**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**Washington,D.C. 20549**

**FORM 10-K**

**(Mark one)**
| **x** | ** ** | **ANNUAL REPORT PURSUANT TO  SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT  OF 1934.** |
|-------|------------|----------------------------------------------------------------------------------------------------------------------|

 

**For the fiscal yearended December 31, 2005**

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

 

**For the transitionperiod from                                to                                 **

**Commission File Number: 0-12798**

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**CHIRON CORPORATION**

(Exact Name of Registrant as Specified in Its Charter)

| **Delaware**                                    | **94-2754624**           |
|-------------------------------------------------|--------------------------|
| (State or Other  Jurisdiction of                | (I.R.S. Employer         |
| Incorporation or  Organization)                 | Identification No.) |
| **4560  Horton Street, Emeryville, California** | **94608**                |
| (Address of  Principal Executive Offices)       | (Zip Code)               |

 

Registrant’sTelephone Number, Including Area Code:  **(510) 655-8730**

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Securities registered pursuant to Section 12(b) ofthe Act:**None**

Securities registered pursuant to Section 12(g) ofthe Act:

**Common Stock, $0.01 Par Value**

**Warrant to PurchaseCommon Stock, $0.01 Par Value**

Indicate by check mark if the registrant is awell-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes: x   No: o

Indicate by check mark if the registrant is notrequired to file reports pursuant to Section 13 or Section 15(d) ofthe Act. Yes: o   No: x

Indicate by check mark whether the registrant (1) hasfiled all reports required to be filed by Section 13 or 15(d) of theSecurities Exchange Act of 1934 during the preceding 12 months (or forsuch shorter period that the registrant was required to file such reports), and(2) has been subject to such filing requirements for the past90 days. Yes: x   No: o

Indicate by check mark if disclosure of delinquentfilers pursuant to Item 405 of Regulation S-K is not contained herein, andwill not be contained, to the best of registrant’s knowledge, in definitiveproxy or information statements incorporated by reference in Part III ofthis Form 10-K or any amendment to this Form 10-K. o

Indicate by check mark whether the registrant is alarge accelerated filer, an accelerated filer, or a non-accelerated filer. Seedefinition of “accelerated filer and large accelerated filer” in Rule 12b-2of the Exchange Act. (Check one):

| Large accelerated filer x |   | Accelerated filer o |   | Non-accelerated filer o |
|---------------------------|--------|---------------------|--------|-------------------------|

 

Indicateby check mark whether the registrant is a shell company (as defined in Rule 12b-2of the Exchange Act). Yes: o   No: x

The aggregate market value of the voting and non-votingstock held by non-affiliates of the registrant, based upon the closing price ofCommon Stock on June 30, 2005 as reported on the NASDAQ National Market,was approximately $2.9 billion. Shares of Common Stock held by eachexecutive officer and director and by each shareholder whose beneficialownership exceeds 5% of the outstanding Common Stock at June 30, 2005 havebeen excluded in that such persons may be deemed to be affiliates. Thisdetermination of affiliate status is not necessarily a conclusive determinationfor other purposes.

Theaggregate market value of voting and non-voting stock held by non-affiliates ofthe registrant as of January 31, 2006 was $3.4 billion. The number ofshares outstanding of each of the registrant’s classes of common stock as of January 31,2006:

| Title of Class      | ** ** | **Number of shares** |
|-------------------------------|------------|--------------------------------|
| Common Stock, $0.01 par value |       | 197,154,517                    |

 

**DOCUMENTS INCORPORATED BY REFERENCE**

Portions of the ProxyStatement to be filed in connection with the solicitation of proxies for theAnnual Meeting of Stockholders to be held on June 22, 2006 areincorporated by reference into Part 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, regulatory approval, new product marketing,acquisitions, litigation, competition, and licensing activities that involverisks and uncertainties and are subject to change. The forward-lookingstatements contained in this 10-K reflect our current expectations on thedate of this 10-K. Actual results, performance or outcomes may differmaterially from current expectations. Our actual performance may differ fromcurrent expectations due to many factors, including additional adversedevelopments 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 ofsuch suspension and the litigation and investigations relating to thesematters, the outcome of clinical trials, regulatory review and approvals,remediation activities, manufacturing capabilities, intellectual propertyprotections and defenses, stock price volatility and marketing effectiveness.In particular 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 the transaction contemplated by the merger agreement with Novartis AG willbe consummated. In addition, we may engage in business opportunities, thesuccessful completion of which is subject to certain risks, including approvalby Novartis, other stockholders, regulatory approvals and the integration ofoperations. We have discussed the important factors that we believe could causeactual results to differ from what is expressed in the forward-lookingstatements, 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: blood testing,vaccines, and biopharmaceuticals. Our revenues, which totaled $1.9 billion in2005, consist of product sales, revenues from a joint business contractualarrangement, collaborative agreement revenues, royalty and license fee revenuesand other revenues, primarily consisting of contract manufacturing and grantrevenues. Our research and development efforts are focused on developingproducts for oncology and infectious and pulmonary disease.

*Blood Testing*

Our Blood Testing segment is dedicated to improvingblood safety through the development and sale of novel blood-screening assaysand equipment that protect the world’s blood supply. Our Blood Testing segment,which reported total revenues of $555.7 million in 2005, is a world leader innucleic acid testing, or NAT, blood screening with a leading position in theU.S, and a strong presence in Europe and Asia. The segment also generatesrevenues from a joint business contractual arrangement, a collaborationagreement, royalties and license fees.

Our Blood Testing segment consists of two separatecollaborations: an alliance with Gen-Probe Incorporated (Gen-Probe) for NATproducts, and a joint business contractual arrangement with Ortho-ClinicalDiagnostics, Inc. (Ortho-Clinical Diagnostics) for immunodiagnosticproducts. Our collaboration with Gen-Probe was formed in 1998 and focuses ondeveloping and commercializing NAT products to screen donated blood, plasma,organs and tissue for viral infection. We sell the collaboration’s assays andinstruments to blood banks under the PROCLEIX® brand name. Our joint business contractualarrangement with Ortho-Clinical Diagnostics was formed in 1989 to develop andsell immunodiagnostic 

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tests to detectretroviruses and hepatitis viruses in blood. Ortho-Clinical Diagnosticsmanufactures and sells the assays and instrument systems. Chiron shares equallyin the profit of the contractual arrangement. Our Blood Testing segment alsoearns royalties and license fees from third parties based on their sales of immunodiagnosticand nucleic acid testing probe diagnostic products utilizing our hepatitis Cvirus and HIV-related patents, for use in blood screening and plasmafractionation markets.

Research and developmentis focused on programs to improve blood safety, including the development of anenzyme conversion system that converts groups A, B and AB red blood cells toenzyme-converted universal blood group O, and the development of ablood-screening assay for variant Creutzfeldt-Jakob disease (vCJD).

*Vaccines*

Our vaccines segment is the fifth largest vaccinesbusiness in the world with total revenues of $602.1 million in 2005. Weoffer approximately 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 influenza,polio, rabies and meningococcal disease. We market our vaccines primarily inthe United States, Germany, Italy and the United Kingdom.

Our heritage in vaccines is traced to the threeEuropean manufacturers we acquired over the past two decades, all of which wereoriginally founded 100 or more years ago: Italy-based Sclavo was acquired in1992, Germany-based Behring was acquired in 1998 and United Kingdom-based PowderJectPharmaceutical plc, or PowderJect, was acquired in July 2003. We acquiredFLUVIRIN® influenza virus vaccine as part of ouracquisition of PowderJect.

Our vaccines segmentresearch and development is focused on developing next generation influenza manufacturingcapability, including our cell culture derived influenza vaccine, developingnew vaccines for pandemic preparedness, and broadening our meningococcalfranchise.

*Biopharmaceuticals*

Our biopharmaceuticalssegment researches, 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 totalrevenues of $629.0 million for the year 2005. Our marketed products includeTOBI® tobramycin solution for inhalation, USP forpseudomonal lung infections in cystic fibrosis patients; PROLEUKIN® (aldesleukin) for injection for metastaticmelanoma and renal cell carcinoma; and BETASERON® (interferon beta-1b) for subcutaneousinjection for multiple sclerosis. In January 2006, the European Commissiongranted marketing approval to Chiron for CUBICIN® (daptomycin), a first-in-class IV antibiotic,adding another commercial product to our portfolio. The marketing approval wasgranted in the 25 member states of the European Union, Iceland, Liechtensteinand Norway. Under the approval, CUBICIN® is indicated for the treatment of complicatedskin and soft-tissue infections (cSSTI) caused by Gram-positive bacteria.Research and development efforts are focused in the areas of oncology andinfectious and pulmonary disease including the development of tobramycininhalation powder, or TIP, a new tobramycin product with an enhanced method ofdelivery and the clinical advancement of tifacogin for the treatment of severecommunity-acquired pneumonia. Our oncology pipeline includes CHIR-258, agrowth factor kinase inhibitor, CHIR-12.12, an anti CD-40monoclonal antibody and CHIR-265, a Raf kinase inhibitor.

*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® 

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(interferon beta-1b)for SC injection in Europe. Some royalties and license fees are not consideredto be associated with any particular business segment and are recordedseparately in the segment data as Other Royalty and License Fee Revenues.Financial information for the reportable segments is included in Note 18, “SegmentInformation” of Notes to Consolidated 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 on developingand commercializing NAT products using transcription-mediated amplification, orTMA, technology to screen donated blood, plasma, organs and tissue for viralinfection. Compared to immunodiagnostic testing, where infection is determinedby the presence of antibodies, testing directly for the presence of viralnucleic acids improves the sensitivity of testing and enables infection to bedetected earlier than with previously approved technologies.

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

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 Assay         |       | Marketed                             |       | Marketed    |       |
| PROCLEIX® WNV Assay               |       |                                 |       |        |       |
| (West Nile Virus)                           |       | Marketed                             |       | N/A         |       |
| PROCLEIX® ULTRIO® Assay |       |                                 |       |        |       |
| (HIV-1, HCV, and HBV)                       |       | Biologics License  Application filed |       | Marketed    |       |

 

The PROCLEIX® HIV-1/HCVAssay is a NAT product that was co-developed with Gen-Probe for thesimultaneous detection of HIV-1 and hepatitis C virus (HCV) inplasma, whole blood, organs and tissue donations. The global need for HIV-1and HCV testing continues to increase. Last year, approximately 5 millionpeople acquired HIV, bringing the number of people in the world living with HIVto 39 million, the highest level ever. Annually, approximately 3 million peopledie from AIDS, the disease caused by HIV infection. HCV is a major cause ofacute hepatitis and chronic liver disease, including cirrhosis and livercancer. Globally, an estimated 170 million persons are chronically infectedwith HCV and 3 to 4 million persons are newly infected each year. The majorcauses of HCV infection worldwide are use of unscreened blood transfusions, andre-use of needles and syringes that have not been adequately sterilized. ThePROCLEIX® HIV-1/HCVAssay received FDA approval in February 2002 and CE (ConformitéEuropéenne) Mark in Europe in January 2003 for use on the semi-automatedPROCLEIX® System. The PROCLEIX® HIV-1/HCV Assay and System arecommercially available in the United States and throughout Europe, Asia,Australia and New Zealand and are under evaluation in Latin America and severalAsian countries.

The PROCLEIX® ULTRIO® Assay is a premiumNAT product offering that adds the direct detection of hepatitis B virus (HBV)to the approved PROCLEIX® HIV-1/HCV Assay, allowing for threeresults to be obtained in the same amount of time using the sameinstrumentation. Over 350 million people worldwide are chronic carriers of HBV,with over 2 billion infected. HBV is the leading cause of liver 

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cancerin the world and is at its highest prevalence in Southeast Asia, SouthernEurope, India and Africa. The PROCLEIX® ULTRIO® Assay received CE Mark Registration in Europeon the semi-automated PROCLEIX® System in January 2004 and on the fullyautomated, high-throughput PROCLEIX® TIGRIS® System in December 2004. We filed aBiologics License Application (BLA) in September 2004 in the United Statesfor use of the PROCLEIX® ULTRIO® Assay on the PROCLEIX®  Systemand the PROCLEIX® TIGRIS® System. OnOctober 3, 2005, the FDA notified Gen-Probe that it considers the PROCLEIX® TIGRIS® System “notsubstantially equivalent’’ to the PROCLEIX® System for screeningdonated blood with the PROCLEIX® ULTRIO® Assay. Gen-Probeexpects to file an amended BLA to respond to the FDA’s questions contained inthis complete review letter.

The PROCLEIX® WNV (West NileVirus) Assay, a NAT product co-developed with Gen-Probe for the detection ofWNV in plasma, whole blood, organs and tissue has been available for sale inthe United States, under an Investigational New Drug, or IND, protocol andlabeled For Investigational Use Only since June 2003. In December 2005,we received marketing approval for the PROCLEIX® WNV Assay on the semi-automated PROCLEIX® System. Sincetesting began under the IND application through December 2005, thePROCLEIX® WNVAssay has detected more than 1,500 West Nile virus contaminated units ofdonated blood, potentially preventing over 4,500 transfusion transmissions ofthe virus. The current market for this product is North America (the UnitedStates & Canada), although European and Latin American medicalauthorities have expressed interest in conducting epidemiological studies.

Inaddition to assays, we also sell equipment under the Gen-Probe collaboration.Blood Testing equipment includes:

·       PROCLEIX® System;

·       PROCLEIX® TIGRIS® System; and

·       PROCLEIX® OPTIVATM System

The PROCLEIX® System is asemi-automated instrument platform that is manufactured by Gen-Probe andmarketed by Chiron and which has been commercially available since receivingFDA clearance in February 2002. The PROCLEIX® OPTIVATMSystem, is a set of modular components that automate several of the stepsperformed manually with the PROCLEIX® System. A portion of the PROCLEIX® OPTIVATM System, the Front-End Pipetor (FEP),received European CE Marking in June 2004. Another component, the PROCLEIX® OPTIVATM ReagentAddition Station (RAS), received CE Marking in April 2005. The PROCLEIX® TIGRIS® System, a nextgeneration, fully automated, high-throughput instrument platform, was launchedin Europe in December 2004. It is also available under IND for use withthe PROCLEIX® WNV Assay in the United States. The PROCLEIX® TIGRIS® System ismanufactured for Gen-Probe and marketed by Chiron. By increasing throughput andautomation, the PROCLEIX® TIGRIS® System is designed to allow smaller pool sizesand to enable individual donor testing (IDT) on a large scale, which isimportant for the detection of diseases with low viremic levels such as WestNile Virus and hepatitis B.

Through its joint businesscontractual arrangement with us, Ortho-Clinical Diagnostics sells a full lineof immunodiagnostic tests for hepatitis viruses and retroviruses and providessupplemental tests and microplate and chemiluminescent instrument systems toautomate test performance and data collection. We manufacture, and performresearch on, viral antigens used by Ortho-Clinical Diagnostics to manufactureimmunodiagnostic testing assays and supplemental hepatitis and HIV tests.Ortho-Clinical Diagnostics manufactures and sells the assays and instrumentsystems. Commercial products sold under the joint business contractual arrangementinclude RIBA® tests, which are immunodiagnostic 

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supplementalconfirmatory tests for HIV and HCV developed and manufactured by us, and a lineof immunodiagnostics screening tests for infectious diseases. We share equallyin the pretax operating earnings generated under the contractual arrangement.The joint business contractual arrangement holds the immunodiagnostic rights toour hepatitis and retrovirus patents and receives royalties from hepatitis Cvirus and HIV tests sold by Abbott Laboratories, Inc. and from hepatitis Cvirus tests sold by Bio-Rad Laboratories, Inc. and certain otherlicensees.

Sales of nucleic acidtesting products accounted for 14%, 14% and 11% of our consolidated totalrevenues in 2005, 2004 and 2003, respectively. Revenues related to ourarrangement with Ortho-Clinical Diagnostics, including the joint businesscontractual arrangement, accounted for approximately 9%, 9% and 8% of ourconsolidated total revenues in 2005, 2004 and 2003, respectively.

*Vaccines*

Our vaccines segment offersapproximately 20 influenza, meningococcal, travel, and pediatric and othervaccines. In our influenza franchise, our established brands include FLUVIRIN® vaccine, AGRIPPAL® vaccine, BEGRIVACTMvaccine, and FLUAD® vaccine. Influenza, a contagious diseasecaused by the influenza virus, affects the respiratory tract, and can causemild to severe illness, and sometimes death. Each year in the United States, onaverage 5% to 20% of the population get influenza, more than 200,000 people arehospitalized from influenza complications, and about 36,000 people die.

In July 2003, weacquired United Kingdom based PowderJect and commenced sales of FLUVIRIN® vaccine, a trivalentinfluenza vaccine. The vast majority of FLUVIRIN® vaccine production has been supplied to theU.S. market.

We manufacture AGRIPPAL® S1 and BEGRIVACTMtrivalent influenza vaccines and FLUAD® MF59 adjuvanted influenza vaccine in ourItalian and German facilities and market them outside of the United States,largely in Europe. In 2005, we also distributed ENZIRA® influenza virus vaccine in the United Kingdom.ENZIRA® vaccine is manufactured by CSL Ltd. InJuly 2005, Chiron reported that it would be unable to supply any BEGRIVACTMvaccine doses for the 2005-2006 influenza season due to a productsterility issue and wrote off its existing product inventory. Investigation ofthe product sterility issue has been completed and implementation of remedialmeasures and facility modifications is underway. In addition to our approvedinfluenza virus vaccines, subsequent to December 31, 2005, we began tomanufacture H5N1-strain candidate influenza virus vaccines under contractfor various government pandemic stockpile programs.

In our meningococcalfranchise, we sell MENJUGATE® vaccine, a conjugate vaccine againstmeningococcal disease caused by the bacterium *N.meningitidis* serogroup C, and MENZBTM, a meningococcal B vaccinedeveloped to protect against a specific meningococcus B strain responsible fora 13-year epidemic in New Zealand. Invasive infection with the bacteria *N. meningitidis* can lead to meningococcalmeningitis and septicemia (blood poisoning). Meningococcal meningitis can becaused by multiple serogroups (A, B, C, W, Y and others) and is associated withboth mortality and morbidity. We have sold MENJUGATE® vaccine under a tender system to nationalgovernments and health systems in a variety of countries including variousEuropean countries, Canada, Argentina and Australia. We have sold MENZBTM in NewZealand.

Our travel vaccinesfranchise includes RABAVERT® and RABIPUR® rabies vaccines and ENCEPURTM, apreservative-free tick-borne encephalitis vaccine.

Our pediatric and other vaccines include DTP, adiphtheria, tetanus and pertussis (whooping cough) vaccine; oral polio vaccine;and Vaxem Hib, glycoconjugate*HaemophilusInfluenzae* vaccine. In 2000, we entered into agreements withSanofi-Aventis (previously Aventis Pasteur MSD) for the distribution of FLUAD® vaccine andMENJUGATE® vaccine. Under the agreements, we market FLUAD® vaccine alone andwe co-promote MENJUGATE® vaccine with Sanofi-Aventis in the UnitedKingdom and

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Ireland. In the rest of Europe, Sanofi-Aventisdistributes, co-markets and sells FLUAD® vaccine and MENJUGATE® vaccine under its own labels, ADIUGRIPTM andMENINVACTTM respectively. Our primary manufacturing facilities for vaccines arelocated in: Siena, Italy; Marburg, Germany; Liverpool, UK; and Ankleshwar,India. We mainly operate in India through a joint venture, Chiron BehringVaccines Private Limited.

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. Wealso supply diphtheria and tetanus (DT) concentrate to GlaxoSmithKline for usein its DT-containing vaccines licensed by the FDA.

In addition, we market our vaccines in other Europeancountries and in the Middle East, the Far East, Africa and South America, andto international health agencies such as UNICEF and the Pan American HealthOrganization.

