 30, 2004.                                            |
| 4.10   |   | Reserved                                                                                                                                                                                                                                                                                                                                                                                                    |
| 10.001 |   | Purchase Agreement  between BNP Leasing Corporation and Chiron, dated June 28, 1996, incorporated  by reference to Exhibit 10.90 of Chiron’s report on Form 10-Q for  the quarterly period ended June 30, 1996.                                                                                                                                                                    |
| 10.002 |   | Lease Agreement between  BNP Leasing Corporation and Chiron, dated June 28, 1996, incorporated by  reference to Exhibit 10.91 of Chiron’s report on Form 10-Q for the  quarterly period ended June 30, 1996.                                                                                                                                                                       |
| 10.003 |   | Ground Lease between BNP  Leasing Corporation and Chiron, dated June 28, 1996, incorporated by  reference to Exhibit 10.92 of Chiron’s report on Form 10-Q for the  quarterly period ended June 30, 1996.                                                                                                                                                                          |

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| 10.004  |   | Second Amendment between BNP Paribas Leasing  Corporation, a Delaware corporation (as successor in interest to BNP Leasing  Corporation) (“BNPLC”), and Chiron, dated July 1, 2003, Incorporated by  reference to Exhibit 10.004 of Chiron’s report on Form 10-Q for the  quarterly period ended June 30, 2003.                                                                                                                                                                                                                                                                                                                                                         |
|---------|--------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| *10.005 |   | Agreement for Lease  dated effective December 23, 2003, between Intercity Pharma Limited, as  developer, and Evans Vaccines Limited, as tenant, incorporated by reference  to Exhibit 10.005 of Chiron’s report on Form 10-K for fiscal year  2003.                                                                                                                                                                                                                                                                                                                                                                                                                                    |
| 10.006  |   | Through 10.101 Reserved                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    |
| 10.102  |   | Amended and Restated  Revolving Credit Agreement, dated as of August 13, 2002, by and between  Chiron and Bank of America, N.A., and exhibits thereto, incorporated by  reference to Exhibit 10.102 of Chiron’s report on Form 10-Q for the  quarterly period ended September 30, 2002.                                                                                                                                                                                                                                                                                                                                                                                           |
| 10.103  |   | Reserved                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   |
| 10.104  |   | Stock Purchase and  Warrant Agreement dated May 9, 1989, between Cetus Corporation and  Hoffmann-La Roche Inc. (initially filed as Exhibit 10.36 of Chiron’s  report on Form 10-Q for the quarterly period ended September 30,  1994), incorporated by reference to Exhibit 10.104 of Chiron’s report on  Form 10-Q for the quarterly period ended June 30, 1999.                                                                                                                                                                                                                                                                                             |
| 10.105  |   | Letter Agreement, dated  as of December 12, 1991, relating to Stock Purchase and Warrant  Agreement between Chiron and Hoffmann-La Roche Inc., incorporated by  reference to Exhibit 10.51 of Chiron’s report on Form 10-K for  fiscal year 1996.                                                                                                                                                                                                                                                                                                                                                                                                                                      |
| 10.106  |   | Through 10.200 Reserved                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    |
| *10.201 |   | Agreement between Chiron  and Ortho Diagnostic Systems, Inc., a New Jersey corporation, dated  August 17, 1989, and Amendment to Collaboration Agreement between Ortho  Diagnostic Systems, Inc. and Chiron, dated December 22, 1989 (with  certain confidential information deleted), (initially filed as  Exhibit 10.29 to Chiron’s report on Form 10-K for fiscal year 1989,  and refiled as Exhibit 10.14 of Chiron’s report on Form 10-Q for  the quarterly period ended September 30, 1994), incorporated by  reference to Exhibit 10.201 of Chiron’s report on Form 10-Q for the  quarterly period ended March 31, 1999. |
| *10.202 |   | License and Supply  Agreement between Ortho Diagnostic Systems, Inc., a New Jersey  corporation, Chiron and Abbott Laboratories, an Illinois corporation, dated  August 17, 1989 (initially filed as Exhibit 10.31 to Chiron’s  report on Form 10-K for fiscal year 1989, and refiled as  Exhibit 10.15 of Chiron’s report on Form 10-Q for the quarter ended  June 30, 1994), incorporated by reference to Exhibit 10.202 of  Chiron’s report on Form 10-Q for the quarterly period ended  March 31, 1999.                                                                                                                               |
| *10.203 |   | Regulatory Filing,  Development and Supply Agreement between Chiron, Cetus Oncology Corporation,  a wholly-owned subsidiary of Chiron, and Schering AG, a German company, dated  as of May 10, 1993 (initially filed as Exhibit 10.50 to Chiron’s  report on Form 10-Q for quarterly period ended September 30, 1993),  incorporated by reference to Exhibit 10.203 of Chiron’s report on  Form 10-K for fiscal year 1998.                                                                                                                                                                                                                                         |

98

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| *10.204 |   | Letter Agreement dated  December 30, 1993 by and between Chiron and Schering AG, a German  company (initially filed as Exhibit 10.51 to Chiron’s report on  Form 10-K for fiscal year 1993), incorporated by reference to  Exhibit 10.204 of Chiron’s report on Form 10-K for fiscal year  1998.                                                                        |
|---------|--------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| *10.205 |   | Amendment Agreement (HDS  Fees and Deeply Discounted Vials) dated as of September 23, 1997 between  Chiron and Schering Aktiengesellschaft, incorporated by reference to  Exhibit 10.205 of Chiron’s report on Form 10-K for fiscal year  1997.                                                                                                                                        |
| 10.206  |   | Reserved                                                                                                                                                                                                                                                                                                                                                                                                   |
| *10.207 |   | Letter Agreement dated  as of December 4, 1997, between Chiron and Ortho Pharmaceutical  Corporation and Ortho Biotech, Inc., incorporated by reference to  Exhibit 10.207 of Chiron’s report on Form 10-K for fiscal year  1997.                                                                                                                                                 |
| *10.208 |   | Reserved                                                                                                                                                                                                                                                                                                                                                                                                   |
| *10.209 |   | Second Amendment  Agreement dated as of June 15, 2001, between Chiron and Schering  Aktiengesellschaft, incorporated by reference to Exhibit 10.209 of  Chiron’s report on Form 10-Q for the quarterly period ended  June 30, 2001.                                                                                                                                               |
| 10.210  |   | Reserved                                                                                                                                                                                                                                                                                                                                                                                                   |
| *10.211 |   | Side Letter Agreement  dated as of December 20, 2002, between Chiron and Schering  Berlin, Inc., incorporated by reference to Exhibit 10.211 of  Chiron’s report on Form 10-Q for the quarterly period ended March 31,  2003, incorporated by reference to Exhibit 10.211 of Chiron’s report on  Form 10-Q for the quarterly period ended June 30, 2003. |
| *10.212 |   | Contract Manufacturing  Agreement dated as of June 12, 2003, between Chiron S.r.l., Chiron  Behring GmbH & Co., and SynCo Bio Partners B.V., incorporated by  reference to Exhibit 10.212 of Chiron’s report on Form 10-Q for the  quarterly period ended June 30, 2003.                                                                                                 |
| *10.213 |   | FDA  Compliance Agreement dated as of June 12, 2003, between Chiron  S.r.l, Chiron Behring GmbH & Co  and SynCo Bio Partners B.V., incorporated by reference to  Exhibit 10.213 of Chiron’s report on Form 10-Q for the quarterly  period ended June 30, 2003.                                                                                                           |
| 10.214  |   | Through 10.300 Reserved                                                                                                                                                                                                                                                                                                                                                                                    |
| *10.301 |   | Settlement Agreement on  Purified IL-2, made as of April 14, 1995, by and between Cetus Oncology  Corporation, dba Chiron Therapeutics, a Delaware corporation, and Takeda  Chemical Industries, Ltd., a Japanese corporation, incorporated by reference  to Exhibit 10.74 of the Chiron’s report on Form 10-Q for the  quarterly period ended July 2, 1995.                      |
| *10.302 |   | Agreement, effective as  of December 21, 1988, by and between Hoffmann-La Roche Inc., a New  Jersey corporation, and Cetus Corporation, incorporated by reference to  Exhibit 10.70 of Chiron’s report on Form 10-Q for the quarterly  period ended April 2, 1995.                                                                                                                |

99

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| *10.303 |   | Agreement, effective as  of December 21, 1988, by and among F. Hoffmann-La Roche Ltd., a Swiss  corporation, Cetus Corporation, and EuroCetus International, B.V., a  Netherlands Antilles corporation, incorporated by reference to  Exhibit 10.71 of Chiron’s report on Form 10-Q for the quarterly  period ended April 2, 1995.                                                                                                                       |
|---------|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| *10.304 |   | License Agreement made  and entered into December 1, 1987, by and between Sloan Kettering  Institute for Cancer Research, a not-for-profit New York corporation, and  Cetus Corporation, incorporated by reference to Exhibit 10.75 of  Chiron’s report on Form 10-Q for the quarterly period ended July 2,  1995.                                                                                                                                       |
| *10.305 |   | Cross-License Agreement  dated as of November 30, 1998, between Chiron and Chiron Diagnostics  Corporation, incorporated by reference to Exhibit 10.311 of Chiron’s  current report on Form 8-K dated November 30, 1998.                                                                                                                                                                                                                                 |
| *10.306 |   | HCV Probe License and  Option Agreement dated September 26, 1999, between Abbott Laboratories,  an Illinois corporation, and Chiron, incorporated by reference to  Exhibit 10.306 of Chiron’s report on Form 10-Q for the quarterly  period ended September 30, 1999.                                                                                                                                                                                    |
| *10.307 |   | HCV Probe License  Agreement dated October 10, 2000, between Chiron, F. Hoffmann-La  Roche Ltd. and Roche Molecular Systems, Inc., incorporated by reference  to Exhibit 10.307 of Chiron’s report on Form 10-Q for the quarterly  period ended September 30, 2000.                                                                                                                                                                            |
| *10.308 |   | HIV Probe License  Agreement dated October 10, 2000, between Chiron, F. Hoffmann-La  Roche Ltd. and Roche Molecular Systems, Inc., incorporated by reference  to Exhibit 10.308 of Chiron’s report on Form 10-Q for quarterly  period ended September 30, 2000.                                                                                                                                                                                |
| *10.309 |   | Blood Screening HCV/HIV  Probe License Agreement dated October 10, 2000, between Chiron, F.  Hoffmann-La Roche Ltd. And Roche Molecular Systems, Inc., incorporated  by reference to Exhibit 10.309 of Chiron’s report on Form 10-Q for  the quarterly period ended September 30, 2000.                                                                                                                                                             |
| 10.310  |   | Reserved                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |
| *10.311 |   | Agreement with Gen-Probe  Incorporated dated June 11, 1998, incorporated by reference to  Exhibit 10.311 of Chiron’s Form 10-K for fiscal year 2000. (We have  omitted certain information from the Agreement relating to rights and  obligations assigned by Chiron to unrelated third party subsequent to the  execution of Agreement. We have identified the omitted information by the  following statement: “Provision Assigned.”)             |
| *10.312 |   | Addendum to Agreement  with Gen-Probe Incorporated dated June 11, 1998, incorporated by  reference to Exhibit 10.312 of Chiron’s Form 10-K for fiscal year  2000. (We have omitted certain information from the Agreement relating to  rights and obligations assigned by Chiron to unrelated third party subsequent  to the execution of Agreement. We have identified the omitted information by  the following statement: “Provision Assigned.”) |

100

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| *10.313 |   | Amendment to Agreement  with Gen-Probe Incorporated dated December 7, 1999, incorporated by  reference to Exhibit 10.313 of Chiron’s Form 10-K for fiscal year  2000. (We have omitted certain information from the Agreement relating to  rights and obligations assigned by Chiron to unrelated third party subsequent  to the execution of Agreement. We have identified the omitted information by  the following statement: “Provision Assigned.”)                       |
|---------|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| *10.314 |   | Amendment No. 2 to  Agreement with Gen-Probe Incorporated dated February 1, 2000,  incorporated by reference to Exhibit 10.314 of Chiron’s report on  Form 10-K for fiscal year 2002. (We have omitted certain  information from the Agreement relating to rights and obligations assigned by  Chiron to unrelated third party subsequent to the execution of Agreement. We  have identified the omitted information by the following statement:  “Provision Assigned.”) |
| *10.315 |   | Blood Screening HCV  Probe License Agreement dated effective as of January 1, 2001, between  Chiron, F. Hoffmann-La Roche Ltd. and Roche Molecular Systems, Inc.,  incorporated by reference to Exhibit 10.315 of Chiron’s report on  Form 10-Q for the quarterly period ended June 30, 2001.                                                                                                                                                                                 |
| *10.316 |   | Blood Screening HIV  Probe License Agreement dated effective as of January 1, 2001, between  Chiron, F. Hoffmann-La Roche Ltd. and Roche Molecular Systems, Inc.,  incorporated by reference to Exhibit 10.316 of Chiron’s report on  Form 10-Q for the quarterly period ended June 30, 2001.                                                                                                                                                                                 |
| *10.317 |   | Association Agreement  Regarding the Sale and Servicing of Blood Screening Products, dated as of  May 1, 2002, between America’s Blood Centers and Chiron, and  Form of Member Supplement, incorporated by reference to  Exhibit 10.317 of Chiron’s report on Form 10-Q for the quarterly  period ended June 30, 2002.                                                                                                                                                   |
| *10.318 |   | Amendment No. 3 to  Agreement with Gen-Probe Incorporated entered into effective April 1,  2002, incorporated by reference to Exhibit 10.318 of Chiron’s report on  Form 10-Q for the quarterly period ended September 30, 2002.                                                                                                                                                                                                                                              |
| *10.319 |   | Sale and Servicing  Agreement made effective as of August 1, 2002, between The American  National Red Cross and Chiron, incorporated by reference to  Exhibit 10.319 of Chiron’s report on Form 10-K for fiscal 2002.                                                                                                                                                                                                                                                                   |
| *10.320 |   | Amendment No. 4 to  Agreement with Gen-Probe Incorporated entered into effective March 5,  2003, incorporated by reference to Exhibit 10.320 of Chiron’s report on  Form 10-Q for the quarterly period ended March 31, 2003.                                                                                                                                                                                                                                                  |
| *10.321 |   | Blood Screening HCV  Probe License Agreement-European Union dated effective as of July 1,  2003, between Chiron, F. Hoffmann-La Roche Ltd., and Roche Molecular  Systems, Inc., incorporated by reference to Exhibit 10.321 of  Chiron’s report on Form 10-Q for the quarterly period ended  June 30, 2003.                                                                                                                                                                   |
| *10.322 |   | Blood Screening HIV  Probe License Agreement-European Union dated effective as of July 1,  2003, between Chiron, F. Hoffmann-La Roche Ltd., and Roche Molecular  Systems, Inc., incorporated by reference to Exhibit 10.322 of  Chiron’s report on Form 10-Q for the quarterly period ended  June 30, 2003.                                                                                                                                                                   |

101

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| *10.323 |   | HCV Probe License and  Option Agreement-European Union dated effective as of July 1, 2003,  between Chiron, F. Hoffmann-La Roche Ltd., and Roche Molecular  Systems, Inc., incorporated by reference to Exhibit 10.323 of  Chiron’s report on Form 10-Q for the quarterly period ended  June 30, 2003. |
|---------|--------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| *10.324 |   | HIV Probe License and  Option Agreement-European Union dated effective as of July 1, 2003,  between Chiron, F. Hoffmann-La Roche Ltd., and Roche Molecular  Systems, Inc., incorporated by reference to Exhibit 10.324 of  Chiron’s report on Form 10-Q for the quarterly period ended  June 30, 2003. |
| *10.325 |   | Agreement,  dated as of July 1, 2003, between The American National Red Cross and  Chiron, incorporated by reference to Exhibit 10.325 of Chiron’s  report on Form 10-Q for the quarterly period ended September 30,  2003.                                                                                 |
| *10.326 |   | WNV Association  Agreement, dated as of July 1, 2003, between America’s Blood Centers and  Chiron, and Form of Member Supplement, incorporated by reference to  Exhibit 10.326 of Chiron’s report on Form 10-Q for the quarterly  period ended September 30, 2003.                                |
| *10.327 |   | Amendment No. 5 to  Agreement with Gen-Probe Incorporated entered into effective as of  January 1, 2004, incorporated by reference to Exhibit 10.327 of  Chiron’s report on Form 10-K for fiscal year 2003.                                                                                                 |
| *10.328 |   | Future Blood Screening  Assay—West Nile Virus Addendum dated October 21, 2003, amending  Agreement entered into as of June 11, 1998 by and between Gen-Probe  Incorporated and Chiron, incorporated by reference to Exhibit 10.328 of  Chiron’s report on Form 10-K for fiscal year 2003.              |
| *10.329 |   | Future Blood Screening  Assay—Ultrios Addendum dated March 24, 2003 amending Agreement entered  into as of June 11, 1998 by and between Gen-Probe Incorporated and  Chiron, incorporated by reference to Exhibit 10.329 of Chiron’s report  on Form 10-K for fiscal year 2003.                         |
| *10.330 |   | Term Sheet effective as  of September 3, 2004 with Roche Diagnostics GmbH, incorporated by reference  to Exhibit 10.330 of Amendment No. 1 to Chiron’s report on  Form 10-Q/A for the quarterly period ended September 30, 2004.                                                                       |
| 10.331  |   | Through 10.400 Reserved                                                                                                                                                                                                                                                                                                              |
| 10.401  |   | Stock Purchase  Agreement, dated as of October 21, 1997, between Bausch & Lomb  Incorporated and Chiron, incorporated by reference to Exhibit 99.1 of  Chiron’s current report on Form 8-K dated January 12, 1998.                                                                                 |
| *10.402 |   | Stock Purchase  Agreement, dated as of September 17, 1998, among Bayer Corporation,  Chiron and Chiron Diagnostics Corporation, and Exhibits thereto, incorporated  by reference to Exhibit 10.402 of Chiron’s report on Form 10-Q for  the quarterly period ended September 27, 1998.                      |
| *10.403 |   | Asset Transfer Agreement  dated November 30, 1998, among Chiron, Chiron Diagnostics Corporation  and Bayer Corporation, incorporated by reference to Exhibit 10.403 of  Chiron’s current report on Form 8-K dated November 30, 1998.                                                                        |
| 10.404  |   | Agreement and Plan of  Merger, dated as of January 6, 2002, among Chiron, Manon Acquisition  Corp. and Matrix Pharmaceutical, Inc., incorporated by reference to  Exhibit (d)(1) of Chiron’s Schedule TO-T No. 00542277, filed  with the Securities and Exchange Commission on January 14, 2002.  |

102

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| 10.405   |   | Through 10.500 Reserved                                                                                                                                                                                                                                                                                     |
|----------|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| **10.501 |   | Chiron 2004 Stock  Compensation Plan, incorporated by reference to Exhibit 10.501 of  Chiron’s report on Form 10-Q for the quarterly period ended  June 30, 2004.                                                                                                                       |
| **10.502 |   | Form of Stock  Option Agreement, and Addendum to Stock Option Agreement (Executives), Chiron  1991 Stock Option Plan, as amended, incorporated by reference to  Exhibit 10.502 of Chiron’s report on Form 10-K for fiscal year  2001.                                                   |
| **10.503 |   | Forms of Stock Option  Agreements, Chiron 1991 Stock Option Plan, as amended, for Non-Employee  Directors of Chiron, incorporated by reference to Exhibit 10.503 of  Chiron’s report on Form 10-Q for the quarterly period ended  June 30, 2002.                                        |
| **10.504 |   | Form of Automatic  Share Right Agreement for Executive Officers, Chiron 1991 Stock Option Plan,  as amended, incorporated by reference to Exhibit 10.504 of Chiron’s  report on Form 10-K for fiscal year 2001.                                                                         |
| **10.505 |   | Form of Amendment  Letter to Automatic Share Rights Letter Agreement for Non-Employee Directors  of Chiron, Chiron 1991 Stock Option Plan, as amended, incorporated by  reference to Exhibit 10.505 of Chiron’s report on Form 10-Q for the  quarterly period ended June 30, 2002. |
| **10.506 |   | Form of Amendment  Letter to Automatic Stock Option Agreement for Non-Employee Directors of  Chiron, Chiron 1991 Stock Option Plan, as amended, incorporated by reference to  Exhibit 10.506 of Chiron’s report on Form 10-Q for the quarterly  period ended June 30, 2002.*       |
| **10.507 |   | Chiron Executive Officer  Severance Plan, incorporated by reference to Exhibit 10.507 of Chiron’s  report on Form 10-K for fiscal year 2003.                                                                                                                                                 |
| **10.508 |   | Form of Performance  Share Rights Agreement (Executive Officers), incorporated by reference to  Exhibit 10.508 of Chiron’s report on Form 10-Q for the quarterly  period ended June 30, 2004.                                                                                      |
| **10.509 |   | Description of Chiron’s  2004 Executive Officers Variable Compensation Program.                                                                                                                                                                                                                        |
| **10.510 |   | Reserved                                                                                                                                                                                                                                                                                                    |
| 10.511   |   | Audit Committee Charter,  incorporated by reference to Exhibit 10.511 of Chiron’s report on  Form 10-K for fiscal year 2002.                                                                                                                                                                 |
| **10.512 |   | Change-in-Control Severance  Plan, incorporated by reference to Exhibit 10.512 to Chiron’s report on  Form 10-Q for the quarterly period ended March 31, 2001.                                                                                                                          |
| **10.513 |   | Form of Performance  Stock Option Agreement for Executive Officers, Chiron 1991 Stock Option Plan,  as amended and restated, incorporated by reference to Exhibit 10.513 of  Chiron’s report on Form 10-K for fiscal year 2001.                                                         |
| **10.514 |   | Form of Amendment  Letter to Share Rights Letter Agreement for Executive Officers, Chiron 1991  Stock Option Plan, as amended and restated, incorporated by reference to  Exhibit 10.514 of Chiron’s report on Form 10-K for fiscal year  2001.                                         |

103

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| **10.515 |   | Form of Amendment  Letter to Stock Option Agreement (Special Executive Form) for Executive  Officers, Chiron 1991 Stock Option Plan, as amended and restated,  incorporated by reference to Exhibit 10.515 of Chiron’s report on  Form 10-K for fiscal year 2001.                                                                                                                                                                                                            |
|----------|--------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.516   |   | Compensation Committee  Charter, incorporated by reference to Exhibit 10.319 of Chiron’s report  on Form 10-K for fiscal year 2002.                                                                                                                                                                                                                                                                                                                                               |
| **10.517 |   | Chiron  Supplemental Executive Retirement Plan, as amended and restated effective  March 1, 2003, incorporated by reference to Exhibit 10.517 of  Chiron’s report on Form 10-Q for the quarterly period ended  March 31, 2003.                                                                                                                                                                                                                                          |
| 10.518   |   | Nominating and Corporate  Governance Committee Charter, incorporated by reference to Exhibit 10.  518 of Chiron’s report on Form 10-Q for the quarterly period ended  June 30, 2003.                                                                                                                                                                                                                                                                                         |
| 10.519   |   | Corporate Governance  Guidelines, as amended and restated, incorporated by reference to Exhibit 10.  519 of Chiron’s report on Form 10-Q for the quarterly period ended  September 30, 2004.                                                                                                                                                                                                                                                                                 |
| 10.520   |   | Finance Committee  Charter, incorporated by reference to Exhibit 10.520 of Chiron’s report  on Form 10-Q for the quarterly period ended June 30, 2004.                                                                                                                                                                                                                                                                                                                       |
| **10.521 |   | Chiron Supplemental  Retirement Plan, incorporated by reference to Exhibit 4.1 to Chiron’s  Registration Statement on Form S-8 (Reg. No. 333-121126), filed  with the Securities and Exchange Commission on December 9, 2004.                                                                                                                                                                                                                                           |
| 10.522   |   | Through 10.600 Reserved                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |
| 10.601   |   | Indemnification  Agreement between Chiron and Dr. William J. Rutter, dated as of  February 12, 1987 (which form of agreement is used for each member of  Chiron’s Board of Directors) (initially filed as Exhibit 10.21 of  Chiron’s report on Form 10-Q for the quarterly period ended  September 30, 1994), incorporated by reference to Exhibit 10.601 of  Chiron’s report on Form 10-Q for the quarterly period ended  June 30, 1999. |
| 10.602   |   | Reserved                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         |
| **10.603 |   | Letter Agreement dated  September 26, 1990 between Chiron and William G. Green (initially filed  as Exhibit 10.41 of Chiron’s report on Form 10-K for fiscal year  1992), incorporated by reference to Exhibit 10.603 of Chiron’s report on  Form 10-K for fiscal year 1998.                                                                                                                                                                                  |
| 10.604   |   | Through 10.610 Reserved                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |
| **10.611 |   | Letter Agreement dated  March 18, 1998 between Chiron and Seán P. Lance, incorporated by  reference to Exhibit 10.611 of Chiron’s report on Form 10-K for  fiscal year 1997.                                                                                                                                                                                                                                                                                            |
| **10.612 |   | Amended and Restated  Promissory Note dated as of August 7, 1998, executed by Seán P. Lance  for the benefit of Chiron, incorporated by reference to Exhibit 10.612  of Chiron’s report on Form 10-K for fiscal year 1998.                                                                                                                                                                                                                                              |
| **10.613 |   | Letter Agreement dated  January 25, 1999 between Chiron and David V. Smith.                                                                                                                                                                                                                                                                                                                                                                                                                 |
| 10.614   |   | Through 10.619 Reserved                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |

104

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| **10.620 |   | Letter Agreement dated  August 1, 2001, between Chiron and Craig A. Wheeler, incorporated by  reference to Exhibit 10.620 of Chiron’s report on Form 10-K for  fiscal year 2002.                                                                                                                                                                                                                                                |
|----------|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| **10.621 |   | Letter Agreement dated  March 19, 2003, between Chiron and Howard H. Pien, incorporated by  reference to Exhibit 10.621 of Chiron’s report on Form 10-Q for the  quarterly period ended March 31, 2003.                                                                                                                                                                                                                    |
| **10.622 |   | Letter Agreement  dated February 16, 2001, between Chiron and John A. Lambert,  incorporated by reference to Exhibit 10.622 of Chiron’s report on  Form 10-Q for the quarterly period ended March 31, 2003.                                                                                                                                                                                                                |
| **10.623 |   | Letter Agreement dated  July 1, 2003, between Chiron and John A. Lambert, incorporated by  reference to Exhibit 10.623 of Chiron’s report on Form 10-K for  fiscal year 2003.                                                                                                                                                                                                                                                   |
| **10.624 |   | Letter Agreement dated  August 12, 2003, between Chiron and Craig A. Wheeler, incorporated by  reference to Exhibit 10.624 of Chiron’s report on Form 10-Q for the  quarterly period ended September 30, 2003.                                                                                                                                                                                                             |
| **10.625 |   | Letter Agreement dated  January 26, 2004 between Chiron and John A. Lambert, incorporated by  reference to Exhibit 10.625 of Chiron’s report on Form 10-K for  fiscal year 2003.                                                                                                                                                                                                                                                |
| **10.626 |   | Letter Agreement dated  July 7, 2004, between Ursula B. Bartels and Chiron, incorporated by  reference to Exhibit 10.626 of Chiron’s report on Form 10-Q for the  quarterly period ended September 30, 2004.                                                                                                                                                                                                               |
| **10.627 |   | Supplemental Pension  Agreement dated as of July 20, 2004, between Chiron and William G.  Green, incorporated by reference to Exhibit 10.627 of Chiron’s report on  Form 10-Q for the quarterly period ended September 30, 2004.                                                                                                                                                                                           |
| 10.628   |   | Through 10.700 Reserved                                                                                                                                                                                                                                                                                                                                                                                                                             |
| 10.701   |   | Investment Agreement  dated as of November 20, 1994 among Ciba-Geigy Limited, Ciba-Geigy  Corporation, Ciba Biotech Partnership, Inc. and Chiron Corporation  (initially filed as Exhibit 10.54 of the Chiron’s current report on  Form 8-K dated November 20, 1994), incorporated by reference to  Exhibit 10.701 of Chiron’s report on Form 10-Q for the quarterly  period ended June 30, 1999. |
| 10.702   |   | Governance Agreement  dated as of November 20, 1994 among Ciba-Geigy Limited, Ciba-Geigy  Corporation and Chiron Corporation (initially filed as Exhibit 10.55 of  Chiron’s current report on Form 8-K dated November 20, 1994),  incorporated by reference to Exhibit 10.702 of Chiron’s report on  Form 10-Q for the quarterly period ended June 30, 1999.                                           |
| 10.703   |   | Subscription Agreement  dated as of November 20, 1994 among Ciba-Geigy Limited, Ciba-Geigy  Corporation, Ciba Biotech Partnership, Inc. and Chiron Corporation  (initially filed as Exhibit 10.56 of Chiron’s current report on  Form 8-K dated November 20, 1994), incorporated by reference  to Exhibit 10.703 of Chiron’s report on Form 10-Q for the quarterly  period ended June 30, 1999.   |

105

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| 10.704   |   | Cooperation and  Collaboration Agreement dated as of November 20, 1994, between  Ciba-Geigy Limited and Chiron Corporation (initially filed as  Exhibit 10.57 of Chiron’s current report on Form 8-K dated  November 20, 1994), incorporated by reference to Exhibit 10.704 of  Chiron’s report on Form 10-Q for the quarterly period ended  June 30, 1999.                                                                                   |
|----------|--------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.705   |   | Registration Rights  Agreement dated as of November 20, 1994 between Ciba Biotech  Partnership, Inc. and Chiron Corporation (initially filed as  Exhibit 10.58 of Chiron’s current report on Form 8-K dated  November 20, 1994), incorporated by reference to Exhibit 10.705 of  Chiron’s report on Form 10-Q for the quarterly period ended  June 30, 1999.                                                                             |
| 10.706   |   | Market Price  Option Agreement dated as of November 20, 1994 among Ciba-Geigy Limited,  Ciba-Geigy Corporation, Ciba Biotech Partnership, Inc. and Chiron  Corporation (initially filed as Exhibit 10.59 of Chiron’s current report  on Form 8-K dated November 20, 1994), incorporated by reference to  Exhibit 10.706 of Chiron’s report on Form 10-Q for the quarterly  period ended June 30, 1999.                                   |
| 10.707   |   | Amendment dated as of  January 3, 1995 among Ciba-Geigy Limited, Ciba-Geigy Corporation, Ciba  Biotech Partnership, Inc. and Chiron Corporation (initially filed as  Exhibit 10.60 of Chiron’s current report on Form 8-K dated  January 4, 1995), incorporated by reference to Exhibit 10.707 of  Chiron’s report on Form 10-Q for the quarterly period ended  September 30, 1999.                                                      |
| 10.708   |   | Supplemental Agreement  dated as of January 3, 1995 among Ciba-Geigy Limited, Ciba-Geigy  Corporation, Ciba Biotech Partnership, Inc. and Chiron Corporation  (initially filed as Exhibit 10.61 of Chiron’s current report on  Form 8-K dated January 4, 1995), incorporated by reference to  Exhibit 10.708 of Chiron’s report on Form 10-Q for the quarterly  period ended September 30, 1999.                                         |
| **10.709 |   | Amendment with Respect  to Employee Stock Option Arrangements dated as of January 3, 1995 among  Ciba-Geigy Limited, Ciba-Geigy Corporation, Ciba Biotech  Partnership, Inc. and Chiron Corporation, (initially filed as  Exhibit 10.62 of Chiron’s current report on Form 8-K dated  January 4, 1995), incorporated by reference to Exhibit 10.709 of  Chiron’s report on Form 10-Q for the quarterly period ended  September 30, 1999. |
| 10.710   |   | Agreement, dated November 27,  1996, between Ciba-Geigy Limited and Chiron, incorporated by reference to  Exhibit 10.92 of Chiron’s current report on Form 8-K filed  with the Commission on December 17, 1996.                                                                                                                                                                                                                                                   |
| 10.711   |   | Amendment dated  March 26, 1997, to Agreement dated November 27, 1996, between  Novartis Pharma AG and Chiron, incorporated by reference to  Exhibit 10.44 of Chiron’s report on Form 10-Q for the quarterly  period ended March 30, 1997.                                                                                                                                                                                                                   |
| 10.712   |   | Letter Agreement dated  December 19, 1997, between Novartis Pharma AG and Chiron, incorporated  by reference to Exhibit 10.712 of Chiron’s report on Form 10-K for  fiscal year 1997.                                                                                                                                                                                                                                                                                  |
| *10.713  |   | Letter Agreement dated  December 24, 1997, between Novartis Corporation and Chiron, incorporated  by reference to Exhibit 10.713 of Chiron’s report on Form 10-K for  fiscal year 1997.                                                                                                                                                                                                                                                                                |

106

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| 10.714   |   | Letter Agreement, dated May 6, 1996, as to  consent to assignment of contracts to Novartis Limited, among the Registrant,  Ciba-Geigy Limited, Ciba-Geigy Corporation and Ciba Biotech  Partnership, Inc., incorporated by reference to Exhibit 10.43 of  Chiron’s report on Form 10-K for fiscal year 1996. |
|----------|--------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| **10.715 |   | Letter Agreement, dated  December 19, 1996, regarding compensation paid by Chiron for director  services performed by employees of Ciba-Geigy Limited, incorporated by  reference to Exhibit 10.44 of Chiron’s report on Form 10-K for  fiscal year 1996.                                                         |
| *10.716  |   | Letter Agreement dated  September 30, 1999, between Novartis Corporation and Chiron,  incorporated by reference to Exhibit 10.716 of Chiron’s report on  Form 10-Q for the quarterly period ended September 30, 1999.                                                                                        |
| *10.717  |   | Chiron Funding L.L.C.  Limited Liability Company Agreement, entered into and effective as of  December 28, 1995, among Chiron, Chiron Biocine Company and Biocine  S.p.A. and Ciba-Geigy Corporation, incorporated by reference to  Exhibit 10.80 of Chiron’s report on Form 10-K for fiscal year 1995.           |
| *10.718  |   | Agreement between  Ciba-Geigy Limited and Chiron made November 15, 1995, incorporated by  reference to Exhibit 10.81 of Chiron’s report on Form 10-K for fiscal  year 1995.                                                                                                                                       |
| 10.719   |   | Reimbursement Agreement  dated as of March 24, 1995, between Ciba-Geigy Limited, a Swiss  corporation, and Chiron, incorporated by reference to Exhibit 10.76 of  Chiron’s report on Form 10-Q for the quarterly period ended July 2,  1995.                                                                 |
| 10.720   |   | Reimbursement Agreement,  dated as of June 28, 1996, between Ciba-Geigy Limited, a Swiss  corporation, and Chiron, incorporated by reference to Exhibit 10.94 of  Chiron’s report on Form 10-Q for the quarterly period ended  June 30, 1996.                                                                |
| 10.721   |   | Reimbursement Agreement,  dated as of July 12, 1996, between Ciba-Geigy Limited, a Swiss  corporation, and Chiron, incorporated by reference to Exhibit 10.93 of  Chiron’s report on Form 10-Q for the quarterly period ended  June 30, 1996.                                                                |
| **10.722 |   | Letter Agreement dated  December 31, 1999 between Novartis Corporation and Chiron, incorporated  by reference to Exhibit 10.44 of Chiron’s report on Form 10-K for  fiscal year 1999.                                                                                                                             |
| 10.723   |   | Letter Agreement dated  December 7, 2000, between Novartis Corporation and Chiron, incorporated  by reference to Exhibit 10.723 of Chiron’s report on Form 10-K for  fiscal year 2000.                                                                                                                            |
| 10.724   |   | Amendment dated  May 18, 2001 to Governance Agreement dated as of November 20, 1994  among Chiron and Novartis AG as successor-in-interest to Ciba-Geigy Limited,  incorporated by reference to Exhibit 10.724 of Chiron’s report on  Form 10-K for fiscal year 2002.                                        |
| 10.725   |   | Amendment dated  October 21, 2002 to Governance Agreement dated as of November 20,  1994, between Chiron and Novartis AG as successor-in-interest to Ciba-Geigy  Limited, incorporated by reference to Exhibit 10.725 of Chiron’s report  on Form 10-K for fiscal year 2002.                                 |

107

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| **10.726 |   | Amendment dated  February 21, 2003 to Governance Agreement dated as of November 20,  1994, between Chiron and Novartis AG, as successor-in-interest to Ciba-Geigy  Limited, incorporated by reference to Exhibit 10.726 of Chiron’s report  on Form 10-Q for the quarterly period ended March 31, 2003. |
|----------|--------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| **10.727 |   | Amendment dated  March 11, 2003 to Governance Agreement dated as of November 20,  1994, between Chiron and Novartis AG, as successor-in-interest to Ciba-Geigy  Limited, incorporated by reference to Exhibit 10.727 of Chiron’s report  on Form 10-Q for the quarterly period ended March 31, 2003.    |
| 10.728   |   | Amendment dated  May 16, 2003 to Governance Agreement incorporated by reference to  Exhibit 10.528 of Chiron’s report on Form 10-Q for the quarterly  period ended June 30, 2003.                                                                                                                            |
| 10.729   |   | Amendment dated  December 5, 2003 to Governance Agreement dated as of November 20,  1994 among Chiron and Novartis AG as successor-in-interest to Ciba-Geigy  Limited, incorporated by reference to Exhibit 10.729 of Chiron’s report  on Form 10-K for fiscal year 2003.                                    |
| 10.730   |   | Through 10.800 Reserved                                                                                                                                                                                                                                                                                                               |
| 10.801   |   | Through 10.900 Reserved                                                                                                                                                                                                                                                                                                               |
| 21       |   | List of Chiron’s Subsidiaries.                                                                                                                                                                                                                                                                                                   |
| 23.1     |   | Consent of Independent  Registered Public Accounting Firm.                                                                                                                                                                                                                                                                            |
| 24       |   | Power of Attorney. We  incorporate the Power of Attorney on pages 109 and 110 by reference.                                                                                                                                                                                                                                      |
| 31.1     |   | Certification of the  Chief Executive Officer pursuant to Rules 13a-14(a) and 15d-14(a) promulgated  under the Securities Exchange Act of 1934, as amended.                                                                                                                                                            |
| 31.2     |   | Certification of the  Chief Financial Officer pursuant to Rules 13a-14(a) and 15d-14(a) promulgated  under the Securities Exchange Act of 1934, as amended.                                                                                                                                                            |
| 32.1     |   | Certification of the  Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted  pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.                                                                                                                                                                    |
| 32.2     |   | Certification of the  Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted  pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.                                                                                                                                                                    |

----

*      Indicates confidential treatment requestedor granted with respect to certain portions of the Exhibit.