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 influenzavaccine franchise products accounted for approximately 12%, 9%, and 19% of ourconsolidated total revenues in 2005, 2004 and 2003, respectively. In 2005,2004, and 2003, sales of FLUVIRIN® vaccine accounted for 5%, 0%, and 12% of ourconsolidated total revenues. As a result of the MHRA’s suspension of ourlicense to manufacture FLUVIRIN® vaccine from October 5, 2004 throughMarch 2, 2005, we had no sales of FLUVIRIN® vaccine in 2004 other than $2.3 million inlate 2003-2004 season sales. Sales of pediatric and other vaccinesaccounted for approximately 9%, 12% and 11% of our consolidated revenues in2005, 2004 and 2003, respectively. No other single vaccine product or class ofvaccine product accounted for 10% or more of our consolidated total revenues inany of the last three fiscal years.

On March 16, 2006, weannounced a recall and withdrawal of MORUPAR®,our measles, mumps and rubella (MMR) vaccine. We previously supplied MORUPAR® vaccine to customers in a limited numberof developing countries, largely via the United Nations Children’s Fund(UNICEF) and the Pan American Health Organization (PAHO), and to Italy.  Resultsof pharmacovigilance surveillance in Italy suggest that MORUPAR® vaccine may beassociated with a higher reported rate of adverse events following immunizationthan other MMR vaccine products.  Weexpect to work with the World Health Organization (WHO) to assist it inconducting a risk-benefit analysis to determine whether UNICEF or PAHO willrequire a limited quantity of the existing inventory of MORUPAR® vaccine fortheir ongoing public health programs.  We have written-off in 2005 approximately$6.0 million of MORUPAR® inventory as a result of the withdrawal andrecorded approximately $1.7 million of product returns reserves in 2005 inconnection with expected returns of 2005 product sales from the recall.

*Biopharmaceuticals*

Our biopharmaceuticalsegment discovers, develops, manufactures and markets a range of therapeuticproducts primarily for cancer and infectious and pulmonary disease. Thefollowing describes our primary marketed products.

*TOBI**®* tobramycin solution for inhalation, USP—*We*manufacture andmarket TOBI® solution, a stable, premixed, proprietaryformulation of the antibiotic tobramycin for delivery by inhalation using anebulizer. TOBI® solution has been tested and approved forcystic fibrosis patients with*Pseudomonasaeruginosa* lung infections and is the first and only inhaledantibiotic solution to be approved by the FDA 

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for cysticfibrosis. Cystic fibrosis is caused by a genetic mutation that prevents cellsfrom building a special protein required for normal movement of sodium chloride(salt) in and out of cells lining the lungs and other organs. This abnormalmovement causes secretion of thick, sticky mucus in the airways. This mucus isnot cleared from the airways and, as a result, bacteria begin to grow, causinginfection.*Pseudomonas aeruginosa*is the most common bacterium causing lung infections in people with cysticfibrosis. 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. Treatment with TOBI® solution decreasesthe bacterial load and improves overall lung function. We market the TOBI® solution in theUnited States, the European Union, Canada, Switzerland, Norway, Israel,Argentina and Brazil.

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

While the preciseanti-tumor mechanism of PROLEUKIN® (aldesleukin) is unknown, research hasdemonstrated that PROLEUKIN® (aldesleukin) induces the proliferation ofimmune cells, including natural killer and cytotoxic T cells that can recognizeand mobilize against tumor-specific antigens on the surface of malignant cells.We market PROLEUKIN® (aldesleukin) directly or through distributorsin the United States and over 50 other countries in North America, Europe, Asiaand South America to treat metastatic renal cell carcinoma (a type of kidneycancer), and in the United States and Canada to treat metastatic melanoma (aform of skin cancer). Studies have demonstrated that PROLEUKIN® (aldesleukin) offers the possibility of acomplete and long-lasting remission in these diseases.

*BETASERON**®* (interferon beta-1b) for SC injection—*We*manufactureBETASERON® (BETAFERON® in Europe) interferon beta-1b which ismarketed by Schering AG and its affiliates, including BerlexLaboratories, Inc. (collectively, “Schering”). Boehringer Ingelheim alsosupplies BETAFERON® interferon beta-1b to Schering for salein Europe. Multiple sclerosis is an autoimmune disease in which the patient’simmune system attacks and destroys an element of the patient’s own central nervoussystem. The active ingredient in BETASERON® is a modified form of a beta interferonproduced naturally by the human body. Interferons help to regulate the immunesystem, and BETASERON® interferon beta-1b is thought to helpslow down the immune system’s attack on nerve tissue. While the ways in whichBETASERON® interferon beta-1b actually affectsmultiple sclerosis are not clearly understood, it has been demonstratedclinically that BETASERON® interferon beta-1b may decrease thenerve damage associated with multiple sclerosis. It has been shown to reducethe overall frequency of multiple sclerosis relapses, which are also calledexacerbations or attacks, as well as the number of moderate and severerelapses. BETASERON® interferon beta-1b is approved forrelapsing/remitting multiple sclerosis in over 70 countries, including theUnited States 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, weand Schering AG launched a room temperature formulation of BETASERON® interferon beta-1b,which is the only beta interferon currently marketed in the United States thatcan 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 United Statesin January 2004 and in Japan in December 2003. On February 24,2006 Schering AG notified Chiron of its intention to exercise its option underthe companies’ Regulatory Filing, Development and Supply Agreement to purchaseor lease all assets used by Chiron in the manufacture for Schering of BETASERON® interferon beta-1b products and all contractualrights at their fair market or lease value. The purchase/lease option issubject to the closing of the 

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proposedacquisition of Chiron by Novartis AG. The agreement requires that the value bedetermined by an independent third party mutually agreed upon by both parties.

* *

*CUBICIN**®* (daptomycin)—*In* January 2006,European Commission granted marketing approval to Chiron for CUBICIN®, a first-in-class IV antibiotic. The marketing approvalwas granted in the 25 member states of the European Union, Iceland,Liechtenstein and Norway. Under the approval, CUBICIN® is indicated for the treatment of complicatedskin and soft-tissue infections (cSSTI) caused by Gram-positive bacteria. TheCUBICIN® antibiotic is also approved by the FDA for thetreatment of complicated skin and skin structure infections caused byGram-positive bacteria, and is marketed in the United States by CubistPharmaceuticals, Inc. We acquired marketing rights to the antibiotic forcertain countries outside of the United States from Cubist. CUBICIN® antibiotic ismanufactured for us by Cubist Pharmaceuticals, Inc.

*CARDIOXANETM dexrazoxane (ICRF-187)**—Dexrazoxane*is the only cardioprotectant indicated to preventcardiac damage induced by anthracyclines, a group of chemotherapy medicationsused to treat a variety of cancers. CARDIOXANETM dexrazoxane is currentlyapproved in 31 countries in over four continents. 

Our biopharmaceutical products are manufacturedprimarily in our Emeryville, California and Vacaville, California facilities. Salesof TOBI® formulation accounted for approximately 12%,12% and 10% of our consolidated total revenues in 2005, 2004 and 2003,respectively. Revenues from BETASERON® interferon beta-1b, which includeproduct sales to Schering and royalties earned on Schering’s European sales ofBETAFERON® interferon beta-1b, accounted forapproximately 11% (7% product sales and 3% royalties), 11% (8% product salesand 3% royalties) and 11% (7% product sales and 4% royalties) of ourconsolidated total revenues in 2005, 2004 and 2003, respectively. No otherbiopharmaceutical product accounted for 10% or more of our consolidated totalrevenues 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 often out-licensed to othercompanies.

*Blood Testing*

Chiron pursues research and development of assays fortransfusion-transmitted diseases, such as variant Creutzfeldt-Jakob disease(vCJD). In August 2004, we supplemented our existing vCJD research anddevelopment 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.

We moved beyond BloodTesting and into the broader realm of blood safety when we entered into acollaboration with ZymeQuest in 2003 to develop and commercialize ZymeQuest’senzyme conversion system. This system is designed to convert groups A, B and ABred blood cells to enzyme-converted universal blood group O (ECO). Thistechnology could fill a critical need for blood and transfusion centers sincebetween 5% and 10% of the global donated blood supply is discarded each yeardue to non-matches between donated blood and patients’ blood type requirements.We made an equity investment in 

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ZymeQuestand obtained worldwide marketing and commercial rights to the technology. In2005 we initiated the pre-pivotal clinical trial for the conversion of type Ared blood cells to ECO, or A-ECO.

*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 mayoffer significant advantages over traditional methods of influenza vaccinemanufacturing by eliminating the dependence on chicken eggs for production. Theremoval of egg supply lead times may enable a more flexible start-up of vaccineproduction in the event of an annual vaccine supply shortfall or an avianinfluenza pandemic. In Europe, we completed an initial Phase 3 study of ourinfluenza cell culture vaccine in the 2004-2005 influenza season, inwhich the vaccine demonstrated satisfactory safety and immunogenicity, and weare conducting the remainder of the Phase 3 program during the 2005-2006influenza season. In the United States we are conducting Phase 1 / Phase 2studies during the 2005-2006 influenza season.

World health agencies are concerned about recentoutbreaks of highly pathogenic avian influenza in poultry and a limited numberof humans and are concerned that the present situation could give rise toanother influenza pandemic. In 2004, we were awarded contracts by the NationalInstitutes of Health (NIH) for production of H5N1 and H9N2 candidate vaccines,to be used by the National Institute of Allergy and Infectious Diseases (NIAID)in clinical studies of safety and immunogenicity. The H9N2 candidate vaccinestudy was completed, using H9N2 antigens with and without Chiron’s adjuvantMF59, and preliminary data indicated that the vaccine formulations containingthe adjuvant MF59 proved highly immunogenic, inducing antibody levels believedto confer protection against the influenza strain while the unadjuvantedvaccine induced significantly lower antibody titers. The NIAID study using ourH5N1 candidate vaccine is ongoing. We have entered into supply contracts withseveral governments, including the U.S. and the UK governments, for influenzavaccines for stockpiles based on the H5N1 avian influenza strain. Thecommercial potential for stockpiling is unclear due to among other things, thefact that larger demands would require greater capacity, the fact thatproduction for stockpiling can only occur between normal seasonal campaigns,and government pressure on pricing. There are also technical obstacles thatneed to be addressed in order to produce a commercial pandemic vaccine.

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 is associated with infections affecting 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 andpersons in close living quarters such as college dorms or military facilitiesare at highest risk for meningococcal disease.

Serotype B, along with serotypes A, C, W and Y causeapproximately 95% of the meningococcal infections worldwide. Multivalentvaccines are effective against more than one serotype. We are developing atetravalent conjugated vaccine against serotypes A, C, W and Y and we arecompleting Phase 2 studies of this ACWY vaccine in a variety of age groups,including ages under two.

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. While ourcurrent meningococcal B product, MENZBTM is efficacious against only a singlestrain of meningococcal B, we are also developing a second-generation vaccinecandidate utilizing our novel genomic approach against Meningococcus B, adisease for which no broadly efficacious vaccine is currently available. Ourmeningococcal B vaccine was in a Phase 1 clinical trial in 2005.

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Through collaborations, weare obtaining human safety and immunogenicity information on hepatitis Cvirus vaccine candidates, and our vaccine against HIV, which is in Phase 1testing in collaboration with NIH. We are also developing novel adjuvants,compounds that amplify the immune response generated by vaccine antigens.

*Biopharmaceuticals*

Research and developmentin the biopharmaceutical segment focuses on protein and small moleculetherapies for cancer and infectious and pulmonary disease.

*Infectious andPulmonary Disease*

*Tifacogin(recombinant Tissue Factor Pathway Inhibitor)—**Tifacogin*acoagulation inhibitor, was developed in collaboration with Pfizer, Inc. InOctober 2003 we acquired all of Pfizer, Inc.’s interest in tifacogin,in return for which Pfizer will receive royalties on sales of tifacogin. In2004 we initiated CAPTIVATE, a Phase 3 trial for tifacogin in patients with severecommunity-acquired pneumonia (CAP). CAP is a serious infection of the lungscaused by various, well-defined pathogens. Severe CAP affects approximately300,000 patients in the United States annually requiring ICU admission, of whomapproximately 30 percent die. In December 2005 an independent DataMonitoring Committee completed an interim analysis of clinical data from thestudy and recommended the continuation of the study.

*Tobramycin inhalationpowder (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 Nektar’snew hand-held, fully portable device. We are currently conducting Phase 3clinical trials of the product.

*Oncology*

Using a translational-medicine approach to drugdevelopment, Chiron’s research department continues to feed a growing oncologypipeline, which includes CHIR-258, CHIR-12.12 and CHIR-265.

*CHIR-258(growth factor kinase inhibitor)—**CHIR-258* is anovel, orally available, highly selective, multi-targeted receptor tyrosinekinase inhibitor, which acts on both tumor cell growth and angiogenesis. As ofJanuary 2006, disease-specific Phase 1 studies of CHIR-258 areongoing in acute myelogenous leukemia (AML), multiple myeloma and melanoma.

*CHIR-12.12—**CHIR-12.12 is a novel, highlypotent, fully human antagonist monoclonal antibody that targets the CD40antigen*. In 2005, we initiated two Phase 1 studies of CHIR-12.12- one in patients with chronic lymphocytic leukemia and a second in patientswith multiple myeloma, both types of cancer that are associated with expressionof the CD40 antigen on the cancer cell surface. This is the first project beingdeveloped under our collaboration agreement with XOMA Ltd. for thecommercialization of therapeutic antibodies for cancer.

CHIR-265*—*In December 2005 we filed an IND forCHIR-265, a novel, orally available, highly selective Raf kinaseinhibitor.

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

Research and developmentexpenses for the years ended December 31, 2005, 2004 and 2003 forChiron-sponsored research, including payments to collaboration partners, were$433.9 million, $431.1 million and $409.8 million, respectively.Under contracts where we recognize revenue based upon research and developmentwork performed, the revenues amounted to $16.3 million, $20.9 million and$16.8 million in 2005, 2004 and 2003, respectively. We recorded these revenuesin “Collaborative agreement revenues” and “Other revenues” in the ConsolidatedStatements of Operations. Generally, 

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theserevenues include fees for research services as they are performed or completedand milestone payments upon attainment of specified benchmarks.

***Business Relationships***

We have important businessrelationships with various companies, including the following.

*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,organs and tissue for viral infection. PROCLEIX® assays and systems incorporate NAT technologyto detect viral RNA and DNA in donated blood and plasma during the very earlystages of infection, when those infectious agents are present but cannot bedetected by immunodiagnostic tests. Gen-Probe manufactures the NAT assays andcertain instruments, and Chiron sells both assays and instruments under thePROCLEIX® brand name. Effective January 1, 2004,under an amendment to the worldwide blood screening collaboration agreementwith Gen-Probe, permanent, fixed revenue sharing percentages were adopted foreach party. Gen-Probe’s share was set at 45.75% of net revenues for assays thatinclude a test for the hepatitis C virus. For commercial assays, that do nottest for hepatitis C virus, such as the West Nile Virus assay, each partyreceives 50% of the net revenues after 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 business contractualarrangement. Our joint business arrangement with Ortho-Clinical Diagnostics isoperated under a contractual arrangement and is not a separate and distinctlegal 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.

*Cubist Pharmaceuticals*

In October 2003, weentered into a license agreement for the development and commercialization ofCubist’s antibiotic, CUBICIN® daptomycin, in Western and Eastern Europe,Australia, New Zealand, India and certain Central American, South American andMiddle Eastern countries. Under the agreement, we are obligated to pay upfrontpayments, regulatory and sales milestones, and a tiered royalty on CUBICIN® daptomycin salesin the territories.

*Schering AG andBerlex Laboratories, Inc.*

Chiron and Berlex, Inc., a subsidiary of ScheringAG of Germany, jointly developed BETASERON® (BETAFERON® in Europe) interferon beta-1b. Under theterms of the Regulatory Filing, Development and Supply Agreement with ScheringAG, BETASERON® product is manufactured by us and sold in theUnited States and Canada by Berlex. BETAFERON® interferon beta-1b is manufactured by usand Boehringer Ingelheim and is sold by Schering AG in Europe. BETAFERON® and BETASERON® revenuesrecognized under this agreement contributed 11% of our consolidated totalrevenues in each of 2005, 2004 and 2003. Under the agreement, for productmanufactured by us and marketed by Schering AG 

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and its affiliates,including Berlex, we receive revenue, which is recorded as product sales. Forproduct manufactured by Boehringer Ingelheim and marketed by Schering in Europeunder the trade name BETAFERON®,we receive royalties net of Schering’s supply costs. The Regulatory Filing,Development and Supply Agreement expires in October 2008 unless renewed.On February 24, 2006 Schering AG notified Chiron of its intention toexercise its option under the Regulatory Filing, Development and SupplyAgreement to purchase or lease all assets used by Chiron in the manufacture forSchering of BETASERON® interferon beta-1b products and allcontractual rights at their fair market or lease value. The purchase/leaseoption is subject to the closing of the proposed acquisition of Chiron byNovartis AG. The agreement requires that the value be determined by anindependent third party mutually agreed upon by both parties.

*NektarTherapeutics, Inc.*

In December 2001, weentered into a collaboration with Nektar (then operating as Inhale TherapeuticSystems) to develop and register an inhalable dry-powder formulation of theantibiotic tobramycin as an extension of our TOBI® formulations franchise. Under the terms of thecollaboration, Nektar is responsible for development of the dry powderformulation and inhalation device, as well as supplying drug product forclinical trials and the market. Chiron is responsible for all other aspects ofdrug development including clinical trial conduct, regulatory submissions,preparation for product launch and sales and marketing of the final drugproduct. Under the agreement, we are obligated to pay upfront payments anddevelopment milestones, and we will pay royalties when the product iscommercialized.

*XOMA Ltd.*

We have a worldwide,exclusive, multi-product, collaborative agreement with XOMA for the developmentand commercialization of antibody products for the treatment of cancer. Underthe terms of the agreement, we and XOMA agreed to jointly research, develop,and commercialize multiple antibody product candidates. Under the agreement, wealso share development and commercialization expenses, including preclinicaland clinical development, manufacturing and worldwide marketing costs, as wellas revenues, generally on a 70-30 basis, with Chiron’s share being 70%and XOMA’s share being 30%. We made an initial payment of $10.0 million,and have made a loan facility of up to $50.0 million available to XOMA,starting on January 1, 2005 to fund 75% of XOMA’s share of developmentexpenses. Under this arrangement, we made $12.1 million in loan advances toXOMA as of December 31, 2005.

***Commercialization***

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

·       We market and distributecertain products, either directly or through distributors. See “Sales andMarketing” below.

·       We develop other productsin collaboration with third parties. Under collaboration agreements, marketingrights may be assigned to us or to the collaborator or shared by both parties.In the event rights are assigned to us, we generally pay royalties to or enterinto revenue split agreements with our collaborator. In the event marketingrights are assigned to the collaborator, we often retain the right tomanufacture and supply key raw materials.

·       We license othertechnologies to third parties, with the licensee assuming responsibility forfurther development. We generally receive royalties on sales of the resultingproduct. Selected agreements under which we currently derive royalty revenuesfor technologies licensed to third parties include:

·        Licensesto F. Hoffmann-La Roche Ltd. 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.

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·        Anagreement with Schering AG relating to BETASERON® (BETAFERON® in Europe) interferon beta-1b asdescribed above.

·        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 agreement with Laboratory Corporation of America Holdings (LabCorp) andits affiliates, for our HCV intellectual property for nucleic acid testing(NAT).

·        Anon-exclusive license agreement with the Blood Transfusion Centers of theGerman Red Cross (Blutspendediensten des Deutsche Rotes Kreuz, or DRK), for theuse of our HCV technology for use in molecular probe “homebrew” bloodscreening.

***Sales and Marketing***

*Blood Testing*

Global marketing and distribution and our U.S. salesorganization for nucleic acid testing products are based in Emeryville,California. Blood Testing has representatives around the world. Internationalsales are conducted out of regional offices, including our primary officeslocated in Paris, France and Hong Kong, China. We sell products to the public sectorthrough tenders (a bid solicitation process) and to private sector blood banksdirectly and through distributors.

In 2002, we signed a multi-year agreement with theAmerican Red Cross, which collects approximately 50% of the 14 to 15 millionunits of blood collected in the United States each year. Under that agreement,the American Red Cross purchases from Chiron certain products, instrumentationand services that enable the American Red Cross to perform amplified nucleicacid screening on the blood it collects. Currently we are a party to multi-yearcontracts awarded through the tender process with the public sector bloodservices of many countries outside the United States, with the most significantin terms of donations being Australia, Italy, South Africa and the UnitedKingdom.

*Vaccines*

Our vaccines marketing andsales organization is based in Marburg, Germany for the German market, inSiena, Italy for the Italian market, and in Oxford, United Kingdom for theUnited Kingdom market. In 2004, we established a U.S. Vaccines headquarters inPhiladelphia, Pennsylvania. In general, we market our influenza and rabiesvaccines in the United States through a network of wholesalers and distributors.In the United States our direct sales efforts are focused on public health,distributor channels, and non-traditional channels, e.g., employers, chain drugheadquarters and service providers. Internationally, our direct sales effortsare focused on pediatricians and general practitioners. We also sell productsto the public sector through tenders and to private sector pharmacies directlyand through wholesalers and distributors.

*BioPharmaceuticals*

Our biopharmaceuticalmarketing and sales organization for the United States is headquartered inEmeryville, California, and European operations are headquartered in Uxbridge,United Kingdom. We focus our sales efforts on specialist physicians,principally oncologists, urologists and pulmonologists, who are based inhospitals and large clinics. Generally, we sell products to wholesalers,distributors, clinics and hospital pharmacies.

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***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 marketing,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 acquiretechnologies from these entities also is intensifying. We actively collaboratewith such entities in research, and have and will continue to license theirtechnologies for further development. However, these institutions also competewith us to recruit scientific personnel and to establish proprietary positionsin technology.

*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-La Roche, 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 introduce policies and mandates that require thisnew technology to be implemented as an additional measure to improve bloodsafety. In developing countries there has been a move to implement nucleic acidbased tests in the private health care sector and we anticipate this expandingto the public arena over the next several years. Competition in this sector isthe same as in the developed countries.

We are the solemanufacturer of hepatitis C virus antigens for use in immunodiagnosticassays sold by the joint business contractual arrangement with Ortho-ClinicalDiagnostics. 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 diagnosticapplications. Many other companies, including F. Hoffmann-LaRoche Limited andBayer Corporation, are significant competitors with respect to these products.

*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 is 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 vaccine cell culture manufacturing technology.

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The competitive factors in vaccines are proven abilityto supply product, price, the introduction of new products including vaccinesagainst diseases for which no vaccine was previously available and newcombination vaccines which can prevent several diseases in a single product.Public health authorities, medical practitioners and patients frequently favorcombination vaccines, particularly in pediatric vaccines, because theyeliminate the need for multiple injections and may increase overall compliancewith recommended vaccination schedules. As new combination vaccines areintroduced, older combinations and single products often become obsolete. Wemay be limited in our ability to develop and market certain combinationvaccines if one of the vaccines, which would otherwise be included in thecombination, is covered by valid and enforceable patents or other proprietaryrights held by third parties.

Prior to the suspension of our Liverpool manufacturinglicense from October 5, 2004 through March 2, 2005, we were one oftwo primary suppliers of influenza vaccine to the United States. Although the licensesuspension has been lifted, our inability to supply FLUVIRIN® vaccine during the2004-2005 influenza season has led a competitor to introduce an influenzavaccine product in the United States during the 2005-2006 season and weexpect competition to continue to increase. Our influenza vaccines approved inEurope also remain competitive there. Competition varies by region according toproduct license approvals. All influenza vaccines producers, including us, facean annual change in influenza strains, which can act as a barrier for newcompetitors.

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

*Biopharmaceuticals*

*TOBI**®* tobramycin solution for inhalation isthe first and only inhaled antibiotic solution to be approved by the FDA forthe treatment of infection associated with cystic fibrosis. The use of oral andintravenous antibiotics to treat pseudomonal and other bacterial infections iswell established and in cystic fibrosis patients with pseudomonal lunginfections, tobramycin is the most commonly used intravenous antibiotic. Theadvantage of inhalation is that it permits higher antibiotic concentrations inthe lung and reduces side effects by limiting systemic exposure. Competitivemedical therapies include generic antibiotics, anti-inflammatory drugs,pharmacist compounded tobramycin solutions, oral replacement enzymes tomaintain nutrition and mucolytics to clear pulmonary secretions. In 2005,Chiesi, a competitor, obtained MRP positive opinion and local approval in Italyfor their cystic fibrosis product.

*PROLEUKIN**®* (aldesleukin) for injection is one oftwo products approved by the FDA to treat metastatic renal cell carcinoma andalso one of two approved treatments for metastatic melanoma. In addition tolongstanding competition for products, such as alpha interferons sold bySchering-Plough Corporation, recent years have been marked by heightenedclinical trial activity that has expanded treatment options for patients,particularly in the area of kidney cancer. Enrollment in these trials andrelated off-label use has reduced the new patient population available forPROLEUKIN® (aldesleukin) in 2005. In December 2005,an orally available kinase inhibitor, Nexavar, jointly sold by Bayer HealthCareand Onyx Pharmaceuticals, was the first of these products previously availablein clinical trials to obtain marketing approval from the FDA to treat kidneycancer patients. This was followed by FDA approval, in January 2006, ofPfizer’s Sutent (sunitinib), an anti-cancer treatment for patients advancedkidney cancer and with gastrointestinal stromal tumors (GIST), a rare stomachcancer. We expect competitive pressures from newly approved products andproducts currently in clinical trials to continue in the future.

*BETASERON**®* (interferon beta-1b) for SC injection,as a treatment for multiple sclerosis, competes with AVONEX®,a recombinant beta interferon, sold by Biogen Idec, Inc., REBIF®, a recombinant beta interferon, from Serono, S.A.(Serono), marketed and sold in the United States by Pfizer Inc., andCOPAXONE® glatiramer acetate injection from TevaPharmaceutical Industries, Ltd. NOVANTRONE® 

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mitoxantrone for injectionconcentrate is marketed and sold by Serono for the treatment of secondaryprogressive multiple sclerosis. In addition, BETASERON® interferon beta-1bcompeted for a number of months with TYSABRI®,a humanized monoclonal antibody which was marketed by Biogen Idec, Inc.and Elan Pharmaceuticals until marketing was suspended by these companies in February 2005.The multiple sclerosis market is highly competitive, and will remain so asvarious other companies have treatments for multiple sclerosis in clinicaldevelopment.

***Government Regulation***

Regulation by governmental authorities in the UnitedStates and other important locations is a significant factor in themanufacture, marketing and sale of our products and in our research anddevelopment 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 United States, Blood Testing products, whetherbased upon nucleic acid testing or immunodiagnostic testing technologies, mayonly be commercially sold pursuant to the terms of approval of specific licenseapplications in which the product’s safety and effectiveness must bedemonstrated based upon well-controlled studies. Upon approval of the licenseapplication, the product may be marketed for the specific uses, which wereidentified in the approval. Facilities, processes and operations used for themanufacture, testing, storage and distribution of our Blood Testing products inthe United States are subject to FDA approval and periodic inspection.

In Europe, our BloodTesting products are regulated through the In Vitro Diagnostic Medical DevicesDirective. In other geographic areas, such as Australia, Canada and Mexico,local regulatory authorities regulate Blood Testing products.

*Vaccines andBiopharmaceuticals*

In the United States, our therapeutic and vaccineproducts (both commercial and investigational) are primarily regulated underfederal law and are subject to rigorous FDA approval procedures. No product canbe marketed in the United States until an appropriate application is approvedby the FDA. The FDA applies the approval procedures on a product-by-productbasis and typically requires, among other things, an extensive three-phasehuman clinical testing program. In Phase 1, studies are conducted with arelatively small number of subjects to assess the safety of the product. InPhase 2, the product is evaluated in a larger group of subjects to beginto assess efficacy and appropriate dosing. Phase 3 studies are conductedin the target population with a number of subjects that is large enough toprovide sufficient data to establish statistically the safety and efficacy ofthe product. The FDA approves products to treat specified medical conditions ordisorders. Further studies would be required to market the product for other uses.The FDA must inspect and approve all facilities used to manufacture, fill, testand distribute biologic products. If any change in manufacturing facilities orprocesses occurs after FDA approval, additional regulatory review and possiblyadditional clinical studies may be required. In addition to standard regulatoryprocedures, many governments have provisions for use of otherwise unapprovedmedical products in a public health emergency.

Licensing procedures inEurope are comparable to those in the United States. In 1995, the EuropeanUnion established a centralized procedure for licensing of products derivedfrom the use of high 

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technology/biotechnologyprocesses. This procedure leads to the grant of a single license for the entireEuropean Union. Effective January 1, 1998, the European Union has alsoadopted a decentralized procedure under which a license granted in one memberstate is mutually recognized by the other member states, leading to a grant oflicenses in member states recognizing the original license. This procedure isreplacing independent national licensing of products in the European Union. Inaddition, products must receive country-pricing approvals in some territoriesbefore they can be marketed in that country.

***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 United States and other important markets.Additionally, we have licensed a number of patents and patent applications fromthird parties. Additional information is provided below on the certain patentsheld or licensed by us that relate to our key products. The existence of suchpatents does not mean they are valid or can be enforced against competitiveproducts. We seek term extensions for some patents, which are available incertain countries based on delays in the grant of regulatory approvals for thesale of products covered by these patents. For these reasons the expirationdates provided below are not definitive.

We consider our trademarks and registered trademarksand those of our subsidiaries, in the aggregate, to be of material importance.All are covered by registrations or pending applications for registration inthe U.S. Patent and Trademark Office and in other countries. Trademarkprotection continues in some countries for as long as the mark is used and, inother countries, for as long as it is registered. Registrations generally arefor fixed, 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 by numerouspatents held by us in the United States 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 theUnited States in 2015 and ex-U.S. in 2010. The HIV patent family expires in theUnited States in 2020. The HIV patent family expired ex-U.S. in 2005. The PROCLEIX® System productline is also covered by several patents held by Gen-Probe and licensed to usfor use in blood testing.

The PROCLEIX® ULTRIO® Assay is covered by several patents held byGen-Probe and licensed to us for use in Blood Testing. The PROCLEIX® WNV Assay iscovered by several patents and pending applications held by Gen-Probe andlicensed to us for use in Blood Testing.

The hepatitis C virus immunoassay diagnosticproducts sold by our joint business contractual arrangement with Ortho-ClinicalDiagnostics are covered by numerous patents in the United States and worldwide.These patents contain claims directed to hepatitis C virus immunoassaymethods, kits and 

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hepatitis C viruspolypeptides. In the United States, certain patents expire between 2011 and2017. The corresponding European family of patents expires in 2010.

The HIV immunoassay diagnostic products sold by ourjoint business contractual arrangement with Ortho-Clinical Diagnostics arecovered by numerous patents in the United States and worldwide. The earliestpatents expire in 2009 in the United States and expired in 2005 in Europe.

We own additional HCV and HIV patent families andpending applications.

We hold the registeredtrademark PROCLEIX® and ULTRIO®, andthe trademark OPTIVATM. TIGRIS® is a trademark of Gen-Probe Incorporated.

*Vaccines*

FLUAD®,our adjuvanted influenza vaccine, contains the proprietary adjuvant MF59. TheU.S. patents containing claims related to MF59 expire in 2018. Patents for MF59in Canada, Japan, Germany, Ireland, Portugal and Hungary expire in 2010. Widelyregistered trademarks of Chiron and our subsidiaries include AGRIPPAL®, FLUAD®, FLUVIRIN®, MENJUGATE®, RABAVERT®, RABIPUR®, and RIBA®. Other trademarks of Chiron and our subsidiaries includeBEGRIVACTM, ENCEPURTM, POLIORALTM and TRIACELLUVAXTM.

*Biopharmaceuticals*

The patent family related to our first generation TOBI® tobramycinsolution for inhalation product includes claims related to product formulationand 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®, theserine-125 interleukin-2 mutein product, and uses thereof. Thepatents related to the PROLEUKIN® product will expire in the United States in2012 and they expired in Europe in 2005.

One of the earliest patent families that relate toBETASERON® and BETAFERON® interferon beta-1b in the United Statesand Europe, respectively, relate to serine-17 interferon-beta proteinused in manufacturing the product. The U.S. patent in this family expires in2007. The terms of the European patent in this family has been extended to 2008through Supplementary 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 Schering AG. CUBICIN® is a trademark ofCubist Pharmaceuticals.

***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.

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***Manufacturing and Raw Materials***

Gen-Probe and Ortho-Clinical Diagnostics manufacturethe products sold by our Blood Testing business segment. In the case ofinstrumentation, third party subcontractors perform manufacturing. We haveengaged both Gen-Probe and Ortho-Clinical Diagnostics in extensive businesscontinuity planning to limit any disruption to our current source of theseblood safety products in the event of a loss of manufacturing capability. Wemaintain several months’ supply of NAT reagents in inventory. Ortho maintainssimilar 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 influenza vaccine products, we must purchase largequantities of chicken eggs. For FLUVIRIN® vaccine, we purchase those eggs from a singlesupplier in the United Kingdom, and pursuant to the contract with that supplierwe have agreed to make specified purchases from that supplier through 2012,subject to our right to terminate this agreement earlier upon payment of atermination 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 primary basic raw material in TOBI® tobramycin, fromtwo of the principal worldwide suppliers of the drug. We anticipate that eitherone of these suppliers alone will be able to supply sufficient quantities tomeet 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 influenza vaccines primary manufacturingfacility in Liverpool, United Kingdom. The new manufacturing facility willreplace a portion of the existing influenza vaccines manufacturing facilitiesin Liverpool, United Kingdom and is anticipated to be available in 2009 for themanufacture of influenza vaccines, subject to regulatory approval.

***Employees***

Our employees are the coreof Chiron and are vital to our success. As of December 31, 2005, Chironand its subsidiaries had approximately 5,500 employees, approximately 2,500 ofwhom were located in the United States. The company has experienced no workstoppages and we consider our employee relations to be good.

***Relationship with Novartis AG***

On October 30, 2005, Chiron entered into anAgreement and Plan of Merger (the “Merger Agreement”) with NovartisCorporation, Novartis Biotech Partnership, Inc. (“Novartis Biotech”), anindirect wholly owned subsidiary of Novartis AG (“Novartis”) and an indirectsubsidiary of Novartis Corporation, and Novartis, as guarantor. Pursuant to theterms of the Merger Agreement, Novartis Biotech will merge with and intoChiron, with Chiron as the surviving corporation and becoming an indirectsubsidiary of Novartis Corporation and an indirect wholly owned subsidiary ofNovartis. Upon 

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completion of the merger,each share of Chiron common stock not held by Novartis or any of itssubsidiaries, Chiron or any of its subsidiaries or a stockholder of Chiron whoperfects appraisal rights, will be converted into the right to receive $45.00per share in cash, without interest. The merger is subject to stockholderapproval and satisfaction of other customary conditions, including governmentaland regulatory approvals. On February 6, 2006, the European Commissionadopted a decision pursuant to Article 6(1)(b) of the CouncilRegulation (EC) No. 139/2004 declaring the combination compatible with thecommon market. This follows approval by the U.S. Federal Trade Commission in December 2005and clearance by the Committee on Foreign Investment in the United States underExon-Florio in January 2006. We expect that the transaction will becompleted in the second quarter of 2006.

Chiron and Novartishave been in an alliance since January 1995. We have entered into a seriesof agreements with Novartis, which provide, among other things and subject tocertain conditions and exceptions:

·       Novartis has the right todesignate for nomination to our Board of Directors three individuals. Thenumber of directors that Novartis may nominate declines if Novartis’ ownershipinterest in us is less than 30%.

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

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

·       Novartis provided certainfunding to us for research on certain adult and pediatric vaccines,Insulin-like Growth Factor-I, Factor VIII gene therapy and Herpes SimplexVirus-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.

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

·       Novartis has an option topurchase newly issued shares of our common stock directly from us at fairmarket value, subject to certain conditions, including the standstillrestrictions described above.

·       Novartis and we willcooperate and collaborate in research, development, manufacturing and marketingof biotechnology products on an arm’s-length basis while remaining independentto pursue our respective corporate strategies and opportunities.

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*, by contacting ourInvestor Relations department at (510) 923-2300 or by sending an e-mailmessage to*investor  relations@chiron.com*:

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

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·       our Corporate GovernanceGuidelines and our Code of Conduct and Commitment to Ethical Conduct; and

·       the charters of the AuditCommittee, Compensation Committee, Nominating and Corporate GovernanceCommittee and Finance Committee of our Board of Directors.

The information contained on our website, or otherwebsites linked to our website, is not part of and is not incorporated byreference into this report.

**ITEM 1A.**        RISKFACTORS

We have discussed the mostsignificant factors that may adversely affect our business and operations in Part II,Item 7, of this 10-K, “Management’s Discussion and Analysis of FinancialCondition and Results of Operations,” under the caption “Factors That May AffectFuture Results.”

**ITEM 1B.**       UNRESOLVEDSTAFF COMMENTS

Not applicable.

**ITEM 2.**                PROPERTIES

*Emeryville Campus*

Our principal executive offices are located inEmeryville, California. As of December 31, 2005, our campus consisted of24 buildings, of which 14 are leased and 10 are owned. Our Emeryvillefacilities include research and development, manufacturing and administrativefacilities and a parking structure for our biopharmaceutical, vaccine and BloodTesting 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 influenza vaccinesprimary manufacturing facility in Liverpool, United Kingdom. The newmanufacturing facility will replace a portion of the existing influenzavaccines manufacturing facilities in Liverpool, United Kingdom and isanticipated to be available in 2009 for the manufacture of influenza 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 followingfacilities for our vaccines operations:

**Owned**

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

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

·       Manufacturingfacilities in Liverpool, United Kingdom and

·       Manufacturing facilities inAnkleshwar, India.

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**Leased**

·       Manufacturingfacilities in Liverpool, United Kingdom,

·       Administrativeoffice in Oxford, United Kingdom,

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

·       Administrativeand sales offices in Mumbai, India,

·       Salesoffice in Philadelphia, Pennsylvania,

·       Salesoffice in Malaysia,

·       Salesoffices in Moscow, Russia,

·       Salesoffices in Szentendre, Hungary,

·       Salesoffices in Sao Paolo, Brazil,

·       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 sales offices in Suresnes, France,

·       Salesoffices in Madrid, Spain,

·       Salesoffices in Lisbon, Portugal,

·       Administrativeand warehouse facilities in Munich, Germany,

·       Salesoffices in Milan, Italy,

·       Salesand administrative offices in Dublin, Ireland,

·       Salesoffices in Quebec, Canada and

·       Sales,marketing and administrative facility in Uxbridge, United Kingdom.

We lease sales andadministrative offices for our Blood Testing operations:

·       Suresnes,France and

·       HongKong, China

We lease facilities in North America and Europeprimarily for sales and service offices.

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. We continuallyevaluate future requirements for our facilities.

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**ITEM 3.**                LEGALPROCEEDINGS

***Average Wholesale Price Litigation***

In November 2004, the County of Nassau 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. InMarch 2005, the County of Nassau filed an amended complaint with the In RePharmaceutical Industry Average Wholesale Price Litigation pre-trialproceedings in the United States District Court for the District ofMassachusetts. Plaintiff alleges that defendants violated federal racketeeringlaws, federal and state laws on Medicaid fraud, and state laws on unfair tradepractice, breach of contract, fraud and unjust enrichment by devising andimplementing a fraudulent pricing scheme against Medicaid beneficiaries, andseeks declaratory relief, as well as compensatory and punitive damages.