**    Indicates management contract orcompensatory plan, contract or arrangement.

108

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**SIGNATURES**

Pursuantto the requirements of Section 13 or 15(d) of the Securities ExchangeAct of 1934, the registrant has duly caused this report to be signed on itsbehalf by the undersigned, thereunto duly authorized.
|                            | **CHIRON CORPORATION** |
|----------------------------|------------------------|
| Date: March 16,  2005 | By:                    | /s/ Howard H. Pien |
|                       |                   | Howard H. Pien |
|                       |                   | *Chief Executive Officer;* |
|                       |                   | *Chairman of the Board* |

 

**POWER OF ATTORNEY**

**KNOW ALL MEN BYTHESE PRESENTS:**

That the undersigned officers and directors of ChironCorporation, a Delaware corporation, do hereby constitute and appoint Howard H.Pien and David V. Smith, and each of them, the lawful attorney and agent orattorneys and agents, with full power and authority to do any and all acts andthings and to execute any and all instruments which said attorneys and agents,and any one of them, determine may be necessary or advisable or required toenable said corporation to comply with the Securities Exchange Act of 1934, asamended, and any rules or regulations or requirements of the Securitiesand Exchange Commission in connection with this Form 10-K Report. Withoutlimiting the generality of the foregoing power and authority, the powersgranted include the power and authority to sign the names of the undersignedofficers and directors in the capacities indicated below to this Form 10-Kreport, to any and all amendments and supplements thereto, and to any and allinstruments or documents filed as part of or in conjunction with this Form 10-Kreport or amendments or supplements thereof, and each of the undersigned herebyratifies and confirms all that said attorneys and agents, or any one of them,shall do or cause to be done by virtue hereof. This Power of Attorney may besigned in several counterparts.

IN WITNESS WHEREOF, each of the undersigned hasexecuted this Power of Attorney as of the date indicated opposite his or hername.

Pursuantto the requirements of the Securities Exchange Act of 1934, this report hasbeen signed below by the following persons on behalf of the registrant and inthe capacities and on the dates indicated.
|                     | **Signature** | ** **                                 | ** ** | ** **           | **Title** | ** ** | ** ** | ** ** | **Date** | ** ** |
|---------------------|---------------|--------------------------------------------|------------|----------------------|-----------|------------|------------|------------|----------|------------|
| /s/  Howard H. Pien |          |                                       |       |                 |
| Howard H. Pien      |          | Chief Executive Officer and Chairman       |       | March 16,  2005 |
|                |          | of the Board (Principal Executive Officer) |       |                 |
| /s/  David V. Smith |          |                                       |       |                 |
| David V. Smith      |          | Vice President, Chief Financial Officer    |       | March 16,  2005 |
|                |          | (Principal Financial and Accounting        |       |                 |
|                |          | Officer)                                   |       |                 |

109

----

 
| /s/ Raymund Breu            |   |     |   |                 |
|-----------------------------|--------|----------|--------|----------------------|
| Raymund  Breu               |   | Director |   | March 16,  2005 |
| /s/ Vaughn D. Bryson        |   |     |   |                 |
| Vaughn D. Bryson            |   | Director |   | March 16,  2005 |
| /s/  Lewis W. Coleman       |   |     |   |                 |
| Lewis W. Coleman            |   | Director |   | March 16,  2005 |
| /s/  Pierre E. Douaze       |   |     |   |                 |
| Pierre E. Douaze            |   | Director |   | March 16,  2005 |
| /s/  J. Richard Fredericks  |   |     |   |                 |
| J. Richard  Fredericks      |   | Director |   | March 16,  2005 |
| /s/  Paul L. Herrling       |   |     |   |                 |
| Paul L. Herrling            |   | Director |   | March 16,  2005 |
| /s/  Denise M. O’Leary |   |     |   |                 |
| Denise M. O’Leary      |   | Director |   | March 16,  2005 |
| /s/  Edward E. Penhoet      |   |     |   |                 |
| Edward E. Penhoet           |   | Director |   | March 16,  2005 |
| /s/  Pieter J. Strijkert    |   |     |   |                 |
| Pieter J. Strijkert         |   | Director |   | March 16,  2005 |

 

 

110

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**Reportof Independent Registered Public Accounting Firmon Consolidated Financial Statements**

**The Board ofDirectors and Stockholders of Chiron Corporation**

We have audited the accompanying consolidated balancesheets of Chiron Corporation as of December 31, 2004 and 2003, and therelated consolidated statements of operations,comprehensive income, stockholders’ equity, and cash flows for each of thethree years in the period ended December 31, 2004. Our audits alsoincluded the financial statement schedule for the three years in the periodended December 31, 2004 listed in the index at item 15(a). These financialstatements and schedule are the responsibility of the Company’s management. Ourresponsibility is to express an opinion on these financial statements based onour audits.

We conducted our audits in accordance with thestandards of the Public Company Accounting Oversight Board (United States). Thosestandards require that we plan and perform the audit to obtain reasonableassurance about whether the financial statements are free of materialmisstatement. An audit includes examining, on a test basis, evidence supportingthe amounts and disclosures in the financial statements. An audit also includesassessing the accounting principles used and significant estimates made bymanagement, as well as evaluating the overall financial statement presentation.We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the financial statements referred toabove present fairly, in all material respects, the consolidated financialposition of Chiron Corporation at December 31, 2004 and 2003, and theconsolidated results of its operations and its cash flows for each of the threeyears in the period ended December 31, 2004, in conformity with U.S.generally accepted accounting principles. Also, in our opinion, the relatedfinancial statement schedule, when considered in relation to the basicfinancial statements taken as a whole, presents fairly, in all materialrespects, the information set forth therein.

Wealso have audited, in accordance with the standards of the Public CompanyAccounting Oversight Board (United States), the effectiveness of ChironCorporation’s internal control over financial reporting as of December 31,2004, based on criteria established in Internal Control—Integrated Frameworkissued by the Committee of Sponsoring Organizations of the Treadway Commissionand our report dated March 11, 2005 expressed an unqualified opinion on management’s assessment of theeffectiveness of internal control over financial reporting and an adverseopinion on the effectiveness of internal control over financial reporting.
|                       | /s/ Ernst & Young LLP |
|-----------------------|--------------------------------|
| Palo Alto, California |                           |
| March 11, 2005   | * *                       |

 

F-1

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**CHIRON CORPORATION  CONSOLIDATED BALANCE SHEETS  (In thousands, except share data)**
| ** **                                                                                          | ** ** | **December 31,** | ** ** |
|-----------------------------------------------------------------------------------------------------|------------|-----------------------|------------|
| ** **                                                                                          | ** ** | **2004**              | ** ** | **2003** | ** ** |
| **ASSETS**                                                                                          |       |                  |       |   |   |
| Current assets:                                                                                     |       |                  |       |   |   |
| Cash and cash equivalents                                                                           |       | $                     | 209,509    |   | $ | 364,270 |   |
| Short-term investments in marketable debt securities                                                |       | 394,112               |       | 174,212 |   |
| Total cash and short-term investments                                                               |       | 603,621               |       | 538,482 |   |
| Accounts receivable, net of allowances of $47,345 in  2004 and $36,865 in 2003                      |       | 392,788               |       | 382,933 |   |
| Current portion of notes receivable                                                                 |       | —                |       | 1,479 |   |
| Inventories, net of reserves of $71,609 in 2004 and  $35,117 in 2003                                |       | 221,154               |       | 199,625 |   |
| Assets held for sale                                                                                |       | —                |       | 2,992 |   |
| Current net deferred income tax asset                                                               |       | 71,287                |       | 50,204 |   |
| Derivative financial instruments                                                                    |       | 4,969                 |       | 9,463 |   |
| Other current assets                                                                                |       | 90,898                |       | 72,471 |   |
| Total current assets                                                                                |       | 1,384,717             |       | 1,257,649 |   |
| Non-current  investments in marketable debt securities                                              |       | 409,421               |       | 560,292 |   |
| Property, plant,  equipment and leasehold improvements, at cost:                                    |       |                  |       |   |   |
| Land and buildings                                                                                  |       | 379,861               |       | 366,275 |   |
| Laboratory, production and office equipment                                                         |       | 637,394               |       | 615,814 |   |
| Leasehold improvements                                                                              |       | 125,858               |       | 112,200 |   |
| Construction-in-progress                                                                            |       | 225,482               |       | 144,162 |   |
|                                                                                                |       | 1,368,595             |       | 1,238,451 |   |
| Less accumulated depreciation and amortization                                                      |       | (569,180              | )          | (548,701 | ) |
| Property, plant, equipment and leasehold  improvements, net                                         |       | 799,415               |       | 689,750 |   |
| Purchased  technologies, net of accumulated amortization of $117,048 in 2004 and $95,836  in 2003   |       | 216,037               |       | 236,707 |   |
| Goodwill                                                                                            |       | 861,394               |       | 787,587 |   |
| Other intangible  assets, net of accumulated amortization of $249,469 in 2004 and $165,530 in  2003 |       | 457,707               |       | 486,889 |   |
| Investments in  equity securities and affiliated companies                                          |       | 100,062               |       | 121,576 |   |
| Equity method  investments                                                                          |       | 889                   |       | 953 |   |
| Non-current notes  receivable                                                                       |       | 7,500                 |       | 7,500 |   |
| Non-current  derivative financial instruments                                                       |       | —                |       | 7,391 |   |
| Other non-current  assets                                                                           |       | 59,055                |       | 38,875 |   |
|                                                                                                |       | $                     | 4,296,197  |   | $ | 4,195,169 |   |

 

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

F-2

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

 
| ** **                                                                                               | ** ** | **December 31,** | ** ** |
|----------------------------------------------------------------------------------------------------------|------------|-----------------------|------------|
| ** **                                                                                               | ** ** | **2004**              | ** ** | **2003** | ** ** |
| **LIABILITIES AND STOCKHOLDERS’ EQUITY**                                                            |       |                  |       |   |   |
| Current liabilities:                                                                                     |       |                  |       |   |   |
| Accounts payable                                                                                         |       | $                     | 129,942    |   | $ | 102,201 |   |
| Accrued compensation and  related expenses                                                               |       | 79,113                |       | 83,311 |   |
| Derivative financial  instruments                                                                        |       | 10,395                |       | 60 |   |
| Current portion of  long-term debt and capital lease                                                     |       | 2,687                 |       | 570 |   |
| Current portion of  unearned revenue                                                                     |       | 35,651                |       | 47,873 |   |
| Income taxes payable                                                                                     |       | 16,363                |       | 15,270 |   |
| Other current liabilities:                                                                               |       | 150,987               |       | 187,628 |   |
| Total current  liabilities                                                                               |       | 425,138               |       | 436,913 |   |
| Long-term debt                                                                                           |       | 936,652               |       | 926,709 |   |
| Long-term portion of  capital lease                                                                      |       | 156,952               |       | 157,677 |   |
| Non-current derivative  financial instruments                                                            |       | 156                   |       | — |   |
| Non-current net deferred  income tax liability                                                           |       | 60,427                |       | 107,496 |   |
| Non-current unearned  revenue                                                                            |       | 26,175                |       | 45,564 |   |
| Other non-current  liabilities                                                                           |       | 79,643                |       | 69,448 |   |
| Minority Interest                                                                                        |       | 9,350                 |       | 7,002 |   |
| Total liabilities                                                                                        |       | 1,694,493             |       | 1,750,809 |   |
| Commitments and contingencies                                                                            |       |                  |       |   |   |
| Stockholders’ equity:                                                                               |       |                  |       |   |   |
| Preferred stock, $0.01  par value; 5,000,000 shares authorized; none outstanding                         |       | —                |       | — |   |
| Common stock, $0.01 par  value; 499,500,000 shares authorized;  191,682,000 outstanding in 2004 and 2003 |       | 1,917                 |       | 1,917 |   |
| Restricted common stock,  $0.01 par value; 500,000 shares authorized;  none outstanding                  |       | —                |       | — |   |
| Additional paid-in  capital                                                                              |       | 2,527,709             |       | 2,503,195 |   |
| Deferred stock  compensation                                                                             |       | (13,825               | )          | (12,871 | ) |
| Accumulated deficit                                                                                      |       | (11,843               | )          | (46,634 | ) |
| Accumulated other  comprehensive income                                                                  |       | 330,491               |       | 216,302 |   |
| Treasury stock, at cost  (4,804,000 shares in 2004 and 4,567,000 shares in 2003)                         |       | (232,745              | )          | (217,549 | ) |
| Total stockholders’  equity                                                                         |       | 2,601,704             |       | 2,444,360 |   |
|                                                                                                     |       | $                     | 4,296,197  |   | $ | 4,195,169 |   |

 

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

F-3

----

**CHIRON CORPORATION CONSOLIDATED STATEMENTS OFOPERATIONS (In thousands, except per share data)**
| **  **                                                                                 | ** ** | **Year Ended December 31,** | ** ** |
|--------------------------------------------------------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                                                                       | ** ** | **2004**                                   | ** ** | **2003** | ** ** | **2002** | ** ** |
| Revenues:                                                                                        |       |                                       |       |   |   |   |   |
| Product sales, net                                                                               |       | $                                          | 1,268,303  |   | $ | 1,345,833 |   | $ | 914,121 |   |
| Revenues from joint business arrangement                                                         |       | 118,246                                    |       | 108,298 |   | 104,576 |   |
| Collaborative agreement revenues                                                                 |       | 18,044                                     |       | 18,562 |   | 22,142 |   |
| Royalty and license fee revenues                                                                 |       | 289,561                                    |       | 250,142 |   | 198,816 |   |
| Other revenues                                                                                   |       | 29,201                                     |       | 43,526 |   | 36,625 |   |
| Total revenues                                                                                   |       | 1,723,355                                  |       | 1,766,361 |   | 1,276,280 |   |
| Operating expenses:                                                                              |       |                                       |       |   |   |   |   |
| Cost of sales (excludes amortization expense related  to acquired developed products)            |       | 669,667                                    |       | 571,897 |   | 341,808 |   |
| Research and development                                                                         |       | 431,128                                    |       | 409,806 |   | 325,792 |   |
| Selling, general and administrative                                                              |       | 465,779                                    |       | 380,388 |   | 283,712 |   |
| Purchased in-process research and development                                                    |       | 9,629                                      |       | 45,300 |   | 45,181 |   |
| Amortization expense of intangible assets acquired  in business combinations and asset purchases |       | 84,503                                     |       | 56,365 |   | 29,857 |   |
| Other operating expenses                                                                         |       | 12,844                                     |       | 11,532 |   | 16,952 |   |
| Total operating expenses                                                                         |       | 1,673,550                                  |       | 1,475,288 |   | 1,043,302 |   |
| Income from  operations                                                                          |       | 49,805                                     |       | 291,073 |   | 232,978 |   |
| Loss on disposal  of assets                                                                      |       | (3,247                                     | )          | (224 | ) | (254 | ) |
| Interest expense                                                                                 |       | (26,093                                    | )          | (19,104 | ) | (12,821 | ) |
| Interest and  other income, net                                                                  |       | 56,797                                     |       | 38,892 |   | 46,616 |   |
| Minority interest                                                                                |       | (1,968                                     | )          | (1,753 | ) | (1,664 | ) |
| Income from  continuing operations before income taxes                                           |       | 75,294                                     |       | 308,884 |   | 264,855 |   |
| Provision for  income taxes                                                                      |       | 21,231                                     |       | 88,546 |   | 83,710 |   |
| Income from  continuing operations                                                               |       | 54,063                                     |       | 220,338 |   | 181,145 |   |
| Gain (loss) from  discontinued operations, net of taxes                                          |       | 24,854                                     |       | 6,975 |   | (320 | ) |
| Net income                                                                                       |       | $                                          | 78,917     |   | $ | 227,313 |   | $ | 180,825 |   |
| Basic earnings per  share:                                                                       |       |                                       |       |   |   |   |   |
| Income from continuing operations                                                                |       | $                                          | 0.29       |   | $ | 1.18 |   | $ | 0.96 |   |
| Net income                                                                                       |       | $                                          | 0.42       |   | $ | 1.22 |   | $ | 0.96 |   |
| Diluted earnings per  share:                                                                     |       |                                       |       |   |   |   |   |
| Income from continuing operations                                                                |       | $                                          | 0.28       |   | $ | 1.15 |   | $ | 0.94 |   |
| Net income                                                                                       |       | $                                          | 0.41       |   | $ | 1.19 |   | $ | 0.94 |   |

 

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

F-4

----

**CHIRON CORPORATION CONSOLIDATED STATEMENTS OFCOMPREHENSIVE INCOME (In thousands)**
| ** **                                                                                                                                                              | ** ** | **Year Ended December 31,** | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                                                                                                                                              | ** ** | **2004**                                   | ** ** | **2003** | ** ** | **2002** | ** ** |
| Net income                                                                                                                                                              |       | $                                          | 78,917     |   | $ | 227,313 |   | $ | 180,825 |   |
| Other comprehensive  income (loss):                                                                                                                                     |       |                                       |       |   |   |   |   |
| Change in foreign currency translation adjustment  during the period, net of tax benefit (provision) of $0 in 2004 and 2003,  respectively and $3,972 in 2002           |       | 131,812                                    |       | 155,782 |   | 89,210 |   |
| Unrealized gains  (losses) from investments:                                                                                                                            |       |                                       |       |   |   |   |   |
| Net unrealized holding gains (losses) arising during  the period, net of tax benefit (provision) of ($3,293), ($5,551) and $4,556  in 2004, 2003 and 2002, respectively |       | 2,460                                      |       | 12,378 |   | (8,765 | ) |
| Reclassification adjustment for net gains included  in income,  net of tax provision of $12,780, $3,654 and $2,569 in 2004,  2003 and 2002, respectively                |       | (20,184                                    | )          | (5,716 | ) | (4,017 | ) |
| Net unrealized gains (losses) from investments                                                                                                                          |       | (17,724                                    | )          | 6,662 |   | (12,782 | ) |
| Minimum pension liability adjustment, net of tax  benefit (provision) of $1,374, ($167) and ($35) in 2004, 2003 and 2002,  respectively                                 |       | 101                                        |       | (1,003 | ) | (281 | ) |
| Other comprehensive income                                                                                                                                              |       | 114,189                                    |       | 161,441 |   | 76,147 |   |
| Comprehensive income                                                                                                                                                    |       | $                                          | 193,106    |   | $ | 388,754 |   | $ | 256,972 |   |

 

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

F-5

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**CHIRON CORPORATIONCONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY(In thousands)**
| ** **                                   | ** ** | ** **            | ** ** | ** **             | ** ** | ** **     | ** ** | ** **            | ** ** | ** **        | ** ** | **Accumulated**         | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
|----------------------------------------------|------------|-----------------------|------------|------------------------|------------|----------------|------------|-----------------------|------------|-------------------|------------|-------------------------|------------|------------|------------|------------|------------|------------|------------|
| ** **                                   | ** ** | ** **            | ** ** | ** **             | ** ** | **Additional** | ** ** | **Deferred**          | ** ** | ** **        | ** ** | **Other**               | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                                   | ** ** | **Common Stock** | ** ** | **Paid-in**            | ** ** | **Stock**      | ** ** | **Accumulated ** | ** ** | **Comprehensive** | ** ** | **Treasury Stock** | ** ** | ** ** | ** ** |
| ** **                                   | ** ** | **Shares**            | ** ** | ** Amount ** | ** ** | **Capital**    | ** ** | **Compensation**      | ** ** | **Deficit**       | ** ** | **Income (Loss)**  | ** ** | **Shares** | ** ** | **Amount** | ** ** | **Total**  | ** ** |
| Balances at  December 31, 2001          |       | 191,682               |       |                   | $          | 1,917          |       |                  | $          | 2,441,281         |       |                    | $          | (17,506    | )          |       |       | $          | (360,997   | ) |   |   | $ | (21,286 | ) |   | (2,341 | ) | $ | (111,061 | ) | $ | 1,932,348 |   |
| Repurchase of  treasury stock                |       | —                |       |                   | —     |           |       | —                |       |              | —     |                    |       |       | —     |       |       |       | —     |   |   | (3,837 | ) | (147,721 | ) | (147,721 | ) |
| Exercise of stock  options                   |       | —                |       |                   | —     |           |       | (1,893                | )          |              | —     |                    |       |       | (37,546    | )          |       |       | —     |   |   | 1,354 |   | 62,604 |   | 23,165 |   |
| Exercise of put  options                     |       | —                |       |                   | —     |           |       | (879                  | )          |              | —     |                    |       |       | —     |       |       |       | —     |   |   | (300 | ) | (10,482 | ) | (11,361 | ) |
| Premiums from put  options                   |       | —                |       |                   | —     |           |       | 4,249                 |       |              | —     |                    |       |       | —     |       |       |       | —     |   |   | — |   | — |   | 4,249 |   |
| Temporary equity  related to put options     |       | —                |       |                   | —     |           |       | (5,290                | )          |              | —     |                    |       |       | —     |       |       |       | —     |   |   | — |   | — |   | (5,290 | ) |
| Tax benefits from  employee stock plans      |       | —                |       |                   | —     |           |       | 8,677                 |       |              | —     |                    |       |       | —     |       |       |       | —     |   |   | — |   | — |   | 8,677 |   |
| Employee stock  purchase plan                |       | —                |       |                   | —     |           |       | —                |       |              | —     |                    |       |       | (3,518     | )          |       |       | —     |   |   | 294 |   | 13,215 |   | 9,697 |   |
| Forfeitures of  deferred stock compensation  |       | —                |       |                   | —     |           |       | (7,488                | )          |              | 7,488      |                    |       |       | —     |       |       |       | —     |   |   | — |   | — |   | — |   |
| Deferred stock  compensation                 |       | —                |       |                   | —     |           |       | 6,551                 |       |              | (6,551     | )                       |       |       | —     |       |       |       | —     |   |   | — |   | — |   | — |   |
| Amortization of  deferred stock compensation |       | —                |       |                   | —     |           |       | —                |       |              | 5,220      |                    |       |       | —     |       |       |       | —     |   |   | — |   | — |   | 5,220 |   |
| Foreign currency  translation adjustment     |       | —                |       |                   | —     |           |       | —                |       |              | —     |                    |       |       | —     |       |       |       | 89,210     |   |   | — |   | — |   | 89,210 |   |
| Net unrealized  loss from investments        |       | —                |       |                   | —     |           |       | —                |       |              | —     |                    |       |       | —     |       |       |       | (12,782    | ) |   | — |   | — |   | (12,782 | ) |
| Minimum pension  liability adjustment        |       | —                |       |                   | —     |           |       | —                |       |              | —     |                    |       |       | —     |       |       |       | (281       | ) |   | — |   | — |   | (281 | ) |
| Net income                                   |       | —                |       |                   | —     |           |       | —                |       |              | —     |                    |       |       | 180,825    |       |       |       | —     |   |   | — |   | — |   | 180,825 |   |
| Balances at  December 31, 2002          |       | 191,682               |       |                   | $          | 1,917          |       |                  | $          | 2,445,208         |       |                    | $          | (11,349    | )          |       |       | $          | (221,236   | ) |   |   | $ | 54,861 |   |   | (4,830 | ) | $ | (193,445 | ) | $ | 2,075,956 |   |
| Repurchase of  treasury stock                |       | —                |       |                   | —     |           |       | —                |       |              | —     |                    |       |       | —     |       |       |       | —     |   |   | (4,199 | ) | (202,788 | ) | (202,788 | ) |
| Exercise of stock  options                   |       | —                |       |                   | —     |           |       | (4,463                | )          |              | —     |                    |       |       | (49,314    | )          |       |       | —     |   |   | 4,367 |   | 174,638 |   | 120,861 |   |
| Exercise of put  options                     |       | —                |       |                   | —     |           |       | (328                  | )          |              | —     |                    |       |       | —     |       |       |       | —     |   |   | (220 | ) | (8,999 | ) | (9,327 | ) |
| Premiums from put  options                   |       | —                |       |                   | —     |           |       | 2,144                 |       |              | —     |                    |       |       | —     |       |       |       | —     |   |   | — |   | — |   | 2,144 |   |
| Temporary equity  related to put options     |       | —                |       |                   | —     |           |       | 19,054                |       |              | —     |                    |       |       | —     |       |       |       | —     |   |   | — |   | — |   | 19,054 |   |
| Tax benefits from  employee stock plans      |       | —                |       |                   | —     |           |       | 33,061                |       |              | —     |                    |       |       | —     |       |       |       | —     |   |   | — |   | — |   | 33,061 |   |
| Employee stock  purchase plan                |       | —                |       |                   | —     |           |       | —                |       |              | —     |                    |       |       | (3,397     | )          |       |       | —     |   |   | 315 |   | 13,045 |   | 9,648 |   |
| Forfeitures of  deferred stock compensation  |       | —                |       |                   | —     |           |       | (1,319                | )          |              | 1,319      |                    |       |       | —     |       |       |       | —     |   |   | — |   | — |   | — |   |
| Deferred stock  compensation                 |       | —                |       |                   | —     |           |       | 9,838                 |       |              | (9,838     | )                       |       |       | —     |       |       |       | —     |   |   | — |   | — |   | — |   |
| Amortization of  deferred stock compensation |       | —                |       |                   | —     |           |       | —                |       |              | 6,997      |                    |       |       | —     |       |       |       | —     |   |   | — |   | — |   | 6,997 |   |
| Foreign currency  translation adjustment     |       | —                |       |                   | —     |           |       | —                |       |              | —     |                    |       |       | —     |       |       |       | 155,782    |   |   | — |   | — |   | 155,782 |   |
| Net unrealized  gain from investments        |       | —                |       |                   | —     |           |       | —                |       |              | —     |                    |       |       | —     |       |       |       | 6,662      |   |   | — |   | — |   | 6,662 |   |
| Minimum pension  liability adjustment        |       | —                |       |                   | —     |           |       | —                |       |              | —     |                    |       |       | —     |       |       |       | (1,003     | ) |   | — |   | — |   | (1,003 | ) |
| Net income                                   |       | —                |       |                   | —     |           |       | —                |       |              | —     |                    |       |       | 227,313    |       |       |       | —     |   |   | — |   | — |   | 227,313 |   |
| Balances at  December 31, 2003          |       | 191,682               |       |                   | $          | 1,917          |       |                  | $          | 2,503,195         |       |                    | $          | (12,871    | )          |       |       | $          | (46,634    | ) |   |   | $ | 216,302 |   |   | (4,567 | ) | $ | (217,549 | ) | $ | 2,444,360 |   |
| Repurchase of  treasury stock                |       | —                |       |                   | —     |           |       | —                |       |              | —     |                    |       |       | —     |       |       |       | —     |   |   | (2,859 | ) | (126,548 | ) | (126,548 | ) |
| Exercise of stock  options                   |       | —                |       |                   | —     |           |       | (1,483                | )          |              | —     |                    |       |       | (41,161    | )          |       |       | —     |   |   | 2,264 |   | 96,395 |   | 53,751 |   |
| Accelerated  vesting of stock options        |       | —                |       |                   | —     |           |       | 2,563                 |       |              | —     |                    |       |       | —     |       |       |       | —     |   |   | — |   | — |   | 2,563 |   |
| Tax benefits from  employee stock plans      |       | —                |       |                   | —     |           |       | 14,868                |       |              | —     |                    |       |       | —     |       |       |       | —     |   |   | — |   | — |   | 14,868 |   |
| Employee stock  purchase plan                |       | —                |       |                   | —     |           |       | —                |       |              | —     |                    |       |       | (2,965     | )          |       |       | —     |   |   | 358 |   | 14,957 |   | 11,992 |   |
| Forfeitures of  deferred stock compensation  |       | —                |       |                   | —     |           |       | (2,582                | )          |              | 2,582      |                    |       |       | —     |       |       |       | —     |   |   | — |   | — |   | — |   |
| Deferred stock  compensation                 |       | —                |       |                   | —     |           |       | 11,148                |       |              | (11,148    | )                       |       |       | —     |       |       |       | —     |   |   | — |   | — |   | — |   |
| Amortization of  deferred stock compensation |       | —                |       |                   | —     |           |       | —                |       |              | 7,612      |                    |       |       | —     |       |       |       | —     |   |   | — |   | — |   | 7,612 |   |
| Foreign currency  translation adjustment     |       | —                |       |                   | —     |           |       | —                |       |              | —     |                    |       |       | —     |       |       |       | 131,812    |   |   | — |   | — |   | 131,812 |   |
| Net unrealized  loss from investments        |       | —                |       |                   | —     |           |       | —                |       |              | —     |                    |       |       | —     |       |       |       | (17,724    | ) |   | — |   | — |   | (17,724 | ) |
| Minimum pension  liability adjustment        |       | —                |       |                   | —     |           |       | —                |       |              | —     |                    |       |       | —     |       |       |       | 101        |   |   | — |   | — |   | 101 |   |
| Net income                                   |       | —                |       |                   | —     |           |       | —                |       |              | —     |                    |       |       | 78,917     |       |       |       | —     |   |   | — |   | — |   | 78,917 |   |
| Balances at  December 31, 2004          |       | 191,682               |       |                   | $          | 1,917          |       |                  | $          | 2,527,709         |       |                    | $          | (13,825    | )          |       |       | $          | (11,843    | ) |   |   | $ | 330,491 |   |   | (4,804 | ) | $ | (232,745 | ) | $ | 2,601,704 |   |

 

The accompanying Notes to Consolidated FinancialStatements are integral to this statement.

F-6

 

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**CHIRON CORPORATION  CONSOLIDATED STATEMENTS OF CASH FLOWS (In thousands)**
| **  **                                                                                                              | ** ** | **Year Ended December 31,** | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                                                                                                    | ** ** | **2004**                                   | ** ** | **2003** | ** ** | **2002** | ** ** |
| Cash flows from  operating activities:                                                                                        |       |                                       |       |   |   |   |   |
| Net Income                                                                                                                    |       | $                                          | 78,917     |   | $ | 227,313 |   | $ | 180,825 |   |
| Adjustments to  reconcile net income to net cash provided by operating activities:                                            |       |                                       |       |   |   |   |   |
| Depreciation and amortization                                                                                                 |       | 185,921                                    |       | 145,723 |   | 124,258 |   |
| Amortization of marketable debt securities                                                                                    |       | 8,682                                      |       | 8,883 |   | 10,152 |   |
| Amortization of deferred stock compensation                                                                                   |       | 7,612                                      |       | 6,997 |   | 5,220 |   |
| Accelerated vesting of stock options                                                                                          |       | 2,563                                      |       | — |   | — |   |
| Amortization of discount on Liquid Yield Option  Notes                                                                        |       | 4,316                                      |       | 8,330 |   | 8,165 |   |
| Amortization of bond issuance costs on Liquid Yield  Option Notes and Convertible Debentures                             |       | 4,433                                      |       | 4,252 |   | 3,344 |   |
| Purchased in-process research and development                                                                                 |       | 9,629                                      |       | 45,300 |   | 45,181 |   |
| Loss on disposal of assets                                                                                                    |       | 3,247                                      |       | 224 |   | 254 |   |
| (Gain) loss from discontinued operations                                                                                      |       | (24,854                                    | )          | (6,975 | ) | 320 |   |
| Net gain on sale of marketable debt securities                                                                                |       | (99                                        | )          | (895 | ) | (339 | ) |
| Net gain on sale of equity securities                                                                                         |       | (34,265                                    | )          | (9,370 | ) | (14,323 | ) |
| Gain on sale of interests in affiliated companies                                                                             |       | (4,183                                     | )          | (2,012 | ) | (5,433 | ) |
| Gain on repayment of debt security                                                                                            |       | 3⁄4                                     |       | — |   | (1,500 | ) |
| Other-than-temporary loss on investments                                                                                      |       | 1,431                                      |       | — |   | 7,525 |   |
| Equity in loss of equity method investments                                                                                   |       | 3,726                                      |       | 2,325 |   | 2,447 |   |
| Minority interest                                                                                                             |       | 1,968                                      |       | 1,753 |   | 1,664 |   |
| Changes in reserves (product returns and rebates  allowance, other accounts receivable allowance and inventory reserves) |       | 78,359                                     |       | 36,466 |   | 33,269 |   |
| Deferred income taxes                                                                                                         |       | (73,298                                    | )          | (14,808 | ) | (5,555 | ) |
| Other, net                                                                                                                    |       | (149                                       | )          | 294 |   | 1,986 |   |
| Changes, excluding  effect of acquisitions and dispositions, to:                                                              |       |                                       |       |   |   |   |   |
| Accounts receivable                                                                                                           |       | (31,517                                    | )          | (69,956 | ) | (69,780 | ) |
| Inventories                                                                                                                   |       | (55,375                                    | )          | 31,726 |   | (49,015 | ) |
| Other current assets                                                                                                          |       | (22,120                                    | )          | (20,584 | ) | 899 |   |
| Derivative financial instruments                                                                                              |       | (603                                       | )          | (674 | ) | 533 |   |
| Other non-current assets                                                                                                      |       | (13,689                                    | )          | (3,105 | ) | (197 | ) |
| Accounts payable, accrued expenses and income taxes  payable                                                                  |       | 94,541                                     |       | 28,168 |   | (39,658 | ) |
| Current portion of unearned revenue                                                                                           |       | (14,314                                    | )          | 12,795 |   | (488 | ) |
| Other current liabilities                                                                                                     |       | (25,525                                    | )          | (19,134 | ) | 12,107 |   |
| Non-current unearned revenue                                                                                                  |       | (16,502                                    | )          | (13,350 | ) | (5,449 | ) |
| Other non-current liabilities                                                                                                 |       | 1,804                                      |       | 14,179 |   | 21,819 |   |
| Net cash provided  by operating activities                                                                                    |       | $                                          | 170,656    |   | $ | 413,865 |   | $ | 268,231 |   |

 

F-7

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**CHIRON CORPORATION  CONSOLIDATED STATEMENTS OF CASH FLOWS (Continued) (In thousands)**

 
| ** **                                                                     | ** ** | **Year Ended December 31,** | ** ** |
|--------------------------------------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                                                     | ** ** | **2004**                                   | ** ** | **2003** | ** ** | **2002** | ** ** |
| Cash flows from  investing activities:                                         |       |                                       |       |   |   |   |   |
| Purchases of investments in marketable debt  securities                        |       | $                                          | (796,942   | ) | $ | (920,768 | ) | $ | (796,506 | ) |
| Proceeds from sale of investments in marketable debt  securities               |       | 431,082                                    |       | 793,161 |   | 251,960 |   |
| Proceeds from maturity of investments in marketable  debt securities           |       | 286,487                                    |       | 420,469 |   | 471,633 |   |
| Proceeds from notes receivable                                                 |       | 1,479                                      |       | 750 |   | 6,402 |   |
| Capital expenditures                                                           |       | (183,691                                   | )          | (139,399 | ) | (105,739 | ) |
| Proceeds from sales of assets                                                  |       | 3,042                                      |       | — |   | 451 |   |
| Purchases of equity securities and interests in  affiliated companies          |       | (6,622                                     | )          | (14,240 | ) | (6,801 | ) |
| Proceeds from sale of equity securities and  interests in affiliated companies |       | 38,675                                     |       | 12,646 |   | 24,875 |   |
| Cash paid for acquisitions, net of cash acquired                               |       | (34,899                                    | )          | (815,420 | ) | (58,350 | ) |
| Other, net                                                                     |       | (10,706                                    | )          | (887 | ) | (6,092 | ) |
| Net cash used in investing activities                                          |       | (272,095                                   | )          | (663,688 | ) | (218,167 | ) |
| Cash flows from  financing activities:                                         |       |                                       |       |   |   |   |   |
| Net repayment of short-term borrowings                                         |       | 3⁄4                                     |       | (2,436 | ) | (455 | ) |
| Repayment of debt and capital leases                                           |       | (382,958                                   | )          | (62,454 | ) | (174 | ) |
| Borrowings from a government agency                                            |       | 5,560                                      |       | 1,243 |   | — |   |
| Payment of issuance costs on Convertible Debentures                            |       | (8,437                                     | )          | (10,684 | ) | — |   |
| Payments to acquire treasury stock                                             |       | (135,007                                   | )          | (207,689 | ) | (155,049 | ) |
| Proceeds from reissuance of treasury stock                                     |       | 69,143                                     |       | 123,625 |   | 27,493 |   |
| Proceeds from issuance of Convertible Debentures                               |       | 385,000                                    |       | 500,000 |   | — |   |
| Proceeds from put options                                                      |       | 3⁄4                                     |       | 2,144 |   | 5,398 |   |
| Net cash provided by (used in) financing activities                            |       | (66,699                                    | )          | 343,749 |   | (122,787 | ) |
| Effect of  exchange rate changes on cash and cash equivalents                  |       | 13,377                                     |       | 22,394 |   | — |   |
| Net increase (decrease) in cash and cash equivalents                           |       | (154,761                                   | )          | 116,320 |   | (72,723 | ) |
| Cash and cash  equivalents at beginning of the year                            |       | 364,270                                    |       | 247,950 |   | 320,673 |   |
| Cash and cash  equivalents at end of the year                                  |       | $                                          | 209,509    |   | $ | 364,270 |   | $ | 247,950 |   |

 

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

F-8

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**CHIRON CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  DECEMBER 31, 2004**

**Note 1—TheCompany and Summary of Significant Accounting Policies**

*The Company and Basis of Presentation*

Chiron Corporation is aglobal biopharmaceutical company that develops, manufactures and marketstherapeutic products for the prevention and treatment of infectious disease andproducts for the treatment of cancer utilizing innovations in biology andchemistry. Chiron participates in three global healthcare markets: (i) bloodtesting; (ii) adult and pediatric vaccines; and (iii) biopharmaceuticals,with an emphasis on the treatment of cancer and infectious disease.