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. In August 2005,the matter was transferred to the In Re Pharmaceutical Industry Average WholesalePrice Litigation in the United States District Court for the District ofMassachusetts.

In June 2005, the City of New York and severalNew York State counties filed a complaint in the In Re Pharmaceutical IndustryAverage Wholesale Price Litigation in the United States District Court for theDistrict of Massachusetts against numerous biotechnology and pharmaceuticalcompanies, including Chiron, in connection with setting average wholesaleprices for various products reimbursed by Medicaid, including TOBI®, PROLEUKIN®, and certaingeneric oncology drugs sold by the Cetus-Ben Venue Therapeutics partnership.Plaintiffs allege that defendants violated federal and state laws regardingMedicaid fraud, and state laws regarding social services fraud, healthregulations, breach of contract, unfair trade practices, and unjust enrichment,and seek declaratory relief, as well as compensatory and punitive damages.

In October 2005, the State of Mississippi throughits Attorney General filed a complaint in the Chancery Court of Hinds County,Mississippi, First Judicial District, against numerous biotechnology andpharmaceutical companies, including Chiron, in connection with setting averagewholesale prices for various products that are reimbursed by Medicare andMississippi Medicaid. The Attorney General alleges that defendants violated theMississippi Medicaid Fraud Control Act, the Mississippi Regulation of Businessfor Consumer Protection Act, and certain Mississippi state common lawprovisions, and seeks declaratory relief as well as damages.

In November 2005, seven New York State countiesfiled complaints in the United States District Courts for the Northern,Southern and Western Districts of New York against numerous biotechnology andpharmaceutical companies, including Chiron, in connection with setting averagewholesale prices for various products reimbursed by Medicaid, including TOBI® and certaingeneric oncology drugs sold by the Cetus-Ben Venue Therapeutics partnership. Plaintiffsallege that defendants violated federal and state laws regarding Medicaidfraud, and state laws regarding social services fraud, health regulations,breach of contract, unfair trade practices, and unjust enrichment, and seekdeclaratory relief, as well as compensatory and punitive damages.

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

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***F. Hoffmann-La Roche A.G. and RocheDiagnostics GmbH—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 GermanPatents. Accordingly, the Court of Appeals granted Chiron requested injunction.Chiron has enforced the injunction. Roche is attempting to appeal this decisionto the German 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 Roche Diagnostics’appeal and denied Roche Diagnostics leave to appeal as a matter of right to theSupreme 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

For a discussion ofdevelopments related to FLUVIRIN® influenza virus vaccine, see Part II,Item 7. “Management’s Discussion and Analysis of Financial Condition andResults of Operations, Factors That May Affect Future Results.”

** **

**A.   FLUVIRIN**® vaccine Securities 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 March 2005, the Court named lead counsel and plaintiff,and in April 2005, lead plaintiff filed a consolidated complaint. Theconsolidated complaint alleges, among other things, that the defendantsviolated certain provisions of the federal securities laws by making false andmisleading statements from July 23, 2003 through October 5, 2004concerning the amount of FLUVIRIN® vaccine Chiron projected to produce and Chiron’shistorical and forecasted financial results, 

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andseeks unspecified monetary damages and other relief from all defendants. Thetrial is scheduled to begin on May 1, 2006.

**B.   FLUVIRIN**® vaccine Shareholder Derivative Actions

Between October 2004and November 2004, six shareholder derivative complaints were filed in theSuperior Court of the State of California for the County of Alameda, namingChiron as a nominal party and naming certain current and former Chiron officersand directors and Novartis AG as defendants in connection with the suspensionof Chiron’s license to manufacture FLUVIRIN® vaccine. One complaint also named Chiron as adefendant and sought relief from Chiron, including an equitable accounting. In December 2004,the six derivative actions were consolidated for discovery and trial under thecaption In re Chiron Corporation Derivative Litigation (the “Derivative Action”).In February 2005, lead plaintiff filed a consolidated complaint, and in May 2005filed an amended consolidated complaint alleging that defendants are liable forbreach of their fiduciary duties of loyalty and care and other duties allegedlyowed to Chiron in connection with Chiron’s acquisition of its Liverpool, UnitedKingdom facility and the British regulatory agency’s decision to suspendtemporarily Chiron’s license to manufacture FLUVIRIN® vaccine at the Liverpool facility, and seekingunspecified monetary damages and other relief from all defendants. Thecomplaints did not seek any affirmative relief from Chiron. In July 2005,the Court granted without prejudice Chiron’s and Novartis’ motions to dismissthe amended consolidated complaint based on three agreements entered in 1994between Chiron and Novartis, all of which contain mandatory forum selectionclauses requiring that any claims arising out of or relating to the agreementsmust be adjudicated in Delaware. Regarding the directors and officers, theCourt also dismissed those claims implicated by the 1994 agreements, and stayedthe remaining claims pending resolution of the action it is anticipatedplaintiffs will file in Delaware. In September 2005, plaintiffs filed anappeal before the Superior Court of the State of California for the County ofAlameda.

**C.   Other FLUVIRIN**® vaccineLegal Matters

In October 2004, Chiron received a grand jurysubpoena issued by the U.S. Attorney’s Office for the United States DistrictCourt for the Southern District of New York requesting production of certaindocuments and materials relating to the suspension of our license. Also in October 2004,the U.S. Securities and Exchange Commission (“SEC”) notified Chiron that itwould conduct an informal inquiry into the suspension with respect to potentialviolations of federal securities laws. The SEC also requested copies of relatedrecords. In February 2005, the SEC issued a formal order of investigationwith respect to potential violations of federal securities laws. In February 2006,the SEC notified Chiron that it was terminating its investigation of whether Chiron violated any federalsecurities laws in connection with the previous suspension by the UK MHRA ofChiron’s license to manufacture FLUVIRIN® influenza virus vaccine, and that noenforcement action would be recommended against the company.

In August 2005, Celltech Pharma (“Celltech”)filed a complaint against Chiron Vaccines and Chiron Behring GmbH &Co. KG (collectively, “Chiron”) in the Tribunal de Commerce of Nanterre inFrance. Celltech alleges that Chiron breached its alleged undertaking toprovide FLUVIRIN® to Celltech for the 2004/2005 influenza seasonin France, and seeks damages.

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

***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 

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No. 5,156,949 (the “‘949 patent”)and in certain U.S. patent applications assigned to Institut Pasteur (the “Changapplications”), relating to HIV immunodiagnostic methods. In the ‘659 Interference,the Board decided that the inventors of Chiron’s ‘949 patent were thefirst to invent the technology at issue. Chiron asserted that Institute Pasteurwas barred from bringing claims per the 1993 HIV Cross-License Agreementbetween Chiron and Institut Pasteur (the “Agreement”), and that InstitutPasteur’s standing to bring its appeal was a matter for arbitration under theterms of the Agreement. In February 2005, the Court ordered the parties toarbitrate the standing issue and the case was administratively dismissed. In March 2005,Chiron sent Institut Pasteur a notice of arbitration, and the arbitrationcommenced in January 2006.

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

***Investigation of Employees of Italian Subsidiary***

Two sales employees of an indirect wholly ownedItalian subsidiary of Chiron were the subject of an investigation by Italianauthorities in Genoa, Italy in connection with a larger investigation into thepurchasing activities of a Genoa hospital and alleged undue influence by thesales employees in the bidding process for the supply of blood testing productsto the hospital. In August 2004, the hospital awarded Chiron a contractfor the supply of blood testing products. Italian authorities also conducted aninvestigation in Milan, Italy concerning alleged corruption and undue influenceby one of the sales employees implicated in the Genoa investigation. In February 2006,the Public Prosecutor of the Tribunal of Genoa concluded the investigation forthe alleged offense of undue interference in public tenders, and has asked theTribunal of Genoa to dismiss charges with respect to one of the employees. Atthis time, we are not aware of any investigation of Chiron with respect tothese matters. Although Chiron is not the subject of any criminal charge, noassurance can be given that Chiron will not become the subject of civilcharges, fines or penalties, or incur other damages or costs, in connectionwith these matters.

It is not known when noron what basis these matters 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. In April 2005, the Court stayed the casepending the outcome of two interferences declared by the U.S. Patent andTrademark Office regarding the ‘276 patent.

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

***Novartis AG Proposed Acquisition Shareholder Suits***

Between September 1 and September 13, 2005,twelve class action lawsuits were filed by Chiron shareholders against Chiron,Novartis AG (“Novartis”), and members of Chiron’s Board of Directors(collectively, the “Defendants”) regarding Novartis’ September 1, 2005offer to acquire the approximately 58% of Chiron shares that Novartis does notalready own for $40 per share (the “Novartis Offer”). Eight of the suits werefiled in the Superior Court of the State of California in Alameda County (the “CaliforniaCourt”) by i) Ronald Abramoff, Harold Adelson, Beverly McCalla, Joan Weisberg,and David Jaroslawicz; ii) Edith Auman; iii) Joseph Fisher, MD, P.C.New Profit Sharing Trust, Trustee Joseph Fisher, MD; iv) WilliamLattarulo; v) Steven Rosenberg and The Harold Grill IRA; vi) TracieScotto; vii) Albert Stein; and viii) William Steiner (the “CaliforniaPlaintiffs”). The remaining four suits were filed in the Court of 

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Chancery of the State ofDelaware in and for New Castle County (the “Delaware Court”) by ix) JudyLongcore; x) Paulena Partners L.L.C.; xi) Sylvia Piven; and xii) theThomas Stone Irrevocable Trust (the “Delaware Plaintiffs”). The eightCalifornia Actions were consolidated, as were the four Delaware Actions. In January 2006,the California Plaintiffs filed a consolidated complaint in the CaliforniaCourt, and in March 2006, the California Plaintiffs and certain of theDelaware Plaintiffs (together, “Plaintiffs’’) filed a second amendedconsolidated complaint in the California Court against the Defendants alleging,among other things, that the Company and the Defendants breached theirfiduciary duties in connection with the merger because the merger price isinadequate, unfair, and the result of an unfair process. The Plaintiffs alsoallege that Chiron’s definitive proxy materials omit material information,include materially misleading statements and are unfairly coercive. In theirprayer for relief, the Plaintiffs seek: (i) to enjoin the merger under theterms presently proposed; (ii) to rescind any transaction or be grantedrescissory damages if a transaction is consummated prior to entry of finaljudgment; and (iii) to direct the individual defendants and Novartis toaccount to Plaintiffs and members of the purported class for all damages causedto them and to account for all profits and any special benefits obtained as a resultof their alleged misconduct. A hearing on the California Plaintiff’santicipated motion for a preliminary injunction is currently scheduled forApril 4, 2006.

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

***Senate Finance Committee Information Request***

In June 2005, Chiron received a voluntary requestfor information from the U.S. Senate Committee on Finance (the “Committee”) inconnection with the Committee’s review of issues relating to the Medicare andMedicaid programs’ coverage of prescription drug benefits. The Committeerequested information from Chiron as to our practices regarding educationalgrants. In January 2006, Chiron received a supplementary informationrequest. Chiron, like the other pharmaceutical companies to whom the Committeehas directed similar requests, is cooperating with the Committee.

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

***Sorin Biomedica/Snia***

In January 2002, Chiron filed a complaint againstSnia in the Court of Milan asserting that Snia’s manufacture and sale ofcertain hepatitis C virus immunodiagnostics in Italy infringe the ‘931 patent.Chiron sought a declaration of infringement based on the ‘931 patent, aswell as damages. In July 2005, the Court rejected Chiron’s claims. Thisjudgment is subject to appeal.

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

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**ITEM 4.**                SUBMISSIONOF MATTERS TO A VOTE OF SECURITY HOLDERS

No matters were brought toa vote of Chiron’s stockholders in the quarter ended December 31, 2005.

**EXECUTIVEOFFICERS OF THE REGISTRANT**

Theexecutive officers of Chiron are as follows, in alphabetical order:

| **Name**          | ** ** | ** ** | ** ** | **Age** | ** ** | **Title**                                                                | ** ** |
|-------------------|------------|------------|------------|---------|------------|--------------------------------------------------------------------------|------------|
| Ursula B. Bartels |       |       | 48         |    |       | Vice  President; General Counsel and Secretary                           |       |
| Jack Goldstein    |       |       | 58         |    |       | President  and Chief Operating Officer                                   |       |
| Anne Hill         |       |       | 46         |    |       | Vice  President, Human Resources                                         |       |
| Jessica M. Hoover |       |       | 48         |    |       | Vice  President; Head of Corporate Business Development                  |       |
| Meghan B. Leader  |       |       | 40         |    |       | Vice  President, Business Support Services and Chief Information Officer |       |
| Howard H. Pien    |       |       | 48         |    |       | Chief  Executive Officer and Chairman of the Board                       |       |
| Rino Rappuoli     |       |       | 53         |    |       | Vice  President; Chief Scientific Officer                                |       |
| David V. Smith    |       |       | 46         |    |       | Vice  President; Chief Financial Officer                                 |       |
| Daniel B. Soland  |       |       | 47         |    |       | Vice  President; President, Chiron Vaccines                              |       |
| Bryan L Walser    |       |       | 40         |    |       | Vice  President, Corporate Strategy                                      |       |
| Gene W. Walther   |       |       | 51         |    |       | Vice  President; President, Chiron Blood Testing                         |       |
| Craig A. Wheeler  |       |       | 45         |    |       | Vice  President; President, Chiron BioPharmaceuticals                    |       |

 

**Ms. Bartels**joined Chiron as Vice President and General Counsel in August 2004. In March 2005,she was designated the Company’s Secretary. Prior to joining Chiron, Ms. Bartelsserved as Vice President of Boehringer Ingelheim Corporation and Senior VicePresident, General Counsel and Secretary of Boehringer IngelheimPharmaceuticals, Inc., where she was responsible for all legal functionsfor the corporation and its five U.S. subsidiaries. Boehringer’s primarybusiness’ focus was branded human pharmaceuticals (primarily respiratory) andmulti-source pharmaceuticals (comprised of subsidiaries, Roxane Laboratoriesand Ben Venue Laboratories). Prior to joining Boehringer in 1999, Ms. Bartelsworked at SmithKline Beecham Corporation (now GlaxoSmithKline) from 1988 to1999, where she progressed from Counsel, Litigation to Vice President andAssociate General Counsel, responsible for the full range of legal operationsin North America for its two U.S. divisions, Pharmaceuticals, and HealthcareServices (including clinical laboratory and pharmacy benefit managementbusinesses). Ms. Bartels was a member of the PhRMA Law Section ExecutiveCommittee from 1994 to 2004, and served as Chair of the Law Section in 2001-2002.Ms. Bartels assembled and led the group that wrote the PhRMA Code.Ms. Bartels began her legal career as a litigation associate at StradleyRonan Stevens and Young, in Philadelphia. She graduated in 1979 from Bryn MawrCollege, A.B. *cum laude*, andattended the University of Virginia School of Law, graduating in 1983.

**Dr. Goldstein**joined Chiron as Vice President and President, Chiron Blood Testing Division inSeptember 2002. In February 2005, Dr. Goldstein was appointed tothe position of President and Chief Operating Officer. He had served as interimChief Operating Officer of Chiron since November 2004. From 2000 to 2002, Dr. Goldsteinwas General Partner at Windamere Venture Partners, L.L.C., a venture fundmaking investments in early stage biotechnology, pharmaceutical, medical deviceand diagnostic companies. From 1997 to 2001, Dr. Goldstein was Presidentand CEO 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.

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**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. Hoover holdsan A.B., with highest honors, from the University of California, Berkeley, anda J.D. from the Yale Law School.

**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, global security and corporate risk-mitigation services,including environmental 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.

**Mr. Pien**joined Chiron as President and Chief Executive Officer, and a director, in April 2003.Upon the resignation of Seán P. Lance as Chiron’s Chairman of the Boardfollowing the annual meeting of stockholders in May 2004, Mr. Pienalso was elected Chairman of the Board. In February 2005, Mr. Pien’stitle of President was transferred to Dr. Goldstein in connection with theformalization of the role of Chief Operating Officer assumed by Dr. Goldstein.Mr. Pien joins Chiron from GlaxoSmithKline (GSK), which resulted from themerger of GlaxoWellcome and SmithKline Beecham, where he spent over twelveyears in positions of international and global management responsibility,including: President of Pharmaceuticals International GSK from December 2000to March 2003, including service as a member of the Corporate ExecutiveTeam; President, Pharmaceuticals, SmithKline Beecham (1998 to 2000); President,Pharmaceuticals-North America, SmithKline Beecham (1998); Senior Vice Presidentand Director-North Asia (1997); Managing Director and Senior Vice President-UK(1995 to 1997); Vice President and Director, Marketing-US (1993 to 1995); VicePresident and Director, Product Marketing-US, heading the arthritis,cardiovascular and vaccine groups (1992 to 1993); and Vice President andDirector of New Product Development-US (1991 to 1992). Prior to joiningSmithKline Beecham, Mr. Pien worked six years for Abbott Laboratories andfive years for Merck & Co., in positions of sales, marketing researchlicensing and product management. Mr. Pien served as a director ofViroPharma Incorporated from 1998 to 2003. He currently serves as a director oftwo non-profit organizations: Oakland Children’s Hospital and Bio-Tech IndustryTrade 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 andthe first recombinant bacterial vaccine, against pertussis. In February 2004,he was promoted to Vice President, Chief Scientific Officer of Chiron.Dr. Rappuoli earned his doctoral and bachelor’s degrees in 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, adiscipline combining cell biology and microbiology, and has pioneered thegenomic approach to vaccine development 

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termed “reversevaccinology”. He is member of numerous international associations, includingthe European Molecular Biology Organization and the American Society forMicrobiology. Dr. Rappuoli also has served on many committees, among whichthe NIH Search Committee for the Director of the Vaccine Research Center(Bethesda, Maryland). He is co-chairman of the R/D Task Force of the GlobalAlliance for Vaccines and Immunization. He has won several prestigiousinternational awards including the Paul Ehrlich, Ludwig Darmstaedter Prize; andIUMS Arima award. Dr. Rappuoli currently serves as a director ofFondazione Monte Dei Paschi di Siena, a private organization in Siena, Italy. Hewas appointed as a foreign associate to the U.S. National Academy of Sciencesin May 2005.

**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**joined Chiron as Vice President and President, Chiron Vaccines in late February 2005.He is responsible for the operations of Chiron’s global vaccine business. 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 ten yearswith GlaxoSmithKline Biologicals in a variety of executive positions, includingVice President and Director, Worldwide Marketing Operations from 1998-2003,and Vice President and Director of SmithKline Beecham Pharmaceuticals, VaccineBusiness 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 inbiotechnology and healthcare. Before that, Dr. Walser trained in theEmergency Medicine program at UCLA, and worked for several years in Los Angeleswith the healthcare practice of the Boston Consulting Group. Dr. Walserearned his undergraduate degree from Stanford, his medical degree from theUniversity of Virginia School of Medicine and his law degree, *magna cum laude*, from Harvard Law School.

**Mr. Walther**initially joined Chiron as a consultant in August 1998, and was appointedas Vice President, Commercial Development, North America and Asia Pacific in January 2001.In February 2005, Mr. Walther was appointed to the position ofPresident, Chiron Blood Testing. He had served as “Acting President”, ChironBlood Testing since November 2004. Mr. Walther has over two decadesof experience 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 1991 to1995, Mr. Walther owned and operated a Seattle-based manufacturing companyinvolved in producing equipment for the outdoor recreational industry. He washead of sales and marketing for Seattle-based Genetic Systems from 1984 to 1991.Prior to that, Mr. Walther worked for Abbott Diagnostics and AmericanHospital Supply Corporation in a variety of sales, marketing and business developmentpositions. Mr. Walther holds a B.S. degree in microbiology and immunologyfrom Michigan State University and a Masters of Business Administration fromthe University of Washington.

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**Mr. Wheeler**joined Chiron as Vice President, President of Chiron BioPharmaceuticals,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.Before joining The Boston Consulting Group, Mr. Wheeler worked for Merck’sMSDRL research unit, where he served as a senior engineer in processdevelopment. He recently served as the leader of The Boston Consulting Group’sScientist’s Network. In partnership with the Rockefeller Foundation, he hasjoined the Global Alliance for TB Drug Development, a public-private partnershipto develop new anti-tuberculosis drugs. Mr. Wheeler was appointed to theboard of directors of Avanir Pharmaceuticals, an AMEX company, in September 2005.

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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, 2005, there were3,543 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.

The quarterly high and lowclosing sales prices (rounded to the nearest one-hundredth) of our common stockfor each quarter of 2005 and 2004 are shown below.

| ** **     | ** ** | **2005** | ** ** | **2004** | ** ** |
|----------------|------------|----------|------------|----------|------------|
| ** **     | ** ** | **High** | ** ** | **Low**  | ** ** | **High** | ** ** | **Low** | ** ** |
| First Quarter  |       | $        | 38.63      |     | $          | 32.61 |   | $ | 56.38 |   | $ | 44.01 |   |
| Second Quarter |       | 38.25    |       | 33.83    |       | 48.59 |   | 42.25 |   |
| Third Quarter  |       | 44.34    |       | 34.96    |       | 48.01 |   | 42.38 |   |
| Fourth Quarter |       | 44.85    |       | 42.66    |       | 45.42 |   | 30.76 |   |
|                |            |          |            |          |            |  |  |  |  |  |  |  |  |

 

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 ofDirectors authorized Chiron to repurchase 5.0 million shares of Chiron commonstock through December 31, 2004. Through December 31, 2004, we madepurchases of 2.9 million shares, although there were no stock repurchases inthe fourth quarter of 2004. On March 10, 2005, the Board of Directorsauthorized Chiron to repurchase 5.0 million shares of Chiron common stockthrough December 31, 2005. From January 1, 2005 through December 31,2005 no shares were repurchased.

**ITEM 6.**                SELECTEDFINANCIAL DATA

We have derived theselected consolidated financial data presented below as of December 31,2005 and 2004 and for the years ended December 31, 2005, 2004 and 2003from the audited Consolidated Financial Statements contained elsewhere in this Form 10-K.The selected consolidated financial data presented below as of December 31,2003, 2002 and 2001 and for the years ended December 31, 2002 and 2001were 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,**                         | ** ** |
|---------------------------------------------------------|------------|--------------------------------------------------------------------|------------|
| ** **                                              | ** ** | **2005**                                                           | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** | **2001** | ** ** |
| ** **                                              | ** ** | **(In thousands, except per share data)** | ** ** |
| Total revenues                                          |       | $                                                                  | 1,919,679  |   | $ | 1,723,355 |   | $ | 1,766,361 |   | $ | 1,276,280 |   | $ | 1,140,667 |   |
| Income from  continuing operations                      |       | 180,470                                                            |       | 54,063 |   | 220,338 |   | 181,145 |   | 174,758 |   |
| Basic earnings  per share from continuing operations    |       | 0.96                                                               |       | 0.29 |   | 1.18 |   | 0.96 |   | 0.92 |   |
| Diluted earnings  per share from continuing operations  |       | 0.94                                                               |       | 0.28 |   | 1.15 |   | 0.94 |   | 0.90 |   |
| Total assets                                            |       | 4,747,479                                                          |       | 4,305,503 |   | 4,195,169 |   | 2,960,344 |   | 2,866,909 |   |
| Long-term debt and  long-term portion of capital leases |       | 1,047,606                                                          |       | 1,093,604 |   | 1,084,386 |   | 416,954 |   | 408,696 |   |
|                                                         |            |                                                                    |            |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

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As discussed in Item 7. “Management’s Discussion andAnalysis of Financial Condition and Results of Operations,” several factorsaffected the comparability of information between 2005 and 2004. The firstfactor relates to our return of FLUVIRIN® product to the U.S. market for the 2005-2006influenza season and our inability to release any FLUVIRIN® product during the 2004-2005 influenzaseason. Chiron had FLUVIRIN® vaccine sales of $96.5 million in late 2005for the 2005-2006 influenza season but no FLUVIRIN® vaccine sales in 2004 (other than $2.3 millionin late 2003-2004 season sales). In 2004, FLUVIRIN® cost of sales included a $91.3 million chargewhen Chiron wrote-off the entire inventory of FLUVIRIN® vaccine. In 2005, we incurred remediationcosts associated with our Liverpool facility of $28.1 million and legalexpenses of $16.6 million relating to the developments with respect to FLUVIRIN®, whereas in 2004, remediationcosts and legal expenses were $2.6 million and $12.1 million, respectively. Inaddition, the amortization expense for the intangible assets associated withour acquisition of PowderJect was $37.0 million in 2005 and $54.7 million in2004. Certain developed product technologies from Chiron’s acquisition ofPowderJect are amortized under the estimated sales method, which considersforecasted FLUVIRIN® sales during each influenza season through theremaining period of the benefit. Related amortization expense decreased in 2005as compared with 2004, reflecting updated forecasted FLUVIRIN® sales. The second factor relates to ourinability to release any BEGRIVACTM product for the 2005-2006 influenzaseason. We reported no BEGRIVACTM sales for 2005 versus $52.7 million ofBEGRIVACTM sales in 2004. In addition, we had to write off the existingBEGRIVACTM product inventory, resulting in a charge of $18.0 million to cost ofsales in 2005. Third, in 2005, we recognized an impairment loss of $14.5million on acquired assets from PowderJect related to ARILVAXTM. Fourth, on June 12,2004, certain holders of our Liquid Yield Option Notes (LYONs) tendered certainof the LYONs for purchase by Chiron. The aggregate purchase price for all theLYONs validly surrendered for purchase was $379.7 million. Fifth, in 2004, weissued $385.0 million aggregate principal amount of convertible debentures,which mature on June 30, 2034. Sixth, in December 2005, we receivedapproximately $300.0 million, in connection with the sale of newly issuedshares of our common stock to a subsidiary of Novartis. Under provisions of the1994 Subscription Agreement with Novartis, as amended, Chiron exercised itsright on October 30, 2005 to have Novartis purchase these shares.

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, which impacted ourresults of operations in 2004. Chiron did not release any FLUVIRIN® product during the 2004-2005 influenzaseason. Chiron had no sales of FLUVIRIN® vaccine in 2004(other than $2.3 million in late 2003-2004 season sales), while FLUVIRIN® vaccine sales were $219.2 million in 2003. In2004, Chiron wrote-off the entire inventory of FLUVIRIN® vaccine, resulting in a $91.3 million chargeto cost of sales, which decreased diluted earnings per share by approximately$0.36 in 2004. In 2004, Chiron incurred remediation costs associated with ourLiverpool facility of $2.6 million and incurred legal expenses of $12.1 millionrelated to the developments with respect to FLUVIRIN®, which together decreased dilutedearnings per share by approximately $0.06 in 2004. In addition, we recorded a$45.3 million charge for purchased in-process research and development for theacquisition of PowderJect in 2003. The amortization expense for the acquiredintangible assets associated with this acquisition was $54.7 million in 2004and $25.3 million in 2003. Second, on June 12, 2004, certain holders ofour LYONs tendered certain of the LYONs for purchase by Chiron. The aggregatepurchase price for all the LYONs validly surrendered for purchase was $379.7million. 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, a privately-held company headquartered in Davis, California, which focuses on the discoveryand validation of targets with potential application to the development of 

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cancer therapeutics. Weacquired Sagres for a preliminary purchase price of $12.0 million and allocated$9.6 million of the preliminary purchase price to purchased-in-process researchand development, which we charged to earnings in 2004.

Factors that affected the comparability of informationbetween 2003 and 2002 include (i) the effects of our acquisition ofPowderJect in July 2003 which resulted in $244.7 million ofadditional revenues, as well as a $45.3 million charge for purchasedin-process research and development in 2003 (the amortization expense for theacquired intangible assets associated with this acquisition was $25.3 million),(ii) we issued $500.0 million of convertible debentures in July 2003and (iii) in July 2003, we entered into a new six-year lease to renta research and development facility in Emeryville, California following theexpiration of the existing operating lease. We accounted for this new lease asa capital lease and, as a result, recorded the leased facility and thecorresponding liability on our balance sheet effective July 1, 2003. Theamount recorded on the balance sheet 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/HCVAssay in the U.S in 2002 which was the primary contributor to an increase inworldwide product sales related to tests and instruments and the provision ofservices from $48.3 million in 2001 to $125.4 million in 2002 and (iii) ouracquisition of Matrix Pharmaceutical, Inc. in 2002 for $67.0 millionincluding a $45.2 million charge for purchased in-process research anddevelopment. The goodwill and assembled workforce amortization expense was$17.1 million in 2001.

See Note 18, “SegmentInformation,” of Notes to Consolidated Financial Statements for geographicinformation and operating results by operating segment.

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

***Recent Developments***

On October 30, 2005, we entered into an Agreementand Plan of Merger (the “Merger Agreement”) with Novartis Corporation, NovartisBiotech Partnership, Inc. (“Novartis Biotech”), an indirect wholly ownedsubsidiary of Novartis AG (“Novartis”) and an indirect subsidiary of NovartisCorporation, and Novartis, as guarantor. Pursuant to the terms of the MergerAgreement, Novartis Biotech will merge with and into our company, with ourcompany as the surviving corporation and becoming an indirect subsidiary ofNovartis Corporation and an indirect wholly owned subsidiary of Novartis. Uponcompletion of the merger, each share of our common stock not held by Novartisor any of its subsidiaries, our company or any of our subsidiaries or astockholder of our company who perfects appraisal rights, will be convertedinto the right to receive $45.00 per share in cash, without interest. Themerger is subject to stockholder approval and satisfaction of other customaryconditions, including governmental and regulatory approvals. On February 6,2006, the European Commission adopted a decision pursuant to Article 6(1)(b) ofthe Council Regulation (EC) No. 139/2004 declaring the combinationcompatible with the common market. This follows approval by the U.S. FederalTrade Commission in December 2005 and clearance by the Committee onForeign Investment in the United States under Exon-Florio in January 2006.We expect that the transaction will be completed in the second quarter of 2006.

Immediately prior to signing the merger agreement, wegave notice to Novartis that we were exercising our right under theSubscription Agreement, dated as of November 20, 1994, as amended, withNovartis (as successor to Ciba-Geigy) to require Novartis or its affiliate topurchase shares of our common stock for an aggregate purchase price of $300.0million at a per share purchase price of $43.50. On December 8, 2005, weclosed on this sale.

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On February 24, 2006 ScheringAG notified Chiron of its intention to exercise its option under the RegulatoryFiling, Development and Supply Agreement to purchase or lease all assets usedby Chiron in the manufacture for Schering of BETASERON® interferon beta-1b products and allcontractual rights at their fair market or lease value. The purchase/leaseoption is subject to the closing of the proposed acquisition of Chiron byNovartis AG. The agreement requires that the value be determined by anindependent third party mutually agreed upon by both parties.

On March 16, 2006, we announced a recall andwithdrawal of MORUPAR®, ourmeasles, mumps and rubella (MMR) vaccine. We previously supplied MORUPAR® vaccine to customers in a limited numberof developing countries, largely via the United Nations Children’s Fund(UNICEF) and the Pan American Health Organization (PAHO), and to Italy.  Resultsof pharmacovigilance surveillance in Italy suggest that MORUPAR® vaccine may beassociated with a higher reported rate of adverse events following immunizationthan other MMR vaccine products.  Weexpect to work with the World Health Organization (WHO) to assist it inconducting a risk-benefit analysis to determine whether UNICEF or PAHO will requirea limited quantity of the existing inventory of MORUPAR® vaccine for theirongoing public health programs.  We have written-off in 2005 approximately$6.0 million of MORUPAR® inventory as a result of the withdrawal andrecorded approximately $1.7 million of product returns reserves in 2005 inconnection with expected returns of 2005 product sales from the recall.

***Introduction***

We are a globalbiopharmaceutical company that participates in three healthcare markets: BloodTesting, vaccines, and biopharmaceuticals. Our revenues, which totaled $1.9billion in 2005, 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 improvingblood safety through the development and sale of novel blood-screening assaysand equipment that protect the world’s blood supply. Our Blood Testing segment,which reported total revenues of $555.7 million in 2005, is a world leader innucleic acid testing, or NAT, blood screening with a leading position in theU.S, and a strong presence in Europe and Asia. The segment also generatesrevenues from a joint business contractual arrangement, a collaborationagreement, royalties and license fees.

Our Blood Testing segmentconsists of two separate collaborations: an alliance with Gen-ProbeIncorporated (Gen-Probe) for NAT products, and a joint business contractualarrangement with Ortho-Clinical Diagnostics, Inc. (Ortho-ClinicalDiagnostics) for immunodiagnostic products. Our collaboration with Gen-Probewas formed in 1998 and focuses on developing and commercializing NAT productsto screen donated blood, plasma, organs and tissue for viral infection. We sellthe collaboration’s assays and instruments to blood banks under the PROCLEIX® brand name. Our joint business contractualarrangement with Ortho-Clinical Diagnostics was formed in 1989 to develop andsell immunodiagnostic tests to detect retroviruses and hepatitis viruses inblood. Ortho-Clinical Diagnostics manufactures and sells the assays andinstrument systems. Chiron and Ortho-Clinical Diagnostics share equally in theprofit of the contractual arrangement. Our Blood Testing segment also earnsroyalties and license fees from third parties based on their sales ofimmunodiagnostic and nucleic acid testing probe diagnostic products utilizingour hepatitis C virus and HIV-related patents, for use in blood screening andplasma fractionation markets.

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Research and developmentis focused on programs to improve blood safety, including the development of anenzyme conversion system that converts groups A, B and AB red blood cells toenzyme-converted universal blood group O, and the development of a bloodscreening assay for variant Creutzfeldt-Jakob disease (vCJD).

*Vaccines*

Our vaccines segment isthe fifth largest vaccines business in the world with total revenues of $602.1million in 2005. We offer approximately 20 pediatric and adult vaccinesincluding influenza, meningococcal, travel and pediatric vaccines. Thesevaccines have protected millions of people globally from potentially fataldiseases such as influenza, polio, rabies and meningococcal disease. We marketour vaccines primarily in the United States, Germany, Italy and the UnitedKingdom.

Our heritage in vaccinesis traced to the three European manufacturers we acquired over the past twodecades, all of which were originally founded 100 or more years ago:Italy-based Sclavo was acquired in 1992, Germany-based Behring was acquired in1998 and United Kingdom-based PowderJect Pharmaceutical plc, or PowderJect, wasacquired in July 2003. We acquired FLUVIRIN® influenza virus vaccine as part of ouracquisition of PowderJect.

Our vaccines segmentresearch and development is focused on developing next generation influenzamanufacturing capability, including our cell culture derived influenza vaccine,developing new vaccines for pandemic preparedness, and broadening ourmeningococcal franchise.

*Biopharmaceuticals*

Our biopharmaceuticalssegment researches, 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 totalrevenues of $629.0 million for the year 2005. Our marketed products includeTOBI® tobramycin solution for inhalation, USP forpseudomonal lung infections in cystic fibrosis patients; PROLEUKIN® (aldesleukin) for injection for metastaticmelanoma and renal cell carcinoma; and BETASERON® (interferon beta-1b) for subcutaneousinjection for multiple sclerosis. In January 2006, the European Commissiongranted marketing approval to Chiron for CUBICIN® (daptomycin), a first-in-class IV antibiotic,adding another commercial product to our portfolio. The marketing approval wasgranted in the 25 member states of the European Union, Iceland, Liechtensteinand Norway. Under the approval, CUBICIN® is indicated forthe treatment of complicated skin and soft-tissue infections (cSSTI) caused byGram-positive bacteria. Research and development efforts are focused in theareas of oncology and infectious and pulmonary disease including thedevelopment of tobramycin inhalation powder, or TIP, a new tobramycin productwith an enhanced method of delivery and the clinical advancement of tifacoginfor the treatment of severe community-acquired pneumonia. Our oncology pipelineincludes CHIR-258, a growth factor kinase inhibitor, CHIR-12.12, ananti CD-40 monoclonal antibody and CHIR-265, a Raf kinaseinhibitor.

*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) 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.

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

**InfluenzaVirus Vaccines Recent Events**

In October 2004, the U.K. regulatory body, theMedicines and Healthcare products Regulatory Agency, or MHRA, suspended ourlicense to manufacture FLUVIRIN® at our Liverpool, U.K. facility. As aresult of the suspension of our license, we did not release any FLUVIRIN® vaccine during the 2004-2005influenza season. On March 2, 2005, the MHRA notified us that it hadlifted the license suspension, giving Chiron clearance to initiate fullproduction of FLUVIRIN® vaccine,conditioned on the understanding that Chiron’s commitment to its remediationplan will continue and will be subject to further inspections by the MHRA.

 

On October 17, 2005 we initiated delivery andrelease of FLUVIRIN® vaccineto customers in the United States for the 2005-2006 influenza season. Asof such time, we had received all necessary approvals from the U.S. Food andDrug Administration (FDA) and MHRA to start supplying FLUVIRIN®  vaccineto the U.S. market.

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 the suspension by the MHRAof our license. In February 2005, after having previously commenced aninformal inquiry, the Securities and Exchange Commission, or SEC, notified usthat it would commence a formal investigation into whether we or our employeesviolated any federal securities laws in connection with these developmentsregarding FLUVIRIN® vaccine,and Chiron subsequently received subpoenas from the SEC requesting productionof certain documents relating to our Liverpool facility and FLUVIRIN® vaccine. In February 2006,the SEC notified us that it had decided to terminate its investigation, andthat no enforcement action had been recommended against us. We also received avoluntary request for information from the United States House ofRepresentatives, Energy and Commerce Committee, Subcommittee on Oversight andInvestigations requesting production of certain documents. Numerous documentshave been collected and produced in response to these requests, and severalwitnesses have been interviewed by the U.S. Attorney’s Office, the SEC staffand Congressional staff. Additional investigations regarding these matters mayarise.

In addition, we and certain of our officers anddirectors 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® vaccine which are described above inPart I, Item 3, “Legal Proceedings.” Certain distributors and otherparties with whom we had contracted to supply FLUVIRIN® vaccine are considering or havecommunicated claims against us as a result of our 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, or CDC, terminated its contracts with us for the supply of FLUVIRIN® vaccine for default on the basis of ourfailure to supply such vaccine to the U.S. government for the 2004-2005influenza season. The CDC has reserved the right to hold us liable for anyexcess costs it may have incurred in replacing any FLUVIRIN® vaccine that we failed to deliverand further has reserved all other remedies provided under the contract. It isnot possible to predict whether any of these claims will be pursued and, if so,whether those claims will be upheld. Investigations, litigation and disputeshave caused us to incur substantial expense and have required significant timeand attention from our management and will continue to do so in the future andcould result in civil action and/or criminal proceedings against us. Theresults of any such investigations, proceedings or disputes could have amaterial adverse effect on our consolidated financial position and results ofoperations and/or cash flow.

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Although the MHRA has lifted its suspension of ourlicense to manufacture FLUVIRIN® vaccine, we expect to incuradditional expenses in connection with ongoing FLUVIRIN® vaccine matters, which could bematerial, including in connection with (1) our continuing remediationefforts at our Liverpool facility; and (2) responding to private lawsuitsand other claims and investigations that exist or may arise.