On December 29, 1997,Chiron completed the sale of its ophthalmics business, Chiron Vision, to Bausch &Lomb Incorporated, and on November 30, 1998, Chiron completed the sale ofits in vitro diagnostics business, Chiron Diagnostics, to Bayer Corporation.Chiron’s Consolidated Statements of Operations reflect the settlement agreementwith the IRS, the settlement agreement with Bayer Corporation, the reversal ofvaluation allowances against deferred tax assets that were established at thetime of sale, and the expiration of certain contractual obligations in the gain(loss) from discontinued operations, net of taxes (see Note 4).

On February 20, 2002,Chiron acquired Matrix Pharmaceutical, Inc., a company that was developingtezacitabine, a drug to treat cancer. Chiron included Matrix’s operatingresults, including the seven business days from February 20 to 28, 2002,in its consolidated operating results beginning on March 1, 2002 (seeNote 5). Matrix is part of Chiron’s biopharmaceuticals segment.

On July 1, 2002,Chiron completed its acquisition of Pulmopharm GmbH, a distributor of TOBI®tobramycin products in Germany and Austria by purchasing the remaining 80.1%ownership. Previously, Chiron owned 19.9% of Pulmopharm and accounted for theinvestment under the equity method. Chiron included Pulmopharm’s operatingresults in its consolidated operating results beginning on July 1, 2002(see Note 5). Pulmopharm is part of Chiron’s biopharmaceutical segment.

On July 8, 2003,Chiron acquired PowderJect Pharmaceuticals plc, a company based in Oxford,England that develops and commercializes vaccines. Chiron included PowderJect’soperating results in its consolidated operating results beginning July 8,2003 (see Note 5). PowderJect is part of Chiron’s vaccines segment.

On July 2, 2004,Chiron acquired Sagres Discovery, a privately held company headquartered inDavis, California, which focuses on the discovery and validation of targetswith potential application to the development of cancer therapeutics. Chironincluded Sagres’ operating results in its consolidated operating resultsbeginning on July 2, 2004 (see Note 5). Sagres is part of Chiron’sbiopharmaceuticals segment.

*Principles ofConsolidation*

The Consolidated FinancialStatements include the accounts of Chiron and its majority-owned subsidiaries.For consolidated majority-owned subsidiaries in which Chiron owns less than100%, Chiron records minority interest in the Consolidated Financial Statementsto account for the ownership interest of the minority owner. Investments inlimited partnerships and interests in which Chiron has an equity interest of50% or less are accounted for using either the equity or cost method. Allsignificant intercompany accounts and transactions have been eliminated inconsolidation.

F-9

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**CHIRON CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) DECEMBER 31, 2004**

**Note1—The Company and Summary of Significant Accounting Policies (Continued)**

Chiron’s most significantconsolidated majority-owned subsidiaries and respective ownership percentagesare as follows:
| **Name **                   | ** ** | ** ** | ** ** | **Percentage  Ownership ** | ** ** |
|----------------------------------|------------|------------|------------|---------------------------------|------------|
| Chiron Corporation  Limited      |       |       | 100        | %                               |       |
| Chiron Investment  Corporation   |       |       | 100        | %                               |       |
| Chiron Italia S.r.l              |       |       | 100        | %                               |       |
| Chiron Vaccines Limited          |       |       | 100        | %                               |       |
| Chiron Vaccines Holdings Limited |       |       | 100        | %                               |       |

 

Chiron is a limitedpartner of several venture capital funds: Burrill Life Sciences Capital Fund,L.P., Forward Ventures V, L.P., TPG Biotechnology Partners, L.P., ForwardVenture IV, L.P. and Burrill Biotechnology Capital Fund, L.P. Chiron accountsfor these investments under the equity method of accounting pursuant toEmerging Issues Task Force Topic No. D-46, “Accounting for LimitedPartnership Investments.”

*Use of Estimates and Reclassifications*

The preparation offinancial statements requires management to make estimates, assumptions andjudgments that affect the reported amounts of assets, liabilities, revenues andexpenses, and related disclosures of contingent assets and liabilities. On anon-going basis, management evaluates its estimates, including those related toinvestments; inventories; derivatives; capital leases; intangible assets;goodwill; purchased in-process research and development; product discounts,rebates and returns; bad debts; collaborative, royalty and licensearrangements; restructuring; pension and other post-retirement benefits; incometaxes; and litigation and other contingencies. Chiron bases its estimates onhistorical experience and on various other assumptions that are believed to bereasonable under the circumstances, the results of which form the basis formaking judgments about the carrying values of assets and liabilities that arenot readily apparent from other sources. Actual results may differ from thoseestimates under different assumptions or conditions.

Chiron’s blood testingsegment includes Chiron’s one-half share in the pretax operating earningsgenerated by the joint business contractual arrangement with Ortho-ClinicalDiagnostics, Inc., a Johnson & Johnson company. Chiron accountsseparately for research and development and manufacturing cost reimbursementsand certain product sale revenues received from Ortho-Clinical Diagnostics butrelating to the joint business contractual arrangement. Chiron’s joint businessarrangement with Ortho-Clinical Diagnostics is a contractual arrangement and isnot a separate and distinct legal entity. Through Chiron’s joint businesscontractual arrangement with Ortho-Clinical Diagnostics, Chiron sells a line ofimmunodiagnostic tests to detect hepatitis viruses and retroviruses andprovides supplemental tests and microplate and chemiluminescent instrumentsystems to automate test performance and data collection. Prior to the firstquarter 2003, Chiron accounted for revenues relating to non-U.S. affiliate saleson a one-quarter lag, with an adjustment of the estimate to actual in thesubsequent quarter. More current information of non-U.S. affiliate sales ofChiron’s joint business contractual arrangement became available in the firstquarter 2003, and as a result, Chiron is able to recognize revenues relating tonon-U.S. affiliate sales on a one-month lag. The effect of this change, net oftax, was an increase to net income by 

F-10

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**CHIRON CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) DECEMBER 31, 2004**

**Note1—The Company and Summary of Significant Accounting Policies (Continued)**

$3.2 millionfor revenues from the joint business contractual arrangement for the year endedDecember 31, 2003.

Chiron recognizes aportion of revenue for product sales of BETASERON® interferon beta-1b uponshipment to its marketing partner, and the remainder based on a contractualpercentage of sales by its marketing partner. Chiron also earns royalties onthe marketing partner’s European sales of BETAFERON® product in those caseswhere Chiron does not supply the product. Prior to the first quarter 2002,Chiron accounted for revenues from non-U.S. product sales on a one-quarter lagand royalties as a percentage of forecast received from its marketing partner,with an adjustment of the estimate to actual in the subsequent quarter. Morecurrent information of non-U.S. BETASERON® product sales became available in2002, and as a result, Chiron is able to recognize revenues from BETASERONproduct sales and BETAFERON product royalties on a current basis. The effect ofthis change, net of tax, was a decrease in net loss for the first quarter 2002and 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.

Chiron owned a facility inCranford, England for international operations which was classified as “Assetsheld for sale” in the Consolidated Balance Sheet at December 31, 2003. Thisfacility was sold in 2004.

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

*Cash Equivalents, Investments in Marketable DebtSecurities and Investments in Equity Securities*

All highly-liquidinvestments with maturities of three months or less from the date of purchaseare considered to be cash equivalents. Cash equivalents and short-terminvestments in marketable debt securities consist principally of money marketinstruments, corporate notes and bonds and government agency securities.Noncurrent investments in marketable debt securities consist principally ofcorporate notes and bonds and government agency securities with maturitiesgreater than one year. The cost of securities sold is based on the specificidentification method for debt securities and on the average cost method forequity securities.

Chiron has classified itsinvestments in debt and equity securities as available-for-sale. Available-for-salesecurities are recorded at fair value based upon year-end quoted market prices.Unrealized gains and losses, deemed as temporary in nature, are reported as aseparate component of comprehensive income or loss.

Chiron periodically reviews its debt and equitysecurities by comparing the market value to the carrying value of the security.For equity investments, impairment, if any, is based on the excess of thecarrying value over the market value. If impairment is consideredother-than-temporary, the security’s cost is written down to market valuethrough earnings. Generally, Chiron believes that an investment is impaired ifits market value has been below its carrying value for each trading day duringthe preceding six-month period. However, in determining whether impairment isconsidered to be other-than-temporary, Chiron considers all available factorsin its evaluation. These factors include but are not limited to 

F-11

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**CHIRON CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) DECEMBER 31, 2004**

**Note1—The Company and Summary of Significant Accounting Policies (Continued)**

(i) whetherthe issuer of the securities is experiencing depressed and declining earningsin relation to competitors, erosion of market share, and deterioratingfinancial position, (ii) whether the issuer is experiencing financialdifficulties and its market is experiencing difficulties, (iii) ongoingactivity in our collaborations with the issuer and (iv) the issuers’prospects for favorable clinical trial results, new product initiatives and newcollaborative agreements.

For debt securities, inaddition to considering factors (i) and (ii) above, we review themarket value of the investment in relation to the carrying value. We generallydo not consider losses due to interest rate fluctuations as evidence ofimpairment, because we have the ability and the intent to hold primarily all ofour debt securities to maturity.

*Inventories*

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

As a result of thedevelopments with respect to FLUVIRIN vaccines discussed in “Note 14—Commitmentsand contingencies,” Chiron wrote-off the entire inventory of FLUVIRIN productin 2004, resulting in a $91.3 million charge to cost of sales.

Inventories,net of reserves, consisted of the following at December 31:
| ** **      | ** ** | **2004**                | ** ** | **2003** | ** ** |
|-----------------|------------|-------------------------|------------|----------|------------|
| ** **      | ** ** | **(In thousands)** | ** ** |
| Finished goods  |       | $                       | 59,206     |     | $          | 38,640 |   |
| Work-in-process |       | 116,660                 |       | 105,359  |       |
| Raw materials   |       | 45,288                  |       | 55,626   |       |
|            |       | $                       | 221,154    |     | $          | 199,625 |   |

 

*Derivative Financial Instruments*

Chiron uses variousderivatives, such as foreign currency option contracts and foreign currencyforward contracts, to reduce foreign exchange risks. Chiron also uses forwardsales contracts to reduce equity securities risk. Derivatives are not used fortrading or speculative purposes. Chiron’s control environment includes policiesand procedures for risk assessment and the approval, reporting and monitoringof foreign currency and equity securities hedging activities. Counterparties toChiron’s hedging agreements are major financial institutions. These hedgingagreements are generally not collateralized. Chiron manages the risk ofcounterparty default on its derivatives through the use of credit standards,counterparty diversification and monitoring of counterparty financialcondition. Chiron has not experienced any losses due to counterparty default.All derivatives are recorded on the balance sheet at fair value. Changes in thefair value of derivatives are accounted for depending upon the exposure beinghedged and whether the derivatives qualify and are designated for hedgeaccounting.

F-12

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**CHIRON CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) DECEMBER 31, 2004**

**Note1—The Company and Summary of Significant Accounting Policies (Continued)**

*Foreign Currency Hedging*

A significant portion ofChiron’s operations consists of manufacturing and sales activities in westernEuropean countries. As a result, Chiron’s financial results may be affected bychanges in the foreign currency exchange rates of those countries.

Chiron may selectivelyhedge anticipated currency exposures by purchasing foreign currency optioncontracts and forward contracts, which are designated as cash flow hedges andtypically expire within twelve months. Changes in the fair value of thesecontracts are recorded in comprehensive income and are recognized in earningswhen the forecasted transaction occurs. When the contracts expire, any amountsrecorded in comprehensive income are reclassified to earnings.

Chiron also uses foreigncurrency forward contracts to mitigate the gains and losses generated by theremeasurement of certain assets and liabilities denominated in foreigncurrencies. These derivatives are not designated as hedges. Changes in the fairvalue of foreign currency forward contracts are recognized currently inearnings. Typically, changes in the fair value of foreign currency forwardcontracts are offset largely by changes upon remeasurement of the underlying assetsand liabilities. These contracts usually have maturities of three months orless.

Because the critical termsof the derivative instrument and the underlying exposure are the same, Chironexpects that changes in the fair value of the underlying exposure will beoffset completely by changes in the fair value of the derivative instrument,both at inception and on an ongoing basis. The critical terms are reviewedquarterly. All time value changes are deemed ineffective and are recognizedimmediately in earnings. Hedge ineffectiveness was not material for the yearsended December 31, 2004, 2003 and 2002.

*Equity Securities Hedging*

Chiron has exposure toequity price risk because of its investments in equity securities. Typically,these securities are obtained through collaboration agreements with otherpharmaceutical and biotechnology partners. Changes in share prices affect thevalue of Chiron’s equity investment portfolio.

Chiron selectively entersinto forward sales contracts, which are designated as fair value hedges andnormally expire within two to four years. At the inception of the hedge, thedifference between the cost and the fair value of the equity security remainsin comprehensive income. Subsequent changes in the fair value of the forwardsales contracts and the underlying equity security are recognized in earnings.When forward sales contracts mature and the underlying equity security is sold,any amounts previously recorded in comprehensive income related to theunderlying equity security sold are reclassified to earnings.

Chiron recognized a gainof $34.3 million related to the termination of ten fair value hedges andthe sale of the underlying shares for the year ended December 31, 2004.This gain was recorded in “Interest and other income, net” in the ConsolidatedStatement of Operations for the year ended December 31, 2004. Chironrecognized a gain of $9.4 million related to the termination of three fairvalue hedges and the sale of the underlying shares for the year ended December 31,2003. This gain was recorded in “Interest and other income, net” in theConsolidated Statement of Operations for the year ended December 31, 2003.Chiron recognized a gain of $7.8 million related to the termination of twofair value hedges and the sale of the underlying shares for the year ended December 31,2002. This gain was recorded in “Interest 

F-13

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**CHIRON CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) DECEMBER 31, 2004**

**Note1—The Company and Summary of Significant Accounting Policies (Continued)**

andother income, net” in the Consolidated Statement of Operations for the yearended December 31, 2002.

*Property, Plant, Equipment and Leasehold Improvements*

Property, plant, equipmentand leasehold improvements are recorded at cost less accumulated depreciation.Depreciation on property, plant and equipment, including assets held undercapital leases, is computed using the straight-line method over the estimateduseful lives of the assets, ranging from 3 to 10 years for equipment and15 to 40 years for buildings. Leasehold improvements are amortized on astraight-line basis over the shorter of the asset’s useful life or remaininglease term. Depreciation and amortization expense was $92.2 million,$75.9 million and $73.2 million in 2004, 2003 and 2002, respectively.Repairs and maintenance are expensed as incurred. Costs incurred inconstruction, including related interest costs, are capitalized during theconstruction period. Interest capitalized for the years ended December 31,2004 and 2003 was $3.3 million and $1.7 million, respectively. There wasno interest capitalized for the year ended December 31, 2002, as it wasnot material.

*Leases*

Leases are recorded ascapital leases when any of the following criteria is met: (i) ownership istransferred to Chiron at the end of the lease term, (ii) the leasecontains a bargain purchase option, (iii) the lease term is at least75 percent of the leased property’s estimated remaining economic life or (iv) thepresent value of the minimum lease payments at the beginning of the lease termis 90 percent or more of the fair value of the leased property. All otherleases are classified as operating leases. Capital leases are recorded asassets and liabilities at the lower of the present value of the minimum leasepayments at the beginning of the lease term or the fair value of the leasedproperty at the inception of the lease. When the lease agreement includes aresidual value guarantee, the leased asset is amortized, using a straight-linemethod, to an amount such that the capital lease liability, net of the bookvalue of the leased asset at the end of the lease term equals an amount thatmay become payable to the lessor due to an estimated decline in fair value ofthe leased asset below the lessors’ total investment. When the lease agreementdoes not include a residual value guarantee, the amount of the leased asset isamortized on a straight-line basis over the lease term.

*Computer Software Costs for Internal Use*

Costs of computer softwaredeveloped for internal use are capitalized and amortized using thestraight-line method over the estimated useful lives of the assets, rangingfrom 3 to 5 years. The unamortized portion of computer software costsdeveloped for internal use was $30.2 million, $14.7 million and$7.7 million at December 31, 2004, 2003 and 2002, respectively.Depreciation and amortization expense stated above includes amortizationexpense related to costs of computer software for internal use of$12.0 million, $7.6 million and $5.7 million in 2004, 2003 and2002, respectively.

F-14

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**CHIRON CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) DECEMBER 31, 2004**

**Note1—The Company and Summary of Significant Accounting Policies (Continued)**

*Intangible and Other Long-Lived Assets*

Intangible assets consistprincipally of purchased technologies, developed product technologies andpatents. Purchased technologies and patents are amortized on a straight-linebasis over their estimated useful lives, ranging from 3 to 17 years.Developed product technologies are amortized using either the estimated salesmethod over 10 years or on a straight-line basis over 1 to 15 years.Chiron periodically reviews the useful lives of its intangible and long-livedassets, which may result in future adjustments to the amortization periods.Amortization expense, including amortization of bond issuance costs, for theyears ended December 31, 2004, 2003 and 2002 was $98.1 million,$74.1 million and $54.4 million, respectively. Amortization ofpurchased technologies, developed product technologies and the majority oftrademarks was included in “Amortization expense of intangible assets acquiredin business combinations and asset purchases” and amortization of patents wasincluded primarily in “Research and development” in the Consolidated Statementsof Operations.

Effective January 1,2002, goodwill (including assembled workforce) and intangible assets withindefinite useful lives are no longer amortized, but instead, are tested forimpairment at least annually. Any impairment loss from the annual test will berecognized as part of operations. Chiron performed its annual impairment testfor goodwill in the third quarter 2004, as of July 1, 2004. Subsequent tothe third quarter 2004, given the developments with respect to FLUVIRIN vaccinediscussed in “Note 14 — Commitments and contingencies,” Chiron considered theimpact of the FLUVIRIN vaccine developments on goodwill. Chiron performed aninterim impairment test for vaccines goodwill as of December 31, 2004given those developments. Based on either the annual or interim analysis,Chiron has no indication of an impairment loss. Chiron will continue to monitorgoodwill for any impairment associated with future developments related to theFLUVIRIN vaccine matters. Chiron performed its annual impairment test in 2003,which indicated no impairment.

For acquisitions made afterJune 30, 2001, intangible assets acquired in a purchase businesscombination are recognized and reported apart from goodwill and any purchaseprice allocable to an assembled workforce may not be accounted for separately.

Chiron evaluated theexisting intangible assets and goodwill that were acquired in purchase businesscombinations prior to July 1, 2001 and reclassified assembled workforcewith a net carrying value of $7.8 million to goodwill on January 1,2002. On January 1, 2002, Chiron reassessed the useful lives and residualvalues of all intangible assets (excluding goodwill and assembled workforce)acquired in purchase business combinations. No adjustments to amortizationperiods were necessary. Chiron has no intangible assets with indefinite usefullives. Chiron also assessed whether there is an indication that goodwill isimpaired as of January 1, 2002. To accomplish this, Chiron identified itsreporting units as of January 1, 2002. Chiron then determined the carryingvalue of each reporting unit by assigning the assets and liabilities, includingthe existing goodwill and intangible assets, to those reporting units as of January 1,2002. Chiron subsequently determined the fair value of each reporting unitusing the present value of expected future cash flows and compared it to thereporting unit’s carrying amount. Each reporting unit’s fair value exceeded itscarrying amount. Based on this analysis, Chiron had no indication of animpairment of goodwill at January 1, 2002.

F-15

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**CHIRON CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) DECEMBER 31, 2004**

**Note1—The Company and Summary of Significant Accounting Policies (Continued)**

Effective January 1,2002, long-lived assets to be held and used are reviewed for impairment whenevents or changes in circumstances indicate that the carrying amount of suchassets may not be recoverable. Determination of recoverability is based on anestimate of undiscounted future cash flows resulting from the use of the assetand its eventual disposition. In the event that such cash flows are not expectedto be sufficient to recover the carrying amount of the assets, the assets arewritten down to their estimated fair values. Long-lived assets to be disposedof by sale are reported at the lower of the carrying value or the fair valueless costs to sell. Long-lived assets to be disposed of other than by sale willhave their useful lives and salvage value revised to reflect the cease of usein the future.

*Put Options*

Chiron has, in the past,used written put options to reduce the effective costs of repurchasing itscommon stock. After expiration of existing put options in the second quarter of2003, Chiron discontinued the use of put options. Chiron had no put optionsoutstanding at December 31, 2004.

*Comprehensive Income*

Chironhas displayed the detailed changes in the components of comprehensive income inthe Consolidated Statements of Comprehensive Income. Accumulated othercomprehensive income (loss) balances by component were as follows (inthousands):
| ** **                               | ** ** | **Foreign  Currency  Translation  Adjustment** | ** ** | **Net Unrealized  Gains (Losses)  from  Investments** | ** ** | **Minimum  Pension  Liability  Adjustment** | ** ** | **Accumulated  Other  Comprehensive  Income (Loss)** | ** ** |
|------------------------------------------|------------|------------------------------------------------|------------|-----------------------------------------------------------------|------------|---------------------------------------------|------------|-----------------------------------------------------------|------------|
| Balance, net, at  December 31, 2001 |       | $                                              | (77,217)   |                                                            |       | $                                           | 57,249     |                                                      |       |   | $ | (1,318 | ) |   |   | $ | (21,286) |   |   |
| Period change                            |       | 89,210                                         |       |                                                            | (12,782    | )                                           |       |                                                      | (281       | ) |   |   | 76,147 |   |   |
| Balance, net, at  December 31, 2002 |       | 11,993                                         |       |                                                            | 44,467     |                                        |       |                                                      | (1,599     | ) |   |   | 54,861 |   |   |
| Period change                            |       | 155,782                                        |       |                                                            | 6,662      |                                        |       |                                                      | (1,003     | ) |   |   | 161,441 |   |   |
| Balance, net, at  December 31, 2003 |       | 167,775                                        |       |                                                            | 51,129     |                                        |       |                                                      | (2,602     | ) |   |   | 216,302 |   |   |
| Period change                            |       | 131,812                                        |       |                                                            | (17,724    | )                                           |       |                                                      | 101        |   |   |   | 114,189 |   |   |
| Balance, net, at December 31, 2004  |       | $                                              | 299,587    |                                                            |       | $                                           | 33,405     |                                                      |       |   | $ | (2,501 | ) |   |   | $ | 330,491 |   |   |

 

In the first and secondquarters of 2001, the foreign currency translation component of comprehensiveincome included the tax effects of the non-permanently reinvested 2000 earningsin Chiron’s German and Italian vaccines business in accordance with theinvestment and tax policy adopted in 2000. During the first and second quartersof 2001, the undistributed 2001 earnings in Chiron’s German and Italianvaccines business were expected to be reinvested permanently and, as a result,no tax effect was provided on the foreign currency translation component ofcomprehensive income. Beginning in the third quarter of 2001, tax effectsassociated with the decision not to permanently reinvest the 2001 earnings inChiron’s German and Italian vaccines business were recorded. For all otherforeign jurisdictions, the undistributed earnings of Chiron’s foreigninvestments are expected to be reinvested permanently. In the fourth quarter2002, Chiron’s German and Italian vaccines subsidiaries remitted dividends toChiron. Chiron included these dividends and the related foreign tax credits indetermining its 2002 tax provision. As a result, Chiron reversed all cumulativetax effects previously recorded associated with its decision not to permanently

F-16

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**CHIRON CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) DECEMBER 31, 2004**

**Note1—The Company and Summary of Significant Accounting Policies (Continued)**

reinvestthe 2001 earnings of its German and Italian vaccines business. In 2004 and2003, all of the undistributed earnings of all Chiron foreign subsidiaries wereconsidered to be permanently reinvested. As such, no tax effect was provided onthe foreign currency translation component of comprehensive income for 2004 and2003. There were no dividends paid from Chiron’s German or Italian vaccinessubsidiaries during 2004 and 2003.

*Treasury Stock*

Treasury stock is statedat cost. Gains on reissuance of treasury stock are credited to “Additionalpaid-in capital”. Losses on reissuance of treasury stock are charged to “Additionalpaid-in capital” to the extent of available net gains on reissuance of treasurystock. Otherwise, losses are charged to “Accumulated deficit.” For the yearsended December 31, 2004, 2003 and 2002, Chiron charged losses of $44.1million, $52.7 million and $41.1 million, respectively, to “Accumulateddeficit” in the Consolidated Balance Sheets.

*Revenue Recognition*

“Product sales, net”primarily consist of revenues recognized upon shipment of products tocustomers. Chiron’s blood-testing segment recognizes revenues related tonucleic acid testing product sales, which primarily consist of revenue derivedfrom the sale and use of assays, revenue derived from the sale, lease or rentalof equipment and revenue from providing field service for the instruments,which are not material. Revenue is recorded based upon the reported resultsobtained from the customer from the use of assays to screen donations or uponsale and delivery of the assays, depending on the underlying contract. In thecase of equipment sales or leases, revenue is recorded upon the sale andtransfer of the title to the instrument or ratably over the life of the leaseterm, respectively. For the provision of service on the instruments, revenue isrecognized ratably over the life of the service agreement. For sales ofBETASERON® interferon beta-1b, Chiron recognizes revenues upon shipmentto its marketing partner, Schering, and additional revenues upon Schering’ssubsequent sale of BETASERON to customers. Upon shipment to Schering, Chironrecognizes the contractually determined fixed amount of the fee to which Chironis entitled because at this point, there is persuasive evidence of anarrangement, delivery has occurred, the price due from Schering is fixed ordeterminable and collectibility is reasonably assured. Upon receiving thecontractual reporting of relevant customer sales from Schering, Chironrecognizes the incremental portion of the fee related to Schering’s shipments toits customers because this portion of the fee is not determinable until receiptof the related sales reports. Provisions for discounts and rebates tocustomers, and returns and other adjustments are provided for in the sameperiod the related product sales are recorded. Provisions for rebates tocustomers and returns and other adjustments are based upon analyses ofhistorical rebates and returns. Provisions for discounts are based upon a setpercentage of the previous month’s sales, which are driven by contractualagreements.

“Revenues from jointbusiness arrangement” represents Chiron’s one-half share in the pretaxoperating earnings generated by the joint business contractual arrangement withOrtho-Clinical Diagnostics. The arrangement was established in 1989, basedlargely on the screening, using immunodiagnostic technology, of blood in bloodbanks and other similar settings for the presence of HIV and hepatitis viruses.Through this arrangement, Ortho-Clinical Diagnostics sells a full line of testsrequired to screen for hepatitis viruses and retroviruses and providessupplemental tests and microplate-

F-17

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**CHIRON CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) DECEMBER 31, 2004**

**Note1—The Company and Summary of Significant Accounting Policies (Continued)**

basedinstrument systems to automate test performance and data collection. Inaddition, Chiron and Ortho-Clinical Diagnostics jointly hold theimmunodiagnostic rights to Chiron’s hepatitis and retrovirus technology andreceive royalties from the sales of hepatitis C virus and HIV tests bylicensees.

Chiron manufactures viralantigens and supplemental hepatitis tests and sells these tests toOrtho-Clinical Diagnostics, while Ortho-Clinical Diagnostics manufactures andsells assays and instrument systems. The revenue from the sale of theseantigens and tests, from Chiron to Ortho-Clinical Diagnostics, are recorded inproduct sales, with the corresponding costs recorded in cost of sales.Reimbursements from Ortho-Clinical Diagnostics for research costs incurred byChiron are recorded in collaborative agreement revenues and the relatedresearch expenses are recorded in research and development expenses. Inaddition to these product revenues and reimbursements, Chiron shares in thedefined pre-tax operating earnings of the Ortho-Clinical Diagnostics jointbusiness activity at a pre-determined percentage (50%), as defined in theagreement, rather than from an ownership interest in an entity. Chiron receivescontractually defined profit sharing payments from Ortho-Clinical Diagnosticson a quarterly basis.

“Collaborative agreementrevenues” are earned and recognized based upon work performed or upon theattainment of specified milestones. Under contracts where Chiron recognizesrevenue based upon research and development work performed, the revenuesamounted to $8.0 million, $9.0 million and $9.8 million in 2004,2003 and 2002, respectively. These amounts were recorded in “Collaborativeagreement revenues” in the Consolidated Statements of Operations.

“Royalty and license feerevenues” consist of product royalty payments and fees under license agreementsand are recognized when earned. Chiron estimates royalty revenues based onprevious period royalties received or on product sales forecast informationprovided by the third party licensee. In the subsequent quarter, Chiron recordsan adjustment equal to the difference between those royalty revenues recordedin the previous quarter and the contractual reporting of the third party’sactual product sales for that period. Up-front refundable fees are deferred andrecognized as revenues upon the later of when they become nonrefundable or whenperformance obligations are completed. Up-front nonrefundable fees where Chironhas no continuing performance obligations are recognized as revenues whencollection is reasonably assured. In situations where continuing performanceobligations exist, up-front nonrefundable fees are deferred and amortizedratably over the performance period. Milestones, if any, related to scientificor technical achievements are recognized in income when the milestone isaccomplished.

“Other revenues” primarilyconsist of fees for manufacturing, sales and marketing services performed,commission fees and grants from government agencies and are recognized whenearned. Other revenues include revenue from contracts where Chiron recognizesrevenue based upon research and development work performed, which amounted to$12.9 million, $7.8 million and $10.1 million in 2004, 2003 and 2002,respectively.

*Contract Manufacturing Revenues and Expenses*

Contractmanufacturing revenues and expenses are recognized upon meeting the criteriafor substantial performance and acceptance as defined in the contract andrecorded in “Other revenues” and “Other operating expenses,” respectively, inthe Consolidated Statements of Operations.

F-18

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**CHIRON CORPORATION  NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) DECEMBER 31, 2004**

**Note 1—The Companyand Summary of Significant Accounting Policies (Continued)**

*Shipping andHandling Fees and Costs*

Shipping and handling feesbilled to customers for product shipments are recorded in “Product sales, net”in the Consolidated Statements of Operations. Shipping and handling costs areincluded in inventory upon inventory purchase and included in “Cost of sales”in the Consolidated Statements of Operations upon sale of product.

*Research andDevelopment Expense and Purchased In-Process Research and Development*

Research and development costs are charged to expensewhen incurred. Major components of research and development expenses consist ofpersonnel costs, including salaries and benefits, clinical studies performed byinvestigators and contract research organizations (CROs), materials andsupplies, and overhead allocations consisting of certain administrative andfacilities related costs. Research costs are associated with performingactivities such as target identification and validation, structure based drugdesign and physical chemistry, and preclinical testing. Development costsinclude those expenses associated with clinical development (performing Phase1, 2 and 3 clinical trials) and pharmaceutical development including productformulation, chemical analysis, process scale-up, preclinical and clinicalsupplies manufacturing and process validation. The trials are generallycontrolled by Chiron, but can include funding commitments to trials controlledby investigators.

At the start of the trial, the total cost of the trialis estimated based upon review of investigator contracts, CROs, othercontractual commitments, and expected patient enrollment. We accrue the costsfor clinical studies ratably over the life of the trial, generally on a perpatient basis as enrollment occurs and as services are provided. We monitorlevels of performance under each contract including the extent of patientenrollment and other activities, and we adjust our estimates, if required, on aquarterly basis. Amounts paid in advance of services being performed aretreated as prepaid expenses and are applied against payments for work performedas defined by the contract.

Generally our clinical trial contracts are terminableby us upon written notice and Chiron is liable only for actual effort expendedby the third parties at any point in time during the contract, regardless ofpayment status. Amounts paid in advance of services being performed will berefunded if a contract is terminated. Additionally, certain contracts includetermination obligations. Such additional termination payments are only recordedto expense if the contract is terminated.

On a quarterly basis, Chiron assesses the future valueof all trials. In the event that Chiron determines that there is insufficientfuture value to Chiron relative to the future cost of the trial, all remainingcontractual expense obligations under the trial are accrued, including costs ofany remaining trial activities, any non-cancelable funding commitments, wrap-upexpenses and patient care commitments. Trials terminated in the event of anaccelerated filing do not qualify for this treatment.

In the fourth quarter 2002, Chiron reached anagreement in principle to transfer responsibility for the SILCAAT trial, aPhase III study for recombinant human interleukin-2 (IL-2, aldesleukin), to theNational Institutes Allergy and Infectious Disease (NIAID) and the Universityof Minnesota. Responsibility for the SILCAAT study was transferred to NIAID andUniversity of Minnesota effective February 14, 2003. 

F-19

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**CHIRON CORPORATION  NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) DECEMBER 31, 2004**

**Note1—The Company and Summary of Significant Accounting Policies (Continued)**

Under the agreement, weare obligated to fund a maximum of $18.0 million over the lifetime of the trialand to supply clinical materials and certain other support services. No furtherfinancial obligations exist under this agreement as of December 31, 2004.In the fourth quarter 2004, Chiron determined that there was not sufficientpotential future value to Chiron to warrant continued recognition of expenseover the original trial period. Accordingly, in the fourth quarter 2004 Chironrecorded an expense of $6.0 million representing the unamortized expensebalance as of December 31, 2004.

Purchased in-processresearch and development from a business combination represents the valueassigned or paid for acquired research and development for which there is noalternative future use as of the date of acquisition. The income approach isgenerally used to value purchased in-process research and development. Theincome approach is based on the premise that the value of a security or assetis the present value of the future earning capacity that is available fordistribution to the subject investors in the security or asset. Purchasedin-process research and development is charged to expense as part of theallocation of the purchase price of a business combination.

*AdvertisingExpenses*

Chiron expenses the costsof advertising, including promotional expenses, as incurred. Advertisingexpenses for the years ended December 31, 2004, 2003 and 2002 were$24.1 million, $20.2 million and $14.8 million, respectively.

*Income Taxes*

Income taxes are accounted for under the liabilitymethod. Deferred tax assets and liabilities are recognized for the future taxconsequences attributable to differences between the financial statementcarrying amounts of existing assets and liabilities and their respective taxbases, net operating losses and business tax credit carryforwards. Deferred taxassets and liabilities are measured using enacted tax rates expected to applyto taxable income in the years in which those temporary differences areexpected to be recovered or settled. The effect on deferred tax assets andliabilities of a change in tax rates is recognized in income in the period thatincludes the enactment date.

A valuation allowance hasbeen established against the recorded deferred income tax assets to the extentthat management believes it more likely than not that a portion of the deferredincome tax assets are not realizable.

*Stock-BasedCompensation*

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

F-20

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**CHIRON CORPORATION  NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) DECEMBER 31, 2004**

**Note1—The Company and Summary of Significant Accounting Policies (Continued)**

The following tableillustrates the effect on net income and related net income per share, hadcompensation cost for the stock-based employee compensation been determinedbased upon the fair value method:
| ** **                                                                                                                                            | ** ** | **2004**                                                           | ** ** | **2003** | ** ** | **2002** | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------------------------------------------------------|------------|----------|------------|----------|------------|
| ** **                                                                                                                                            | ** ** | **(In thousands, except per share data)** | ** ** |
| Net income  (loss):                                                                                                                                   |       |                                                               |       |     |       |     |       |
| As reported                                                                                                                                           |       | $                                                                  | 78,917     |     | $          | 227,313  |       | $ | 180,825 |   |
| Add: Stock-based employee compensation expense  included in reported net income, net of related tax effects                                 |       | 4,703                                                              |       | 5,571    |       | 3,185    |       |
| Less: Total stock-based employee compensation  expense determined under fair value based method for all awards, net of related  tax effects |       | 86,801                                                             |       | 100,849  |       | 67,142   |       |
| Pro forma                                                                                                                                             |       | $                                                                  | (3,181     | )        | $          | 132,035  |       | $ | 116,868 |   |
| Basic net income (loss) per share:                                                                                                                    |       |                                                               |       |     |       |     |       |
| As reported                                                                                                                                           |       | $                                                                  | 0.42       |     | $          | 1.22     |       | $ | 0.96 |   |
| Pro forma                                                                                                                                             |       | $                                                                  | (0.02      | )        | $          | 0.71     |       | $ | 0.62 |   |
| Diluted net income (loss) per share:                                                                                                                  |       |                                                               |       |     |       |     |       |
| As reported                                                                                                                                           |       | $                                                                  | 0.41       |     | $          | 1.19     |       | $ | 0.94 |   |
| Pro forma                                                                                                                                             |       | $                                                                  | (0.02      | )        | $          | 0.69     |       | $ | 0.61 |   |

 

*Foreign CurrencyTranslation*

The financial statementsof Chiron’s foreign subsidiaries and equity investments are generally measuredusing the local currency. Accordingly, the assets and liabilities of Chiron’sforeign subsidiaries and equity investments are translated into U.S. dollarsusing the exchange rates in effect at the end of the period. Revenues andexpenses are translated using the average exchange rates for the period.Adjustments resulting from currency translations are included in comprehensiveincome.