BEGRIVACTM vaccine is manufactured at our facility inMarburg, Germany. In July 2005, we reported that we would be unable tosupply any BEGRIVACTM vaccine doses for the 2005-2006 influenza season dueto a product sterility issue and wrote off our existing product inventoryresulting in charges of $18.0 million to cost of sales in 2005. Investigationof the product sterility issue has been completed and implementation ofremedial measures and facility modifications is underway. Our inability tosupply BEGRIVACTM vaccine as planned to non-U.S. markets for the 2005-2006influenza season or, if remedial efforts are delayed or not successful, futureseasons could have a material adverse affect on our business and results ofoperations. In addition, it is possible that distributors and other partieswith whom we had contracted to supply influenza vaccine may make claims againstus as a result of Chiron not supplying influenza vaccine. Any such claims maycause us to incur substantial expense and require significant time and attentionfrom our management. The results of any such claims could have a materialadverse effect on our consolidated financial position and results of operationsand/or cash flow.

Our previous inability to supply influenza vaccineshas led to loss of market share and may lead to loss of additional market sharein future seasons. Following the announcement of our FLUVIRIN® license suspension,competitors announced plans to introduce influenza vaccine products in theUnited States and sought expedited regulatory approval to do so. Even thoughthe license suspension has been lifted, some of our customers may continue tochoose to purchase influenza vaccine from other providers as their productsbecome available in the United States. Loss of market share in the UnitedStates or foreign markets could have a material adverse effect on our businessand results of operations. Delays in start-up procedures for ramping up to fullproduction and normal manufacturing issues inherent in the complexity ofinfluenza vaccine production had adversely affected the amount of FLUVIRIN® vaccine that we were ableto produce for the 2005-2006 influenza season and may result in furtherloss of market share.

For additional information concerning the risks weface as a result of these influenza vaccine developments, see “Factors That May AffectFuture Results—*Developments with respect toinfluenza vaccines over the past year may harm our business and results ofoperations.”* 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.

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***SummaryConsolidated 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,**                                 | ** ** | **2005 vs.** | ** ** | **2004 vs.** | ** ** | **2005 vs.** | ** ** | **2004 vs.** | ** ** |
| ** **                                             | ** ** | **2005**                                                                   | ** ** | **2004**          | ** ** | **2003**          | ** ** | **2004** | ** ** | **2003** | ** ** | **2004** | ** ** | **2003** | ** ** |
| ** **                                             | ** ** | **($ in 000’s, except per share data)** | ** ** |
| Product sales,  net                                    |       | $                                                                          | 1,421,494  |              | $          | 1,268,303         |       | $ | 1,345,833 |   | $ | 153,191 |   | $ | (77,530 | ) |   | 12.1 | % |   |   | (5.8 | )% |   |
| Revenue from  joint business arrangement               |       | 136,701                                                                    |       | 118,246           |       | 108,298           |       | 18,455 |   | 9,948 |   |   | 15.6 | % |   |   | 9.2 | % |   |
| Royalty and  license fee revenues                      |       | 317,006                                                                    |       | 289,561           |       | 250,142           |       | 27,445 |   | 39,419 |   |   | 9.5 | % |   |   | 15.8 | % |   |
| Other revenues                                         |       | 31,394                                                                     |       | 29,201            |       | 43,526            |       | 2,193 |   | (14,325 | ) |   | 7.5 | % |   |   | (32.9 | )% |   |
| Total revenues                                         |       | 1,919,679                                                                  |       | 1,723,355         |       | 1,766,361         |       | 196,324 |   | (43,006 | ) |   | 11.4 | % |   |   | (2.4 | )% |   |
| Gross profit margin                                    |       | 48                                                                         | %          | 47                | %          | 58                | %          |   |   |   |   |   |   |   |   |   |   |   |   |
| Research and  Development expenses                     |       | 433,891                                                                    |       | 431,128           |       | 409,806           |       | 2,763 |   | 21,322 |   |   | 0.6 | % |   |   | 5.2 | % |   |
| Selling, general  and administrative expenses          |       | 501,193                                                                    |       | 459,502           |       | 380,388           |       | 41,691 |   | 79,114 |   |   | 9.1 | % |   |   | 20.8 | % |   |
| Purchased in-process  research and development         |       | —                                                                     |       | 9,629             |       | 45,300            |       | (9,629 | ) | (35,671 | ) |   | (100.0 | )% |   |   | (78.7 | )% |   |
| Impairment loss  on acquired intangible assets         |       | 15,658                                                                     |       | —            |       | —            |       | 15,658 |   | - |   |   | 100.0 | % |   |   | — |   |   |
| Income from  continuing operations                     |       | 180,470                                                                    |       | 54,063            |       | 220,338           |       | 126,407 |   | (166,275 | ) |   | 233.8 | % |   |   | (75.5 | )% |   |
| Diluted earnings  per share from continuing operations |       | $                                                                          | 0.94       |              | $          | 0.28              |       | $ | 1.15 |   | $ | 0.66 |   | $ | (0.87 | ) |   | 235.7 | % |   |   | (75.7 | )% |   |

 

*2005 compared with 2004*

Income from continuingoperations was $180.5 million or $0.94 per diluted share and $54.1 million or$0.28 per diluted share in 2005 and 2004, respectively.

Income from continuing operations increased in 2005 ascompared with 2004 primarily due to $96.5 million of FLUVIRIN® sales in 2005 forthe 2005-2006 influenza season, a $91.3 million charge to cost of salesin 2004 resulting from the write-off of our entire FLUVIRIN® vaccineinventory in the third quarter of 2004 and $18.3 million lower amortizationexpense in 2005, primarily resulting from a revision of estimated future sales.In 2004, we did not have any FLUVIRIN® sales for the 2004-2005 influenza season.The lower amortization expense related to certain developed producttechnologies from our acquisition of 

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PowderJect, which areamortized under the estimated sales method over ten years. These factors wereoffset by a lost contribution from sales of BEGRIVACTM influenza virus vaccineas there were no sales of BEGRIVACTM vaccine in 2005 as compared with $52.7million of sales in 2004, FLUVIRIN® vaccine remediation costs charged to cost ofsales of $28.1 million in 2005 and $2.6 million in 2004, and the impairmentloss in 2005 of $15.6 million on acquired intangible assets from ouracquisition of PowderJect.

Revenues increased in 2005 as compared with 2004 primarilydue to increased product sales, increased royalty and license fee revenue andincreased revenues from the joint business arrangement. The change in totalrevenues was attributable in part to the movement in exchange rates, inparticular the movements in the Euro and British Pound against the U.S. dollar.The movement in exchange rates had a minimal impact on total revenues in 2005.However, since our Euro and British Pound denominated expenses have alsochanged due to the movement in exchange rates, our income per share fromcontinuing operations decreased $0.01 per diluted share in 2005, due to higherexpenses compared with revenues denominated in Euros and British Pounds.

Product sales increased in 2005 as compared with 2004primarily due to $96.5 million of FLUVIRIN® sales in 2005 for the 2005-2006influenza season. In 2004, we did not have any FLUVIRIN® sales for the 2004-2005 influenzaseason. Product sales also increased due to increases in sales of our travelvaccines, PROCLEIX® product sales, TOBI® tobramycin,Meningococcal vaccines and BETASERON® interferon beta 1b. These increases wereoffset primarily by no sales of BEGRIVACTM vaccine in 2005 as compared with$52.7 million of sales in 2004, and decreases in sales of our pediatric andother vaccines and PROLEUKIN® (aldesleukin).

Revenues from joint business arrangement increased in2005 as compared with 2004 due to higher profitability realized by the jointbusiness arrangement

Royalty and license fee revenues increased in 2005 ascompared with 2004 primarily due to recognition of royalties from a settlementwith a third party on patents owned by Rockefeller University, for which we arethe exclusive licensee, increased BETAFERON® productroyalties, increase in royalties from Roche for use of our patents in the bloodscreening and plasma fractionation markets and increase in royalties from ourhepatitis C virus agreement with Roche. These increases are offset by$40.0 million in royalties relating to the September 2004 Roche settlementrecognized in 2005, as compared with recognition of $46.0 million in the 2004.

In 2005, gross profit margin increased to 48% from 47%in 2004 primarily due to $96.5 million of FLUVIRIN® sales in 2005 for the 2005-2006influenza season and a $91.3 million charge to cost of sales in 2004 resultingfrom the write-off of our entire FLUVIRIN® vaccineinventory in the third quarter of 2004. In 2004, we did not have any FLUVIRIN® sales for the 2004-2005influenza season. These factors were offset by a lost contribution from salesof BEGRIVACTM influenza virus vaccine as there were no sales of BEGRIVACTMvaccine in 2005 as compared with $52.7 million of sales in 2004 and FLUVIRIN® vaccineremediation costs charged to cost of sales of $28.1 million in 2005 and $2.6million in 2004.

Gross profit margins do not include amortizationexpense from acquired developed products, an intangible asset related tobusiness combinations.

The main components of the increase in research anddevelopment expenses in 2005 as compared with 2004 relate to the cost ofdevelopment efforts in our oncology, and meningococcal vaccine franchises,tifacogin and cell culture-derived influenza vaccine program. These increaseswere partially offset by research and development programs that had beendiscontinued prior to 2005.

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The increase inselling, general and administrative expenses in 2005 as compared with 2004 wasdue to a broad range of activities including costs associated with the proposedmerger between Chiron and Novartis AG, pre-launch costs for CUBICIN® daptomycin inEurope, higher employee-related costs, costs related to compliance with theSarbanes-Oxley Act, and higher FLUVIRIN® vaccine-related legal costs.

The effective tax rate for2005 was 11.0% of pretax income from continuing operations. The effective taxrate for 2004 was 28.2% of pretax income from continuing operations, includingthe charge for purchased in process research and development related to theSagres acquisition, which was not tax deductible, and 25.0% of pre-tax incomeexcluding such charge. The effective tax rate was higher in 2004 principallydue to the impact of inter-company transfers of certain product rights in 2004,which increased foreign income taxes. There were no such transfers of productrights in 2005. Further, the effective tax rate in 2005 also includes increasedbenefits from state tax credits and certain foreign tax benefits which are, asa percentage of pre-tax income, higher than would be the case with higherlevels of pre-tax income from FLUVIRIN® influenza vaccine sales. We do not considerthis tax rate to be indicative of our effective tax rate going forward. Theeffective tax rate may be affected in future periods by changes in management’sestimates with respect to our deferred tax assets and other items affecting theoverall tax rate.

*2004 compared with2003*

As described above, there were no sales of FLUVIRIN® vaccine for the2004-2005 season. Sales of FLUVIRIN® influenza vaccine were $219.2 million forthe year ended December 31, 2003. A contractual decline in the BETASERON® interferon beta-1broyalty rate, described in more detail below, resulted in a $34.8 milliondecline in total revenues for the twelve months ended December 31, 2004.Our total revenues were affected by the movement in exchange rates, inparticular the movements in the Euro and British Pound against the U.S. dollar.The movement in exchange rates added approximately 3% to our total revenues forthe twelve months ended December 31, 2004. As described above, wewrote-off our entire FLUVIRIN® product inventory, resulting in a$91.3 million charge to cost of sales, incurred remediation costsassociated with our Liverpool facility of $2.6 million, and incurred legalexpenses of $12.1 million related to the FLUVIRIN® vaccine developments discussed above under *“Influenza Virus Vaccines Recent Events*”,which decreased diluted earnings per share by approximately $0.42 for thetwelve months ended December 31, 2004. Also since our Euro and BritishPound denominated expenses have increased due to the movement in exchangerates, our earnings per share from continuing operations declined $0.08 perdiluted share for the twelve months ended December 31, 2004, as ourexpenses denominated in Euros and British Pounds exceeded our revenuesdenominated in those currencies.

Product sales decreased in 2004 as compared with 2003as there were no FLUVIRIN® influenza vaccine sales for the 2004-2005season. The decrease in FLUVIRIN® vaccine sales was partially offset byincreased sales in PROCLEIX® product sales, TOBI® tobramycin inhalation solution, otherinfluenza vaccines products, PROLEUKIN® (aldesleukin) and travel vaccines. Sales ofPROCLEIX® product sales and TOBI® tobramycin products increased 25% and 24%,respectively, in 2004 as compared with 2003.

Royalty and licenses fees increased significantly in2004 compared with 2003 due to the Roche settlement regarding our HIV patent inthe U.S. The settlement included a $78.0 million lump sum payment, ofwhich $14.0 million was recognized in the third quarter 2004. In addition,the settlement resulted in $31.8 million of previously deferred royaltyand license payments, being recognized in the third quarter 2004. The impact ofthese items from the Roche settlement was an approximate $0.18 increase indiluted earnings per share for 2004. Royalties and license fees also increased$7.9 million from a non-exclusive license we granted to the German Red Crossand $6.5 million from a licensing agreement with LabCorp.

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

Gross profit margins do not include amortizationexpense from acquired developed products, an intangible asset related tobusiness combinations.

The main components of the increase in research anddevelopment expenses in 2004 as compared with 2003 include our infectiousdisease franchise, primarily tifacogin, our oncology franchise, ourmeningococcus vaccine franchise and our flu cell-culture program. Theseincreases were partially offset by the discontinuance of development oftezacitabine and PA-2794. In addition, 2003 included expenses related tothe in-licensing of CUBICIN® (daptomycin) and technology from ZymeQuestInc. and Infectio Diagnostic Inc.

The increase in selling general and administrativeexpenses in 2004 as compared with 2003 mainly reflects an $18.0 millionincrease due to the movement in the Euro and British Pound exchange rates,$12.3 million from a full year of PowderJect expenses and $12.1 million inlegal expenses related to the FLUVIRIN® developments discussed above under *“Influenza Virus Vaccines Recent Events*”.The remaining increase in selling, general and administrative expenses isprimarily due to defense of our patents and technology, on-going marketing andpre-launch programs to support the continued growth of our business andinvestment in geographic penetration for our products and costs related tocompliance with the Sarbanes-Oxley Act.

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

***Critical Accounting Policies and the Use of Estimates***

The preparation of financial statements requires us tomake estimates, assumptions and judgments that affect the reported amounts ofassets, liabilities, revenues and expenses, and related disclosures ofcontingent assets and liabilities. On an on-going basis, we evaluate ourestimates, including those related to investments; inventories; derivatives;capital leases; intangible assets; goodwill; purchased in-process research anddevelopment; product discounts, rebates and returns; bad debts; collaborative,royalty and 

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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.

We believe thefollowing critical accounting policies incorporate our more significantjudgments and estimates used in the preparation of our Consolidated FinancialStatements:

·       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 beother-than-temporary, we consider all available factors in the evaluation.These factors may 

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include, but are notlimited to, (i) whether the issuer of the securities is experiencingdepressed and declining earnings in relation to competitors, erosion of marketshare, and deteriorating financial position, (ii) whether the issuer isexperiencing financial difficulties and its market is experiencingdifficulties, (iii) ongoing activity in our collaborations with theissuer, if any, and (iv) the issuer’s prospects for favorable clinicaltrial results, new product initiatives and new collaborative agreements.Decreases in the fair value of these securities may impact our profitability.To reduce this risk, we hedge a portion of our equity securities exposurethrough 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 reserve. In addition, we operate in a highlycompetitive environment, with rapidly changing technologies. New technology orchanges in production processes may result in product obsolescence. As aresult, we may be required to record additional inventory 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 

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period. We exercisejudgment in determining whether the forecast information provided by licenseesis sufficiently reliable for us to base our royalty revenue recognitionthereon.

·       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 contingencies, whichmanagement believes to be adequate. As part of our long-term tax planningstrategy, we transfer certain product rights through inter-companytransactions. Tax expense and the effective tax rate increase in the yearsthese transactions take place, with the expected future benefit being lowertaxation of future product 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 adjustedto $503.0 million in the fourth quarter 2003. During 2004, we completedthe planned divestiture of certain research operations in Madison, Wisconsinand Oxford, United Kingdom and certain vaccines operations in Sweden, weadjusted the previously recorded obligation related to an assumed defined benefitplan, revised estimates of exit costs associated with certain contractualobligations under supply and research agreements related to the divestedresearch operations and other direct acquisition costs, and revised estimatesof certain receivables and insurance estimates. The net impact of these itemsresulted in an increase to goodwill associated with the PowderJect acquisitionof $17.9 million and goodwill was adjusted from $503.0 million in 2003 to$520.9 million 

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in 2004. Once it isestablished, we must test goodwill annually for impairment using a two-stepprocess as required by SFAS No. 142, Goodwill and Other Intangible Assets.In addition, in certain circumstances, we must assess if goodwill should betested for impairment between annual tests. Intangible assets with definiteuseful lives must be tested for impairment in accordance with SFAS No. 144,Accounting for the Impairment or Disposal of Long-Lived Assets. When we conductour impairment tests for goodwill and intangibles, factors that are consideredimportant in determining whether impairment might exist include significantcontinued under-performance compared to peers, significant changes in theunderlying business and products of our reporting units, or other factorsspecific to each asset or reporting unit being evaluated. Any changes in keyassumptions about the business and its prospects, or changes in marketconditions or other externalities, could result in an impairment charge andsuch a charge could have a material adverse effect on our consolidated resultsof operations. For example, in the third quarter of 2005, we recognized animpairment loss of $14.5 million on acquired intangible assets from ouracquisition of PowderJect related to ARILVAXTM, a yellow fever vaccine. Thisimpairment loss was due to a focus of our resources towards the influenzamarket, resulting in a reduction of the expected activity for ARILVAXTM.

The accounting policies of our reportable segments arethe same as those described in Note 1, “The Company and Summary ofSignificant Accounting Policies,” in the Notes to Consolidated FinancialStatements.

Certain minor arithmeticalvariances between the following narrative and the Consolidated Financial Statementsmay arise due to rounding.

**Results of Operations**

***Blood Testing***

| ** **                                    | ** ** | ** **                                                    | ** ** | ** **        | ** ** | ** **        | ** ** | **$ Change** | ** ** | **% Change** | ** ** |
|-----------------------------------------------|------------|---------------------------------------------------------------|------------|-------------------|------------|-------------------|------------|-------------------|------------|-------------------|------------|
| ** **                                    | ** ** | **Year Ended December 31,**                    | ** ** | **2005 vs.** | ** ** | **2004 vs.** | ** ** | **2005 vs.** | ** ** | **2004 vs.** | ** ** |
| ** **                                    | ** ** | **2005**                                                      | ** ** | **2004**          | ** ** | **2003**          | ** ** | **2004**          | ** ** | **2003**          | ** ** | **2004** | ** ** | **2003** | ** ** |
| ** **                                    | ** ** | **($ in 000’s, except percentages)** | ** ** |
| Product sales,  net:                          |       |                                                          |       |              |       |              |       |              |       |              |       |   |   |   |   |   |   |   |   |
| PROCLEIX® products                  |       | $                                                             | 273,407    |              | $          | 249,809           |       | $                 | 200,066    |              | $          | 23,598 |   | $ | 49,743 |   |   | 9.4 | % |   |   | 24.9 | % |   |
| Ortho-clinical  Diagnostics                   |       | 31,298                                                        |       | 27,844            |       | 28,391            |       | 3,454             |       | (547              | )          |   | 12.4 | % |   |   | (1.9 | )% |   |
|                                          |       | 304,705                                                       |       | 277,653           |       | 228,457           |       | 27,052            |       | 49,196            |       |   | 9.7 | % |   |   | 21.5 | % |   |
| Revenue from  joint business arrangement      |       | 136,701                                                       |       | 118,246           |       | 108,298           |       | 18,455            |       | 9,948             |       |   | 15.6 | % |   |   | 9.2 | % |   |
| Collaborative  agreement revenues             |       | 7,222                                                         |       | 8,044             |       | 9,012             |       | (822              | )          | (968              | )          |   | (10.2 | )% |   |   | (10.7 | )% |   |
| Royalty and  license fee revenues             |       | 106,045                                                       |       | 89,192            |       | 75,407            |       | 16,853            |       | 13,785            |       |   | 18.9 | % |   |   | 18.3 | % |   |
| Other revenues                                |       | 1,031                                                         |       | 979               |       | 466               |       | 52                |       | 513               |       |   | 5.3 | % |   |   | 110.1 | % |   |
| Total Blood  Testing revenues                 |       | $                                                             | 555,704    |              | $          | 494,114           |       | $                 | 421,640    |              | $          | 61,590 |   | $ | 72,474 |   |   | 12.5 | % |   |   | 17.2 | % |   |
| Gross profit  margin                          |       | 41                                                            | %          | 42                | %          | 41                | %          |              |       |              |       |   |   |   |   |   |   |   |   |
| Research and  development expenses            |       | $                                                             | 27,966     |              | $          | 29,238            |       | $                 | 32,469     |              | $          | (1,272 | ) | $ | (3,231 | ) |   | (4.4 | )% |   |   | (10.0 | )% |   |
| Selling, general and  administrative expenses |       | $                                                             | 46,024     |              | $          | 41,885            |       | $                 | 40,206     |              | $          | 4,139 |   | $ | 1,679 |   |   | 9.9 | % |   |   | 4.2 | % |   |

 

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**Product sales**

*PROCLEIX**®* Products*  *On January 15, 2004, the PROCLEIX® ULTRIO® Assayfor HIV-1/HCV/HBV received European CE marking for use on thesemi-automated PROCLEIX® System, and on December 14, 2004, thePROCLEIX® ULTRIO® Assay received European CE marking for use onthe fully automated, high throughput PROCLEIX® TIGRIS® System. Under a collaboration agreement withGen-Probe, we market and sell the PROCLEIX® HIV-1/HCV Assay, the PROCLEIX® ULTRIO® Assay and relatedinstrument systems. In addition to selling directly in the U.S., we also sellin various international markets, directly and through distributors. We recordrevenue based upon the reported results obtained from the customer from the useof assays to screen donations or upon sale and delivery of the assays,depending on the underlying contract. In the case of equipment sales or leases,we record revenue upon the sale and transfer of the title to the instrument orratably over the life of the lease term, respectively. For the provision ofservice on the instruments, we recognize revenue ratably over the life of theservice agreement.