*Concentration ofRisk*

Financial instruments,which potentially expose Chiron to concentrations of credit risk, consistprimarily of cash, investments (such as debt securities), derivatives and tradeaccounts receivable. Chiron invests cash, which is not required for immediateoperating needs, in a diversified portfolio of financial instruments issued byfinancial institutions and other issuers with strong credit ratings.

By policy, the amount of credit exposure to any oneinstitution or issuer is limited. These investments are generally notcollateralized and primarily mature within three years. In 2001, Chironrecorded a charge of $1.5 million to write-down debt securities with aface value of $5.0 million due to the decline in the credit rating of theissuer. On March 1, 2002, the issuer paid Chiron the full principal plusinterest. Chiron has not experienced any losses due to counterparty default.

F-21

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**CHIRON CORPORATION  NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) DECEMBER 31, 2004**

**Note1—The Company and Summary of Significant Accounting Policies (Continued)**

Chiron uses various derivatives to reduce foreignexchange risks and equity securities risk. Counterparties to these derivativeagreements are major financial institutions. Chiron manages the risk ofcounterparty default through the use of credit standards, diversification andmonitoring of financial conditions of these institutions. Chiron has notexperienced any losses due to counterparty default.

Chiron has not experienced any significant creditlosses from its accounts receivable from the joint business contractualarrangement, royalty and license fee agreements or collaborative researchagreements, and none are currently expected. Other accounts receivable arisefrom product sales to customers and as a result of contract manufacturingactivities. Chiron performs ongoing credit evaluations of these customers andgenerally does not require collateral. Chiron maintains reserves for potentialtrade and non-trade receivable credit losses, and such losses have been withinmanagement’s expectations.

Chiron purchases bulk powdered tobramycin, the primarybasic raw material in TOBI® tobramycin, from two of the principal worldwidesuppliers of the drug. Chiron anticipates that either one of these suppliersalone will be able to supply sufficient quantities to meet current needs;however, there is some degree of risk that these suppliers will not be able tomeet future demand in a timely and cost-effective manner. As a result, Chiron’soperations could be adversely affected by an interruption or reduction in thesupply of bulk-powdered tobramycin.

Chiron has entered into contracts with third partiesfor the production and packaging of TOBI® solution and the pre-filled diluentsyringe for BETASERON® interferon beta-1b. Over time, Chiron can usealternative production and packaging sources. However, if the contracted thirdparties become unable to produce or package sufficient quantities of TOBItobramycin or the pre-filled diluent syringe for BETASERON interferon beta-1bdue to work stoppages or other factors, Chiron’s operations could bedisrupted until alternative sources are secured.

In connection with the production of Chiron’s fluvaccine products, Chiron must purchase large quantities of chicken eggs.Currently, for FLUVIRIN® vaccine, Chiron purchases those eggs and incubationservices from a single supplier in the United Kingdom and, pursuant to thecontract with that supplier, Chiron has agreed to make specified purchases fromthat supplier through 2009, subject to our right to terminate this agreementearlier upon payment of a termination fee. If Chiron’s supplier were to fail tosupply eggs in sufficient quantities or quality, including as a result of anyhealth or other issues related to the chickens, Chiron’s business would bematerially adversely affected.

In nucleic acid testing,Chiron relies on our collaborative partner, Gen-Probe, to manufacture the WestNile virus assay, currently in use on an investigational-use basis in the U.S.and the PROCLEIX® HIV-1/ HCV Assay. Chiron currently sources the relatedinstrument system from third party suppliers. Currently, Gen-Probe is the onlymanufacturer of nucleic acid testing products using Transcription MediatedAmplification technology. In immunodiagnostics, under the Ortho-ClinicalDiagnostics contract, Chiron manufactures bulk reagents and antigens andconfirmatory test kits sold in the clinical diagnostics and blood screeningfields. While Chiron and Chiron’s partners work to mitigate the risksassociated with being a key provider, there is some degree of risk that Chiron’spartner, Gen-Probe, will not be able to provide sufficient quantities of thePROCLEIX HIV-1/ HCV Assay and the West Nile Virus Assay or that Chiron will notbe able to manufacture sufficient bulk reagents and antigens and confirmatorytest kits for immunodiagnostic products. As a result, Chiron’s operations couldbe adversely affected.

F-22

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**CHIRON CORPORATION  NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) DECEMBER 31, 2004**

**Note1—The Company and Summary of Significant Accounting Policies (Continued)**

*New AccountingStandards*

In December 2004, theFinancial Accounting Standards Board (FASB) issued Statement of FinancialAccounting Standards No. 123 (Revised 2004), *Share-Based Payment* (SFAS 123R), which requires the costresulting from all share-based payment transactions to be recognized in theconsolidated financial statements. That cost will be measured based on the fairvalue of the equity instruments issued or on the fair value of liabilitiesincurred. Under SFAS 123R, the fair-value-based method for recognition ordisclosure of compensation expense will be applied using the modifiedprospective application transition method or the modified retrospectiveapplication transition method. Chiron currently measures compensation expensefor its stock-based employee compensation under the intrinsic method. Theadoption of SFAS 123R will have a material impact on Chiron’s consolidatedfinancial statements. Current option values of using the Black-Scholes formulamay not be indicative of results from the valuation methodologies Chironfinally adopts. The adoption of SFAS 123R is effective for Chiron commencingthe beginning of the third quarter 2005.

**Note 2—Earnings PerShare**

Basic earnings per share is based upon theweighted-average number of common shares outstanding. Diluted earnings pershare is based upon the weighted-average number of common shares and dilutivepotential common shares outstanding. Dilutive potential common shares couldresult from (i) the assumed exercise of outstanding stock options andequivalents, which are included under the treasury-stock method; (ii) performancebased share rights awards to the extent that dilutive shares are assumedissuable; (iii) the assumed exercise of outstanding put options, which areincluded under the reverse treasury-stock method; and (iv) convertiblenotes and debentures, which are included under the if-converted method, ifapplicable. Due to rounding, quarterly amounts may not sum to full yearamounts.

Contingently convertible debt instruments (“CoCos”)are included in diluted earnings per share, if dilutive. For the year ended December 31,2004, Chiron’s $500.0 million contingently convertible debentures due 2033 (“2033Debentures”) and Chiron’s $385.0 million contingently convertible debenturesdue 2034 (“2034 Debentures”) were excluded from the computations of dilutedearnings per share as each of these CoCos were not dilutive.

F-23

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**CHIRON CORPORATION  NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) DECEMBER 31, 2004**

**Note2—Earnings Per Share (Continued)**

The following table setsforth the computation for basic and diluted earnings per share on income fromcontinuing operations for the years ended December 31:
| ** **                                                                        | ** ** | **2004**                                                           | ** ** | **2003** | ** ** | **2002** | ** ** |
|-----------------------------------------------------------------------------------|------------|--------------------------------------------------------------------|------------|----------|------------|----------|------------|
| ** **                                                                        | ** ** | **(In thousands, except per share data)** | ** ** |
| Income  (Numerator):                                                              |       |                                                               |       |     |       |     |       |
| Income from continuing operations                                                 |       | $                                                                  | 54,063     |     | $          | 220,338  |       | $ | 181,145 |   |
| Plus: Interest on 1.625% contingently convertible  debentures, net of taxes       |       | 3⁄4                                                             |       | 2,638    |       | —   |       |
| Income from continuing operations, plus impact from  assumed conversions          |       | $                                                                  | 54,063     |     | $          | 222,976  |       | $ | 181,145 |   |
| Shares  (Denominator):                                                            |       |                                                               |       |     |       |     |       |
| Weighted-average common shares outstanding                                        |       | 187,545                                                            |       | 186,835  |       | 188,792  |       |
| Effect of dilutive securities:                                                    |       |                                                               |       |     |       |     |       |
| Stock options and equivalents                                                     |       | 2,657                                                              |       | 4,339    |       | 3,357    |       |
| Put options                                                                       |       | 3⁄4                                                             |       | 1        |       | 3        |       |
| 1.625% contingently convertible debentures                                        |       | 3⁄4                                                             |       | 2,740    |       | —   |       |
| Weighted-average common shares outstanding, plus  impact from assumed conversions |       | 190,202                                                            |       | 193,915  |       | 192,152  |       |
| Basic earnings  per share from continuing operations                              |       | $                                                                  | 0.29       |     | $          | 1.18     |       | $ | 0.96 |   |
| Diluted earnings  per share from continuing operations                            |       | $                                                                  | 0.28       |     | $          | 1.15     |       | $ | 0.94 |   |

 

Thefollowing table sets forth the computation for basic and diluted earnings pershare on net income for the years ended December 31:
| ** **                                                                        | ** ** | **2004**                                                           | ** ** | **2003** | ** ** | **2002** | ** ** |
|-----------------------------------------------------------------------------------|------------|--------------------------------------------------------------------|------------|----------|------------|----------|------------|
| ** **                                                                        | ** ** | **(In thousands, except per share data)** | ** ** |
| Income (Numerator):                                                               |       |                                                               |       |     |       |     |       |
| Net income                                                                        |       | $                                                                  | 78,917     |     | $          | 227,313  |       | $ | 180,825 |   |
| Plus: Interest on 1.625% contingently convertible  debentures, net of taxes       |       | 3⁄4                                                             |       | 2,638    |       | —   |       |
| Net income, plus impact from assumed conversions                                  |       | $                                                                  | 78,917     |     | $          | 229,951  |       | $ | 180,825 |   |
| Shares (Denominator):                                                             |       |                                                               |       |     |       |     |       |
| Weighted-average common shares outstanding                                        |       | 187,545                                                            |       | 186,835  |       | 188,792  |       |
| Effect of  dilutive securities:                                                   |       |                                                               |       |     |       |     |       |
| Stock options and equivalents                                                     |       | 2,657                                                              |       | 4,339    |       | 3,357    |       |
| Put options                                                                       |       | 3⁄4                                                             |       | 1        |       | 3        |       |
| 1.625% contingently convertible debentures                                        |       | 3⁄4                                                             |       | 2,740    |       | —   |       |
| Weighted-average common shares outstanding, plus  impact from assumed conversions |       | 190,202                                                            |       | 193,915  |       | 192,152  |       |
| Basic earnings  per share                                                         |       | $                                                                  | 0.42       |     | $          | 1.22     |       | $ | 0.96 |   |
| Diluted earnings per  share                                                       |       | $                                                                  | 0.41       |     | $          | 1.19     |       | $ | 0.94 |   |

 

F-24

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**CHIRON CORPORATION  NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) DECEMBER 31, 2004**

**Note2—Earnings Per Share (Continued)**

Stock options to purchase 13.4 million shares,7.3 million shares and 15.1 million shares with exercise pricesgreater than the average market prices of common stock were outstanding duringthe years ended December 31, 2004, 2003 and 2002, respectively. Theseoptions were excluded from the respective computations of diluted earnings pershare, as their inclusion would be antidilutive.

The dilutive effect of CoCos must be included indiluted earnings per share regardless of whether the triggering contingency hasbeen satisfied, if dilutive. For the year ended December 31, 2004, 7.3million shares of common stock issuable upon conversion of the 2033 Debentureswere excluded from the computations of diluted earnings per share as theirinclusion would be antidilutive.

If the 2034 Debentures are tendered for conversion,the value (“Conversion Value”) of cash and shares of Chiron’s common stock, ifany, to be received by a holder converting $1,000 principal amount of thedebentures will be determined by multiplying the applicable conversion rate bya weighted average price. Chiron will deliver the Conversion Value to debentureholders as follows: (1) an amount in cash (“Principal Return”) equal tothe lesser of (a) the aggregate Conversion Value of the debentures to beconverted and (b) the aggregate principal amount of the debentures to beconverted and (2) if the aggregate Conversion Value of the debentures tobe converted is greater that the Principal Return, an amount in shares (“NetShares”) equal to the aggregate Conversion Value less the Principal Return (“NetShare Amount”). The number of Net Shares to be paid will be determined bydividing the Net Share Amount by a weighted average price. If dilutive, commonshares to be added to the diluted shares outstanding would be determined by thenet share settlement of the 2034 Debentures. For the year ended December 31,2004, the assumed conversion of the 2034 Debentures was not dilutive.

In addition, for the years ended December 31,2004, 2003 and 2002, 0.6 million shares, 5.2 million shares and 5.2 millionshares of common stock issuable upon conversion of the Liquid Yield OptionNotes were excluded from the computations of diluted earnings per share astheir inclusion would be antidilutive. During 2004, Chiron was required topurchase a significant portion of the LYONs.

F-25

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**CHIRON CORPORATION  NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) DECEMBER 31, 2004**

**Note 3—SupplementalCash Flow Information**
| ** **                                                             | ** ** | **2004**                | ** ** | **2003**  | ** ** | **2002** | ** ** |
|------------------------------------------------------------------------|------------|-------------------------|------------|-----------|------------|----------|------------|
| ** **                                                             | ** ** | **(In thousands)** | ** ** |
| Interest paid                                                          |       | $                       | 18,771     |      | $          | 2,310    |       | $ | 876 |   |
| Income taxes paid                                                      |       | $                       | 51,651     |      | $          | 70,240   |       | $ | 132,124 |   |
| Investing and financing  activities:                                   |       |                    |       |      |       |     |       |
| Acquisitions:                                                          |       |                    |       |      |       |     |       |
| Cash acquired                                                          |       | $                       | —     |      | $          | 92,178   |       | $ | 18,208 |   |
| Fair value of all other assets acquired                                |       | 11,327                  |       | 1,074,668 |       | 53,682   |       |
| Liabilities assumed                                                    |       | (724                    | )          | (141,110  | )          | (4,980   | )          |
| Reduction of income taxes payable                                      |       | —                  |       | —    |       | 1,739    |       |
| Income taxes payable                                                   |       | —                  |       | (17,741   | )          | —   |       |
| Net deferred tax asset (liability)                                     |       | 1,420                   |       | (60,170   | )          | 8,425    |       |
| Carrying value of original investment                                  |       | —                  |       | —    |       | (310     | )          |
| Cash payable for asset purchase                                        |       | (780                    | )          | —    |       | —   |       |
| Acquisition costs not yet paid as of December 31, 2004,  2003 and 2002 |       | (22                     | )          | (40,930   | )          | (707     | )          |
| Total cash paid                                                        |       | $                       | 11,221     |      | $          | 906,895  |       | $ | 76,057 |   |
| Capital Lease                                                          |       | $                       | —     |      | $          | 157,500  |       | $ | — |   |

 

**Note 4—DiscontinuedOperations**

In astrategic effort to focus on its core businesses of blood-testing, vaccines andbiopharmaceuticals, Chiron completed the sale of Chiron Diagnostics and ChironVision in 1998 and 1997, respectively. The “Gain (loss) from discontinuedoperations, net of taxes” consisted of the following for the years ended December 31:
| ** **                                                   | ** ** | **2004**                | ** ** | **2003** | ** ** | **2002** | ** ** |
|--------------------------------------------------------------|------------|-------------------------|------------|----------|------------|----------|------------|
| ** **                                                   | ** ** | **(In thousands)** | ** ** |
| Reversal of  reserves (net charge) for indemnity obligations |       | $                       | —     |     | $          | (5,222   | )          | $ | — |   |
| Gain resulting  from IRS settlement                          |       | 12,459                  |       | —   |       | —   |       |
| Employee  settlement                                         |       | —                  |       | —   |       | (438     | )          |
| Reversal of income  tax reserves from Bayer settlement       |       | 12,395                  |       | —   |       | —   |       |
| Income tax  benefit                                          |       | —                  |       | 12,197   |       | 118      |       |
| ** **                                                   |       | $                       | 24,854     |     | $          | 6,975    |       | $ | (320 | ) |

 

Chiron and Bayer Corporation, or Bayer, were involvedin a dispute with respect to their respective rights to certain royalty refundsreceivable for which a settlement was reached in 2004. Under this settlementagreement, we made a settlement payment to Bayer in 2004. This settlementincludes an agreement that all outstanding items with Bayer related to the saleof Chiron Diagnostics are resolved and no future indemnity obligations arerequired. Chiron released previously established reserves deemed to be excessfollowing this settlement. This settlement resulted in a net gain of$12.4 million in 2004. This net gain primarily relates to a tax benefit asa result of the settlement payment to Bayer.

F-26

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**CHIRON CORPORATION  NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) DECEMBER 31, 2004**

**Note4—Discontinued Operations (Continued)**

In 2004, Chiron and the IRS entered into a settlementagreement closing the open tax years 1996 to 1998. Pursuant to this settlementagreement we recognized a tax benefit of approximately $12.5 million in2004.

Chiron reversed approximately $2.3 million related tounutilized reserves for Chiron Diagnostics and Chiron Vision in 2003.

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

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

Chiron recognized an income tax benefit of $12.2million and $0.1 million in 2003 and 2002, respectively. The tax benefit in2003 related to the settlement agreement between Bayer, as discussed above andthe reversal of valuation allowances against deferred tax assets that wereestablished at the time of the sale of Chiron Diagnostics. The tax benefit in2002 related to the charge for a settlement with a former employee arising outof the sale, as discussed above.

Basic and diluted earningsper share from discontinued operations were both $0.13 for the year ended December 31,2004. Basic and diluted earnings per share from discontinued operations wereboth $0.04 for the year ended December 31, 2003. Discontinued operationshad no impact on basic and diluted earnings per share for the year ended December 31,2002.

**Note 5—Acquisitions**

**Sagres Discovery  **OnJuly 2, 2004, Chiron acquired Sagres Discovery (“Sagres”), a privatelyheld company headquartered in Davis, California, which focuses on the discoveryand validation of targets with potential application to the development ofcancer therapeutics. Chiron acquired Sagres for a preliminary purchase price of$12.0 million.

F-27

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**CHIRON CORPORATION  NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) DECEMBER 31, 2004**

**Note5—Acquisitions (Continued)**

Sagres is part of Chiron’sbiopharmaceuticals segment. Chiron accounted for the acquisition as an assetpurchase and included Sagres’ operating results in its consolidated operatingresults beginning on July 2, 2004. The components of the preliminarypurchase price and allocation thereof based on estimated fair values aresummarized in the following table (in thousands). The preliminary purchaseprice reflects acquisition costs, which include contractual severance, directacquisition costs and facility exit costs. Chiron is in the process offinalizing certain estimates including those for severance and facility exitcosts for certain research facilities; thus both the preliminary purchase priceand the allocation of the preliminary purchase price are subject to change.
| Consideration and acquisition costs:                         |   |   |   |
|--------------------------------------------------------------|--------|--------|--------|
| Cash paid for asset  purchase                                |   | $      | 10,113 |   |
| Cash payable for asset  purchase                             |   | 780    |   |
| Acquisition costs paid  as of December 31, 2004         |   | 1,108  |   |
| Acquisition costs not  yet paid as of December 31, 2004 |   | 22     |   |
| Total preliminary  purchase price                            |   | $      | 12,023 |   |
| Allocation of preliminary purchase price:                    |   |   |   |
| Assets acquired                                              |   | $      | 1,698  |   |
| Liabilities assumed                                          |   | (724   | )      |
| Deferred tax assets                                          |   | 1,420  |   |
| Purchased in-process  research and development               |   | 9,629  |   |
| Total preliminary  purchase price                            |   | $      | 12,023 |   |

 

Chiron allocated the preliminary purchase price basedon the fair value of the assets acquired and liabilities assumed. Chironallocated a portion of the preliminary purchase price to purchased in-processresearch and development, which it charged to earnings in 2004.

For acquisition costs related to Sagres, Chiron paid$1.1 million as of December 31, 2004. These payments are reflected inthe Consolidated Statement of Cash Flows as a component of “Cash paid foracquisitions, net of cash acquired” for the year ended December 31, 2004.

The deferred tax assets primarily related to futureutilization of net operating loss carryforwards. Chiron acquired federal andstate net operating loss carryforwards of approximately $25.0 million and$20.6 million, respectively and federal and state business creditsattributed to Sagres of approximately $1.7 million and $1.3 million,respectively. The available utilization of such net operating loss and businesstax credit carryforwards is limited in any one year to approximately$0.2 million per annum over the next twenty years under provisions of theInternal Revenue Code. As such, a significant portion of Sagres’ net operatingloss carryforwards is expected to expire unutilized.

F-28

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**CHIRON CORPORATION  NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) DECEMBER 31, 2004**

**Note5—Acquisitions (Continued)**

**PowderJect  **OnJuly 8, 2003, Chiron acquired PowderJect, a company based in Oxford,England that develops and commercializes vaccines. Chiron acquired all of theoutstanding shares of common stock of PowderJect for 550 pence per ordinaryshare, which, including estimated acquisition costs, resulted in a totalpurchase price of approximately $938.6 million. During 2004, the followingadjustments were made to the purchase price and allocation of the purchaseprice:

·       Duringthe second quarter 2004, Chiron completed the planned divestiture of certainresearch operations in Madison, Wisconsin and Oxford, England and certainvaccines operations in Sweden. The divestiture of these operations included thedisposition of net assets of $14.7 million (which included $15.5 millionof cash), deferred taxes of $9.4 million, and exit liabilities of$21.6 million. The net impact of the divestiture resulted in an increaseto goodwill of $2.5 million in the second quarter 2004. Also, during thesecond quarter of 2004, Chiron adjusted the previously recorded obligationrelated to an assumed defined benefit plan, which resulted in an increase togoodwill of $8.1 million.

·       Duringthe third quarter 2004, Chiron revised estimates of exit costs associated withcertain contractual obligations under supply and research agreements related tothe divested research operations and other direct acquisition costs. Also,during the third quarter 2004, Chiron revised estimates of exit costsassociated with the divestiture of certain research operations in Madison,Wisconsin. The net impact of the revision of these estimates resulted in anincrease to goodwill of $14.0 million, an increase to acquisition costs of$14.5 million and a decrease to current liabilities assumed of$0.5 million.

·       Duringthe fourth quarter 2004, Chiron revised estimates of certain receivables andinsurance liabilities. The net impact of these revisions resulted in a decreaseto goodwill of $6.6 million, a decrease to acquisition costs of $2.1 million,an increase to accounts receivable of $1.0 million, a decrease to currentliabilities of $2.5 million and a decrease to long-term liabilities of $1.4million.

As a result of the above adjustments, the purchaseprice was revised from $947.8 million at December 31, 2003 to $938.6 millionat December 31, 2004. Goodwill was revised from $503.0 million at December 31,2003 to $520.9 million at December 31, 2004.

PowderJect is part of Chiron’s vaccines segment.Chiron accounted for the acquisition as a business combination and includedPowderJect’s operating results in its consolidated operating results beginning July 8,2003.

F-29

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**CHIRON CORPORATION  NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) DECEMBER 31, 2004**

**Note5—Acquisitions (Continued)**

The components of thepurchase price, and the allocation thereof based on estimated fair values aresummarized in the following table (in thousands).
| Consideration and  acquisition costs:                                  |   |    |    |
|------------------------------------------------------------------------|--------|---------|---------|
| Cash paid for common stock                                             |   | $       | 831,026 |   |
| Cash paid for options on common stock                                  |   | 59,153  |    |
| Acquisition costs paid as of December 31, 2004                    |   | 24,861  |    |
| Estimated acquisition costs not yet paid as of  December 31, 2004 |   | 23,590  |    |
| Total purchase price                                                   |   | $       | 938,630 |   |
| Allocation of  purchase price:                                         |   |    |    |
| Cash and cash equivalents                                              |   | $       | 76,685  |   |
| Short-term marketable securities                                       |   | 8,840   |    |
| Accounts receivable, net                                               |   | 40,600  |    |
| Inventories                                                            |   | 64,924  |    |
| Property, plant and equipment                                          |   | 60,589  |    |
| Goodwill                                                               |   | 520,890 |    |
| Acquired intangible assets                                             |   | 335,500 |    |
| Other assets                                                           |   | 4,876   |    |
| Income taxes payable                                                   |   | (17,741 | )       |
| Current liabilities                                                    |   | (51,260 | )       |
| Net deferred tax liability                                             |   | (69,566 | )       |
| Long-term liabilities                                                  |   | (81,007 | )       |
| Purchased in-process research and development                          |   | 45,300  |    |
| Total purchase  price                                                  |   | $       | 938,630 |   |

 

Chiron allocated the purchase price based on the fairvalue of the assets acquired and liabilities assumed. Chiron allocated a portionof the purchase price to purchased in-process research and development, whichit charged to earnings in 2003. Purchased in-process research and developmentrepresented the valuation of acquired, to-be-completed research projects.Purchased in-process research and development was determined using the incomeapproach, which is based on the premise that the value of a security or assetis the present value of the future earning capacity that is available fordistribution to the subject investors in the security or asset. In valuing thepurchased in-process research and development, Chiron usedprobability-of-success-adjusted cash flows and a 14% discount rate. Cash flowsfrom projects including those relating to (i) certain travel vaccines and (ii) vaccinesfor allergies were assumed to commence between 2004 and 2012. Given the highrisk associated with the development of new drugs, Chiron probability-adjustedthe revenue and expense forecasts to reflect the risk of advancement throughthe regulatory approval process based on the stage of development in theregulatory process. Such a valuation requires significant estimates andassumptions. Chiron believes that the fair value assigned to purchasedin-process research and development is based on reasonable assumptions. Toassist in determining the value of the purchased in-process research anddevelopment, a third-party valuation was obtained as of the acquisition date.

F-30

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**CHIRON CORPORATION  NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) DECEMBER 31, 2004**

**Note5—Acquisitions (Continued)**

Acquired intangible assets included the fair value ofdistribution rights, a contract manufacturing agreement and developed producttechnologies. The distribution rights and the contract manufacturing agreementare being amortized on a straight-line basis over 1 to 4 years. Theweighted average amortization period for these intangible assets is2 years. Developed product technologies are being amortized using eitherthe estimated sales method over 10 years or on a straight-line basis over1 to 15 years. The weighted average amortization period for theseintangible assets is 11 years. The weighted average amortization periodfor total acquired intangible assets is 10 years.

Income taxes payable of $17.7 million relates tocurrent tax liabilities associated with PowderJect at the date of acquisition.The net deferred tax liability of $69.6 million is comprised of currentand non-current deferred tax assets of $31.1 million primarily related tonet operating losses incurred from April 1, 2003 through the acquisitiondate, reserves and depreciation timing differences and a non-current deferredtax liability of $100.7 million related to acquired intangibles.

For acquisition costs related to PowderJect, Chironpaid $8.2 million and $16.7 million for 2004 and 2003, respectively.The net assets from the divestiture of certain research operations in Madison,Wisconsin and Oxford, England and certain vaccines operations in Swedenincluded $15.5 million of cash. For the acquisition of PowderJect, cash paidfor common stock and options on common stock was $890.2 million for 2003.These payments are reflected in the Consolidated Statement of Cash Flows as acomponent of “Cash paid for acquisitions, net of cash acquired” for the yearsended December 31, 2004 and 2003, respectively.

**Pulmopharm GmbH  **OnJuly 1, 2002, Chiron completed the acquisition of Pulmopharm GmbH, adistributor of TOBI® tobramycin products in Germany and Austria by purchasingthe remaining 80.1% ownership that Chiron did not previously own. Previously,Chiron owned 19.9% of Pulmopharm and accounted for the investment under theequity method. Chiron’s acquisition of all of the remaining outstanding sharesof common stock of Pulmopharm, including estimated acquisition costs, resultedin a total purchase price of approximately $3.7 million, which included$0.2 million for a contingent payment relating to future revenues duringthe earn-out period. The acquisition resulted in the recognition of$3.8 million of intangible assets relating to the distribution rights,$1.2 million of goodwill, $0.3 million of tangible assets and$1.6 million of deferred tax liabilities on the acquisition date. Theamortization period for acquired intangible assets relating to the distributionrights is 3.75 years. In addition, on the acquisition date, the carryingvalue of the original investment in Pulmopharm, which totaled$0.3 million, was reclassified to goodwill. Chiron accounted for theacquisition as a business combination and included Pulmopharm’s operatingresults in its consolidated operating results beginning on July 1, 2002.Pulmopharm is part of Chiron’s biopharmaceuticals segment. During 2003, thecontingent payment of $0.2 million was reversed and goodwill was adjustedaccordingly, as certain revenues were not achieved during the earn-out period.

**Matrix Pharmaceutical, Inc.  **OnFebruary 20, 2002, Chiron acquired Matrix Pharmaceutical, Inc., acompany that was developing tezacitabine, a drug to treat cancer. Chironacquired all of the outstanding shares of common stock of Matrix Pharmaceuticalat $2.21 per share, which, including acquisition costs, resulted in a totalpurchase price of approximately $67.0 million. Matrix Pharmaceutical ispart of Chiron’s biopharmaceuticals segment. Tezacitabine expanded Chiron’sportfolio of cancer therapeutics in the

F-31

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**CHIRON CORPORATION  NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) DECEMBER 31, 2004**

**Note5—Acquisitions (Continued)**

development stage. Developmentof tezacitabine was discontinued in the first quarter of 2004 based on theanalysis of the data from a Phase II trial in patients with gastroesophagealcancer.

Chironaccounted for the acquisition as an asset purchase and included MatrixPharmaceutical’s operating results, including the seven business days from February 20to 28, 2002, in its consolidated operating results beginning on March 1,2002. The components and allocation of the purchase price, based on their fairvalues, consisted of the following (in thousands):
| Consideration and acquisition costs:           |   |   |   |
|------------------------------------------------|--------|--------|--------|
| Cash paid for common  stock                    |   | $      | 58,737 |   |
| Cash paid for options on  common stock         |   | 2,231  |   |
| Acquisition costs                              |   | 6,078  |   |
| Total purchase price                           |   | $      | 67,046 |   |
| Allocation of purchase price:                  |   |   |   |
| Cash and cash  equivalents                     |   | $      | 17,337 |   |
| Assets held for sale                           |   | 2,300  |   |
| Deferred tax asset                             |   | 10,000 |   |
| Other assets                                   |   | 1,469  |   |
| Purchased in-process  research and development |   | 45,181 |   |
| Accounts payable                               |   | (2,898 | )      |
| Reduction of income  taxes payable             |   | 1,739  |   |
| Accrued Liabilities                            |   | (8,082 | )      |
| Total purchase price                           |   | $      | 67,046 |   |

 

Acquisition costs included contractual severance andinvoluntary termination costs, as well as other direct acquisition costs.Approximately $5.1 million represented severance payments, assumed byChiron, to eligible employees as defined by their employment agreements.

Chiron allocated the purchase price based on the fairvalue of the assets acquired and liabilities assumed. Chiron allocated aportion of the purchase price to purchased in-process research and development,which was charged to earnings in 2002. Purchased in-process research anddevelopment represented the fair value, calculated usingprobability-of-success-adjusted cash flows and a 20% discount rate, at theacquisition date. Chiron assumed cash flows from tezacitabine to commence after2005. As with all pharmaceutical products, the probability of commercialsuccess for any research and development project is highly uncertain.

Chiron ceased manufacturing operations at the SanDiego, California facility and closed the facility during the third quarter2002.

As indicated in the above table, a portion of thepurchase price was allocated to assets held for sale. In March 2002,Chiron sold the leasehold improvements and assigned the lease related to afacility located in Fremont, California. Chiron received an amount equivalentto the fair value of the assets at the date of acquisition.

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**CHIRON CORPORATION  NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) DECEMBER 31, 2004**

**Note5—Acquisitions (Continued)**

Chiron paid $0.7 million related to severancepayments included in acquisition costs for Matrix Pharmaceuticals andPathogenesis for the year ended December 31, 2003. This payment isreflected in the Consolidated Statement of Cash Flows as a component of “Cashpaid for acquisitions, net of cash acquired” for the year ended December 31,2003.

In March 2002, Chiron paid $6.0 millionrelated to a bank loan assumed during the purchase of Matrix Pharmaceutical.This payment is reflected on the Consolidated Statement of Cash Flows as acomponent of “Cash paid for acquisitions, net of cash acquired” for the yearended December 31, 2002.

The deferred tax assetprimarily related to future utilization of net operating loss carryforwards.Chiron acquired federal and state net operating loss carryforwards and businesscredits attributed to Matrix Pharmaceutical of approximately$290.6 million and $9.5 million, respectively. The utilization ofsuch net operating loss and business tax credit carryforwards is limited in anyone year under provisions of the Internal Revenue Code. As such, a significantportion of Matrix Pharmaceutical’s net operating loss carryforwards is expectedto expire unutilized.

**Note 6—Restructuringand Reorganization**

For the year ended December 31, 2004, Chironrecorded net restructuring and reorganization charges of $2.5 million. Thecharges, included in “Selling, general and administrative” and “Research anddevelopment” in the consolidated statement of operations, consisted oftermination and other employee-related costs recognized in connection with thereorganization of our Seattle facility and the closure of our Basel,Switzerland research facilities and Amsterdam manufacturing facilities. Terminationnotices have been provided for all the facilities. Of the 27 positions forelimination at the Seattle and Basel, Switzerland facilities, 27 wereterminated at December 31, 2004. Of the 15 positions for elimination atthe Amsterdam facility, 7 were terminated as of December 31, 2004.

As of December 31,2004, $1.1 million was included in “Other current liabilities” in theConsolidated Balance Sheet. As of December 31, 2003, $0.6 million wasincluded in “Other current liabilities” in the Consolidated Balance Sheet.

**Note 7—RocheSettlement**

In October 2000, Chiron entered into threelicense agreements with F. Hoffman-La Roche Limited  (“Roche”) and several of its affiliatedcompanies related to the settlement of certain litigation in the U.S. andcertain other countries for use of Chiron’s hepatitis C virus and HIV nucleicacid testing intellectual property. Two agreements relate to *in vitro* diagnostics products. The thirdagreement relates to blood screening, which was superseded in May 2001 bytwo new agreements, one for hepatitis C virus and one for HIV.

An HIV-related patent directed to nucleic acid testingmethods for HIV-1 was issued in the U.S. on March 13, 2003. This patentwill expire seventeen years from the date of issuance. The issuance of thepatent triggered a milestone payment to Chiron of $10.0 million fromRoche, which was received in April 2003. As permitted under the terms ofits licensing agreement, Roche decided to institute arbitration proceedings inregard to the application of the U.S. patent. Chiron had deferred recognitionof the

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**CHIRON CORPORATION  NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) DECEMBER 31, 2004**

**Note7—Roche Settlement (Continued)**

$10.0 millionmilestone payment, interest, royalties received and royalties accrued under thepatent until the resolution of this dispute. On September 10, 2004, Chironreached a settlement agreement with Roche. Under the terms of the settlementagreement, the milestone payment along with any royalties received prior to March 31,2004 became non-refundable. Accordingly in 2004, Chiron has recognized$10.0 million in license fees and $21.8 million in royalties up untilJune 30, 2004, which had previously been deferred, of which$16.3 million has been recognized as revenue in Chiron’s other segment and$5.5 million has been recognized as revenue in Chiron’s blood testingsegment. Chiron also recognized $0.8 million in interest on the licensefee. Also under the settlement agreement, in the first quarter of 2005, Chironis entitled to receive a lump-sum payment of $78.0 million in lieu ofroyalties beyond January 1, 2005. Roche may elect under the terms of theagreement to obtain a partial refund and revert to paying royalties on thesales of its products in North America. The amount of such potential refundranges between $64.0 million and $0.0 million. The refund availabledecreases in increments over the quarters of 2005 and 2006. As such, Chironexpects to recognize $64.0 million of the payment as revenue over 2005 and2006. The remaining $14.0 million is nonrefundable and was recognized asrevenue for the three months ended September 30, 2004, of which$9.3 million has been recognized as revenue in Chiron’s other segment and$4.7 million has been recognized as revenue in Chiron’s blood testingsegment. Revenues earned from diagnostic products are included in Chiron’sother segment and revenues earned from blood screening are included in Chiron’sblood-testing segment.