The increase in product sales in 2005 as compared with2004 was primarily due to (i) $20.6 million from the conversion tothe PROCLEIX® ULTRIO® Assay from the PROCLEIX® HIV-1/HCV Assay outside the U.S. andfrom continued penetration into several markets abroad and (ii) $4.7million from instrument sales and services in the U.S. These increases werepartially offset by a $1.7 million decline in donations in the U.S.

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.

Under a collaboration agreement with Gen-Probe, wemarket and sell the PROCLEIX® HIV-1/HCVAssay, the PROCLEIX® ULTRIO® Assay and related instrument systems. The Foodand Drug Administration, or FDA, notified Gen-Probe on October 3, 2005that it considers the PROCLEIX® TIGRIS® System “not substantially equivalent” to theenhanced semi-automated PROCLEIX® System (eSAS) for screening donated humanblood with the PROCLEIX® ULTRIO® Assay. The FDA made this determination inresponse to Gen-Probe’s 510(k) application for the TIGRIS system. Gen-Probeis in discussions with the FDA to resolve the outstanding issues.

*Ortho-ClinicalDiagnostics**  *Underour joint business contractual arrangement with Ortho-Clinical Diagnostics, wemanufacture bulk reagents and antigens and confirmatory test kits forimmunodiagnostic products. The increase in 2005 as compared with 2004 primarilyrelated to $3.5 million from the timing of manufacturing services under thearrangement for Ortho-Clinical Diagnostics. Sales in 2004 as compared with 2003remained consistent. 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 “Royaltyand license fee revenues—Bayer” below).

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

**Revenuesfrom joint business arrangement****  **The increase in revenue from thejoint business arrangement in 2005 as compared with 2004 was primarily due to$19.6 million from higher profitability realized by the joint businessarrangement offset by a decline of $2.2 million in royalties. The increase inrevenue from joint business arrangement in 2004 as compared with 2003 wasprimarily due to (i) $9.8 million for higher profits fromOrtho-Clinical Diagnostics’ U.S. operations and foreign affiliates and (ii) $5.3million for an increase in royalties. These increases were partially offset byreorganization 

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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.”

**Collaborativeagreement 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.

**Royaltyand license fee revenues****  **Our Blood Testing segment earns royalties from thirdparties based on their sales of immunodiagnostic and nucleic acid testing probediagnostic products utilizing our hepatitis C virus (HCV) and HIV-related (HIV)patents, for use in the blood screening and plasma fractionation markets. OurBlood Testing segment also earns license fees related to our HCV and HIVpatents for technologies used by third parties to develop products for use inthe blood screening and plasma fractionation markets. Royalty revenues earnedfrom diagnostic products are included in our other segment.

The increase in royalty and license fee revenues in2005 as compared with 2004 was primarily due to (i) $13.5 million inroyalties from the Roche settlement, (ii) $7.6 million in royalties fromRoche due to rate increases resulting from certain countries entering the EUand an increase in reported donations, (iii) $7.0 million in fees androyalties from our licensing agreement with LabCorp, (iv) $6.3 million inlicense fees under our license agreements with the German Red Cross for the useof our hepatitis C virus (HCV) technology for use in molecular probe “home brew”blood screening and (v) $2.7 million from a settlement with the SNBTSregarding our HCV and HIV patents. These increases were partially offset by (i) $10.1million recognized in the third quarter of 2004 for deferred revenues and anon-refundable portion of the Roche settlement reached in September 2004,as described below, (ii) $7.9 million in the third quarter of 2004 due torecognition of a portion of the license fee under our license agreements withthe German Red Cross for the use of our HIV-1 and hepatitis C virus (HCV)technology for use in molecular probe “home brew” blood screening and (iii) $6.5million in the fourth quarter of 2004 under our licensing agreement withLabCorp for our HCV intellectual property for nucleic acid testing (NAT).

The increase in royalty and license fee revenues in2004 as compared with 2003 was primarily due to (i) $10.1 million forthe settlement with Roche, as described below, (ii) $7.9 million dueto 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 foruse in molecular probe “home brew” blood screening and (iii) $6.5 millionunder our licensing agreement with LabCorp for our HCV intellectual propertyfor nucleic acid testing (NAT). These increases were partially offset by a$7.0 million license fee from Baxter A.G. related to our HCV and HIVtechnology 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.

*Rochesettlement**  *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 relates to blood screening.

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An HIV-related patent directed to nucleic acid testingmethods for HIV-1 was issued in the U.S. on March 13, 2003. Thispatent will expire seventeen years from the date of issuance. As permittedunder the terms of its licensing agreement, Roche decided to institutearbitration proceedings in regard to the application of the U.S. patent. OurBlood Testing segment had deferred recognition of royalties received androyalties accrued under the patent until the resolution of this dispute. On September 10,2004, we reached a settlement agreement with Roche. Under the terms of the settlementagreement, 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 2005, wereceived a lump-sum payment of $78.0 million in lieu of royalties beyond January 1,2005. For 2005, we recognized an aggregate of $40.0 million, with $26.5 millionof revenue from this settlement recognized in our other segment and $13.5million of revenue from this settlement recognized in our Blood Testing segment. 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 the refundavailable to Roche decreases in increments over the quarters of 2005 and 2006.As such, we are recognizing $64.0 million of the $78.0 million payment asrevenue during 2005 and 2006. This revenue will be split between our BloodTesting segment and our other segment. The remaining $14.0 million isnon-refundable and was recognized as revenue in 2004, of which,$9.3 million has been recognized as revenue in our other segment and$4.7 million has been recognized as revenue in our Blood Testing segment. Weexpect to recognize the remaining $24.0 million during 2006. Currently theapplicable issued HCV-related patents expire in 2015 for the U.S. and in 2010for Europe. The applicable issued HIV-related patent in Europe expired in October 2005.

Revenues under these blood screening agreements were$79.8 million, $69.0 million and $61.8 million in 2005, 2004 and 2003,respectively. The $79.8 million in 2005 includes $13.5 million of nonrefundablerevenue under the September 10, 2004 settlement agreement with Roche, asdiscussed above. The $69.0 million in 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 underthe September 10, 2004 settlement agreement with Roche, as discussedabove. The impact on revenues in 2005 and 2004 from these items from the September 10,2004 settlement with Roche is summarized under “Other—Royalty and license feerevenues” below.

*GermanRed Cross Settlement**  *Wehave granted a non-exclusive license to the German Red Cross for use of our HIV-1and HCV technology for use in molecular probe “home brew” blood screeningthrough 2008. Of this license fee payment, $3.2 million and $7.9 millionwere recognized as royalty and license fee revenues in 2005 and 2004,respectively, and the remaining balance of $4.5 million is expected to berecognized 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. In 2005 werecognized $6.3 million of revenue from the exercise of certain of theseoptions by the German Red Cross. The licensing terms also cover potential pastinfringements.

*LabCorp**  *We have entered into a licensingagreement for our hepatitis C virus intellectual property for nucleic acidtesting. The agreement gives LabCorp, including its subsidiary, NationalGenetics Institute, a semi-exclusive license to use our patented HCV NATtechnology in screening plasma donations in the United States, subject toexisting licenses and certain conditions. In 2004, we recognized a $6.5 millionfee associated with this agreement. Revenue under this agreement was $7.0million in 2005.

*ScottishNational Blood Service**  *In2005, we reached a $2.7 million settlement with the Scottish National BloodTransfusion Service regarding certain of our HCV and HIV patents which wasrecognized as revenue in 2005.

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*BaxterA.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 $0.9 million, $1.3 million and$8.6 million in 2005, 2004 and 2003, respectively. We recognized a licensefee of $7.0 million for these agreements in the second quarter 2003.

*Bayer**  *In June 2001, Chiron andOrtho-Clinical Diagnostics entered into an agreement with Bayer Corporation(Bayer) for the clinical diagnostic market. Under this agreement, Bayermanufactures 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 are recognizing 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.In addition, our ability to generate additional royalty and license feerevenues may depend, in part, on our ability to market and capitalize on ourtechnologies.

**Grossprofit margin****  **Thedecrease in gross profit margin in 2005 as compared with 2004 was primarily dueto additional support and service costs associated with our fully automated,high throughput PROCLEIX® TIGRIS® System.

Gross profit margin increased in 2004 as compared with2003 due to a positive impact by an adjustment to cost of goods sold in 2004pursuant to our collaboration agreement with Gen-Probe. The Blood Testing grossprofit margin benefited from an amendment in November 2003 to theworldwide blood screening collaboration agreement between Chiron and Gen-Probein order to adopt permanent, fixed revenue shares for each party. Effective January 1,2004, Gen-Probe’s share was set at 45.75% of net revenues for assays, thatinclude a test for HCV. For commercial assays, that do not test for HCV, suchas the  PROCLEIX® WNV Assay, theagreement remains unchanged with each party retaining 50% of the net revenuesafter deduction of specified expenses.

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

**Researchand development expenses****  **The decrease in research and development expenses in2005 as compared with 2004 was primarily due to $7.5 million decrease in costsrelating to our nucleic acid testing products, partially offset by $6.2 millionfor research activities focused primarily on the development of an immunoassayto detect prions in blood that cause variant Creutzfeldt-Jakob disease.

The decrease in research and development expenses in2004 as compared with 2003 was primarily due to (i) $6.5 million frompurchased in-process technology associated with our investment in ZymeQuest, Inc.in 2003 (we are collaborating with ZymeQuest to develop and commercialize aenzymatic conversion system which converts group A, B and AB red blood cells toenzyme-converted group O (ECO®) redblood cells) and (ii) $2.6 million from costs associated with an agreementwith Infectio Diagnostics Inc. in 2003, in which we licensed proprietarynucleic acid-based technology for the rapid detection of bacterialcontamination in platelets and blood products. These decreases were partiallyoffset by (i) $4.9 million due to the increased development effortsrelating to nucleic acid testing products in 2004 and (ii) $1.0 millionrelated to acquisition of in-process technologies in 2004, focused primarily onresearch into variant Creutzfeldt-Jakob disease.

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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 expenses****  **The increase in selling, general andadministrative expenses in 2005 as compared with 2004 was primarily due to$2.5 million to support the geographic expansion of our customer base forthe PROCLEIX® HIV-1/HCV Assay ininternational markets.

The increase in selling, general and administrativeexpenses in 2004 as compared with 2003 was primarily due to (i) $2.1 millionfrom the support and pre-launch costs associated with the PROCLEIX® TIGRIS® System, a fullyautomated testing system and (ii) $1.6 million to support thegeographic expansion of our customer base for the PROCLEIX® HIV-1/HCV Assay particularly in LatinAmerica and Asia markets. These increases were partially offset by a decreasein other costs of $2.1 million.

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,**                    | ** ** | **2005 vs.** | ** ** | **2004 vs.** | ** ** | **2005 vs.** | ** ** | **2004 vs.** | ** ** |
| ** **                                           | ** ** | **2005**                                                      | ** ** | **2004**          | ** ** | **2003**          | ** ** | **2004**          | ** ** | **2003**          | ** ** | **2004** | ** ** | **2003** | ** ** |
| ** **                                           | ** ** | **($ in 000’s, except percentages)** | ** ** |
| Product sales, net:                                  |       |                                                          |       |              |       |              |       |              |       |              |       |   |   |   |   |   |   |   |   |
| Influenza vaccines:                                  |       |                                                          |       |              |       |              |       |              |       |              |       |   |   |   |   |   |   |   |   |
| Other Influenza  vaccines (includes  BEGRIVACTM) |       | $                                                             | 128,900    |              | $          | 151,158           |       | $                 | 113,188    |              | $          | (22,258 | ) | $ | 37,970 |   |   | (14.7 | )% |   |   | 33.5 | % |   |
| FLUVIRIN® vaccine                          |       | 96,455                                                        |       | 2,255             |       | 219,240           |       | 94,200            |       | (216,985          | )          |   | 4,177 | % |   |   | (99.0 | )% |   |
| Influenza  vaccines                                  |       | 225,355                                                       |       | 153,413           |       | 332,428           |       | 71,942            |       | (179,015          | )          |   | 46.9 | % |   |   | (53.9 | )% |   |
| Meningococcal  vaccines                              |       | 43,361                                                        |       | 27,739            |       | 65,548            |       | 15,622            |       | (37,809           | )          |   | 56.3 | % |   |   | (57.7 | )% |   |
| Travel vaccines                                      |       | 147,507                                                       |       | 96,864            |       | 87,831            |       | 50,643            |       | 9,033             |       |   | 52.3 | % |   |   | 10.3 | % |   |
| Pediatric and  other   vaccines                      |       | 164,308                                                       |       | 200,948           |       | 192,511           |       | (36,640           | )          | 8,437             |       |   | (18.2 | )% |   |   | 4.4 | % |   |
|                                                 |       | 580,531                                                       |       | 478,964           |       | 678,318           |       | 101,567           |       | (199,354          | )          |   | 21.2 | % |   |   | (29.4 | )% |   |
| Collaborative  agreement revenues                    |       | 4,328                                                         |       | 8,646             |       | 4,222             |       | (4,318            | )          | 4,424             |       |   | (49.9 | )% |   |   | 104.8 | % |   |
| Royalty and  license fee revenues                    |       | 5,184                                                         |       | 5,234             |       | 12,747            |       | (50               | )          | (7,513            | )          |   | (1.0 | )% |   |   | (58.9 | )% |   |
| Other revenues                                       |       | 12,058                                                        |       | 17,282            |       | 13,522            |       | (5,224            | )          | 3,760             |       |   | (30.2 | )% |   |   | 27.8 | % |   |
| Total vaccines  revenues                             |       | $                                                             | 602,101    |              | $          | 510,126           |       | $                 | 708,809    |              | $          | 91,975 |   | $ | (198,683 | ) |   | 18.0 | % |   |   | (28.0 | )% |   |
| Gross profit  margin                                 |       | 31                                                            | %          | 23                | %          | 53                | %          |              |       |              |       |   |   |   |   |   |   |   |   |
| Research and  development expenses                   |       | $                                                             | 139,520    |              | $          | 135,380           |       | $                 | 129,719    |              | $          | 4,140 |   | $ | 5,661 |   |   | 3.1 | % |   |   | 4.4 | % |   |
| Selling, general  and administrative expenses        |       | $                                                             | 158,556    |              | $          | 158,569           |       | $                 | 135,808    |              | $          | (13 | ) | $ | 22,761 |   |   | (0.0 | )% |   |   | 16.8 | % |   |
| Amortization  expense                                |       | $                                                             | 41,218     |              | $          | 59,519            |       | $                 | 31,248     |              | $          | (18,301 | ) | $ | 28,271 |   |   | (30.7 | )% |   |   | 90.5 | % |   |
| Impairment loss on  acquired intangible assets       |       | $                                                             | 15,658     |              | $          | —            |       | $                 | —     |              | $          | 15,658 |   | $ | — |   |   | 100 | % |   |   | — |   |   |

 

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**Productsales****  **Wesell influenza, meningococcal, travel, pediatric and other vaccines. Ourvaccines are sold in the U.S., Germany, Italy, the United Kingdom, as well asin other international markets.

*Influenzavaccines**  *Asdescribed above under*“Influenza VirusVaccines Recent Events,”* as a result of recent developments withrespect to FLUVIRIN® andBEGRIVACTM vaccines, we had FLUVIRIN® vaccinesales of $96.5 million in 2005 and no BEGRIVACTM vaccine sales in 2005. Sales ofFLUVIRIN® influenzavaccine were $2.3 million in 2004 for late 2003-2004 influenzaseason and sales of BEGRIVACTM influenza vaccine were $52.7 million in 2004. The decrease in sales of our otherinfluenza vaccines is due to (i) no BEGRIVACTM sales in 2005 and (ii) amanufacturing upgrade of facilities that produce influenza vaccine for thesouthern hemisphere. In 2004, sales of our other influenza vaccines to thesouthern hemisphere were $9.9 million. These decreases were partially offset byprice increases for our other influenza vaccines.

In 2004, we had $2.3 million of FLUVIRIN® sales for late 2003-2004 season. Salesof FLUVIRIN® influenza vaccine were $219.2 million in2003. Sales of our remaining influenza vaccines increased in 2004 as comparedwith 2003 primarily due to approximately $19.3 million for price increasesand $11.2 million for the favorable movement in the Euro to U.S. Dollarexchange rate.

*Meningococcalvaccines**  *Theincrease in meningococcal vaccines sales in 2005 as compared with 2004 wasprimarily due to (i) $8.9 million increase in tender sales of MENJUGATE® vaccine in Spain, (ii) $7.8 millionof MENZBTM meningococcal B vaccine sales to the Ministry of Health in NewZealand and (iii) a $1.8 million increase in tender sales ofMENJUGATE® vaccinein Portugal. These increases are partially offset by a $2.7 million decrease intender sales of MENJUGATE® vaccinein Australia and a $2.3 million decrease in tender sales of MENJUGATE® vaccine in the UnitedKingdom.

The decrease in meningococcal vaccines sales in 2004as compared with 2003 was primarily due to a reduction of $51.1 million insales of MENJUGATE® vaccine due to significant price erosion andreduced volume due to competition. This decrease was partially offset by salesin 2004 of $13.3 million of MENZBTM meningococcal B vaccine to the Ministryof Health in New Zealand.

*Travelvaccines**  *Theincrease in travel vaccines sales in 2005 as compared with 2004 was primarilydue to: (i) a $27.8 million increase in tick-borne encephalitis (TBE)vaccine sales. Sales in the first quarter of 2004 were lower than in the firstquarter of 2005 by $12.0 million due to $15.1 million of sales in the fourthquarter of 2003; TBE vaccines are typically sold in the first half of the year;and in addition, the second and third quarters of 2005 compared with the secondand third quarters of 2004 reflected a $17.9 million increase in the TBEvaccine sales due to growth in the overall market and a number of marketinginitiatives, (ii) $13.8 million from increased demand for our rabiesvaccines in the U.S., primarily due to a product recall from a competitor andprice increases, and increased sales to Canada, (iii) $7.5 million fromincreased demand for our rabies vaccines in Asia and (iv) $7.4 millionfrom increased demand for our rabies vaccines in Europe, primarily due totender sales to Turkey, Hungary and the U.K. These increases were partiallyoffset by a decline of (i) $3.3 million due to a focus of our resourcestowards the influenza market and a reduction in activity for ARILVAXTM in 2005.ARILVAXTM remains in our portfolio of trademarks and we may re-enter the yellowfever vaccine market in the future with this product and (ii) $1.5 millionin sales of Dukoral vaccine due to the divestiture in the second quarter of2004 of certain vaccines operations in Sweden acquired in our acquisition ofPowderJect.