Theimpact on revenues in 2004 from these items from the September 10, 2004settlement with Roche is summarized below (in thousands).
| ** **                                  | ** ** | **Other  Segment** | ** ** | **Blood-testing  Segment** | ** ** | **Total** | ** ** |
|---------------------------------------------|------------|--------------------|------------|----------------------------|------------|-----------|------------|
| Deferred revenues  recognized               |       | $                  | 16,313     |                       |       | $         | 5,453      |   |   | $ | 21,766 |   |
| Deferred license  fee recognized            |       | 10,000             |       |                       | —     |      |       | 10,000 |   |
| Non-refundable  portion of Roche settlement |       | 9,333              |       |                       | 4,667      |      |       | 14,000 |   |
| Total royalty and  license fee revenue      |       | $                  | 35,646     |                       |       | $         | 10,120     |   |   | $ | 45,766 |   |

 

F-34

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**CHIRON CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) DECEMBER 31, 2004**

**Note 8—IntangibleAssets**

Intangibleassets subject to amortization consisted of the following (in thousands):
| ** **                                             | ** ** | **December 31, 2004** | ** ** | **December 31, 2003** | ** ** |
|--------------------------------------------------------|------------|---------------------------------|------------|---------------------------------|------------|
| ** **                                             | ** ** | **Gross  Carrying  Value**      | ** ** | **Accumulated  Amortization**   | ** ** | **Net Carrying  Value** | ** ** | **Gross  Carrying  Value** | ** ** | **Accumulated  Amortization** | ** ** | **Net Carrying  Value** | ** ** |
| Purchased  technologies                                |       | $                               | 333,085    |                            |       | $ | 117,048 |   |   |   | $ | 216,037 |   |   | $ | 332,543 |   |   | $ | 95,836 |   |   |   | $ | 236,707 |   |   |
| Patents                                                |       | $                               | 132,385    |                            |       | $ | 71,616 |   |   |   | $ | 60,769 |   |   | $ | 119,675 |   |   | $ | 61,747 |   |   |   | $ | 57,928 |   |   |
| Trademarks                                             |       | 65,609                          |       |                            | 25,450     |   |   |   | 40,159 |   |   | 61,082 |   |   | 20,507 |   |   |   | 40,575 |   |   |
| Licenses and  technology rights                        |       | 47,745                          |       |                            | 34,079     |   |   |   | 13,666 |   |   | 49,087 |   |   | 27,818 |   |   |   | 21,269 |   |   |
| Developed product  technologies                        |       | 374,025                         |       |                            | 77,253     |   |   |   | 296,772 |   |   | 347,233 |   |   | 23,093 |   |   |   | 324,140 |   |   |
| Customer  relationships                                |       | 31,234                          |       |                            | 12,421     |   |   |   | 18,813 |   |   | 28,824 |   |   | 9,952 |   |   |   | 18,872 |   |   |
| Know how(1)                                            |       | 14,185                          |       |                            | 7,548      |   |   |   | 6,637 |   |   | 13,090 |   |   | 6,023 |   |   |   | 7,067 |   |   |
| Databases                                              |       | 7,100                           |       |                            | 2,012      |   |   |   | 5,088 |   |   | 7,100 |   |   | 1,538 |   |   |   | 5,562 |   |   |
| Other(2)                                               |       | 34,893                          |       |                            | 19,090     |   |   |   | 15,803 |   |   | 26,328 |   |   | 14,852 |   |   |   | 11,476 |   |   |
| Total other intangible assets                          |       | $                               | 707,176    |                            |       | $ | 249,469 |   |   |   | $ | 457,707 |   |   | $ | 652,419 |   |   | $ | 165,530 |   |   |   | $ | 486,889 |   |   |
| Total intangible assets  subject to amortization  |       | $                               | 1,040,261  |                            |       | $ | 366,517 |   |   |   | $ | 673,744 |   |   | $ | 984,962 |   |   | $ | 261,366 |   |   |   | $ | 723,596 |   |   |

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(1)          Upon acquisition of a100% interest in Chiron Behring by the second quarter 1998, Chiron acquired aportfolio of products that were created by Behring and are currently being soldinternationally. These products embody Chiron Behring’s proprietary “know-how”consisting of unpatented technology and trade secrets. Since the unpatentedtechnology and trade secrets meet the separability criterion, Chiron hasrecognized them collectively as a separate intangible asset apart from goodwillin accordance with SFAS No. 141, Business Combinations. 

(2)          Bond issuance costs witha gross carrying value of $29.4 million and accumulated amortization of $13.8million were included in “Other” at December 31, 2004. Bond issuance costswith a gross carrying value of $20.9 million and accumulated amortization of$9.4 million were included in “Other” at December 31, 2003.

Aggregateamortization expense is as follows (in thousands):
| For the year  ended December 31, 2004 (reported)  |   | $ | 98,180  |   |
|--------------------------------------------------------|--------|---|---------|--------|
| For the year  ended December 31, 2005 (estimated) |   | $ | 103,378 |   |
| For the year  ended December 31, 2006 (estimated) |   | $ | 108,086 |   |
| For the year  ended December 31, 2007 (estimated) |   | $ | 105,822 |   |
| For the year  ended December 31, 2008 (estimated) |   | $ | 79,798  |   |
| For the year ended  December 31, 2009 (estimated) |   | $ | 54,714  |   |

 

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**CHIRON CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) DECEMBER 31, 2004**

**Note8—Intangible Assets (Continued)**

The changes in thecarrying value of goodwill by reporting unit consisted of the following (inthousands):
| ** **                                   | ** ** | **Biopharmaceuticals** | ** ** | **Vaccines** | ** ** | **Total** | ** ** |
|----------------------------------------------|------------|------------------------|------------|--------------|------------|-----------|------------|
| Balance as of  December 31, 2002        |       |                   | $          | 199,225      |       |      | $          | 40,521 |   | $ | 239,746 |   |
| PowderJect Goodwill acquired (Note 5)   |       |                   | —     |         |       | 502,961   |       | 502,961 |   |
| Reversal of contingent payment (Note 5) |       |                   | (200       | )            |       | —    |       | (200 | ) |
| Effect of exchange rate changes              |       |                   | —     |         |       | 56,613    |       | 56,613 |   |
| Realization of tax benefits(3)               |       |                   | (11,533    | )            |       | —    |       | (11,533 | ) |
| Balance as of  December 31, 2003        |       |                   | 187,492    |         |       | 600,095   |       | 787,587 |   |
| PowderJect Adjustment (Note 5)               |       |                   | —     |         |       | 17,929    |       | 17,929 |   |
| Effect of exchange rate changes              |       |                   | —     |         |       | 51,184    |       | 51,184 |   |
| Realization of tax benefits(3)               |       |                   | 4,694      |         |       | —    |       | 4,694 |   |
| Balance as of  December 31, 2004        |       |                   | $          | 192,186      |       |      | $          | 669,208 |   | $ | 861,394 |   |

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(3)          SFAS No. 109, *Accounting for Income Taxes,* requires that the realizationof acquired tax benefits subject to valuation allowance be applied to goodwill.

Chiron performed itsannual impairment test for goodwill in the third quarter 2004, as of July 1,2004. Subsequent to the third quarter 2004, given the developments with respectto FLUVIRIN vaccine discussed in “Note 14—Commitments and Contingencies,”Chiron considered the impact of the FLUVIRIN vaccine developments on goodwill.Chiron performed an interim impairment test for vaccines goodwill as of December 31,2004 given those developments. Based on either the annual or interim analysis,Chiron has no indication of an impairment loss. Chiron will continue to monitorgoodwill for any impairment associated with future developments related to theFLUVIRIN vaccine matters.

**Note 9—Research andDevelopment Arrangements**

Chiron participates in a number of research anddevelopment arrangements with other pharmaceutical and biotechnology companiesto research, develop and market certain technologies and products. Chiron andits collaborative partners generally contribute certain technologies andresearch efforts and commit, subject to certain limitations and cancellationclauses, to share costs related to certain research and development activities,including those related to clinical trials. At December 31, 2004,aggregate noncancelable funding commitments for 2005 under collaborativearrangements are $37.2 million. There are no noncancelable fundingcommitments under collaborative arrangements thereafter. Chiron may also berequired to make payments to certain collaborative partners upon theachievement of specified milestones. At December 31, 2004, aggregatemilestone payments that may become due under these noncancelable collaborativearrangements totaled $5.4 million. These milestone payments are due upon theachievement of various technical milestones, completion of trials andregulatory filings. From the inception of these contracts up until December 31,2004, total costs incurred under these collaborative arrangements totaled $25.3 million.

In addition to these collaboration arrangements,Chiron has entered into contracts where Chiron is responsible for all the costsrelated to research and development activities. At December 31, 2004, 

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**CHIRON CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) DECEMBER 31, 2004**

**Note9—Research and Development Arrangements (Continued)**

aggregate annualnoncancelable commitments under these contracts are as follows:2005—$3.7 million and 2006—$3.1 million. At December 31, 2004aggregate milestone payments that may become due under these noncancelablearrangements totaled $22.1 million. These milestone payments are due uponthe achievement of various technical milestones, completion of trials andregulatory filings. From inception of these contracts up until December 31,2004, total costs incurred under these contracts totaled $23.9 million.

In March 2004, Chiron entered into a worldwide,exclusive, multi-product, collaborative arrangement with XOMA Ltd. for thedevelopment and commercialization of antibody products for the treatment ofcancer. Under the terms of the arrangement, the parties agreed to jointlyresearch, develop, and commercialize multiple antibody product candidates.Under the arrangement, the parties agreed to share development andcommercialization expenses, including preclinical and clinical development,manufacturing and worldwide marketing costs, as well as revenues, generally ona 70-30 basis, with Chiron’s share being 70% and XOMA’s share being 30%. Chironagreed to make an initial payment of $10.0 million, which has been paid asof December 31, 2004, and to make a loan facility of up to$50.0 million available to XOMA, starting on January 1, 2005 to fund75% of XOMA’s share of development expenses.

In October 2003, Chiron entered into a licenseagreement with Cubist Pharmaceuticals, Inc. for the development andcommercialization of Cubist’s antibiotic daptomycin for injection in Westernand Eastern Europe, Australia, New Zealand, India and certain Central American,South American and Middle Eastern countries. In exchange for these developmentand commercialization rights, Chiron agreed to pay Cubist up to$50.0 million. This $50.0 million includes $18.0 million, whichwas paid by Chiron in the fourth quarter 2003, $10.0 million of which wasused to purchase restricted Cubist common stock at a 50 percent premiumover market price, and up to $32.0 million of additional payments toCubist upon the achievement of certain regulatory and sales milestones. Chironwill also pay Cubist a tiered royalty on daptomycin for injection made byChiron. Chiron recorded $10.6 million of the up front payment related tothe purchase of in-process research and development with no alternate futureuse as research and development expenses in 2003 and $6.7 million and $0.7million of the up front payment as an equity investment and prepaid researchand development, respectively, in the Consolidated Balance Sheet at December 31,2003. The equity investment was recorded at fair value. This agreement iscancelable by Chiron at any time with twelve months written notice. As of December 31,2004, Chiron has not paid any amount in regard to milestones or royalties. In2004, Chiron adjusted the previously recorded equity investment for an “otherthan temporary” write-down of $1.4 million. As a result of the write-down, theequity investment was recorded at $5.3 million as of December 31, 2004.

In June 2000, Chiron invested in aSingapore-based venture, S*BIO Pte Ltd, to research and developtherapeutic, diagnostic, vaccine and antibody products. Chiron also grantedS*BIO certain rights to its gene expression and combinatorial chemistrytechnology. Under this arrangement, Chiron received approximately$23.7 million over three years for technology transfer and researchservices. Chiron recognized collaborative agreement revenues of$8.8 million in 2002 under this arrangement. Since inception, Chiron hasinvested $8.0 million for a 19.9% ownership interest, which was written offentirely 

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**CHIRON CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) DECEMBER 31, 2004**

**Note9—Research and Development Arrangements (Continued)**

due to the early stage ofS*BIO’s research and development activities. Chiron accounts for the investmenton the cost method. The technology transfer period ended in the third quarter2002.

On November 1, 1999, Chiron entered into a patentand license agreement with Scios, Inc. Under this agreement, Chironadvanced $7.5 million in return for a promissory note, which was recordedas “Non-current notes receivable” in the Consolidated Balance Sheets at both December 31,2004 and 2003. The note, which bears interest at the prime rate (5.25% at December 31,2004 and 4.0% at December 31, 2003), is due with accrued interest on December 31,2006 and will be forgiven (principal and accrued interest) if the U.S. Food andDrug Administration approves any product covered by the patent and licenseagreement for marketing in the U.S. prior to December 31, 2006. Chiron maypay additional milestone payments if certain development objectives are met. Inaddition, Chiron may pay royalties of 4% on future net product sales of theproduct under the patent and license agreement.

On December 28, 2000, Chiron received a$3.5 million promissory note in consideration for a payment under abiopharmaceutical license agreement with SkyePharma plc. The note bore interestat the London interbank offered rate plus 3.0% (4.4% at December 31,2002). The interest was due quarterly, and the principal was payable in threeequal installments. The first payment of $1.2 million was received in 2001and the final two payments were received in 2002. In November 2002, Chironsigned an agreement with SkyePharma to terminate their collaboration andmanufacturing agreements. As a result of the termination, Chiron granted backto SkyPharma plc the rights licensed by Chiron under the collaborationagreement for $3.0 million. Chiron included this amount as a component of “Otherrevenues” in the Consolidated Statements of Operations in 2002. Chiron recordeda $1.0 million promissory note in connection with this transaction whichwas presented in “Current portion of notes receivable” at December 31,2003 in the Consolidated Balance Sheet and was paid in 2004.

Occasionally, Chironinvests in equity securities of its corporate partners. The price of these securitiesis subject to significant volatility. Chiron performs periodic reviews fortemporary or other-than-temporary impairment of its securities and recordsadjustments to the carrying values of those securities accordingly. In 2004,Chiron recognized losses attributable to the other-than-temporary impairment ofcertain of these equity securities of $1.4 million, as discussed above.There was no such loss in 2003. In 2002, Chiron recognized losses attributableto the other-than-temporary impairment of certain of these equity securities of$7.5 million.

**Note 10—Related PartyTransactions**

*Relationship withNovartis AG*

Chiron has an alliance with Novartis, a global lifesciences company headquartered in Basel, Switzerland. Through a series oftransactions that became effective in January 1995, Novartis acquiredshares of Chiron’s common stock, which, when combined with shares already heldby Novartis, represented 49.9% of the then-outstanding common stock of Chiron.Chiron, in turn, acquired from Novartis all of the capital stock of ChironDiagnostics Corporation (formerly Ciba Corning Diagnostics Corp.) and Chiron 

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**CHIRON CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) DECEMBER 31, 2004**

**Note10—Related Party Transactions (Continued)**

Vaccines Company andChiron S.p.A. (formerly The Biocine Company and Biocine S.p.A.). As a result ofdilution stemming primarily from the issuance of common stock under Chiron’semployee stock option and stock purchase plans, and in connection with certainacquisitions, as of December 31, 2004, Novartis held approximately 42.4%of Chiron’s outstanding common stock.

Chiron’s relationship withNovartis includes a series of arrangements which affect Chiron’s corporategovernance, investment policies, research, development, manufacturing andmarketing. Chiron and Novartis continue to work together on an arm’s-lengthbasis while remaining independent to pursue their respective corporatestrategies. In connection with those transactions, Chiron and Novartis enteredinto certain agreements which are described below.

*The GovernanceAgreement*

*Standstill.  *Underthe Governance Agreement, Novartis has agreed not to increase its ownershipinterest in Chiron above 55% unless:

(i)            a majority of theindependent directors, as defined in the Governance Agreement, of Chiron’sBoard approve acquisition of additional equity securities, in which caseNovartis may increase its ownership interest up to 79.9%;

(ii)        the increase in Novartis’ownership interest is the result of an action by Chiron (such as there-purchase of outstanding common stock or the sale of common stock to Novartisor its affiliates); or

(iii)    the acquisition is part of a “buy-outtransaction”, in which Novartis acquires all of Chiron’s outstanding capitalstock in accordance with certain procedures described in the GovernanceAgreement.

Pursuant to the Governance Agreement, Novartis has theright, but not the obligation, to propose a buy-out transaction. Except asprovided below, neither Novartis nor Chiron have any “put” or “call” optionsthat would obligate either party to enter into a buy-out transaction. IfNovartis proposes a buy-out transaction, it must offer to buy all of Chiron’soutstanding equity securities at a price based upon a “third party sale value”(i.e., the value that an unaffiliated third party would be expected to pay topurchase all of Chiron’s equity securities in an arm’s-length transactionnegotiated by a willing seller and a willing buyer).

If Novartis proposes a buy-out transaction, theindependent directors, acting solely on behalf of Chiron’s stockholders otherthan Novartis, would consider the proposal, and with approval of a majority ofindependent directors, may accept it subject to stockholder approval. If theindependent directors do not accept the proposal, Novartis may request binding arbitrationto determine the third party sale value. The independent directors may delaythe arbitration for a period of up to one year under certain circumstances. Upondetermination of the third party sale value by arbitration, Novartis may eitherproceed with the proposed buy-out transaction at the third party sale valuedetermined by arbitration or withdraw its proposed buy-out transaction inaccordance with terms set forth in the Governance Agreement. If Novartiswithdraws its proposed buy-out transaction following the determination of thirdparty sale value by arbitration, Novartis cannot withdraw any subsequentproposal that results in a second arbitration to determine the third party salevalue of Chiron.

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**CHIRON CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) DECEMBER 31, 2004**

**Note10—Related Party Transactions (Continued)**

*Proxy Solicitations and VotingTrusts.  *The Governance Agreement further provides thatunless and until Novartis and its affiliates own all of Chiron’s capital stock,they will not solicit proxies or initiate or encourage shareholders to initiateproposals, nor will they encourage any persons with respect to the voting ofequity securities of Chiron or enter into any voting trust or similararrangement to vote any of Chiron’s equity securities.

*Anti-dilution Provisions.  *Underthe Governance Agreement, if Chiron’s Board of Directors authorizes theissuance of any equity securities and convertible debt, Novartis, with certainexceptions, has the right to purchase a portion of the securities sufficient topreserve its ownership interest in Chiron. If Novartis elects to do so,Novartis must purchase the securities at the same time and on the same termsand conditions as the new securities are issued and sold to third parties. Ifthe securities are issued for consideration other than cash, Novartis isrequired to pay the fair market value of the securities (as determined inaccordance with the Governance Agreement).

*Certain Corporate Transactions.  *TheGovernance Agreement provides that as long as Novartis owns at least 40% ofChiron’s outstanding voting stock, Chiron may not engage in certain corporate transactionswithout Novartis’ approval. These transactions generally include significantdebt or equity issuances, debt or equity repurchases, most mergers andacquisitions, the payment of cash dividends, amendments to Chiron’s RestatedCertificate of Incorporation or Bylaws, and other transactions that mightadversely impact the rights of Novartis, or discriminate against Novartis, as aChiron stockholder. In addition, a majority of the directors of Chiron’s Boardwho have been designated by Novartis must approve certain other corporatetransactions as described in the Governance Agreement.

*Transactions Between Chiron andNovartis.  *In addition, under the Governance Agreement,a majority of the independent directors or holders of a majority of Chiron’svoting stock which is held by unaffiliated stockholders, must approve anycontract, agreement or transaction with Novartis in which the amount involvedexceeds $60,000.

*Nomination of Directors and Votingof Shares.  *Under the Governance Agreement, theNominating and Corporate Governance Committee of Chiron’s Board is responsible,among other things, for recommending the nomination of directors. TheNominating and Corporate Governance Committee must nominate three “managementdirectors” who are employees of Chiron or any other director designated as suchby the committee and three directors who have been designated for nomination byNovartis (known as “investor directors” pursuant to the Governance Agreement). Theremaining directors are to be individuals who have not been an officer oremployee of Chiron, any affiliate or associate of Chiron, or of an entity thatderived five percent or more of its revenues or earnings in its most recentfiscal year from transactions involving Chiron, any affiliate or associate ofChiron, or who have not been affiliated, compensated by or consulted for orcontracted with Chiron, Novartis or any of their respective affiliates (knownas “independent directors” pursuant to the Governance Agreement). The number ofdirectors whom Novartis may designate declines if Novartis’ ownership interestin Chiron declines to less than 30%. The Bylaws currently fix the number ofdirectors at ten.

The Governance Agreement further provides that as longas Novartis continues to own at least 40% of Chiron’s outstanding capitalstock, the Nominating and Corporate Governance Committee will be comprised ofthree independent directors and two investor directors; and if Novartis’percentage interest 

F-40

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**CHIRON CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) DECEMBER 31, 2004**

**Note10—Related Party Transactions (Continued)**

of Chiron’s outstandingcapital stock is less than 40%, the committee will be comprised of threeindependent directors and one investor director. A majority of the independentdirectors designate the independent directors who serve on the Nominating andCorporate Governance Committee, and a majority of the investor directorsdesignate the investor directors who serve on the committee. A quorum of theNominating and Corporate Governance Committee required for any action requiresthe attendance of at least two independent directors and both investor directormembers. The Nominating and Corporate Governance Committee acts by majorityvote of the entire committee; provided, however, that as long as Novartis’percentage interest is at least 40%, no action to nominate a director may betaken by the committee that is opposed by both of the investor directors. Beginningin the year 2006, as long as Novartis owns at least 49% of Chiron’s outstandingcapital stock, the investor directors of the committee will have the decidingvote with respect to nomination of any directors, meaning the vote of the twoinvestor directors will control over the vote of the independent directors.

*MeasurementStandards.  *The Governance Agreement further providesthat the Board will set and approve Measurement Standards to evaluate Chiron’sperformance for each fiscal year. If the applicable Measurement Standards arenot met for any fiscal year, the Governance Agreement provides that a committeecomprised of the three investor directors, three independent directors and onemanagement director, called the Strategic Planning Committee, will be created. Thepurpose of the committee will be to prepare and recommend to the Board aremedial plan intended to restore Chiron to compliance with the MeasurementStandards. In addition, until the Measurement Standards are met for asubsequent full fiscal year, a majority of the Board, which majority mustinclude a majority of all the investor directors and a majority of all theindependent directors, is required to approve any such remedial plan and theChiron operating plan and budget, and to set executive officer compensation. IfChiron does not meet the Measurement Standards for two consecutive fiscalyears, (i) the Strategic Planning Committee is empowered by the Board(until the applicable Measurement Standards are met for a full fiscal year) toset the compensation and terminate the employment of Chiron’s executiveofficers and (ii) a majority of the Board, which majority must include amajority of all the investor directors and a majority of all the independentdirectors, is required to approve certain additional matters, including thehiring of new executive officers, the issuance of new equity securities, theincurrence of indebtedness other than in the ordinary course and the initiationof material acquisitions. Until 2004, Chiron had met the applicable MeasurementStandards each year since 1995. Chiron did not meet the 2004 MeasurementStandards as a result of the suspension in 2004 of Chiron’s license tomanufacture FLUVIRIN vaccine and Chiron’s failure to release any FLUVIRINvaccine for the 2004-2005 influenza season. While the Board has taken stepsconsistent with the role of the Strategic Planning Committee, directing thepreparation of and approving a remedial plan to bring Chiron back to compliancewith applicable Measurement Standards, the Board has not established aStrategic Planning Committee at this time.

*The InvestmentAgreement*

*Bank Debt Guarantee.  *Underthe terms of the Investment Agreement, Novartis agreed to guarantee certainChiron obligations under revolving credit facilities through January 1,2008, the date on which the guarantee will expire. The principal amount ofindebtedness under the guaranteed credit facilities outstanding at any one timemay not exceed a specified cap. That cap is $402.5 million. The cap may be 

F-41

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**CHIRON CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) DECEMBER 31, 2004**

**Note10—Related Party Transactions (Continued)**

increased or decreased incertain circumstances that are described in the Investment Agreement, asamended. In November 1996, Chiron and Novartis agreed that Chiron couldincrease the maximum borrowing amount under the guaranteed credit facilities byup to $300.0 million, for a maximum borrowing amount under the cap of $702.5million. In exchange for this increase, the amount of Chiron’s common stockrequired to be purchased by a Novartis affiliate, at Chiron’s request, asdescribed below under “Subscription Agreement”, would be reduced by an equalamount. Chiron also agreed to enter into a separate agreement with Novartis foreach obligation guaranteed by Novartis under which Chiron agrees to reimburseNovartis for any payments made or out-of-pocket expenses incurred by Novartisin connection with the guarantee (each, a “Reimbursement Agreement”). Chiron’sobligations under the Reimbursement Agreements are, at the request of Novartis,to be fully collateralized by collateral (which means guaranteed by assetspledged by Chiron) acceptable to Novartis. In 2004 Novartis guaranteed $100.0million under a U.S. credit facility for Chiron’s benefit for which there wereno borrowings outstanding at December 31, 2004 (see Note 13) and $173.3million of Chiron’s lease commitments (See Note 14). The remaining maximumborrowing amount under the cap was $429.2 million at December 31, 2004.

Also under the terms of the Investment Agreement,Chiron granted to individuals who on November 20, 1994 held options underChiron’s stock option plan the right to receive cash payments from Novartisupon surrender for cancellation of such options. The right to receive thepayment vests as the underlying options vest. Once vested, the right isexercisable at any time the option is outstanding. For options that vestedafter 1995, the optionee must surrender the underlying options to receive thepayment. In 2004, 2003 and 2002, Novartis made no payments to eligible optionholders in connection with the surrender for cancellation of such options.

*The Limited Liability Company Agreement(also known as the “R &D Funding Agreement”).  *TheInvestment Agreement also provided that Novartis would make certain researchfunding available to Chiron. Novartis’ commitment was memorialized in theLimited Liability Company Agreement entered into between Chiron and NovartisCorporation, a U.S. subsidiary of Novartis AG, in December 1995, or the “R &DFunding Agreement”. The R&D Funding Agreement provided that Novartis wouldpurchase interests in a limited liability company as a means of providing thisfunding. In December 2000, this agreement was amended to provide that,through December 31, 2001, at Chiron’s request, Novartis would fund up to100% of the development costs incurred between January 1, 1995 and December 31,2000 on these projects. The amount of funding that Novartis was obligated toprovide was subject to an aggregate limit of $265.0 million. Novartis funded$265.0 million over the term of this agreement. Although Novartis’ agreement topurchase interests expired on December 31, 2001, there are certain royaltyand co-promotion rights that remain.

Under the R&D Funding Agreement, Novartis fundedcertain research and development projects (known as the “Funded Projects”). TheFunded Projects included certain adult and pediatric vaccines, Insulin-LikeGrowth Factor-1, Factor VIII gene therapy (“Factor VIII”) and Herpes SimplexVirus-thymidine kinase (“HSV-tk”). In exchange for providing the funding,Novartis has certain rights, as described below, in certain adult and pediatricvaccines, Insulin-Like Growth Factor-1, Factor VIII and HSV-tk known as the “Products”.

F-42

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**CHIRON CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) DECEMBER 31, 2004**

**Note10—Related Party Transactions (Continued)**

In consideration of the funding provided by Novartisunder the R&D Funding Agreement, Novartis Corporation receives royalties onworldwide sales from the Products, if any, which Chiron successfully develops. Novartisalso has co-promotional rights, in countries other than in North America andEurope, for certain adult vaccines. Under the R&D Funding Agreement, Chironis obligated to pay royalties on the designated Products for a minimum of tenyears from the later of October 1, 2001 or the date of the firstcommercial sale of individual Products covered by the amended R&D FundingAgreement. For the years ended December 31, 2004, 2003 and 2002, Chironrecorded royalties to Novartis of $0.6 million, $2.4 million and $2.3 million,respectively, which we recorded in “Cost of sales” in the ConsolidatedStatement of Operations.

*The Cooperation and CollaborationAgreement.  *Chiron also agreed to work with Novartis tocollaborate in research and development, marketing and manufacturing, and togive each party access to the other party’s technology and reciprocal “most-favorednation” rights for certain licenses. The agreement provides a means by whichChiron or Novartis may specifically propose to collaborate with the other partyin an area of research and development, yet retain a 90-day right of firstnegotiation with respect to that area. Neither Chiron nor Novartis has theright to enter into any material research and development collaboration relatedto Chiron’s strategic mission with any third party if it is anticipated thatthe third party’s only contribution to the collaboration will be funding,unless Chiron or Novartis has first offered to the other party an opportunityto collaborate on the same terms as offered by that third party. Therestrictions do not apply to collaborations that are not funded commercially,such as grants, or financing arrangements with third parties where the thirdparty receives a return on the financed amount. Also, under the Cooperation andCollaboration Agreement, Novartis and Chiron have: (i) a reciprocal rightof first refusal to market certain products developed by the other party orwhich the other party has the right to market, and (ii) a reciprocal rightof first negotiation to manufacture certain products developed by the otherparty or which the other party has the right to manufacture.

*Market Price Option Agreement.  *Underthis agreement, Chiron granted to an affiliate of Novartis an option topurchase newly issued shares of equity securities directly from Chiron at fairmarket value. Under the terms of this agreement, known as the Market PriceOption Agreement, Novartis has the right to purchase from Chiron shares ofnewly issued common stock, but not to exceed at any time an amount, which whenadded to other shares held directly or indirectly by Novartis, would increaseNovartis’ aggregate ownership above 55% of Chiron’s then outstanding commonstock. Novartis may exercise this option at any time. Novartis also mayexercise the option repeatedly, with a minimum purchase equal to $1.0 millioneach time. Novartis may not exercise the option if it owns shares representingless than 30% of the aggregate number of votes entitled to be voted at anelection of directors of Chiron. In addition, one of the following “exerciseconditions” must be satisfied: (i) Novartis is restricted by law frompurchasing equity securities from any person other than Chiron (including anyrestriction resulting from Novartis’ possession of non-public materialinformation concerning Chiron); (ii) there is insufficient liquidity inthe open market to permit Novartis to purchase the number of shares it desires,either within the time period it desires or without unduly affecting the priceof the shares; or (iii) Novartis’ ownership interest in Chiron at thattime is below 50% and it wishes (and is permitted under then applicablestandstill provisions of the Governance Agreement) to increase its ownershipinterest to above 50% (although if this is the only 

F-43

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**CHIRON CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) DECEMBER 31, 2004**

**Note10—Related Party Transactions (Continued)**

exercise condition that issatisfied, Novartis is not permitted to purchase shares that would increase itsownership interest above 51%).

*SubscriptionAgreement.  *Under a Subscription Agreement withNovartis, Chiron has the right to require Novartis to purchase common stockdirectly from Chiron at fair market value, up to a maximum subscription amount.Currently, the maximum subscription amount is $500.0 million. The subscriptionamount will be reduced in certain circumstances, as described in theSubscription Agreement, and is also subject to reduction by the amount of anyincrease if the amount Novartis is required to guarantee under the InvestmentAgreement is increased above $402.5 million. In November 1996, Chiron andNovartis agreed that Chiron could increase the maximum borrowing amount underthe guaranteed credit facilities by up to $300.0 million, as discussed under “BankDebt Guarantee” above. As a result, if the bank debt guarantee is increased by$300.0 million, the maximum subscription amount would be decreased to $200.0million. Novartis’ obligation to purchase the shares is subject to thesatisfaction of certain closing conditions described in the SubscriptionAgreement. The Subscription Agreement expires in January 2006. Novartishas not purchased any securities from Chiron pursuant to the Market PriceOption Agreement or the Subscription Agreement (including the 2.75% ConvertibleDebentures issued in June 2004, the 1.625% Convertible Debentures issuedin July 2003 and the Liquid Yield Option Notes issued in June 2001).

*The April 2003Agreement*

In April 2003, Chironacquired exclusive worldwide development and commercial rights from Novartisfor PULMINQ TM inhalation solution, a therapy under evaluation for treatment ofrejection and reduction of mortality in lung transplant recipients for$0.5 million, which was expensed as research and development costs in 2003.In 2004, Chiron submitted a new drug application to the FDA for marketingapproval of PULMINIQ.

*SynCo B.V.Agreements*

In December 1999, Chiron sold its Amsterdammanufacturing facility and related machinery and equipment assets to SynCoB.V., a company owned by a director of Chiron, for $15.0 million in cash.The sale of the Amsterdam manufacturing facility resulted in a gain of$1.2 million, of which $0.3 million was deferred as a result of theleaseback described below. Chiron amortized the unearned revenue as a reductionto rent expense over the lease term.

Chiron leased back office and warehouse space in theAmsterdam facility for some operational and administrative activities. Thelease was a noncancelable-operating lease, which expired at December 31,2004 and has not been extended. Annual rent and utilities was 1.1 million Euro($1.4 million), 1.2 million Euro ($1.3 million), and1.4 million Euro ($1.3 million) for the years ended December 31,2004, 2003 and 2002, respectively.

As of December 31, 1999, Chiron exercised itsoption to lease certain equipment under the same terms as the office andwarehouse lease. For the years ended December 31, 2003 and 2002, Chironincurred expenses of 0.04 million Euro ($0.04 million) and0.03 million Euro ($0.03 million), respectively. Also, at the optionof SynCo, Chiron may provide various administrative services to SynCo. As of 

F-44

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**CHIRON CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) DECEMBER 31, 2004**

**Note10—Related Party Transactions (Continued)**

December 31, 2004, nosuch administrative services were being provided. At the option of Chiron,SynCo may provide various manufacturing and quality control services to Chiron.In July 2001, Chiron and SynCo entered into another agreement, to includethe manufacture of certain vaccine products through January 1, 2004 uponChiron’s request. For the years ended December 31, 2003 and 2002, Chironincurred expenses of approximately $2.5 million and $0.9 million,respectively, which were included in “Cost of Sales” in the ConsolidatedStatements of Operations, related to such manufacture of certain vaccineproducts.

Effective June 2003, Chiron and SynCo B.V.executed a seven and a half-year contract manufacturing agreement. Under thisagreement, SynCo agreed to provide services related to the production ofcertain of Chiron’s vaccine products for the European and U.S. marketscommencing in 2004. Chiron has a firm binding order for products to bedelivered by SynCo in 2005 and 2006 under this agreement. Chiron’s minimumpurchase obligation under this agreement, which depends on the quantitiespurchased by Chiron in years 2007 through 2010, inflation and movement in theEuro to U.S. Dollar exchange rate, is expected to be approximately$33.7 million over the remaining term of the agreement. For the year endedDecember 31, 2004, Chiron incurred expenses of approximately$1.3 million, which was included in “Cost of Sales” in the ConsolidatedStatements of Operations, related to such manufacture of certain vaccineproducts.

Simultaneously in June 2003,Chiron and SynCo B.V. executed an FDA compliance agreement. Under thisagreement, Chiron will fund certain costs required to bring SynCo’s Amsterdammanufacturing facility into compliance to support approval by the U.S. Food andDrug Administration to manufacture certain vaccine products for the U.S.market. Chiron’s funding commitment under this agreement is expected to beapproximately $10.9 million through the first quarter 2005, of whichChiron had paid 4.7 million Euro ($5.5 million) for the year ended December 31,2003 and 2.5 million Euro ($3.3 million) for the year ended December 31,2004, respectively, which are recorded in “Research and development” in theConsolidated Statements of Operations.

*ZymeQuestAgreements*

In December 2003,Chiron entered into an agreement with ZymeQuest, Inc. to develop andcommercialize ZymeQuest’s enzymatic conversion system, which converts groups A,B and AB red blood cells to enzyme-converted group O red blood cells. Inaddition, Chiron paid $7.5 million for an equity investment in ZymeQuestand acquired 13.92% of ZymeQuest’s outstanding shares. The excess over Chiron’sshare of ZymeQuest’s net tangible assets was $6.5 million, which wasrecorded as “Research and development” in the Consolidated Statements ofOperations for the year ended December 31, 2003. At December 31, 2004and 2003, our equity investment in ZymeQuest was $0.5 million and $1.0 million,respectively and is included in “Equity method investments,” in theConsolidated Balance Sheets. Chiron has development funding commitments withZymeQuest of $10.0 million, which has been included under noncancelable fundingcommitments under collaborative agreements in “Note 9—Research and DevelopmentArrangements.”

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**CHIRON CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) DECEMBER 31, 2004**

**Note 11—JointBusiness Arrangement**

“Revenues from joint business arrangement” representsChiron’s one-half share in the pretax operating earnings generated by the jointbusiness contractual arrangement with Ortho Clinical Diagnostics. Thearrangement was established in 1989, based largely on the screening, usingimmunodiagnostic technology, of blood in blood banks and other similar settingsfor the presence of HIV and hepatitis viruses. Through this arrangement,Ortho-Clinical Diagnostics sells a full line of tests required to screen forhepatitis viruses and retroviruses and provides supplemental tests andmicroplate-based instrument systems to automate test performance and datacollection. In addition, Chiron and Ortho-Clinical Diagnostics jointly hold theimmunodiagnostic rights to Chiron’s hepatitis and retrovirus technology andreceive royalties from the sales of hepatitis C virus and HIV tests bylicensees.

Chiron manufactures viral antigens and supplementalhepatitis tests and sells these tests to Ortho-Clinical Diagnostics, whileOrtho-Clinical Diagnostics manufactures and sells assays and instrumentsystems. The revenue from the sale of these antigens and tests, from Chiron to Ortho-ClinicalDiagnostics, are recorded in product sales, with the corresponding costsrecorded in cost of sales. Reimbursements from Ortho-Clinical Diagnostics forresearch costs incurred by Chiron and the related research expenses are separatelyrecorded. In addition to these product revenues and reimbursements, Chironshares in the defined pre-tax operating earnings of the Ortho-ClinicalDiagnostics joint business activity at a pre-determined percentage (50%), asdefined in the agreement, rather than from an ownership interest in an entity.Chiron receives contractually defined profit sharing payments fromOrtho-Clinical Diagnostics on a quarterly basis.

Chiron records its share of earnings from the jointbusiness contractual arrangement on a one-month lag using estimates provided byOrtho-Clinical Diagnostics. Profit sharing distributions are payable to Chironwithin 90 days after the end of each quarter. At December 31, 2004and 2003, $41.3 million and $34.5 million, respectively, were due fromOrtho Clinical Diagnostics for profit sharing and reimbursement of costs. In2004, 2003 and 2002, Chiron’s 50% share of the earnings from the joint businesscontractual arrangement, which was recorded in “Revenues from joint businessarrangement,” was $118.2 million, $108.3 million and $104.6 million,respectively. Revenues recognized under the cost reimbursement portion of thearrangement in 2004, 2003 and 2002 were $27.8 million, $28.4 millionand $22.7 million, respectively, for product sales and $8.0 million,$9.0 million and $9.4 million, respectively, for collaborativeresearch. The cost of sales associated with the product sales recognizedrelated to this arrangement in 2004, 2003 and 2002 were $28.5 million,$29.0 million and $22.7 million, respectively. Research anddevelopment costs incurred for collaborative research related to thisarrangement in 2004, 2003 and 2002 were $8.3 million, $10.0 millionand $10.7 million, respectively.

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**CHIRON CORPORATION  NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) DECEMBER 31, 2004**

**Note 12—Fair Value ofFinancial Instruments**

*MarketableSecurities*

Available-for-salesecurities consisted of the following at December 31:
| ** **           | ** ** | **2004**                | ** ** | **2003**                | ** ** |
|----------------------|------------|-------------------------|------------|-------------------------|------------|
| ** **           | ** ** | **Adjusted  Cost**      | ** ** | **Unrealized  Gains**   | ** ** | **Unrealized  Losses** | ** ** | **Fair  Value** | ** ** | **Adjusted  Cost** | ** ** | **Unrealized  Gains** | ** ** | **Unrealized  Losses** | ** ** | **Fair  Value** | ** ** |
| ** **           | ** ** | **(In thousands)** | ** ** | **(In thousands)** | ** ** |
| U.S. Government      |       | $                       | 163,855    |                    |       | $ | — |   |   |   | $ | (634 | ) |   | $ | 163,221 |   | $ | 147,477 |   |   | $ | 269 |   |   |   | $ | (2 | ) |   | $ | 147,744 |   |
| State Debt           |       | 125,848                 |       |                    | 22         |   |   |   | (277 | ) |   | 125,593 |   | — |   |   | — |   |   |   | — |   |   | — |   |
| Corporate Debt  |       | 486,806                 |       |                    | 144        |   |   |   | (1,263 | ) |   | 485,687 |   | 575,913 |   |   | 615 |   |   |   | (345 | ) |   | 576,183 |   |
| Other                |       | 29,032                  |       |                    | —     |   |   |   | — |   |   | 29,032 |   | 10,577 |   |   | — |   |   |   | — |   |   | 10,577 |   |
|                 |       | 805,541                 |       |                    | 166        |   |   |   | (2,174 | ) |   | 803,533 |   | 733,967 |   |   | 884 |   |   |   | (347 | ) |   | 734,504 |   |
| Equity               |       | 25,879                  |       |                    | 45,743     |   |   |   | (100 | ) |   | 71,522 |   | 29,568 |   |   | 66,908 |   |   |   | (202 | ) |   | 96,274 |   |
|                 |       | $                       | 831,420    |                    |       | $ | 45,909 |   |   |   | $ | (2,274 | ) |   | $ | 875,055 |   | $ | 763,535 |   |   | $ | 67,792 |   |   |   | $ | (549 | ) |   | $ | 830,778 |   |

 

Related to equity securities, Chiron selectivelyenters into forward sales contracts, which are designated as fair value hedges.At the inception of the hedge, the difference between the cost and the fairvalue of the equity security remains in comprehensive income. Unrealized gainsrecorded in other comprehensive income relating to equity securities prior topurchase of equity forward contracts were $30.6 million and $51.6 million at December 31,2004 and 2003, respectively. For hedged securities, subsequent offsettingchanges in the fair value of the forward sales contract and the underlyingequity security are recognized in earnings.

Available-for-salesecurities were classified in the Consolidated Balance Sheets as follows at December 31:
| ** **                                                                                                                       | ** ** | **2004**                | ** ** | **2003** | ** ** |
|----------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------|------------|----------|------------|
| ** **                                                                                                                       | ** ** | **(In thousands)** | ** ** |
| Short-term  investments in marketable debt securities                                                                            |       | $                       | 394,112    |     | $          | 174,212 |   |
| Non-current  investments in marketable debt securities                                                                           |       | 409,421                 |       | 560,292  |       |
| Investments in  marketable equity securities, included in “Investments in equity securities  and affiliated companies” |       | 71,522                  |       | 96,274   |       |
|                                                                                                                             |       | $                       | 875,055    |     | $          | 830,778 |   |

 

F-47

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**CHIRON CORPORATION  NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) DECEMBER 31, 2004**

**Note 12—FairValue of Financial Instruments (Continued)**

The cost and estimatedfair value of available-for-sale debt securities by contractual maturityconsisted of the following at December 31, 2004:
| ** **                | ** ** | **Adjusted  Cost**      | ** ** | **Fair  Value** | ** ** |
|---------------------------|------------|-------------------------|------------|-----------------|------------|
| ** **                | ** ** | **(In thousands)** | ** ** |
| Due in one year  or less  |       | $                       | 395,320    |            | $          | 394,112 |   |
| Due in one to  five years |       | 407,021                 |       | 406,221         |       |
| Due after ten  years      |       | 3,200                   |       | 3,200           |       |
|                      |       | $                       | 805,541    |            | $          | 803,533 |   |

 

Chiron had no tradingsecurities at December 31, 2004 and 2003.

*Other FinancialInstruments*

Thecarrying amounts and fair values of other financial instruments, were asfollows at December 31:
| ** **                                              | ** ** | **2004**                | ** ** | **2003**            | ** ** |
|---------------------------------------------------------|------------|-------------------------|------------|---------------------|------------|
| ** **                                              | ** ** | **Carrying  Amount**    | ** ** | **Fair Value** | ** ** | **Carrying  Amount** | ** ** | **Fair Value** | ** ** |
| ** **                                              | ** ** | **(In thousands)** | ** ** |
| Notes receivable                                        |       | 7,500                   |       | 8,966               |       | 8,979 |   | 11,486 |   |
| Employee loans  receivable                              |       | 1,037                   |       | 1,371               |       | 2,314 |   | 2,529 |   |
| Non-current  interest receivables                       |       | 3,857                   |       | 3,857               |       | — |   | — |   |
| Deposits                                                |       | 2,487                   |       | 2,206               |       | 1,744 |   | 1,620 |   |
| Interest  receivable on equity forward sales contracts  |       | 1,288                   |       | 1,288               |       | 2,808 |   | 2,808 |   |
| Non-current  payable                                    |       | 318                     |       | 318                 |       | 554 |   | 554 |   |
| Liquid Yield  Option Notes                              |       | 47,336                  |       | 46,980              |       | 422,746 |   | 435,465 |   |
| 1.625%  Convertible Debenture Notes                     |       | 500,000                 |       | 467,500             |       | 500,000 |   | 555,060 |   |
| 2.75% Convertible  Debenture Notes                      |       | 385,000                 |       | 375,568             |       | — |   | — |   |
| Other notes  payable (see Note 13)                      |       | 4,316                   |       | 4,316               |       | 3,963 |   | 3,963 |   |
| *Derivative  financial instruments:*                    |       |                    |       |                |       |   |   |   |   |
| Equity forward sales contracts (asset)                  |       | 4,969                   |       | 4,969               |       | 10,637 |   | 10,637 |   |
| Foreign currency forward contracts (asset)              |       | —                  |       | —              |       | 6,144 |   | 6,144 |   |
| Foreign currency option contracts (asset)               |       | —                  |       | —              |       | 73 |   | 73 |   |
|                                                    |       | 4,969                   |       | 4,969               |       | 16,854 |   | 16,854 |   |
| Foreign currency forward contracts (liability)          |       | 10,395                  |       | 10,395              |       | 60 |   | 60 |   |
| Equity forward  sales contracts (non-current liability) |       | 156                     |       | 156                 |       | — |   | — |   |

 

The fair value estimates provided above were based oninformation available at December 31, 2004 and 2003. Judgment was requiredin interpreting market data to develop the estimates of fair value. As such,these estimated fair values are not necessarily indicative of the amounts thatChiron could realize in a current market exchange.

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**CHIRON CORPORATION  NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) DECEMBER 31, 2004**

**Note12—Fair Value of Financial Instruments (Continued)**

The carrying values ofnon-current interest receivable, variable rate notes receivable, certainemployee loans receivable and notes payable approximated fair value due to themarket-based nature of these instruments. The fair values of the fixed ratenotes receivable, employee loans receivable and the deposits were based on thediscounted value of expected future cash flows using current rates for assetswith similar maturities. The carrying value of the non-current payableapproximated fair value due to the market-based nature of that instrument. Thefair values of Liquid Yield Option Notes, 1.625% Convertible Debenture Notesand 2.75% Convertible Debenture Notes were based on the market price at theclose of business on the last day of the fiscal year. Changes in the fair valuesof these notes have no effect on our financial position. The fair values of theequity forward sales contracts (including the related interest receivable), theforeign currency forward contracts, and the foreign currency option contractswere based on estimated market prices, determined by a broker. Included incurrent assets and current liabilities were certain other financial instrumentswhose carrying values approximated fair value due to the short-term nature ofsuch instruments.

*Equity ForwardSales Contracts*

Beginning in 2001, Chirondesignated its equity forward sales contracts as fair value hedges. “Interestand other income, net” in the Consolidated Statements of Operations for theyears ended December 31, 2004, 2003 and 2002 included net gains of $0.5million, $0.5 million and $1.1 million, respectively, for changes inthe time value of these fair value hedges. Chiron considers all time valuechanges to be ineffective and, therefore, recognizes them immediately inearnings.

*Foreign CurrencyForward Contracts*

Foreign currency forwardcontracts are used to mitigate the effect of currency changes on transactionsdenominated in foreign currencies and are not accounted for as hedges usinghedge accounting treatment under SFAS No. 133, Accounting for DerivativeInstruments and Hedging Activities. Foreign currency transaction gains/(losses)from continuing operations, net of the impact of hedging with foreign currencyforward contracts, were ($0.4) million, $5.5 million and $0.7 millionin 2004, 2003 and 2002, respectively.

*Foreign CurrencyOption Contracts*

Beginning in 2001, Chirondesignated its foreign currency option contracts as cash flow hedges. For cashflow hedges, derivative gains and losses included in comprehensive income arereclassified into earnings at the time the forecasted revenue is recognized.

*Embedded DerivativeInstruments*

The contingent cash interest feature of the LiquidYield Option Notes is considered an embedded derivative. The value of theembedded derivative is reassessed at each balance sheet date, and any changefrom the prior balance sheet date is reflected currently in earnings. Thechange in the value of the embedded derivative was not material for the yearsended December 31, 2004, 2003, and 2002, respectively.

F-49

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**CHIRON CORPORATION  NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) DECEMBER 31, 2004**

**Note12—Fair Value of Financial Instruments (Continued)**

*Unrealized Losses*

Chiron’s unrealized lossposition consisted of the following at December 31, 2004:
| ** **                                                                | ** ** | **Unrealized loss position  for less than 12 months  prior to 12/31/04** | ** ** | **Unrealized loss position for  12 months or longer prior to  12/31/04** | ** ** | **Total**            | ** ** |
|---------------------------------------------------------------------------|------------|------------------------------------------------------------------------------------------------------------------|------------|------------------------------------------------------------------------------------------------------------------|------------|----------------------|------------|
| **Description of securities**                                   | ** ** | ** **                                                                                                       | ** ** | **Fair Value**                                                                                              | ** ** | **Unrealized  Loss** | ** ** | **   Fair Value   ** | ** ** | **   Unrealized     Loss** | ** ** | **Fair Value** | ** ** | **Unrealized  Loss** | ** ** |
| ** **                                                                | ** ** | **(In thousands)**                                                                                          | ** ** |
| US Treasury  obligations and direct obligations of US Government Agencies |       | 162,459                                                                                                          |       |                                                                                                             | 648        |                 |       |   | — |   |   |   | — |   |   | 162,459 |   |   | 648 |   |   |
| Federal agency  mortgage backed securities                                |       | 73,886                                                                                                           |       |                                                                                                             | 271        |                 |       |   | — |   |   |   | — |   |   | 73,886 |   |   | 271 |   |   |
| Corporate bonds                                                           |       | 390,336                                                                                                          |       |                                                                                                             | 1,157      |                 |       |   | 10,408 |   |   |   | 98 |   |   | 400,744 |   |   | 1,255 |   |   |
| Subtotal, debt securities                                                 |       | 626,681                                                                                                          |       |                                                                                                             | 2,076      |                 |       |   | 10,408 |   |   |   | 98 |   |   | 637,089 |   |   | 2,174 |   |   |
| Common Stock                                                              |       | 1,999                                                                                                            |       |                                                                                                             | 100        |                 |       |   | — |   |   |   | — |   |   | 1,999 |   |   | 100 |   |   |
| Total temporarily  impaired securities                                    |       | 628,680                                                                                                          |       |                                                                                                             | 2,176      |                 |       |   | 10,408 |   |   |   | 98 |   |   | 639,088 |   |   | 2,274 |   |   |
|                                                                           |            |                                                                                                                  |            |                                                                                                                  |            |                      |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

With respect to the fixedincome portfolio, Chiron has the ability and intent to hold these investmentsuntil a forecasted recovery of fair value up to the cost basis, which incertain cases may be until maturity.

**Note 13—DebtObligations**

Long-termdebt consisted of the following at December 31:
| ** **                                                                                       | ** ** | **2004**                | ** ** | **2003** | ** ** |
|--------------------------------------------------------------------------------------------------|------------|-------------------------|------------|----------|------------|
| ** **                                                                                       | ** ** | **(In thousands)** | ** ** |
| Convertible  Debentures maturing in 2034                                                         |       | $                       | 385,000    |     | $          | — |   |
| Convertible  Debentures maturing in 2033                                                         |       | 500,000                 |       | 500,000  |       |
| Liquid Yield  Option Notes, net of unamortized discount of $32,794 in 2004 and $307,254 in  2003 |       | 47,336                  |       | 422,746  |       |
| Other notes  payable                                                                             |       | 6,757                   |       | 3,963    |       |
| Current portion  of other notes payable                                                          |       | (2,441                  | )          | —   |       |
|                                                                                             |       | $                       | 936,652    |     | $          | 926,709 |   |

 

*ConvertibleDebentures Maturing in 2034*

On June 22, 2004, Chiron issued$385.0 million aggregate principal amount of convertible debentures, whichmature on June 30, 2034. The convertible debentures accrue interest at arate of 2.75% per year and interest is payable on each June 30 and December 30commencing on December 30, 2004. The debentures are senior, unsecuredobligations of Chiron and rank equal in right of payment with all of Chiron’sexisting and future unsecured and unsubordinated indebtedness.

The holders of the debentures may convert theirdebentures when certain Chiron common stock price targets have been met atcertain times, if the trading price for the debentures falls below certainlevels for a 

F-50

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**CHIRON CORPORATION  NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) DECEMBER 31, 2004**

**Note13—Debt Obligations (Continued)**

specified period of time,if the debentures have been called for redemption, if the credit ratingassigned to Chiron’s long-term senior debt is below specified levels, upon theoccurrence and continuance of specified corporate transactions or in connectionwith a transaction or event constituting a change in control. The initialconversion rate is 14.9254 shares of Chiron common stock per $1,000 principalamount of debentures. This is equivalent to an initial conversion price ofapproximately $67.00 per share of Chiron common stock.

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

If a change in control occurs on or prior to July 5,2010, under certain circumstances, holders of the debentures will receive amake whole premium on debentures tendered for repurchase and for debenturesconverted in connection with a change in control. The amount of the make wholepremium will be based on the price paid per share of Chiron common stock in atransaction constituting a change in control and is payable in Chiron commonstock.

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

On or after July 5, 2010, Chiron may redeem forcash all or part of the debentures at a redemption price equal to 100% ofprincipal amount of the debentures to be redeemed, plus accrued and unpaidinterest, if any, up to the redemption date.

Bond issuance costs inconnection with the issuance of the debentures amounted to approximately$8.4 million and are being amortized to interest expense on astraight-line basis, which approximates the effective interest method, over sixyears, which represents the period from the issue date to the earliest putdate. Bond issuance costs are recorded in “Other intangible assets, net” in theConsolidated Balance Sheet at December 31, 2004.

*ConvertibleDebentures Maturing in 2033*

On July 30, 2003, Chiron issued$500.0 million aggregate principal amount of convertible debentures, whichmature on August 1, 2033. The convertible debentures accrue interest at arate of 1.625% per year and interest is payable on February 1 and August 1commencing February 1, 2004. The debentures are 

F-51

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**CHIRON CORPORATION  NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) DECEMBER 31, 2004**

**Note13—Debt Obligations (Continued)**

senior, unsecuredobligations of Chiron and rank equal in right of payment with all of Chiron’sexisting and future unsecured and unsubordinated indebtedness.

On December 13, 2004, Chiron and U.S. BankNational Association, as trustee (the “Trustee”), entered into a supplementalindenture (the “First Supplemental Indenture”) to the Indenture, dated as of July 30,2003 (the “Indenture”), relating to $500.0 million aggregate principal amountof Chiron’s 15¤8%Convertible Debentures due 2033. The First Supplemental Indenture modifiedcertain provisions of the Indenture pertaining to the repurchase of theconvertible debentures by Chiron at the option of the holder at specified datesand under certain change in control transactions, as discussed below. Undereach of these modified provisions, Chiron has eliminated Chiron’s right tosettle the repurchases with Chiron common stock, so that all such repurchasesshall be made with cash.

The holders of the debentures may convert theirdebentures into shares of Chiron common stock when certain Chiron common stockprice targets have been met at certain times, if the debentures have beencalled for redemption, if the credit rating assigned to Chiron’s long-termsenior debt is below specified levels or upon the occurrence and continuance ofspecified corporate transactions. For each $1,000 principal amount ofdebentures surrendered for conversion, the holder will receive 14.6113 sharesof Chiron common stock. This is equivalent to an initial conversion price ofapproximately $68.44 per share of common stock. Upon conversion, holders willnot receive any cash payment for accrued interest. Instead, accrued interest willbe deemed paid by the common stock received by holders on conversion.

The holders of the debentures may require Chiron torepurchase the debentures on August 1, 2008, August 1, 2013, August 1,2018, August 1, 2023 and August 1, 2028. The repurchase price will beequal to the principal and accrued and unpaid interest. Payments forrepurchases shall be made in the form of cash.

On or after August 5, 2008, Chiron may redeem forcash all or part of the debentures at a redemption price of principal plusaccrued and unpaid interest. All such payments shall be made in the form ofcash.

If Chiron undergoes certain change in controltransactions, the holders of the debentures have the option to require Chironto repurchase all or part of the debentures. The repurchase price will be equalto the principal and accrued and unpaid interest. Payments for repurchasesshall be made in the form of cash.

Bond issuance costsamounted to approximately $10.9 million and are being amortized tointerest expense on a straight-line basis, which approximated the effectiveinterest method, over five years, which represents the period from the issuedate to the earliest redemption date. These bond issuance costs are recorded in“Other intangible assets, net” in the Consolidated Balance Sheets at December 31,2004 and 2003.

*Liquid Yield OptionNotes*

In June 2001, Chiron issued zero coupon LiquidYield Option Notes (LYONs) with a face value of $730.0 million and a yieldto maturity of 2.0%. The LYONs were carried net of an original issue discountof $328.2 million, which was being accreted to interest expense over thelife of the LYONs using the effective interest method. No beneficial conversionfeature existed at the time of the issuance of the LYONs. The LYONs mature on June 12,2031 at a face value of $1,000 per note. The LYONs are 

F-52

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**CHIRON CORPORATION  NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) DECEMBER 31, 2004**

**Note13—Debt Obligations (Continued)**

uncollateralized andunsubordinated, and rank equal in right of payment to Chiron’s existing andfuture uncollateralized and unsubordinated indebtedness.

On June 12, 2004, certain LYONs holders, at theiroption, tendered $649.9 million in aggregate principal amount at maturityfor purchase by Chiron. The purchase price for the LYONs was $584.31 in cashper $1,000 in principal amount at maturity. The aggregate purchase price forall the LYONs validly surrendered for purchase was $379.7 million. At December 31,2004, there remains outstanding $80.1 million in aggregate principalamount at maturity and an accreted balance of $47.3 million for the LYONs.

Beginning after June 12, 2006, the holder mayreceive contingent cash interest during any six-month period if the averagemarket price of the LYONs is greater than or equal to the threshold specifiedin the indenture. The contingent cash interest in respect of any quarterlyperiod will equal 0.0625% of the average market price of a LYONs for a fivetrading day measurement period preceding the applicable six-month period.

At theoption of the holder, Chiron may be required to purchase all, or a portion, ofthe remaining LYONs on the following dates at the following prices for eachnote with face value of $1,000:
| **Date**            | ** ** | ** ** | ** ** | **Price** | ** ** |
|---------------------|------------|------------|------------|-----------|------------|
| June 12,  2006 |       | $          | 608.04     |      |
| June 12,  2011 |       | $          | 671.65     |      |
| June 12,  2016 |       | $          | 741.92     |      |
| June 12,  2021 |       | $          | 819.54     |      |
| June 12, 2026  |       | $          | 905.29     |      |

 

The purchase prices would increase for any accruedoriginal issue discount thereon. If the holders require Chiron to purchase all,or a portion, of the LYONs, Chiron may choose to pay the purchase price incash, Chiron common shares, or any combination of the two.

Holders may convert the LYONs at any time on or beforethe maturity date. For each LYONs converted, the holder will receive 7.1613shares of Chiron common stock. Any accrued original discount and unpaidcontingent cash interest are ineligible for conversion.

Upon a change in control of Chiron occurring on orbefore June 12, 2006, each holder may require Chiron to purchase all or aportion of such holder’s LYONs for cash at a price equal to 100% of the issueprice for such LYONs plus any accrued original issue discount to the date ofpurchase. The change in control definition allows Novartis to acquirebeneficial ownership of up to 79.9% of Chiron’s common stock without triggeringa change in control for purposes of the LYONs.

Chiron may redeem all or a portion of the LYONs forcash at any time after June 12, 2006, at specified redemption prices.

Bond issuance costsamounted to approximately $10.0 million and are being amortized tointerest expense on a straight-line basis, which approximated the effectiveinterest method, over three years, which 

F-53

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**CHIRON CORPORATION  NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) DECEMBER 31, 2004**

**Note13—Debt Obligations (Continued)**

representsthe period from the issue date to the earliest put date. Bond issuance costsare recorded in “Other intangible assets, net” in the Consolidated BalanceSheet at December 31, 2003.

*Other Notes Payable*

Chiron has various other notes payable which consistprimarily of various agreements with a governmental body in Italy for whichChiron may borrow up to 8.6 million Euros ($11.6 million at December 31,2004) for research purposes. Under these facilities, Chiron has an outstandingbalance of 5.0 million Euros ($6.8 million) as of December 31, 2004 withinterest rates that range from 2% to 6% and maturities that range from 2005 to2013. Future maturities of other notes payable are as follows: 2005-$2.4 million;2006-$0.9 million; 2007-$0.9 million; 2008-$1.1 million;2009-$1.1 million and $0.3 million thereafter.

During 2004, Chiron repaid$2.9 million of other notes payable that were collateralized by land andbuilding of a facility that was sold in 2004.

*Short-TermBorrowings*

Under a revolving,committed, uncollateralized credit agreement with a major financialinstitution, Chiron can borrow up to $100.0 million in the U.S. Thiscredit facility is guaranteed by Novartis AG under a November 1994Investment Agreement, provides various interest rate options and matures in February 2006.There were no borrowings outstanding under this credit facility at December 31,2004 and 2003. In December 1999, Chiron and Novartis amended the November 1994Investment Agreement to reduce the maximum amount of our obligations thatNovartis would guarantee from $725.0 million to $702.5 million. TheNovartis loan guarantee will expire on January 1, 2008 unless certain debtratings are triggered which would extend the guarantee on a declining basisratably over the subsequent three-year period. Chiron also has various creditfacilities available outside the U.S. There were no outstanding borrowingsunder these facilities at December 31, 2004 and 2003. One facility ismaintained for our 51%-owned Indian subsidiary, and allows for total borrowingsof 200 million Indian Rupee ($4.6 million at December 31, 2004).There were no outstanding borrowings under this facility at December 31,2004 and 2003.

**Note 14—Commitmentsand Contingencies**

*FLUVIRIN® influenzavirus vaccine*

On October 5, 2004, the U.K. regulatory body, theMedicines and Healthcare products Regulatory Agency, or MHRA, sent Chiron aletter prohibiting us from releasing any FLUVIRIN vaccine doses manufactured atour Liverpool facility since March 2, 2004 and suspending our license tomanufacture influenza virus vaccine in our Liverpool facility for three months(later extended for an additional three months). In that letter, the MHRAasserted that our manufacturing process did not comply with U.K. goodmanufacturing practices regulations. Following the MHRA’s decision and aninspection by the Food and Drug Administration, or FDA, the FDA sent Chiron awarning letter citing violations of good 

F-54

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**CHIRON CORPORATION  NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) DECEMBER 31, 2004**

**Note14—Commitments and Contingencies (Continued)**

manufacturing practices. Chironprovided the FDA with a written response to the warning letter on January 7,2005. As a result of the suspension of Chiron’s license, Chiron did not releaseany FLUVIRIN product during the 2004-2005 influenza season.

On March 2, 2005, the MHRA notified us that ithad lifted the license suspension, giving Chiron clearance to initiate fullproduction of FLUVIRIN® vaccine, conditioned on the understanding that Chiron’scommitment to remediation will continue. The FDA is still expected to conduct afull inspection to determine whether deficiencies noted in the warning letterthe FDA issued in December 2004 have been resolved. If Chiron fails toadequately address the matters discussed in the warning letter, the FDA maymodify Chiron’s U.S. license in an adverse manner, take action that couldresult in imposition of fines, require temporary or permanent cessation offuture selling of FLUVIRIN vaccine or take other action that could reduceChiron’s ability to market FLUVIRIN vaccine.

Chiron received a grandjury subpoena issued by the U.S. Attorney’s Office for the Southern District ofNew York in October 2004 requesting production of certain documentsrelating to FLUVIRIN vaccine and the suspension by the MHRA of our license. In February 2005,the Securities and Exchange Commission notified Chiron that it would commence aformal investigation into whether Chiron or its employees have violated anyfederal securities laws in connection with these developments regardingFLUVIRIN, after having previously commenced an informal inquiry. Chiron alsoreceived a voluntary request for information from the United States House ofRepresentatives Committee on Energy and Commerce requesting production ofcertain documents. Numerous documents have been collected and produced in responseto these requests, and several witnesses have been interviewed by the U.S.Attorney’s Office and the SEC staff and additional interviews are anticipated. Additionalinvestigations regarding these matters may arise. In addition, Chiron andcertain of our officers and directors have also been named as defendants inseveral putative shareholder class action and derivative lawsuits allegingvarious claims arising out of or relating to these developments regardingFLUVIRIN vaccine. Chiron has been contacted by certain parties who may bringclaims against us as a result of Chiron’s inability to supply FLUVIRIN vaccinein the 2004-2005 season, including the U.S. Centers for Disease Control andPrevention and certain distributors of FLUVIRIN vaccine who have suggested thatthey are entitled to compensation under their contracts for the 2004-2005season. It is not possible to predict whether any of these claims will bepursued and, if so, whether those claims will be upheld. Investigations,litigation and disputes have caused Chiron to incur substantial expense, andhave required significant time and attention from Chiron’s management and willcontinue to do so in the future and could result in civil and/or criminal penaltiesagainst Chiron. The results of any such investigations, proceedings or disputescould have a material adverse effect on Chiron’s cash flow.

F-55

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**CHIRON CORPORATION  NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) DECEMBER 31, 2004**

**Note 14—Commitmentsand Contingencies (Continued)**

*Capital Commitments*

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

In April 2001, Chiron, Rhein Biotech N.V. (nowpart of Berna Biotech) and GreenCross Vaccine Corporation entered into acollaboration to research and develop certain pediatric combination vaccineproducts for sale outside of Europe and North America. The collaborationagreement requires capital commitments from Chiron, Berna Biotech and GreenCross Vaccine. Chiron’s commitment is approximately 31.6 million Euro($42.9 million at December 31, 2004) for the expansion of Chiron’s Italianmanufacturing facilities, of which Chiron had incurred costs of26.9 million Euro ($36.5 million), as of December 31, 2004. Thisagreement began in the fourth quarter 2001 and is expected to continue through 2006.

Chiron had various other firmpurchase and capital project commitments totaling approximately$19.8 million at December 31, 2004.

*Operating Leases*

Chironleases laboratory, office and manufacturing facilities, land and equipmentunder noncancelable operating leases, which expire through 2021. Rent expense,net of sublease income, from continuing operations was $41.1 million,$37.7 million and $28.0 million in 2004, 2003 and 2002, respectively.Future minimum lease payments under these leases, net of future minimum paymentsto be received under subleases, are as follows (in millions):
| 2005       |   | $ | 32.7  |   |
|------------|--------|---|-------|--------|
| 2006       |   | $ | 30.7  |   |
| 2007       |   | $ | 25.9  |   |
| 2008       |   | $ | 21.6  |   |
| 2009       |   | $ | 17.5  |   |
| Thereafter |   | $ | 133.8 |   |

 

There were no rentals tobe received under noncancelable subleases as of December 31, 2004.

*Capital Lease*

In July 2003, Chiron entered into a new six-yearlease to rent a research and development facility in Emeryville, California(R&D Property) following the expiration of the existing lease accounted foras an operating lease. Chiron accounted for this new lease as a capital leaseand, as a result, recorded the leased 

F-56

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**CHIRON CORPORATION  NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) DECEMBER 31, 2004**

**Note14—Commitments and Contingencies (Continued)**

asset and thecorresponding liability of $157.5 million on its balance sheet. This amount representsthe present value of minimum lease payments, including the residual valueguarantee. The lease provides a $156.0 million residual value guarantee fromChiron to the lessors in the event fair value of the R&D Property declinesbelow the total investment of $173.3 million made by the lessors in the R&DProperty. Consequently, Chiron’s maximum payment obligation is $156.0 millionupon termination of the lease on or before July 1, 2009. The leased assetis amortized, using a straight-line method, to an amount such that the capitallease liability, net of the book value of the leased asset at the end of thelease term equals an amount that may become payable to the lessor due to an estimateddecline in fair value of the leased asset below the lessors’ total investmentof $173.3 million. Chiron estimated the fair value of the R&D Property atthe end of the lease term will be approximately $168.9 million. The fairvalue at the end of the lease term was estimated using the cost approach inwhich appraised value at lease inception is modified by estimates for buildingcost appreciation and building component depreciation through the six-yearlease term. This valuation requires significant estimates and assumptions. Chironbelieves the fair value assigned is based on reasonable assumptions. Aggregateamortization of the leased asset over the term of the lease is estimated to beapproximately $6.0 million. For the years ended December 31, 2004 and2003, $1.0 million and $0.5 million were recorded as amortization expense forthe capital lease.

At the inception of the lease, the future minimumlease payments, exclusive of a residual value guarantee, are approximately$15.7 million over the lease term. The lease payments representvariable-rate interest payments indexed to a three-month London interbankoffered rate plus 40 basis points. On or before July 1, 2009, Chiron canchoose to either purchase the facility from the lessors or sell the facility toa third party. This option accelerates if Chiron defaults on its lease paymentsor in the event of other defined events. If Chiron chooses to purchase thefacility from the lessors the specified purchase consideration under the leaseagreement is $173.3 million. Novartis has guaranteed (under provisions of theInvestment Agreement) payments on this lease commitment, including payment ofthe residual value guarantee, to a maximum of $173.3 million.

Property,plant and equipment includes the following amounts for assets subject tocapital leases:
| ** **                     | ** ** | **2004**                | ** ** | **2003** | ** ** |
|--------------------------------|------------|-------------------------|------------|----------|------------|
| ** **                     | ** ** | **(In thousands)** | ** ** |
| Buildings                      |       | $                       | 157,500    |     | $          | 157,500 |   |
| Equipment                      |       | —                  |       | 1,012    |       |
|                           |       | 157,500                 |       | 158,512  |       |
| Less accumulated  depreciation |       | (1,500                  | )          | (806     | )          |
|                           |       | $                       | 156,000    |     | $          | 157,706 |   |

 

F-57

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**CHIRON CORPORATION  NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) DECEMBER 31, 2004**

**Note14—Commitments and Contingencies (Continued)**

Future minimum leasepayments and residual value guarantee under the capital lease obligations areas follows:
| ** **                                                                | ** ** | **(In thousands)** | ** ** |
|---------------------------------------------------------------------------|------------|-------------------------|------------|
| 2005                                                                      |       |                    | $          | 2,624 |   |   |
| 2006                                                                      |       |                    | 2,624      |   |   |
| 2007                                                                      |       |                    | 2,624      |   |   |
| 2008                                                                      |       |                    | 2,624      |   |   |
| 2009                                                                      |       |                    | 157,965    |   |   |
| Total minimum  lease payments and residual value guarantee                |       |                    | 168,461    |   |   |
| Amounts  representing interest                                            |       |                    | (11,263    | ) |   |
| Present value of net  minimum lease payment and residual value  guarantee |       |                    | $          | 157,198 |   |   |

 

Theabove capital lease obligations have been reflected in the accompanyingconsolidated Balance Sheets as follows:
| ** **                          | ** ** | **2004**                | ** ** | **2003** | ** ** |
|-------------------------------------|------------|-------------------------|------------|----------|------------|
| ** **                          | ** ** | **(In thousands)** | ** ** |
| Current portion  of capital lease   |       | $                       | 246        |     | $          | 570 |   |
| Long-term portion  of capital lease |       | 156,952                 |       | 157,677  |       |
|                                |       | $                       | 157,198    |     | $          | 158,247 |   |

 

*Cetus HealthcareLimited Partnerships*

In 1987 and 1990, Cetusand its affiliate, EuroCetus International N.V., exercised their options torepurchase all of the limited partnership interests in Cetus Healthcare LimitedPartnership and Cetus Healthcare Limited Partnership II. Under the CetusHealthcare Limited Partnership purchase agreements, which expired on December 31,2001, Chiron was obligated to pay royalties on sales of certain therapeuticproducts in the U.S. and certain diagnostic products worldwide, as well as aportion of license, distribution or other fees with respect to such products,to the former limited partners of Cetus Healthcare Limited Partnership. Underthe Cetus Healthcare Limited Partnership II purchase agreements, which expireon December 31, 2005, Chiron is obligated to pay royalties and a portionof other income with respect to sales of certain products in Europe to theformer limited partners of Cetus Healthcare Limited Partnership II. Chiron isunable to estimate future costs subject to this obligation since these costsare based on future product sales. Under these partnerships, Chiron paidroyalties of $3.0 million, $2.8 million and $3.4 million for the years ended December 31,2004, 2003 and 2002, respectively.

*Other Commitmentsand Contingencies*

In March 2004, Chiron entered into a worldwide,exclusive, multi-product, collaborative arrangement with XOMA Ltd. for thedevelopment and commercialization of antibody products for the treatment ofcancer. Under the terms of the arrangement, the parties agreed to jointlyresearch, develop, and commercialize multiple antibody product candidates.Under the arrangement, the parties agreed to share 

F-58

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**CHIRON CORPORATION  NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) DECEMBER 31, 2004**

**Note14—Commitments and Contingencies (Continued)**

development andcommercialization expenses, including preclinical and clinical development,manufacturing and worldwide marketing costs, as well as revenues, generally ona 70-30 basis, with Chiron’s share being 70% and XOMA’s share being 30%. Chironagreed to make an initial payment of $10.0 million, which has been paid asof December 31, 2004, and to make a loan facility of up to$50.0 million available to XOMA, starting on January 1, 2005 to fundXOMA’s share of development expenses. The collaboration will initially focus onpreclinical, process development and scale up work. In December 2004,Chiron filed an IND application for a monoclonal antibody oncologycompound, anti-CD40. This is the first project being developed underthe collaboration agreement with Xoma for the commercialization of therapeuticantibodies for cancer.

Effective June 2003, Chiron and SynCo B.V., arelated party, executed a seven and a half-year contract manufacturingagreement. Under this agreement, SynCo agreed to provide services related tothe production of certain of Chiron’s vaccine products for the European andU.S. markets commencing in 2004. Chiron has a firm binding order for productsto be delivered by SynCo in 2005 and 2006 under this agreement. Chiron’sminimum purchase obligation under this agreement, which depends on thequantities purchased by Chiron in years 2007 through 2010, inflation andmovement in the Euro to U.S. Dollar exchange rate, is expected to beapproximately $33.7 million over the remaining term of the agreement.

Effective February 2003, Chiron and BaxterPharmaceutical Solutions LLC executed an eight-year manufacturing and supplyagreement. Under this agreement, Baxter agreed to perform certain manufacturingprocedures and supply Chiron with a key component for a certainbiopharmaceutical product. Chiron has certain minimum purchase obligationsunder this agreement and is required to pay the difference, if any, between theactual quantity purchased and the minimum purchase obligation. Chiron canterminate this agreement in the fifth year with prior notice. Chiron’s minimumpurchase obligation under this agreement is expected to be approximately$38.2 million over four years from regulatory approval, which occurred in2003. Chiron has paid $18.5 million towards the minimum purchaseobligation as of December 31, 2004.

In connection with the production of our flu vaccineproducts, Chiron must purchase large quantities of chicken eggs. Currently, forFLUVIRIN® vaccine, Chiron purchases those eggs and incubation services from asingle supplier in the United Kingdom and, pursuant to the contract with thatsupplier, Chiron has agreed to make specified purchases of 12.5 millionBritish Pounds ($23.9 million at December 31, 2004) each year from thatsupplier through 2009, subject to Chiron’s right to terminate this agreementearlier upon payment of a termination fee.

In August 2003, Chiron entered into a$2.5 million revolving credit agreement with Nektar Therapeutics tosupport the financing of equipment, facility improvements and other capitalexpenditures related to the manufacture of clinical supplies in support of aprogram to develop a dry powder formulation of TOBI® tobramycin. Each advancemade under this revolving line of credit matures on the sixth anniversary ofthe initial advance. As of December 31, 2004, Nektar Therapeutics has notdrawn from the revolving line of credit.

F-59

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**CHIRON CORPORATION  NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) DECEMBER 31, 2004**

**Note14—Commitments and Contingencies (Continued)**

Effective October 2002, Chiron and MedicalAssociates Network, Inc., Medimop Medical Projects, Ltd. and MedimopMedical Projects North, Ltd. (referred to as Med Parties in this section)executed a five-year supply agreement. Under this agreement, the Med Partiesagreed to provide Chiron with a presentation device for certain pharmaceuticalproducts. Chiron has agreed to fund the Med Parties up to $1.5 millionthrough 2003 to acquire the tools and equipment to manufacture the presentationdevice of which Chiron has paid $1.5 million as of December 31, 2004.Under this agreement, Chiron has minimum purchase requirements. Chiron’sminimum purchase obligation for the next three years is approximately$19.1 million. Chiron can now terminate the agreement subject totwelve-months notification. If Chiron does not terminate the agreement by December 31,2007, the agreement will be automatically renewed for an additional twelvemonths.

Effective June 2002, Chiron and VWR International, Inc.executed a seven-year managed services agreement. Under this agreement, VWRagreed to provide Chiron purchasing and delivery services. Chiron can terminatethis agreement at any time with six-months notice and a minimum paymentobligation of $0.4 million. If Chiron does not terminate this agreement,payments to VWR are expected to be approximately $6.5 million, of whichapproximately $0.9 million has been paid as of December 31, 2004. Atthe end of the initial term, Chiron has the option to renew the agreement foran additional three years.

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

In 2003, Chiron also entered into a four-yearCommunication Services Agreement with Infonet USA Corporation. The contractrequires a minimum monthly payment of $0.1 million and Chiron’s commitmentat December 31, 2004 totaled $3.3 million.

Effective August 1, 2003, Chiron and IBMCorporation amended and restated the previous ten-year information technologyservices agreement which was effective on July 1, 1998. Under this revisedagreement, IBM agreed to provide Chiron with a full range of informationservices until March 31, 2010. Chiron can now terminate this agreement, subjectto certain termination charges. Minimum future payments to IBM are expected tobe approximately $50.4 million. Payments to IBM are subject to adjustmentdepending upon the levels of services and infrastructure equipment provided byIBM, as well as inflation.

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**CHIRON CORPORATION  NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) DECEMBER 31, 2004**

**Note14—Commitments and Contingencies (Continued)**

At December 31, 2004 Chiron had $13.7 millioncommitted under letters of credit, which are required by German law, related toongoing legal proceedings in Germany. Chiron also had various performance bondsand insurance-related letters of credit in the amount of $20.0 millionavailable at December 31, 2004. There are no amounts outstanding underthese letters of credit at December 31, 2004.

Chiron had noncancelable purchase orders for ongoingoperations of $56.0 million at December 31, 2004.

Chiron has various commitments and contingenciesassociated with research and development arrangements with other pharmaceuticaland biotechnology companies (Note 9).

Chiron is self-insured up to specific levels forcertain liabilities. Our self-insurance liability at December 31, 2004,for general liability coverage does not reflect incurred but not reportedclaims or claims for unknown occurrence, as the amount of this accrual cannotbe reasonably estimated at December 31, 2004.

Chiron is subject to indemnification provisions underits agreements with other companies in its ordinary course of business,typically with business partners, contractors, clinical sites, insurers andcustomers. Under these provisions Chiron generally indemnifies and holdsharmless the indemnified party for losses suffered or incurred by theindemnified party as a result of Chiron’s activities. These indemnificationprovisions generally survive termination of the underlying agreement. In somecases, the maximum potential amount of future payments Chiron could be requiredto make under these indemnification provisions is unlimited. The estimated fairvalue of the indemnity obligations of these agreements is minimal. Accordingly,Chiron has no liabilities recorded for these agreements as of December 31,2004. Chiron has not incurred material costs to defend lawsuits or settleclaims related to these indemnification agreements.

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

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

F-61

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**CHIRON CORPORATION  NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) DECEMBER 31, 2004**

**Note 15—Stockholders’Equity**

*Stock CompensationPlan*

The Chiron 2004 Stock Compensation Plan, as amendedand restated on February 13, 2004, (“Plan”), formerly the Chiron 1991Stock Option Plan offers incentives and rewards, in the form of options, stockissuances, restricted shares, share rights, share units, stock appreciationrights (collectively, “awards”) and purchase rights to purchase shares ofChiron common stock at periodic intervals through a purchase program. The PlanAdministrator determines the terms of the awards (including the vesting and thepurchase price (if any) to be paid for shares acquired under the awards).

Options may be either nonqualified stock options(which may not have an exercise price less than 85% of the fair market value ofthe shares on the grant date) or incentive stock options (which may not have anexercise price less than the fair market value of the shares on the grantdate). Options are generally granted with an exercise price equal to the fairmarket value of the common stock on the grant date, are exercisable ininstallments over a four year period (subject to acceleration upon atermination of employment following certain events) and have a term of tenyears.

Prior to 2004, we granted stock options under the Planto certain executives pursuant to the Executive Long-Term Incentive Programwhich vest upon the earlier of completion of seven years of service or theachievement of specified performance objectives as established by theCompensation Committee of the Board of Directors. The Compensation Committeeawarded 800,000, and 955,000 such stock options (which are included in thebelow tables) in 2003 and 2002, respectively. No stock options were awarded in2004 pursuant to the Executive Long-Term Incentive Program. At December 31,2004, 2003 and 2002, 893,400, 380,200 and 171,600 stock options, respectively,were exercisable under the Executive Long-Term Incentive Program. Because theyare granted with an exercise price equal to fair market value, Chiron does notrecord compensation expense related to these stock options.

During 2004, certain executives received performancebased share rights awards. These share rights awards entitle the participant toreceive shares upon the attainment of certain pre-established performance goalsas established by the Compensation Committee of the Board of Directors. Inaccordance with Accounting Principles Board Opinion No. 25, “Accountingfor Stock Issued to Employees, (Opinion No. 25)” compensation expenserelated to these awards is based on the extent to which the performancecriteria are met. No such expense was recognized in 2004. There were 122,000performance based share rights awards granted in 2004; no shares were issued in2004 under such awards.

In 2004, the Compensation Committee awarded certainkey individuals an aggregate of 340,424 share rights that vest over four yearsof service, and also awarded 30,474 share rights to non-employee directors thatwere fully vested at the time of grant and issuable following the cessation oftheir service on the Board. In 2003, the Compensation Committee awarded certainkey individuals an aggregate of 188,450 share rights that vest over four years,and also awarded 33,190 share rights to non-employee directors that were fullyvested at the time of grant and issuable following the cessation of theirservice on the Board. In 2002, the Compensation Committee awarded certain keyindividuals an aggregate of 164,883 share rights that generally vest over fouryears. There were no share rights awarded to non-employee directors in 2002.The intrinsic value of the share rights is recognized ratably over the relatedvesting periods. In 2004, 2003 

F-62

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**CHIRON CORPORATION  NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) DECEMBER 31, 2004**

**Note15—Stockholders’ Equity (Continued)**

and 2002, Chironrecognized $7.6 million, $7.4 million and $5.2 million ofcompensation expense, related to these share rights, respectively.

In May 2004, the stockholders approved theincorporation of the 1997 Employee Stock Purchase Program into the Plan. Pursuantto this program, eligible employees may purchase shares of Chiron common stock overa 12-month offering period through payroll deductions. At the end of eachquarter in the offering period, funds deducted from participating employees’salaries are used to purchase common stock at 85% of the lower of market valueat the quarterly purchase date or the employees’ date of participation in theoffering period. Purchases of shares made under the program (includingpurchases under the 1997 Employee Stock Purchase Plan prior to itsincorporation into the Plan) were 0.4 million in 2004 and 0.3 million ineach of the years 2003 and 2002. Up to 6.4 million shares may be issued underthe Purchase Program.

At December 31, 2004, 79.2 million shares ofChiron’s common stock have been reserved for issuance over the term of the Planand 20.0 million shares were available for future awards under the Plan.

The aggregate number of shares of Chiron’s commonstock that may be issued under the Plan will be increased on the first tradingday of January of each fiscal year (beginning in 2004) by the lesser of1.0% of the number of Chiron common equivalent shares outstanding as of thelast day of the preceding fiscal year or 3.0 million shares.

A summary of stock optionand share right activity is as follows:
| ** **                                                                                                                | ** ** | **2004**   | ** ** | **2003**   | ** ** | **2002**   | ** ** |
|---------------------------------------------------------------------------------------------------------------------------|------------|------------|------------|------------|------------|------------|------------|
| Outstanding  options and share rights at  January 1,                                                                 |       | 27,145,205 |       | 25,985,907 |       | 22,099,984 |       |
| Granted                                                                                                                   |       | 6,234,969  |       | 7,236,493  |       | 7,092,665  |       |
| Forfeited                                                                                                                 |       | (3,858,974 | )          | (1,710,648 | )          | (1,853,120 | )          |
| Exercised                                                                                                                 |       | (2,263,908 | )          | (4,366,547 | )          | (1,353,622 | )          |
| Outstanding  options and share rights at December 31,                                                                |       | 27,257,292 |       | 27,145,205 |       | 25,985,907 |       |
| Options  exercisable at December 31,                                                                                 |       | 14,953,563 |       | 12,913,430 |       | 12,548,651 |       |
| Weighted average  exercise price of:                                                                                      |       |       |       |       |       |       |       |
| Outstanding options at December 31,                                                                                  |       | $          | 40.85      |       | $          | 39.56      |       | $ | 36.84 |   |
| Options granted                                                                                                           |       | $          | 42.08      |       | $          | 43.11      |       | $ | 39.02 |   |
| Options forfeited                                                                                                         |       | $          | 43.78      |       | $          | 43.66      |       | $ | 42.20 |   |
| Options exercised                                                                                                         |       | $          | 23.74      |       | $          | 27.68      |       | $ | 17.11 |   |
| Weighted-average  grant-date fair value of options granted during the year calculated pursuant  to SFAS No. 123      |       | $          | 19.35      |       | $          | 24.47      |       | $ | 22.78 |   |
| Weighted-average  grant-date fair value of share rights granted during the year calculated  pursuant to SFAS No. 123 |       | $          | 45.29      |       | $          | 44.20      |       | $ | 39.76 |   |

 

F-63

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**CHIRON CORPORATION  NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) DECEMBER 31, 2004**

**Note 15—Stockholders’Equity (Continued)**

The weighted-average grant-date fair value of eachoption and share right grant was estimated using the Black-Scholes-Mertonformula and the following weighted-average assumptions: expected volatility of43%, 61% and 62% for 2004, 2003 and 2002, respectively; risk-free interestrates of 3.6%, 3.3% and 2.8% for 2004, 2003 and 2002, respectively; and anaverage expected life of 5 years for 2004, 6 years for 2003 and 5years for 2002. No dividends were factored into the calculation in 2004, 2003or 2002.

Thefollowing table summarizes information concerning options and share rights at December 31,2004:
| ** **                                  | ** ** | **Outstanding** | ** ** | **Exercisable**         | ** ** |
|---------------------------------------------|------------|-----------------|------------|-------------------------|------------|
| **Range of Exercise Prices** | ** ** | ** **      | ** ** | **Number  Outstanding** | ** ** | **Weighted-  Average  Remaining  Contractual Life** | ** ** | **Weighted-Average  Exercise Price** | ** ** | **Number  Outstanding** | ** ** | **Weighted-  Average  Exercise Price** | ** ** |
| Less than $39                               |       | 9,913,685       |       |                    | 6.17       |   |   |   | $ | 29.88 |   |   | 6,555,663 |   |   | $ | 29.32 |   |   |
| $39 to $44                                  |       | 6,242,648       |       |                    | 8.25       |   |   |   | 42.48 |   |   | 2,135,493 |   |   | 42.83 |   |   |
| $44 to $51                                  |       | 7,277,702       |       |                    | 7.77       |   |   |   | 48.02 |   |   | 3,894,925 |   |   | 47.56 |   |   |
| $51 to $57                                  |       | 3,823,257       |       |                    | 7.03       |   |   |   | 52.94 |   |   | 2,367,482 |   |   | 53.27 |   |   |
|                                        |       | 27,257,292      |       |                    | 7.19       |   |   |   | $ | 40.85 |   |   | 14,953,563 |   |   | $ | 39.79 |   |   |
|                                             |            |                 |            |                         |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

Purchaserights granted under the Purchase Program are not included in the table above.The weighted-average grant-date fair value of these purchase rights wasestimated using the Black-Scholes Merton formula the following assumptions:expected volatility of 32%, 23% and 35% for 2004, 2003 and 2002, respectively;risk-free interest rates of 2.8% for 2004, and 1.3% for 2003 and 2002; and anaverage expected life of one year for 2004, 2003 and 2002. No dividends werefactored into the calculation in 2004, 2003 and 2002, respectively. Theweighted-average fair value of the purchase rights granted was $11.00, $11.18and $10.39 per share in 2004, 2003 and 2002, respectively.

*Put Options*

In January 2001,Chiron initiated a put option program. Under this program, Chiron entered intocontracts with third parties to sell put options on Chiron stock, entitling theholders to sell to Chiron a specified number of shares at a specified price pershare on a specified date. In connection with the sales, Chiron collectedpremiums, which were recorded in “Additional paid-in capital” in theConsolidated Balance Sheets. For the years ended December 31, 2003 and2002, Chiron recorded a premium of $2.1 million and $4.3 million,respectively and, for contracts which expired, purchased 0.2 million and0.3 million shares, in connection with the put option program. As of December 31,2004, Chiron had no outstanding put options.

As of December 31,2002, Chiron had an outstanding put option contract with a third partyentitling the holder to sell to Chiron 0.5 million shares at $38.11 pershare. The option expired unexercised on January 29, 2003. This put optioncontract was initially classified as equity. However, because the settlementoptions available to Chiron could require Chiron to deliver cash if the putoption was exercised by the counter-party, the cash redemption value, totaling$19.1 million, was reclassified from “Additional paid-in capital” to “Putoptions” in temporary equity in the Consolidated Balance Sheet at December 31,

F-64

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**CHIRON CORPORATION  NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) DECEMBER 31, 2004**

**Note15—Stockholders’ Equity (Continued)**

2002.Upon expiration, the options were not exercised and the temporary equity of$19.1 million was reclassified to permanent equity in the first quarter2003.

*Stock Repurchase Program*

Since2001, Chiron’s Board of Directors has authorized the repurchase of Chiron commonstock on the open market to offset the dilution associated with the operationof the stock option and employee stock purchase programs and the granting ofshare rights. On December 5, 2003, the Board of Directors authorizedChiron to repurchase 5.0 million shares of Chiron common stock through December 31,2004. Through December 31, 2004, Chiron made purchases of 2.9 millionshares, although there were no stock repurchases in the fourth quarter of 2004.On March 10, 2005, the Board of Directors authorized Chiron to repurchase5.0 million shares of Chiron common stock through December 31, 2005.

**Note 16—OtherEmployee Benefit Plans**

*Retirement SavingsPlans*

Chiron sponsors adefined-contribution savings plan under Section 401(k) of theInternal Revenue Code covering substantially all full-time U.S. employees.Participating employees may contribute up to 25% of their eligible compensationup to the annual Internal Revenue Service contribution limits. Chiron alsosponsors various defined-contribution savings plans covering its full-timenon-U.S. employees including defined-contribution plans associated with theacquisition of PowderJect (Note 5). In addition, Chiron sponsors aSupplemental Executive Retirement Program, which allows U.S. executives to deferup to 25% of their eligible compensation. Executives may also defer anadditional 75% of their annual bonuses. Chiron matched employee contributionsaccording to specified formulas and contributed $10.7 million,$9.3 million and $6.9 million in 2004, 2003 and 2002, respectively,related to these plans.

*Pension Plan*

Chiron has a non-contributory retirement programcovering substantially all employees of its wholly-owned German subsidiary. Thebenefits for this program are based primarily on years of service and employeecompensation. The program is a defined-benefit pension plan and is notexternally funded.

Thecomponents of net periodic pension costs were as follows for the years ended December 31:
| ** **                 | ** ** | **2004**                | ** ** | **2003** | ** ** | **2002** | ** ** |
|----------------------------|------------|-------------------------|------------|----------|------------|----------|------------|
| ** **                 | ** ** | **(in thousands)** | ** ** |
| Service cost               |       | $                       | 571        |     | $          | 404      |       | $ | 383 |   |
| Interest cost              |       | 749                     |       | 717      |       | 595      |       |
| Termination  benefits      |       | —                  |       | 31       |       | —   |       |
| Recognized  actuarial loss |       | 135                     |       | 45       |       | 83       |       |
|                       |       | $1,455                  |       | $        | 1,197      |     | $          | 1,061 |   |
|                            |            |                         |            |          |            |          |            |  |  |  |

 

F-65

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**CHIRON CORPORATION  NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) DECEMBER 31, 2004**

**Note16—Other Employee Benefit Plans (Continued)**

The change in theprojected benefit obligation, reconciliation of funded status and weightedaverage assumptions were as follows for the years ended December 31:
| ** **                                        | ** ** | **2004**                | ** ** | **2003** | ** ** | **2002** | ** ** |
|---------------------------------------------------|------------|-------------------------|------------|----------|------------|----------|------------|
| ** **                                        | ** ** | **(in thousands)** | ** ** |
| Change in projected  benefit obligation:          |       |                    |       |     |       |     |       |
| Projected benefit obligation at beginning of year |       | $                       | 14,425     |     | $          | 12,310   |       | $ | 9,163 |   |
| Service cost                                      |       | 571                     |       | 404      |       | 383      |       |
| Interest cost                                     |       | 749                     |       | 717      |       | 595      |       |
| Benefits paid                                     |       | (447                    | )          | (380     | )          | (271     | )          |
| Actuarial (gain) loss                             |       | 1,573                   |       | (742     | )          | 559      |       |
| Transfer                                          |       | —                  |       | (563     | )          | —   |       |
| Other                                             |       | 311                     |       | 286      |       | 36       |       |
| Foreign currency translation                      |       | 1,538                   |       | 2,393    |       | 1,845    |       |
| Projected benefit obligation at end of year       |       | $                       | 18,720     |     | $          | 14,425   |       | $ | 12,310 |   |
| Reconciliation of  funded status:                 |       |                    |       |     |       |     |       |
| Funded status                                     |       | $                       | (18,720    | )        | $          | (14,425  | )          | $ | (12,310 | ) |
| Unrecognized actuarial loss                       |       | 3,837                   |       | 2,092    |       | 2,478    |       |
| Unrecognized prior service cost                   |       | (4,455                  | )          | (2,952   | )          | (1,781   | )          |
| Net amount  recognized                            |       | $                       | (19,338    | )        | $          | (15,285  | )          | $ | (11,613 | ) |
| Weighted average  assumptions:                    |       |                    |       |     |       |     |       |
| Discount rate                                     |       | 5.25                    | %          | 5.00     | %          | 6.00     | %          |
| Rate of  compensation increase                    |       | 2.50                    | %          | 2.75     | %          | 3.00     | %          |

 

The amounts recognized inthe Consolidated Balance Sheets were as follows at December 31:
|                                    | ** ** | **2004**                | ** ** | **2003** | ** ** | **2002** | ** ** |
|-----------------------------------------|------------|-------------------------|------------|----------|------------|----------|------------|
| ** **                              | ** ** | **(in thousands)** | ** ** |
| Accrued pension  cost                   |       | $                       | 14,883     |     | $          | 12,333   |       | $ | 9,832 |   |
| Accumulated other  comprehensive income |       | 4,455                   |       | 2,952    |       | 1,781    |       |
|                                    |       | $                       | 19,338     |     | $          | 15,285   |       | $ | 11,613 |   |

 

The accumulated benefitobligation was $18.3 million and $14.6 million at December 31, 2004 and2003, respectively.

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**CHIRON CORPORATION  NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) DECEMBER 31, 2004**

**Note 16—OtherEmployee Benefit Plans (Continued)**

*Contributions*

Chiron expects tocontribute $4.0 million to this pension plan in 2005.

*Estimated Future Benefit Payments*
| ** ** | ** ** | **Estimated Future  Benefit Payments at  December 31,2004** | ** ** |
|------------|------------|---------------------------------------------------------------------------------|------------|
|       |       | **(In thousands)**                                                         |       |
| 2005       |       |                                                                            | $          | 547 | ** ** |   |
| 2006       |       |                                                                            | 566        | ** ** |   |
| 2007       |       |                                                                            | 629        | ** ** |   |
| 2008       |       |                                                                            | 682        | ** ** |   |
| 2009       |       |                                                                            | 769        | ** ** |   |
| 2010-2014  |       |                                                                            | 4,921      | ** ** |   |

 

Chiron also sponsors defined benefit plans associatedwith the acquisition of PowderJect on July 8, 2003 (Note 5). Thebenefits for these defined benefit plans are based primarily on years ofservice and employee compensation. Chiron contributes a percentage ofpensionable earnings if the defined benefit plan is in a deficit position.These contributions are determined by a qualified independent actuary based onan annual valuation.

Thecomponents of net periodic pension costs for these defined benefit plans are asfollows for the years ended December 31:
| ** **                      | ** ** | **   2004   ** | ** ** | **  2003  ** | ** ** |
|---------------------------------|------------|----------------------------------------------|------------|----------------------------------|------------|
| ** **                      | ** ** | **(In thousands)**                      | ** ** |
| Service cost                    |       | $                                            | 1,896      |                             | $          | 903 |   |
| Interest cost                   |       | 1,396                                        |       | 606                              |       |
| Expected return  on plan assets |       | (1,090                                       | )          | (422                             | )          |
| Recognized  actuarial loss      |       | —                                       |       | 191                              |       |
|                            |       | $                                            | 2,202      |                             | $          | 1,278 |   |

 

F-67

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**CHIRON CORPORATION  NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) DECEMBER 31, 2004**

**Note16—Other Employee Benefit Plans (Continued)**

The change in theprojected benefit obligations, change in the fair value of plan assets,reconciliation of funded status and weighted average assumptions of thesedefined benefit plans are as follows for the years ended December 31:
| ** **                                          | ** ** | **2004**                | ** ** | **2003**   | ** ** |
|-----------------------------------------------------|------------|-------------------------|------------|------------|------------|
| ** **                                          | ** ** | **(In thousands)** | ** ** |
| Change in projected  benefit obligation:            |       |                    |       |       |       |
| Projected benefit obligation at beginning of period |       | $                       | 28,683     |       | $          | 22,685 |   |
| Service cost                                        |       | 1,896                   |       | 903        |       |
| Interest cost                                       |       | 1,396                   |       | 606        |       |
| Benefits paid                                       |       | (158                    | )          | (60        | )          |
| Actuarial loss                                      |       | 574                     |       | 1,339      |       |
| Other                                               |       | —                  |       | 1,012      |       |
| Divestiture(1)                                      |       | (6,649                  | )          | —     |       |
| Foreign currency translation                        |       | 1,875                   |       | 2,198      |       |
| Projected benefit obligation at end of year         |       | $                       | 27,617     |       | $          | 28,683 |   |
| Change in the fair value  of plan assets:           |       |                    |       |       |       |
| Fair Value of plan assets at beginning of period    |       | $                       | 15,162     |       | $          | 10,679 |   |
| Actual return on plan assets                        |       | 1,516                   |       | 1,501      |       |
| Employee contributions                              |       | 370                     |       | 171        |       |
| Employer contributions                              |       | 1,367                   |       | 754        |       |
| Other                                               |       | —                  |       | 976        |       |
| Benefits paid                                       |       | (178                    | )          | (31        | )          |
| Divestiture(1)                                      |       | (2,216                  | )          | —     |       |
| Foreign currency translation                        |       | 1,144                   |       | 1,112      |       |
|                                                |       | $                       | 17,165     |       | $          | 15,162 |   |
| Reconciliation of  funded status:                   |       |                    |       |       |       |
| Funded status                                       |       | $                       | (10,452    | )          | (13,521    | ) |
| Unrecognized actuarial loss                         |       | 638                     |       | 8,636      |       |
| Net amount  recognized                              |       | $                       | (9,814     | )          | $          | (4,885 | ) |
| Weighted average  assumptions:                      |       |                    |       |       |       |
| Discount rate                                       |       | 5.30                    | %          | 5.25%-5.40 | %          |
| Rate of compensation increase                       |       | 4.30                    | %          | 3.00       | %          |
| Expected  long-term rate of return on plan assets   |       | 7.38                    | %          | 7.00%-7.75 | %          |

----

(1)          In2004, Chiron divested certain research operations in Sweden, which included theassociated pension plan (Note 5). The remaining benefit plan is associated withoperations in England.

F-68

----

**CHIRON CORPORATION  NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) DECEMBER 31, 2004**

**Note16—Other Employee Benefit Plans (Continued)**

The amounts recognized inthe Consolidated Balance Sheets for the se benefit plans are as follows at December 31:
| ** **                              | ** ** | **2004**                | ** ** | **2003** | ** ** |
|-----------------------------------------|------------|-------------------------|------------|----------|------------|
| ** **                              | ** ** | **(In thousands)** | ** ** |
| Accrued pension  cost                   |       | $                       | 9,814      |     | $          | 4,885 |   |
| Accumulated other  comprehensive income |       | —                  |       | —   |       |
|                                    |       | $                       | 9,814      |     | $          | 4,885 |   |

 

The accumulated benefitobligation was $22.7 million and $17.7 million at December 31, 2004 and2003, respectively.

*Plan Assets*
| ** **         | ** ** | **Plan Assets at  December 31,** | ** ** |
|--------------------|------------|-------------------------------------------------|------------|
| ** **         | ** ** | **2004**                                        | ** ** | **2003** | ** ** |
| ** **         | ** ** | **(In thousands)**                              | ** ** |
| **Asset Category** |       | ** **                                      | ** ** |   |   |
| Equity securities  |       | $                                               | 16,255     | ** ** | $ | 12,823 |   |
| Debt Securities    |       | 695                                             | ** ** | 89 |   |
| Other              |       | 215                                             | ** ** | 2,250 |   |
| Total              |       | $                                               | 17,165     | ** ** | $ | 15,162 |   |

 

The trustees’ basic strategy is to invest newcontribution income in fixed interest securities in order to gradually increasethe proportion of fixed interest assets held and reduce the proportion ofequities.

The long-term rate ofreturn is based on a weighted average of the expected returns on the individualasset classes.

*Contributions*

Chiron expects tocontribute $1.3 million to this pension plan in 2005.

*Estimated FutureBenefit Payments*
| ** ** | ** ** | **Estimated Future  Benefit Payments at  December 31,  2004** | ** ** |
|------------|------------|-----------------------------------------------------------------------------------|------------|
| ** ** | ** ** | **(In thousands)**                                                           | ** ** |
| 2005       |       |                                                                              | $          | 111 |   |   |
| 2006       |       |                                                                              | 171        |   |   |
| 2007       |       |                                                                              | 163        |   |   |
| 2008       |       |                                                                              | 212        |   |   |
| 2009       |       |                                                                              | 259        |   |   |
| 2010-2014  |       |                                                                              | 2,990      |   |   |

 

F-69

----

**CHIRON CORPORATION  NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) DECEMBER 31, 2004**

**Note 16—Other Employee Benefit Plans (Continued)**

*PostemploymentBenefits Other Than to Retirees*

In December 2003, the Board of Directors approvedan executive severance plan for its executive officers, excluding the Chairman,Chief Executive Officer and certain other executives with employmentagreements. The plan provides a single level of coverage for all executiveswho, as a result of workforce reduction or job elimination, lose theirpositions with Chiron. The severance benefit is equivalent to 6 weeks salaryand target bonus per year of service with a minimum payment of 26 weeks andmaximum payment of 104 weeks severance, plus various insurance coverage.

In February 2001, the Board of Directors approveda change in control severance plan for its executive officers. The planprovides for three levels of coverage: Tier 1 is applicable to the ChiefExecutive Officer and provides a change in control severance benefit of threetimes base salary and bonus plus various insurance coverage; Tier 2applies to other Executive Committee members and provides a change in controlseverance benefit of two times base salary and bonus plus various insurancecoverage; and Tier 3 applies to all other executives and provides a changein control severance benefit equal to one time base salary and bonus plusvarious insurance coverage.

Effective October 1, 1997 (restated October 15,1998), Chiron adopted the Chiron Corporation Severance Plan, which providescertain post employment salary and employee benefits to employees who areinvoluntarily terminated as a result of a workforce reduction or jobelimination.

Benefits payable underthese plans are accrued when it is probable that employees will be entitled tobenefits and the amount can be reasonably estimated in accordance with SFAS No. 112,“Employers’ Accounting for Post Employment Benefits”. Amounts accrued underthese plans in 2004 and 2003 were not material.

**Note 17—Non-OperatingIncome and Expense**

*Interest and OtherIncome, Net*

“Interestand other income, net” in the Consolidated Statements of Operations consistedof the following for the years ended December 31:
| ** **                                                     | ** ** | **2004**                | ** ** | **2003** | ** ** | **2002** | ** ** |
|----------------------------------------------------------------|------------|-------------------------|------------|----------|------------|----------|------------|
| ** **                                                     | ** ** | **(In thousands)** | ** ** |
| Interest income                                                |       | $                       | 23,359     |     | $          | 23,187   |       | $ | 36,203 |   |
| Write-down of equity  securities (see Notes 1 and 9)      |       | (1,431                  | )          | —   |       | (7,525   | )          |
| Net gain on sale  of marketable debt securities                |       | 99                      |       | 895      |       | 339      |       |
| Net gain on sale  of equity securities                         |       | 34,265                  |       | 9,370    |       | 14,323   |       |
| Gain on sale of  interests in affiliated companies (see below) |       | 4,183                   |       | 2,012    |       | 5,433    |       |
| Gain on repayment  of debt security (see below)                |       | —                  |       | —   |       | 1,500    |       |
| Net realized gain  (loss) on foreign exchange transactions     |       | (360                    | )          | 5,451    |       | 702      |       |
| Equity in loss of  equity method investments (see below)       |       | (3,726                  | )          | (2,325   | )          | (2,447   | )          |
| Other income  (expense)                                        |       | 408                     |       | 302      |       | (1,912   | )          |
|                                                           |       | $                       | 56,797     |     | $          | 38,892   |       | $ | 46,616 |   |

 

F-70

----

**CHIRON CORPORATION  NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) DECEMBER 31, 2004**

**Note17—Non-Operating Income and Expense (Continued)**

In December 1998, Chiron completed the sale ofits 30% interest in General Injectibles & Vaccines, Inc. to HenrySchein, Inc. and received payment in full of certain advances made byChiron to General Injectibles & Vaccines. The agreement also providedfor Chiron to receive additional payments, calculated as a pre-determinedpercentage of the gross profit of products contributed by General Injectibles &Vaccines to Henry Schein, through 2003. Chiron received $4.2 million,$2.0 million and $5.4 million in 2004, 2003 and 2002, respectively,which was included in gain on sale of interests in affiliated companies.

In the second quarter 2001, Chiron recorded a chargeof $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 Chiron $5.1 million—the full principal plusinterest. Chiron recorded $1.5 million in gain on repayment of debtsecurity for the year ended December 31, 2002.

As discussed inNote 1, Chiron is a limited partner in several venture capital funds.Chiron accounts for these investments under the equity method of accountingpursuant to Emerging Issues Task Force Topic No. D-46, “Accountingfor Limited Partnership Investments.”

**Note 18—SegmentInformation**

Chiron is organized based on the products and servicesthat it offers. Under this organizational structure, there are three reportablesegments: (i) blood-testing, (ii) vaccines and (iii) biopharmaceuticals.The blood-testing segment consists of an alliance with Gen-Probe and Chiron’sone-half share in the pretax operating earnings generated by the joint businesscontractual arrangement with Ortho-Clinical Diagnostics. Chiron’s alliance withGen-Probe is focused on developing and commercializing nucleic acid testingproducts using Transcription-Mediated Amplification technology to screendonated blood and plasma products for viral infection. Chiron’s joint businessarrangement with Ortho-Clinical Diagnostics is operated under a contractualarrangement and is not a separate and distinct legal entity. Through Chiron’sjoint business contractual arrangement with Ortho-Clinical Diagnostics, Chironsells a line of immunodiagnostic tests to detect hepatitis viruses andretroviruses and provides supplemental tests and microplate andchemiluminescent instrument systems to automate test performance and datacollection. The blood-testing segment also earns royalties from third partiesbased on their sales of immunodiagnostic and nucleic acid testing probediagnostic products utilizing Chiron’s hepatitis C virus and HIV-relatedpatents, for use in blood screening and plasma fractionation markets. Thevaccines segment consists principally of adult and pediatric vaccines for viraland bacterial infections. Chiron sells these vaccines primarily in the U.S.,Germany, Italy, and the United Kingdom, as well as in other internationalmarkets. The vaccines segment is also involved in the development of novelvaccines and vaccination technology. The biopharmaceuticals segment consists oftherapeutic products and services, with an emphasis on the treatment of cancerand infectious diseases, using the development and acquisition of technologiesrelated to therapeutic proteins, antibodies and small molecules. Thebiopharmaceuticals segment earns royalties on third party sales of severalproducts, including BETAFERON® interferon beta-1b and earns license fees fortechnologies, such as hepatitis C virus-related patents, used by third partiesto develop therapeutic products.

F-71

----

**CHIRON CORPORATION  NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) DECEMBER 31, 2004**

**Note 18—SegmentInformation (Continued)**

Revenues and expenses associated with Chiron’sresearch and development activities specifically benefit each of the reportablesegments and as such, have been included in the results of operations of therespective reportable segment.

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

The accountingpolicies of Chiron’s reportable segments are the same as those described inNote 1—The Company and Summary of Significant Accounting Policies. Chironevaluates the performance of its segments based on each segment’s income (loss)from continuing operations, excluding certain special items such as purchasedin-process research and development, which is shown as a reconciling item inthe table below.

F-72

----

**CHIRON CORPORATION  NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) DECEMBER 31, 2004**

**Note18—Segment Information (Continued)**

The following segmentinformation excludes all significant intersegment transactions as thesetransactions are eliminated for management reporting purposes (in thousands): 
| ** **                                             | ** ** | **2004** | ** ** | **2003** | ** ** | **2002**  | ** ** |
|--------------------------------------------------------|------------|----------|------------|----------|------------|-----------|------------|
| *Revenues*                                             |       |     |       |     |       |      |       |
| Blood testing:                                         |       |     |       |     |       |      |       |
| Product sales, net:                                    |       |     |       |     |       |      |       |
| PROCLEIX® system                                  |       | $        | 249,809    |     | $          | 200,066   |       | $ | 125,392 |   |
| Ortho-Clinical  Diagnostics                            |       | 27,844   |       | 28,391   |       | 22,652    |       |
| Total product sales, net                               |       | 277,653  |       | 228,457  |       | 148,044   |       |
| Revenues from joint  business arrangement              |       | 118,246  |       | 108,298  |       | 104,576   |       |
| Collaborative agreement  revenues                      |       | 8,044    |       | 9,012    |       | 9,420     |       |
| Royalty and license fee  revenues                      |       | 89,192   |       | 75,407   |       | 53,548    |       |
| Other revenues                                         |       | 979      |       | 466      |       | 232       |       |
| Total blood testing  revenues                          |       | 494,114  |       | 421,640  |       | 315,820   |       |
| Vaccines:                                              |       |     |       |     |       |      |       |
| Product sales, net:                                    |       |     |       |     |       |      |       |
| Flu vaccines                                           |       | 153,413  |       | 332,428  |       | 89,995    |       |
| Meningococcus vaccines                                 |       | 27,739   |       | 65,548   |       | 54,971    |       |
| Travel vaccines                                        |       | 96,864   |       | 87,831   |       | 64,335    |       |
| Pediatric and other  vaccines                          |       | 200,948  |       | 192,511  |       | 148,108   |       |
| Total product sales, net                               |       | 478,964  |       | 678,318  |       | 357,409   |       |
| Collaborative agreement  revenues                      |       | 8,646    |       | 4,222    |       | 655       |       |
| Royalty and license fee  revenues                      |       | 5,234    |       | 12,747   |       | 12,309    |       |
| Other revenues                                         |       | 17,282   |       | 13,522   |       | 17,890    |       |
| Total vaccines revenues                                |       | 510,126  |       | 708,809  |       | 388,263   |       |
| Biopharmaceuticals:                                    |       |     |       |     |       |      |       |
| Product sales, net:                                    |       |     |       |     |       |      |       |
| BETASERON® interferon  beta-1b                    |       | 130,572  |       | 124,936  |       | 118,513   |       |
| TOBI® tobramycin                                  |       | 212,876  |       | 172,047  |       | 146,874   |       |
| PROLEUKIN® aldesleukin                            |       | 129,377  |       | 115,075  |       | 114,281   |       |
| Other                                                  |       | 38,861   |       | 27,000   |       | 29,000    |       |
| Total product sales, net                               |       | 511,686  |       | 439,058  |       | 408,668   |       |
| Collaborative agreement  revenues                      |       | 1,354    |       | 5,328    |       | 12,067    |       |
| Royalty and license fee  revenues                      |       | 71,527   |       | 87,698   |       | 63,314    |       |
| Other revenues                                         |       | 10,940   |       | 29,538   |       | 17,464    |       |
| Total biopharmaceuticals  revenues                     |       | 595,507  |       | 561,622  |       | 501,513   |       |
| Other:                                                 |       |     |       |     |       |      |       |
| Royalty and license fee  revenues                      |       | 123,608  |       | 74,290   |       | 69,645    |       |
| Other revenues                                         |       | —   |       | —   |       | 1,039     |       |
| Total other revenues                                   |       | 123,608  |       | 74,290   |       | 70,684    |       |
| Total revenues                                         |       | $        | 1,723,355  |     | $          | 1,766,361 |       | $ | 1,276,280 |   |
| *Income(loss)  from continuing operations*             |       |     |       |     |       |      |       |
| Blood testing                                          |       | $        | 259,702    |     | $          | 214,444   |       | $ | 178,006 |   |
| Vaccines                                               |       | (214,776 | )          | 95,092   |       | 69,572    |       |
| Biopharmaceuticals                                     |       | 9,423    |       | 39,343   |       | 19,884    |       |
| Other                                                  |       | 5,085    |       | (12,506  | )          | 10,697    |       |
| Segment income from  operations                        |       | 59,434   |       | 336,373  |       | 278,159   |       |
| Operating expense  reconciling item:                   |       |     |       |     |       |      |       |
| Purchased in-process  research and development         |       | (9,629   | )          | (45,300  | )          | (45,181   | )          |
| Income from operations                                 |       | 49,805   |       | 291,073  |       | 232,978   |       |
| Loss on disposal of  assets                            |       | (3,247   | )          | (224     | )          | (254      | )          |
| Interest expense                                       |       | (26,093  | )          | (19,104  | )          | (12,821   | )          |
| Interest and other  income, net                        |       | 56,797   |       | 38,892   |       | 46,616    |       |
| Minority interest                                      |       | (1,968   | )          | (1,753   | )          | (1,664    | )          |
| Income from continuing  operations before income taxes |       | $        | 75,294     |     | $          | 308,884   |       | $ | 264,855 |   |

** **

F-73

----

**CHIRON CORPORATION  NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) DECEMBER 31, 2004**

**Note18—Segment Information (Continued)**

 

***Segment Assets, Depreciation and Amortization Expensesand Capital Expenditures***

Chiron does not evaluate the performance of andallocate resources to its reportable segments based on the financial positionof each reportable segment. Rather, Chiron evaluates the performance of andallocates resources to its reportable segments based on (i) income fromcontinuing operations, including depreciation and amortization expenses, and (ii) capitalexpenditures.

Depreciationand amortization expenses for property, plant, equipment and leaseholdimprovements and intangible assets, are included with other operating expenses.Depreciation and amortization expenses not specifically related to a reportablesegment are allocated to each segment based upon each segment’s percentage oftotal selling, general and administrative expenses and research and developmentexpenses. Depreciation and amortization expenses for each reportable segmentwere as follows:
| ** **                                    | ** ** | **2004**                | ** ** | **2003** | ** ** | **2002** | ** ** |
|-----------------------------------------------|------------|-------------------------|------------|----------|------------|----------|------------|
| ** **                                    | ** ** | **(In thousands)** | ** ** |
| *Depreciation  and amortization expenses*     |       |                    |       |     |       |     |       |
| Blood testing                                 |       | $                       | 6,569      |     | $          | 7,881    |       | $ | 4,742 |   |
| Vaccines                                      |       | 127,732                 |       | 83,473   |       | 54,760   |       |
| Biopharmaceuticals                            |       | 41,192                  |       | 44,859   |       | 58,337   |       |
| Other                                         |       | 10,428                  |       | 9,510    |       | 6,419    |       |
| Total  depreciation and amortization expenses |       | $                       | 185,921    |     | $          | 145,723  |       | $ | 124,258 |   |

 

Capital expenditures arespecifically identified by each reportable segment. Capital expenditures foreach reportable segment were as follows:
| ** **                  | ** ** | **2004**                | ** ** | **2003** | ** ** | **2002** | ** ** |
|-----------------------------|------------|-------------------------|------------|----------|------------|----------|------------|
| ** **                  | ** ** | **(In thousands)** | ** ** |
| *Capital  expenditures*     |       |                    |       |     |       |     |       |
| Blood testing               |       | $                       | 6,353      |     | $          | 2,449    |       | $ | 4,120 |   |
| Vaccines                    |       | 109,218                 |       | 66,310   |       | 28,140   |       |
| Biopharmaceuticals          |       | 52,828                  |       | 197,872  |       | 38,674   |       |
| Other                       |       | 15,292                  |       | 30,268   |       | 34,805   |       |
| Total capital  expenditures |       | $                       | 183,691    |     | $          | 296,899  |       | $ | 105,739 |   |

 

Capital expenditures in2003 for the “Biopharmaceuticals” segment include a capital lease addition of$157.5 million as discussed in Note 14.

F-74

----

**CHIRON CORPORATION  NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) DECEMBER 31, 2004**

**Note18—Segment Information (Continued)**

*Geographic AreaInformation*

Revenues from productsales by geographic area are based on the customers’ shipping locations ratherthan the customers’ country of domicile. Collaborative agreement, license fee,revenues from joint business arrangement and other revenues by geographic areaare based on the country of domicile of the counterparty to the agreement.Royalty revenues by geographic area are based on the location to which theproduct earning the royalties is shipped.
| ** **     | ** ** | **2004**                | ** ** | **2003** | ** ** | **2002**  | ** ** |
|----------------|------------|-------------------------|------------|----------|------------|-----------|------------|
| ** **     | ** ** | **(In thousands)** | ** ** |
| *Revenues*     |       |                    |       |     |       |      |       |
| Domestic       |       | $                       | 780,116    |     | $          | 865,878   |       | $ | 624,597 |   |
| Belgium        |       | 51,919                  |       | 60,757   |       | 30,673    |       |
| Canada         |       | 21,632                  |       | 23,863   |       | 19,995    |       |
| France         |       | 50,286                  |       | 58,126   |       | 48,777    |       |
| Germany        |       | 183,193                 |       | 199,951  |       | 152,485   |       |
| Italy          |       | 86,009                  |       | 70,014   |       | 46,118    |       |
| Japan          |       | 42,696                  |       | 41,638   |       | 31,167    |       |
| United Kingdom |       | 70,805                  |       | 71,577   |       | 46,386    |       |
| Other          |       | 436,699                 |       | 374,557  |       | 276,082   |       |
| Total revenues |       | $                       | 1,723,355  |     | $          | 1,766,361 |       | $ | 1,276,280 |   |

 
| ** **               | ** ** | **2004**                | ** ** | **2003** | ** ** | **2002** | ** ** |
|--------------------------|------------|-------------------------|------------|----------|------------|----------|------------|
| ** **               | ** ** | **(In thousands)** | ** ** |
| *Long-lived assets*      |       |                    |       |     |       |     |       |
| Domestic                 |       | $                       | 446,683    |     | $          | 422,596  |       | $ | 246,431 |   |
| Germany                  |       | 79,509                  |       | 50,926   |       | 30,217   |       |
| Italy                    |       | 168,721                 |       | 125,772  |       | 83,435   |       |
| United Kingdom           |       | 87,566                  |       | 76,279   |       | 4,572    |       |
| Other                    |       | 16,936                  |       | 14,177   |       | 8,903    |       |
| Total long-lived  assets |       | $                       | 799,415    |     | $          | 689,750  |       | $ | 373,558 |   |

 

*Major Customers*

One significant customeraccounted for 10.6%, 10.7% and 13.1% of total revenues in 2004, 2003 and 2002,respectively. Chiron’s biopharmaceuticals segment revenue included 30.8%, 33.7%and 33.3% of revenues from the major customer in 2004, 2003 and 2002,respectively. Chiron’s blood testing, vaccines and other segments had no majorcustomers in 2004, 2003 and 2002.

F-75

----

**CHIRON CORPORATION  NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) DECEMBER 31, 2004**

**Note 19—Income Taxes**

Forfinancial reporting purposes, “Income from continuing operations before incometaxes” included the following components for the years ended December 31:
| ** **             | ** ** | **2004**                | ** ** | **2003** | ** ** | **2002** | ** ** |
|------------------------|------------|-------------------------|------------|----------|------------|----------|------------|
| ** **             | ** ** | **(In thousands)** | ** ** |
| Domestic income        |       | $                       | 229,651    |     | $          | 170,964  |       | $ | 161,145 |   |
| Foreign income  (loss) |       | (154,357                | )          | 137,920  |       | 103,710  |       |
|                   |       | $                       | 75,294     |     | $          | 308,884  |       | $ | 264,855 |   |

 

*Components ofProvision for Income Taxes from Continuing Operations*

Significantcomponents of the provision for income tax expense from continuing operationswere as follows for the years ended December 31: 
| ** **                                             | ** ** | **2004**                | ** ** | **2003** | ** ** | **2002** | ** ** |
|--------------------------------------------------------|------------|-------------------------|------------|----------|------------|----------|------------|
| ** **                                             | ** ** | **(In thousands)** | ** ** |
| Current tax expense:                                   |       |                    |       |     |       |     |       |
| Domestic                                               |       | $                       | 62,360     |     | $          | 89,502   |       | $ | 44,785 |   |
| Foreign                                                |       | 32,169                  |       | 13,852   |       | 44,480   |       |
|                                                   |       | 94,529                  |       | 103,354  |       | 89,265   |       |
| Deferred tax expense  (benefit):                       |       |                    |       |     |       |     |       |
| Domestic                                               |       | (13,567                 | )          | (5,634   | )          | (8,045   | )          |
| Foreign                                                |       | (59,731                 | )          | (9,174   | )          | 2,490    |       |
|                                                   |       | (73,298                 | )          | (14,808  | )          | (5,555   | )          |
| Provision for income  taxes from continuing operations |       | $                       | 21,231     |     | $          | 88,546   |       | $ | 83,710 |   |

 

In 2004, 2003 and 2002, Chiron realized stock optiontax benefits, recorded as an increase to additional paid-in capital, ofapproximately $14.9 million, $33.1 million and $8.7 million,respectively.

Chiron is presently under examination in severaldomestic and international tax jurisdictions. While there is no assurance thatChiron will prevail in all tax examinations in the event the taxing authoritiesdisagree with Chiron’s interpretation of the tax law, Chiron’s management doesnot believe, based upon information known to it, that the final resolution ofany of these audits will have a material adverse effect upon Chiron’sconsolidated financial position and results of operations and cash flows.Adequate provisions have been made for these tax examinations.

The total amount ofgoodwill attributable to the purchase of PowderJect is $520.9 million, of whichapproximately $248.5 million is expected to be deductible for state income taxpurposes over the next fifteen years.

F-76

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**CHIRON CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) DECEMBER 31, 2004**

**Note 19—IncomeTaxes (Continued)**

*Rate Reconciliation*

A reconciliation of theexpected statutory tax rate (computed at the U.S. statutory income tax rate of35.0%) to the actual tax rate on income from continuing operations for theyears ended December 31 is as follows:
| ** **                                                                     | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** |
|--------------------------------------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Expected  statutory tax rate                                                   |       | 35.0     | %          | 35.0     | %          | 35.0     | %          |
| Increases (reductions)  in tax resulting from the following:                   |       |     |       |     |       |     |       |
| State taxes, net of federal benefit                                            |       | (10.8    | )%         | 0.9      | %          | 0.4      | %          |
| Net impact of foreign tax rates and foreign tax  credits                       |       | (55.5    | )%         | (12.7    | )%         | (20.7    | )%         |
| Tax effect of intercompany transfers of product  rights(1)                     |       | 74.0     | %          | 1.9      | %          | 18.7     | %          |
| Purchased in-process research and development (see  below)                     |       | 4.5      | %          | 5.1      | %          | 6.0      | %          |
| Tax benefit attributed to Extraterritorial Income Exclusion                    |       | (4.1     | )%         | (1.0     | )%         | (0.8     | )%         |
| Utilization of current year research &  development tax credits       |       | (14.2    | )%         | (2.8     | )%         | (1.8     | )%         |
| Redetermination of prior years research &  development tax credits(2) |       | —   |       | —   | %          | (5.3     | )%         |
| Other                                                                          |       | (0.7     | )%         | 2.3      | %          | 0.1      | %          |
| Actual tax rate on  income from continuing operations                          |       | 28.2     | %          | 28.7     | %          | 31.6     | %          |

----

(1)          Tax effect of intercompanytransfers between Chiron’s subsidiaries represent current year tax expensearising from the transfer of rights related to a product under development. The taxes payable by theselling subsidiary were expensed, as the outcome of the related product developmentprogram, which has no future alternative use, is uncertain.

(2)          Inconnection with an IRS audit of the return filings for 1996, 1997 and 1998,Chiron determined that it had understated its claimed research and developmentcredits in those years. Based on Chiron’s recomputations and the final IRSaudit results, Chiron claimed additional credits of approximately$14.0 million.

Purchased in-processresearch and development charge in 2004 was a permanent difference associatedwith the acquisition of Sagres (Note 5). Purchased in-process research and development chargein 2003 was a permanent difference associated with the acquisition ofPowderJect (Note 5). The purchased in-process research and development chargein 2002 was a permanent difference associated with the acquisition of MatrixPharmaceutical.

*Summary of Deferred Income Taxes*

Deferred income taxesreflect the net tax effects of temporary differences between the carryingamounts of assets and liabilities for financial reporting purposes and theirbasis for income tax purposes and the tax effects of net operating loss and taxcredit carryforwards.

F-77

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**CHIRON CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) DECEMBER 31, 2004**

**Note19—Income Taxes (Continued)**

Net deferred tax assetshave been recognized based on management’s estimates of future taxable incomefor U.S. and certain foreign jurisdictions in which Chiron’s operations havehistorically been profitable.

Significant components ofChiron’s deferred income tax assets and liabilities from continuing operationswere as follows at December 31:
| ** **                                                  | ** ** | **2004**                | ** ** | **2003** | ** ** |
|-------------------------------------------------------------|------------|-------------------------|------------|----------|------------|
| ** **                                                  | ** ** | **(In thousands)** | ** ** |
| Deferred income tax  assets:                                |       |                    |       |     |       |
| Capitalized research and development costs                  |       | $                       | 779        |     | $          | 932 |   |
| Deferred revenue                                            |       | 16,332                  |       | 31,688   |       |
| Basis difference of equity investments                      |       | 26,824                  |       | 38,777   |       |
| Reserves and expense accruals                               |       | 62,950                  |       | 62,753   |       |
| Net operating loss carryovers                               |       | 131,799                 |       | 54,775   |       |
| Business tax credit carryovers                              |       | 43,508                  |       | 38,481   |       |
| Depreciation and amortization                               |       | 7,695                   |       | —   |       |
| Other deferred income tax assets                            |       | 5,906                   |       | 2,105    |       |
|                                                        |       | 295,793                 |       | 229,511  |       |
| Less valuation allowance                                    |       | (59,769                 | )          | (35,204  | )          |
|                                                        |       | 236,024                 |       | 194,307  |       |
| Deferred income tax  liabilities:                           |       |                    |       |     |       |
| Basis differences—purchase accounting and  intangibles |       | 170,644                 |       | 181,867  |       |
| Patent costs expensed for tax purposes                      |       | 16,267                  |       | 12,222   |       |
| Depreciation and amortization                               |       | —                  |       | 4,430    |       |
| Tax effect of unrealized other comprehensive income         |       | 19,364                  |       | 30,368   |       |
| Tax effect of contingent payment debt instrument            |       | 18,889                  |       | 22,446   |       |
| Other deferred income tax liabilities                       |       | —                  |       | 266      |       |
|                                                        |       | 225,164                 |       | 251,599  |       |
| Net deferred  income tax asset (liability)                  |       | $                       | 10,860     |     | $          | (57,292 | ) |

 

Theabove net deferred income tax asset (liability) has been reflected in theaccompanying Consolidated Balance Sheets as follows:
| ** **                                 | ** ** | **2004**                | ** ** | **2003** | ** ** |
|--------------------------------------------|------------|-------------------------|------------|----------|------------|
| ** **                                 | ** ** | **(In thousands)** | ** ** |
| Current asset                              |       | $                       | 71,287     |     | $          | 50,204 |   |
| Non-current liability                      |       | (60,427                 | )          | (107,496 | )          |
| Net deferred income tax  asset (liability) |       | $                       | 10,860     |     | $          | (57,292 | ) |

 

Chiron has permanentlyinvested approximately $117.0 million of earnings of certain foreignsubsidiaries outside the U.S. Should such earnings be remitted to the U.S.,additional U.S. taxes of approximately $24.1 million would accrue.

F-78

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**CHIRON CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) DECEMBER 31, 2004**

**Note19—Income Taxes (Continued)**

On October 22, 2004,the American Jobs Creation Act of 2004 (the Act) was signed into law. The Actincludes a temporary incentive for U.S. multinationals to repatriateaccumulated income earned outside the U.S. at an effective tax rate of 5.25%.On December 21, 2004, the FASB issued Staff Position 109-2, *Accounting and Disclosure Guidance for the ForeignEarnings Repatriation Provisions within the American Jobs Creation Act of 2004(*FSP 109-2*).*FSP 109-2 allows companies additional time to evaluate the effect of thelaw on whether unrepatriated foreign earnings continue to qualify forSFAS No. 109’s exception to recognizing deferred tax liabilities andwould require explanatory disclosures from those who need the additional time.Through December 31, 2004, Chiron has not provided deferred taxes on foreignearnings because such earnings were intended to be indefinitely reinvestedoutside the U.S. Whether Chiron will ultimately take advantage of thisprovision depends on a number of factors including reviewing futureCongressional guidance before a decision can be made. Until that time, Chironwill make no change in its current intention to indefinitely reinvestaccumulated earnings of its foreign subsidiaries. If it becomes apparent thatChiron will repatriate these earnings, a one-time tax charge to Chiron’sconsolidated results of operations could occur. That amount has not yet beendetermined and Chiron will continue to evaluate the matter in 2005.

The Act also includes anelimination of the tax benefit of the Extraterritorial Income Exclusion over 2005and 2006.

The net increase in thevaluation allowance for the years ended December 31, 2004, 2003 and 2002was $24.6 million,$21.1 millionand $13.2 million respectively, primarily attributable to acquired netoperating losses of Matrix Pharmaceutical in 2002 and ofPowderJect in 2003 as well as foreign net operating losses in 2003 and 2004 injurisdictions where Chiron has no history of taxable income.

*Tax Operating Loss and Credit Carryforwards*

At December 31, 2004,Chiron had foreign net operating loss carryforwards of approximately$351.5 million, substantially all of which is available to offset futuretaxable income without limitation. $154.1 million of the foreign net operatingloss carryforwards are also subject to valuation allowances as the use of thosecarryforwards are not considered to be more likely than not.

At December 31, 2004,Chiron had federal net operating loss carryforwards, attributable to theacquisition of Matrix Pharmaceuticalof approximately $46.5 million, which are available to offset futuredomestic taxable income ratably through 2021.

At December 31, 2004,Chiron had federal net operating loss carryforwards attributable to theacquisition of Sagres of$25.0 million. The available utilization of the net operating losses is limitedin any one year under provisions of the Internal Revenue Code. As such, asignificant portion of Sagres’s net operating loss carryforwards is expected toexpire unutilized.

At December 31, 2004,Chiron had $19.9 million of state net operating loss carryforwards, whichexpire between 2010 and 2023 and state net operating loss carryforwards,attributable to the acquisition of Matrix Pharmaceutical of approximately$24.6 million, which are available to offset future state taxable incomeratably through 2013 and state net operating loss carryforwards attributable tothe acquisition of Sagres ofapproximately $20.6 million which are available to offset future state taxableincome 

F-79

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**CHIRON CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) DECEMBER 31, 2004**

**Note19—Income Taxes (Continued)**

ratablythrough 2015. The available utilization of the net operating losses is limitedin any one year under provisions of the Internal Revenue Code. As such, asignificant portion of Sagres’s net operating loss carryforwards is expected toexpire unutilized.

At December 31, 2004,Chiron had state business tax credit carryovers of $28.5 million, whichare available to offset future state tax liabilities without limitation, andforeign business tax credit carryovers of $15.0 million.

**Note 20—QuarterlyFinancial Data (Unaudited)**

During Chiron’s year-end financialstatement review and Section 404 Sarbanes-Oxley review, Chiron determined that certain salesof the travel vaccine recorded as revenues in the second quarter of 2004 shouldnot have been recorded as revenue at that time, and that portions of thosesales should have been recorded as revenues in the third and fourth quarters of2004 and possibly in later quarters.

In the third quarter of2004, product sales were understated by $5.6 million, cost of sales wereunderstated by $0.9 million and income taxes were understated by $1.2 million.This resulted in a $3.5 million understatement of income from continuingoperations and net income and a $0.01 understatement of diluted income fromcontinuing operations per share ($0.14 pershare instead of the $0.13 pershare as previously reported).On the September 30, 2004 consolidated balance sheet, current portion ofunearned revenue was understated by $7.6 million and income taxes payable wasoverstated by $1.9 million.

In the second quarter of2004, product sales were overstated by $13.9 million, cost of sales wereoverstated by $1.5 million and income taxes were overstated by $3.1 million.This resulted in a $9.3 million overstatement of income from continuing operationsand net income and a$0.05 overstatement of diluted income from continuing operations per share ($0.12 per share instead of the $0.17 pershare as previously reported). On the June 30, 2004consolidated balance sheet, current portion of unearned revenue was understatedby $12.3 million and income taxes payable was overstated by $3.1 million.

F-80

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**CHIRON CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) DECEMBER 31, 2004**

**Note20—Quarterly Financial Data (Unaudited) (Continued)**

Income statement  informationpreviously reported in the second and third quarters of 2004 in our Quarterly Reports on Form 10-Qis restated as follows:
| ** **                                                                                                                 | ** ** | **2004**                                  | ** ** |
|----------------------------------------------------------------------------------------------------------------------------|------------|-------------------------------------------|------------|
| ** **                                                                                                                 | ** ** | **Sept. 30**                         | ** ** | **Sept. 30** | ** ** | **June 30** | ** ** | **June 30** | ** ** |
| ** **                                                                                                                 | ** ** | **Reported**                              | ** ** | **Restated** | ** ** | **Reported** | ** ** | **Restated** | ** ** |
| ** **                                                                                                                 | ** ** | **(In thousands, except per share data)** | ** ** |
| Total revenues                                                                                                             |       | $                                         | 523,967    |   | $ | 529,536 |   | $ | 393,623 |   | $ | 379,752 |   |
| Gross margin from  net product sales (Cost of sales excludes amortization expense related  to acquired developed products) |       | 132,358                                   |       | 137,023 |   | 164,367 |   | 151,993 |   |
| Income from continuing  operations:                                                                                        |       |                                      |       |   |   |   |   |   |   |
| Income                                                                                                                     |       | 23,948                                    |       | 27,447 |   | 32,093 |   | 22,812 |   |
| Basic income per share                                                                                                     |       | 0.13                                      |       | 0.15 |   | 0.17 |   | 0.12 |   |
| Diluted income per share                                                                                                   |       | 0.13                                      |       | 0.14 |   | 0.17 |   | 0.12 |   |
| Net income:                                                                                                                |       |                                      |       |   |   |   |   |   |   |
| Income                                                                                                                     |       | 23,498                                    |       | 26,997 |   | 44,552 |   | 35,271 |   |
| Basic income per share                                                                                                     |       | 0.13                                      |       | 0.14 |   | 0.24 |   | 0.19 |   |
| Diluted income  per share                                                                                                  |       | 0.12                                      |       | 0.14 |   | 0.23 |   | 0.18 |   |
|                                                                                                                            |            |                                           |            |  |  |  |  |  |  |  |  |  |  |

 
| ** **                                                                                                                 | ** ** | **2004**                                   | ** ** |
|----------------------------------------------------------------------------------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                                                                                                 | ** ** | ** **                                 | ** ** | **Sept. 30** | ** ** | **June 30** | ** ** | ** ** | ** ** |
| ** **                                                                                                                 | ** ** | **Dec. 31**                           | ** ** | **Restated** | ** ** | **Restated** | ** ** | **Mar. 31** | ** ** |
| ** **                                                                                                                 | ** ** | **(In  thousands, except per share data)** | ** ** |
| Total revenues                                                                                                             |       | $                                          | 434,395    |   | $ | 529,536 |   | $ | 379,752 |   | $ | 379,672 |   |
| Gross margin from  net product sales (Cost of sales excludes amortization expense related  to acquired developed products) |       | 155,255                                    |       | 137,023 |   | 151,993 |   | 154,365 |   |
| Income (loss) from  continuing operations:                                                                                 |       |                                       |       |   |   |   |   |   |   |
| Income (loss)                                                                                                              |       | (23,123                                    | )          | 27,447 |   | 22,812 |   | 26,927 |   |
| Basic income (loss) per share                                                                                              |       | (0.12                                      | )          | 0.15 |   | 0.12 |   | 0.14 |   |
| Diluted income (loss) per share                                                                                            |       | (0.12                                      | )          | 0.14 |   | 0.12 |   | 0.14 |   |
| Net income (loss):                                                                                                         |       |                                       |       |   |   |   |   |   |   |
| Income(loss)                                                                                                               |       | (23,123                                    | )          | 26,997 |   | 35,271 |   | 39,772 |   |
| Basic income (loss) per share                                                                                              |       | (0.12                                      | )          | 0.14 |   | 0.19 |   | 0.21 |   |
| Diluted income  (loss) per share                                                                                           |       | (0.12                                      | )          | 0.14 |   | 0.18 |   | 0.21 |   |
|                                                                                                                            |            |                                            |            |  |  |  |  |  |  |  |  |  |  |

 

F-81

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**CHIRON CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) DECEMBER 31, 2004**

**Note20—Quarterly Financial Data (Unaudited) (Continued)**
| ** **                                                                                                                 | ** ** | **2003**                                                           | ** ** |
|----------------------------------------------------------------------------------------------------------------------------|------------|--------------------------------------------------------------------|------------|
| ** **                                                                                                                 | ** ** | **Dec. 31**                                                   | ** ** | **Sept. 30** | ** ** | **June 30** | ** ** | **Mar. 31** | ** ** |
| ** **                                                                                                                 | ** ** | **(In thousands, except per share data)** | ** ** |
| Total revenues                                                                                                             |       | $                                                                  | 554,581    |   | $ | 540,473 |   | $ | 350,272 |   | $ | 321,035 |   |
| Gross margin from  net product sales (Cost of sales excludes amortization expense related  to acquired developed products) |       | 234,103                                                            |       | 258,294 |   | 148,508 |   | 133,031 |   |
| Income (loss) from  continuing operations:                                                                                 |       |                                                               |       |   |   |   |   |   |   |
| Income (loss)                                                                                                              |       | 117,963                                                            |       | (20,153 | ) | 61,459 |   | 61,069 |   |
| Basic income (loss) per share                                                                                              |       | 0.63                                                               |       | (0.11 | ) | 0.33 |   | 0.33 |   |
| Diluted income (loss) per share                                                                                            |       | 0.59                                                               |       | (0.11 | ) | 0.32 |   | 0.32 |   |
| Net income (loss):                                                                                                         |       |                                                               |       |   |   |   |   |   |   |
| Income (loss)                                                                                                              |       | 121,800                                                            |       | (18,979 | ) | 61,997 |   | 62,495 |   |
| Basic income (loss) per share                                                                                              |       | 0.65                                                               |       | (0.10 | ) | 0.33 |   | 0.33 |   |
| Diluted income  (loss) per share                                                                                           |       | 0.61                                                               |       | (0.10 | ) | 0.33 |   | 0.33 |   |
|                                                                                                                            |            |                                                                    |            |  |  |  |  |  |  |  |  |  |  |

 

Certain minor arithmeticalvariances between the table above and the Consolidated Financial Statements mayarise due to rounding.

Historically, Chiron’soperating results have varied considerably from period to period due to thenature of Chiron’s collaborative, royalty and license arrangements and theseasonality of the vaccine products. In addition, the mix of products sold andthe introduction of new products will affect the comparability of gross marginsfrom quarter to quarter. As a consequence, Chiron’s results in any one quarterare not necessarily indicative of results to be expected for a full year.

*Continuing Operations*

The recent developmentswith respect to FLUVIRIN vaccine, as discussed above, impacted our results ofoperations for the third and fourth quarter 2004. Chiron did not release anyFLUVIRIN product during the 2004-2005 influenza season. Chiron had no sales ofFLUVIRIN vaccine in 2004 (other than $2.3 million in late 2003-2004 seasonsales), while FLUVIRIN vaccine sales were $219.2 million in 2003. In the thirdquarter 2004, Chiron wrote-off the entire inventory of FLUVIRIN vaccine,resulting in a $91.3 million charge to cost of sales which decreased dilutedearnings per share by approximately $0.36 for the third quarter 2004. In thefourth quarter 2004, Chiron incurred remediation cost associated with ourLiverpool facility of $2.6 million and incurred legal expenses of $12.1 millionrelated to the FLUVIRIN developments discussed in Note 14 above, whichincreased diluted loss per share by approximately $0.06 for the fourth quarter2004.

On July 2, 2004,Chiron acquired Sagres  andChiron accounted for the acquisition as an asset purchase and included Sagres’soperating results in its consolidated operating results beginning on July 2,2004 (Note 5). Sagres is part of Chiron’s biopharmaceuticals segment. Chironallocated $9.6 million of the purchase price to purchased-in-process researchand development, which Chiron charged to earnings in the third quarter 2004.

In 2004, Chiron and Roche reached a settlementregarding our HIV patent in the U.S (Note 7).The settlement included a $78.0 million lump sum payment, of which $14.0 millionwas recognized in the third 

F-82

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**CHIRON CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) DECEMBER 31, 2004**

**Note20—Quarterly Financial Data (Unaudited) (Continued)**

quarter2004. In addition, the settlement resulted in $31.8 million of previouslydeferred royalties and license payments, which was recognized in the thirdquarter 2004. The impact of these revenue items from the Roche settlement wasan approximate $0.18 increase in diluted earnings per share in the thirdquarter 2004.

On June 12, 2004,certain LYONs holders, at their option, tendered $649.9 million in aggregateprincipal amount at maturity for purchase by Chiron. The purchase price for theLYONs was $584.31 in cash per $1,000 in principal amount at maturity. Theaggregate purchase price for all the LYONs validly surrendered for purchase was$379.7 million. At December 31, 2004, there remains outstanding $80.1million in aggregate principal amount at maturity and an accreted balance of$47.3 million for the LYONs.

On June 22, 2004,Chiron issued $385.0 million aggregate principal amount of convertibledebentures, which mature on June 30, 2034. The convertible debenturesaccrue interest at a rate of 2.75% per year and interest is payable on June 30and December 30 commencing on December 30, 2004.

On July 8, 2003,Chiron acquired PowderJect (Note 5), a company based in Oxford, Englandthat develops and commercializes vaccines. Total revenues for PowderJect were$128.2 million and $116.5 million in the fourth quarter 2003 and thethird quarter 2003, respectively. Gross margin from net product sales forPowderJect was $56.1 million and $69.6 million in the fourth quarter2003 and the third quarter 2003, respectively.

Chiron allocated$122.7 million of the purchase price to purchased in-process research anddevelopment, which it charged to earnings in the third quarter 2003. In thefourth quarter 2003, upon completion of strategic assessments of the value ofcertain research and development projects, Chiron revised the allocation of thepurchase price resulting in a $77.4 million decrease to purchasedin-process research and development which was offset to goodwill. Theamortization expense for the acquired intangibles associated with thisacquisition was $13.2 million and $12.1 million in the fourth quarter2003 and the third quarter 2003, respectively.

On July 30, 2003,Chiron issued $500.0 million aggregate principal amount of convertibledebentures, which mature on August 1, 2033. The convertible debenturesaccrue interest at a rate of 1.625% per year and interest is payable on February 1and August 1 commencing February 1, 2004.

*Discontinued Operations (Note 4)*

“Gain (loss) fromdiscontinued operations, net of taxes” included a settlement with BayerCorporation, primarily relating to a tax benefit as a result of the settlementpayment. This settlement resulted in a net gain of $12.8 million in the firstquarter of 2004.

“Gain (loss) fromdiscontinued operations, net of taxes” also included a settlement agreementbetween Chiron and the IRS closing the open tax years 1996 to 1998. Thissettlement resulted in a tax benefit of approximately $12.5 million in thesecond quarter 2004.

“Gain (loss) fromdiscontinued operations, net of taxes” included an income tax benefit of$3.8 million in the fourth quarter of 2003. The tax benefit related to thereversal of valuation allowances against deferred tax assets that wereestablished at the time of the sale of Chiron Diagnostics, as the timingdifferences for which such valuation allowances relate have now been reversedor written off.

F-83

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**SCHEDULE II**

**CHIRON CORPORATIONVALUATION AND QUALIFYING ACCOUNTS AND RESERVESYEARS ENDED DECEMBER 31, 2004, 2003 and 2002**
| **Description**                           | ** ** | ** **              | ** ** | **Balance at  Beginning      of Year    ** | ** ** | **Charged to  Costs and  Expenses,  Net of Reversals** | ** ** | ** Utilizations ** | ** ** | **Balance At  End  of Year** | ** ** |
|-------------------------------------------|------------|-------------------------|------------|----------------------------------------------------------------------------------------------|------------|----------------------------------------------------------------------------|------------|------------------------------|------------|----------------------------------------|------------|
| ** **                                | ** ** | **(In thousands)** | ** ** |
| 2004:                                     |       |                    |       |                                                                                         |       |                                                                       |       |                         |       |                                   |       |   |   |   |   |   |   |
| Product returns  and rebates allowance    |       |                    | $          | 26,850                                                                                       |       |                                                                       |       | $                            | 18,106     |                                   |       |   | $ | (18,245 | ) |   |   | $ | 26,711 |   |   |
| Other accounts  receivable allowance      |       |                    | 10,015     |                                                                                         |       |                                                                       | 17,662     |                         |       |                                   | (7,043     | ) |   |   | 20,634 |   |   |
| Inventory  reserves                       |       |                    | 35,117     |                                                                                         |       |                                                                       | 42,591     |                         |       |                                   | (6,099     | ) |   |   | 71,609 |   |   |
| Restructuring and  reorganization accrual |       |                    | 645        |                                                                                         |       |                                                                       | 2,519      |                         |       |                                   | (2,090     | ) |   |   | 1,074 |   |   |
| 2003:                                     |       |                    |       |                                                                                         |       |                                                                       |       |                         |       |                                   |       |   |   |   |   |   |   |
| Product returns  and rebates allowance    |       |                    | $          | 15,913                                                                                       |       |                                                                       |       | $                            | 19,537     |                                   |       |   | $ | (8,600 | ) |   |   | $ | 26,850 |   |   |
| Other accounts  receivable allowance      |       |                    | 7,630      |                                                                                         |       |                                                                       | 3,615      |                         |       |                                   | (1,230     | ) |   |   | 10,015 |   |   |
| Inventory  reserves                       |       |                    | 32,762     |                                                                                         |       |                                                                       | 13,314     |                         |       |                                   | (10,959    | ) |   |   | 35,117 |   |   |
| Restructuring and  reorganization accrual |       |                    | 334        |                                                                                         |       |                                                                       | 1,654      |                         |       |                                   | (1,343     | ) |   |   | 645 |   |   |
| 2002:                                     |       |                    |       |                                                                                         |       |                                                                       |       |                         |       |                                   |       |   |   |   |   |   |   |
| Product returns  and rebates allowance    |       |                    | $          | 11,489                                                                                       |       |                                                                       |       | $                            | 15,660     |                                   |       |   | $ | (11,236 | ) |   |   | $ | 15,913 |   |   |
| Other accounts  receivable allowance      |       |                    | 7,283      |                                                                                         |       |                                                                       | 1,869      |                         |       |                                   | (1,522     | ) |   |   | 7,630 |   |   |
| Inventory  reserves                       |       |                    | 26,892     |                                                                                         |       |                                                                       | 15,740     |                         |       |                                   | (9,870     | ) |   |   | 32,762 |   |   |
| Restructuring and  reorganization accrual |       |                    | 693        |                                                                                         |       |                                                                       | —     |                         |       |                                   | (359       | ) |   |   | 334 |   |   |

 

In addition, to the charges reflected above for 2004,Chiron wrote-off the entire inventory of FLUVIRIN product in 2004, resulting ina $91.3 million charge to cost of sales.

F-84

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