The increase in travel vaccines sales in 2004 ascompared with 2003 was primarily due to $25.7 million driven by increaseddemand for our rabies vaccines in the U.S., primarily due to a product recallfrom a competitor and increased demand of our rabies vaccines in Europe andAsia. The increase was partially offset by the fact that we had $15.1 millionof sales of our tick-borne encephalitis vaccine in late 2003, which istypically sold in the first half of the year.

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*Pediatricand other vaccines**  *Salesof our pediatric and other vaccines decreased in 2005 as compared with 2004primarily due to (i) a $24.0 million decline in polio vaccines andmeasles, mumps and rubella vaccines sales due to product write-offs and a lackof product availability as a result of manufacturing upgrades, (ii) an $8.8million decrease due to the timing of tender sales for our polio vaccines andmeasles, mumps and rubella vaccines, (iii) a $6.7 million decline due tothe planned divestiture of certain vaccines operations in Sweden in the secondquarter of 2004 acquired from our acquisition of PowderJect, (iv) a $14.5million decrease from the interruption of production of certain vaccines in ourLiverpool plant to focus on our remediation efforts at that plant and(v) a $1.7 million decrease due to product returns reserves in 2005in connection with expected returns of 2005 product sales from the recall ofMORUPAR®, ourmeasles, mumps and rubella vaccine. These decreases were partially offset by a$19.2 million increase related to the timing of sales for diphtheria, tetanusand pertussis vaccines.

The increase in our pediatric and other vaccines salesin 2004 as compared with 2003 was primarily due to an additional$21.3 million related to the timing of tender sales for our polio vaccinesand diphtheria, tetanus and pertussis vaccines, offset partially by (i) $7.3million due to the planned divestiture of certain vaccines operations in Swedenin the second quarter 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.

Certain of our vaccine products are seasonal,particularly our influenza vaccines, which have higher sales primarily in thesecond half of the year. Our TBE vaccine is also seasonal with higher salestypically in the first half of the year. Certain of our vaccines requireregulatory 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 influenza vaccines developments. For more information on this, see*“Influenza Virus Vaccines Recent Events”*above. In addition, we expect MENJUGATE® vaccine sales to continue to fluctuate as public healthauthorities consider adoption of broad vaccination programs and competitivepressures continue to increase.

On October 27, 2005, we announced that we won acontract to supply the U.S. government with pre-pandemic influenza vaccine fora stockpile to protect against the H5N1 avian influenza virus strain. Under theagreement with the Department of Health and Human Services (HHS), we agreed toprovide a bulk stockpile of H5N1 influenza vaccine, which we expect to produceat our Liverpool manufacturing facility using the U.S.-licensedcommercial-scale manufacturing process. On February 24, 2006, we announcedthat the HHS had agreed to extend delivery terms for this stockpile. Prior toturning to seasonal FLUVIRIN® production, we hadproduced approximately 70% of the order. We expect to resume work on fulfillingthe contract following completion of the FLUVIRIN® vaccinecampaign in the fall. On February 24, 2006 we announced that we enteredinto a contract to supply the UK government with a stockpile of H5N1 influenzavaccine produced at our Siena manufacturing facility. Production of the H5N1stockpiles vaccine under these agreements is not expected to affect productionof our annual influenza virus vaccines. Delivery of the stockpile remainssubject to internal and regulatory release procedures.

**Collaborativeagreement revenues****  **Werecognize collaborative agreement revenues for fees received as we performresearch services and achieve specified milestones. Collaborative agreementrevenues in 2005 as compared with 2004 decreased primarily due to $2.6 millionin lower milestone payments related to an agreement to supply MENZBTMmeningococcal B vaccine to the Ministry of Health in New Zealand.

Collaborative agreement revenues in 2004 as comparedwith 2003 increased primarily due to (i) $1.4 million in highermilestone payments related to an agreement to supply MENZBTM meningococcal Bvaccine to the Ministry of Health in New Zealand and (ii) $3.0 millionin increased collaborative agreement revenues following a full year of collaborativerevenues in 2004 from our acquisition of PowderJect.

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The balance ofcollaborative agreement revenues recognized in our vaccines segment consistedof various other arrangements, which individually were not material.

Collaborative agreementrevenues tend to fluctuate based on the amount and timing of research servicesperformed, the status of projects under collaboration and the achievement ofmilestones. Due to the nature of our collaborative agreement revenues, resultsin any one period are not necessarily indicative of results to be achieved inthe future. In addition, the collaboration agreements typically provide forcertain milestone payments and various royalties on future product sales if thecollaborative partners commercialize a product using our technology. Also, ourability to generate additional collaborative agreement revenues may depend, inpart, on our ability to initiate and maintain relationships with potential andcurrent collaborative partners.

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

*GlaxoSmithKline**  *An agreement with GlaxoSmithKlineplc provides for royalties on sales of certain vaccine products. Under thisagreement, we recognized $3.2 million, $2.9 million and $7.1 millionof such royalties in 2005, 2004 and 2003, respectively.  Royalties were consistent between 2005 and2004. The decrease in royalties in 2004 compared with 2003 was primarily due tothe expiration of various patents under this agreement.

*Other**  *In 2005, 2004 and 2003, werecognized $0.9 million, $1.0 million and $5.6 million, respectively,of royalty revenues primarily on third party sales of hepatitis B virus vaccineproducts. Certain patents related to the production of hepatitis B vaccine productsexpired beginning in 2004, which resulted in reductions in royalty revenuesrecognized under one arrangement.

The balance of royalty andlicense fee revenues recognized in our vaccines segment consisted of variousother 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 thefuture. Also, the license agreements typically provide for certain milestonepayments and various royalties on future product sales if the licenseescommercialize a product using our technology. However, we have no assurancethat the licensee will meet their development objectives or commercialize aproduct using our technology. In addition, our ability to generate additionalroyalty and license fee revenues may depend, in part, on our ability to marketand capitalize on our technologies.

**Other revenues**

*Grant and contractrevenues**  *Ourvaccines segment other revenues included grant and contract revenues of $10.0million, $13.4 million and $9.7 million in 2005, 2004 and 2003,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 $6.1 million, $8.1 million and $7.3 million in 2005, 2004and 2003, respectively.

The balance of otherrevenues consisted of various other agreements, which individually were notmaterial.

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

**Grossprofit  ** Gross profit margin increased in 2005 ascompared with 2004 primarily due to $96.5 million of FLUVIRIN® vaccine sales in 2005 for the 2005-2006influenza season and a $91.3 million charge to cost of sales resulting from thewrite-off of our entire FLUVIRIN® vaccineinventory in the third quarter of 2004. In 2004, we did not have any FLUVIRIN® vaccine sales for the 2004-2005influenza 

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season. Thesefactors were partially offset by (i) a lost contribution from sales ofBEGRIVACTM influenza virus vaccine as there were no sales of BEGRIVACTM vaccinein 2005 as compared with  $52.7 millionof sales in 2004, (ii) an $18.0 million charge for the write-off ofBEGRIVACTM product inventory due to product sterility issues, (iii) FLUVIRIN® vaccine remediation costs charged to cost ofsales of $28.1 million in 2005 and $2.6 million in 2004, (iv) adecline in sales of our Polio and MMR vaccines due to lack of productavailability as a result of manufacturing upgrades, (v) $19.1 millioncharged to cost of sales in 2005 due to the write-off of certain FLUVIRIN® vaccine inventory primarily due to normalmanufacturing issues and excess finished product and semi-finished product atthe end of the season and (vi) $6.0 million charged to cost of salesin 2005 due to the write-off of MORUPAR® inventory as aresult of the withdrawal.

Gross profit margin declined in 2004 as compared with2003 primarily due to (i) the fact 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. In addition, 2004 includedapproximately $2.6 million in FLUVIRIN® vaccine remediation costs, which were chargedto cost of sales. Gross profit margin was also negatively impacted by reducedsales and margins of the MENJUGATE® product. These factors were offset by higherprices of our other influenza vaccines products and increased sales of our rabiesvaccine in the U.S. market.

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 of intangible assets acquired in businesscombinations and asset purchases’ 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.

**Researchand development expenses****  **The increase in research and development expenses in2005 as compared with 2004 was primarily due to $8.3 million fromadvancing our quadrivalent meningococcal vaccine candidate for serogroups A,C,Wand Y, and $4.8 million from our flu cell culture development program. Theseincreases were partially offset by $7.2 million for our Phase III trial forMENJUGATE® meningococcus C vaccine in the United Statesin 2004, with no comparable spending in 2005, and the second quarter of 2004divestiture of certain research and development operations, acquired in theacquisition of PowderJect. The divested operations included $4.2 million inresearch and development expenses in 2004.

The increase in research and development expenses in2004 as compared with 2003 was primarily due to (i) $7.3 million from flucell culture and (ii) $7.1 million from the advancement of severalprograms in our meningococcal franchise. These increases were mainly offset bythe effects of the planned divestiture of certain research operations,associated with our acquisition of PowderJect, in Madison, Wisconsin andOxford, United Kingdom during the second quarter of 2004. Research anddevelopment expense associated with these operations in 2004 as compared with2003 decreased $8.8 million.

In 2004, we successfully concluded our Phase III trialfor MENJUGATE® meningococcus C vaccine in the United States.We will not be filing a Biologics License Application for the vaccine andinstead focus our resources on advancing our quadrivalent meningococcus vaccinecandidate for serogroups 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 expenses****  **The decrease in selling, general andadministrative expenses in 2005 as compared with 2004 was due to (i) areduction of $4.1 million as a result of the planned 

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divestiture of certainPowderJect operations in the second quarter 2004, (ii) $3.0 million fromthe recovery of bad debt and (iii) $4.5 million from reductions inmarketing activities. These decreases were partially offset by increases of (i) $2.8million due to the movement in the Euro and British pound to U.S. Dollar exchangerate, (ii) an additional $3.4 million for costs related to compliance withthe Sarbanes-Oxley Act, (iii) an additional $2.5 million from theestablishment of sales and marketing operations in the U.S., (iv) $2.4 millionfor executive severance and (v) an additional $1.7 million of personnelcosts.

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

**Amortization expenses****  **The decrease in amortization expensein 2005 as compared with 2004 was due to lower amortization expense related tocertain developed product technologies from our acquisition of PowderJect,which are amortized under the estimated sales method. The estimated salesmethod considers forecasted FLUVIRIN® salesduring each influenza season through the remaining period of the benefit.Related amortization was $34.2 million as compared with $48.2 million in 2005and 2004,  respectively reflectingupdated forecasted FLUVIRIN® sales.The increase in amortization expense in 2004 as compared with 2003 primarilyrelated to the intangible assets acquired following our third quarter 2003PowderJect acquisition.

**Impairmentloss on acquired intangible assets  ** In 2005, werecognized an impairment loss of $14.5 million on acquired intangible assetsfrom our acquisition of PowderJect related to ARILVAXTM, a yellow fever vaccine.This impairment loss was due to a focus of our resources towards the influenzamarket, resulting in a reduction of the expected activity for ARILVAXTM.ARILVAXTM remains in our portfolio of trademarks and we may re-enter the yellowfever vaccine market in the future with this product. In addition, in 2005, werecognized an impairment loss of $1.1 million on acquired intangible assetsfrom our acquisition of PowderJect related to a contract manufacturingagreement. This impairment loss was due to a reduction of the expected activityfor this contract manufacturing agreement.

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***Biopharmaceuticals***

| ** **                                    | ** ** | ** **                                                    | ** ** | **$ Change** | ** ** | **% Change** | ** ** |
|-----------------------------------------------|------------|---------------------------------------------------------------|------------|-------------------|------------|-------------------|------------|
| ** **                                    | ** ** | **Year Ended December 31,**                    | ** ** | **2005 vs.** | ** ** | **2004 vs.** | ** ** | **2005 vs.** | ** ** | **2004 vs.** | ** ** |
| ** **                                    | ** ** | **2005**                                                      | ** ** | **2004**          | ** ** | **2003**          | ** ** | **2004** | ** ** | **2003** | ** ** | **2004** | ** ** | **2003** | ** ** |
| ** **                                    | ** ** | **($ in 000’s, except percentages)** | ** ** |
| Product sales, net:                           |       |                                                          |       |              |       |              |       |   |   |   |   |   |   |   |   |   |   |   |   |
| BETASERON® interferon beta-1b  |       | $                                                             | 142,238    |              | $          | 130,572           |       | $ | 124,936 |   | $ | 11,666 |   | $ | 5,636 |   |   | 8.9 | % |   |   | 4.5 | % |   |
| TOBI® tobramycin                    |       | 232,624                                                       |       | 212,876           |       | 172,047           |       | 19,748 |   | 40,829 |   |   | 9.3 | % |   |   | 23.7 | % |   |
| PROLEUKIN® (aldesleukin)            |       | 123,549                                                       |       | 129,377           |       | 115,075           |       | (5,828 | ) | 14,302 |   |   | (4.5 | )% |   |   | 12.4 | % |   |
| Other                                         |       | 37,847                                                        |       | 38,861            |       | 27,000            |       | (1,014 | ) | 11,861 |   |   | (2.6 | )% |   |   | 43.9 | % |   |
|                                          |       | 536,258                                                       |       | 511,686           |       | 439,058           |       | 24,572 |   | 72,628 |   |   | 4.8 | % |   |   | 16.5 | % |   |
| Collaborative  agreement revenues             |       | 1,534                                                         |       | 1,354             |       | 5,328             |       | 180 |   | (3,974 | ) |   | 13.3 | % |   |   | (74.6 | )% |   |
| Royalty and  license fee revenues        |       | 72,950                                                        |       | 71,527            |       | 87,698            |       | 1,423 |   | (16,171 | ) |   | 2.0 | % |   |   | (18.4 | )% |   |
| Other revenues                                |       | 18,305                                                        |       | 10,940            |       | 29,538            |       | 7,365 |   | (18,598 | ) |   | 67.3 | % |   |   | (63.0 | )% |   |
| Total  biopharmaceuticals revenues            |       | $                                                             | 629,047    |              | $          | 595,507           |       | $ | 561,622 |   | $ | 33,540 |   | $ | 33,885 |   |   | 5.6 | % |   |   | 6.0 | % |   |
| Gross profit  margin                          |       | 72                                                            | %          | 72                | %          | 72                | %          |   |   |   |   |   |   |   |   |   |   |   |   |
| Research and  development expenses            |       | $                                                             | 266,405    |              | $          | 266,511           |       | $ | 247,618 |   | $ | (106 | ) | $ | 18,893 |   |   | (0.0 | )% |   |   | 7.6 | % |   |
| Selling, general  and administrative expenses |       | $                                                             | 148,453    |              | $          | 142,114           |       | $ | 117,505 |   | $ | 6,339 |   | $ | 24,609 |   |   | 4.5 | % |   |   | 20.9 | % |   |
| Amortization expense                     |       | $                                                             | 24,988     |              | $          | 24,984            |       | $ | 25,117 |   | $ | 4 |   | $ | (133 | ) |   | 0.0 | % |   |   | (0.5 | )% |   |

 

**Productsales****  **Biopharmaceuticalproduct sales in 2005, 2004 and 2003 consisted principally of BETASERON® interferon beta-1b, TOBI® tobramycin and PROLEUKIN® (aldesleukin) products.

*BETASERON*®* interferon beta-1b**  *We manufacture interferon beta-1bwhich is marketed by Schering AG and its affiliates, including BerlexLaboratories, Inc. (collectively Schering), under the trade namesBETASERON® (in the U.S and other non-European markets)and BETAFERON® (in Europe). Boehringer Ingelheim alsosupplies BETAFERON® interferon beta-1b to Schering for salein Europe. For product we manufacture, we recognize a portion of revenue forproduct sales upon shipment to Schering and the remainder based on acontractual percentage of sales by Schering, both of which we record as productsales. For product manufactured by Boehringer Ingelheim and marketed bySchering in Europe under the trade name BETAFERON®, we receive royalties calculated at thesame percentage of sales less the amount paid or incurred by Schering forsupply costs, which we record in royalty and license fee revenues. Starting inthe fourth quarter 2003, the amount we record as product sales and BETAFERON® royalties, based on a percentage of sales bySchering, declined by five percentage points pursuant to our contractualagreement with Schering. As a result, the percentage of sales per unit on whichour payments are based has decreased, reducing our per unit revenue byapproximately 18% (for sales of Chiron product) and approximately 34% (forroyalties from sales of Boehringer Ingelheim product) from that received priorto the decline. However, there are a number of mitigating considerations,including (i) the transitional supply agreement and (ii) the volumemix of Chiron product and Boehringer Ingelheim product. We believe theseconsiderations have partially offset this 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-filleddiluent syringe was launched in January 2004 and enhances the deliverymode and shortens preparation, helping to simplify injections of BETASERON® 

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interferon beta-1b.In the first quarter 2003, the U.S. Food and Drug Administration approved newlabeling for BETASERON® interferon beta-1b. The labeling expandsthe indication for BETASERON® interferon beta-1b to treat allrelapsing forms of multiple sclerosis to reduce the frequency of clinicalexacerbations. Relapsing forms of multiple sclerosis includerelapsing-remitting, the most common form, and secondary progressive multiplesclerosis with relapses.

Pursuant to our agreement with Schering, we begansupplying BETAFERON® product to Schering in the fourth quarter 2002for certain additional European markets, which were previously supplied byBoehringer Ingelheim. This resulted in a shift of revenue recognized under thisagreement to product sales, and a decrease in royalty revenues beginning in thefourth quarter 2002. In 2003, Schering extended its supply agreement withBoehringer Ingelheim through 2008. The exact shift of revenue in the futurewill be contingent on our production capacity, Schering’s minimum purchasecommitment under the extended supply agreement with Boehringer Ingelheim, andmarket demand. The shift to product sales is expected to increase over the nextthree years. We expect overall, biopharmaceutical earnings to be largelyunaffected by the transition. In order to supply BETAFERON® toSchering, we are required to make capital improvements to our existingmanufacturing facilities to increase capacity. During 2005, 2004 and 2003, werecorded charges related to process development and test runs associated withthis project. See “Research and development expenses” below.

The increase in BETASERON® product sales in 2005 as comparedwith 2004 primarily related to (i) $8.4 million from price increases and (ii) $5.0million from a shift of revenue from royalties to product sales as Scheringbegan to sell product manufactured by us in additional European markets. Theseincreases were partially offset by (i) $3.1 million from reduced shipmentsto Berlex and (ii) $0.9 million from inventory ordering patterns.

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

On February 24, 2006 Schering AG notified Chironof its intention to exercise its option under the Regulatory Filing,Development and Supply Agreement to purchase or lease all assets used by Chironin the manufacture for Schering of BETASERON® interferon beta-1b products and allcontractual rights at their fair market or lease value. The purchase/leaseoption is subject to the closing of the proposed acquisition of Chiron byNovartis AG. The agreement requires that the value be determined by anindependent third party mutually agreed upon by both parties.

*TOBI®tobramycin solution for inhalation**  *We sell TOBI® solution directly in the U.S. and certaininternational markets. The increase in sales in 2005 as compared with 2004 wasprimarily due to (i) $15.9 million due to price increases and (ii) $12.5million due to increased patient demand in both the United States and Europe.These increases were partially offset by $7.5 million reduction due toinventory ordering patterns and $0.8 million for a government rebateadjustment.

The increase in sales in 2004 as compared with 2003was primarily due to (i) $16.0 million in increased patient demand inthe U.S, (ii) $9.2 million in price increases, (iii) $6.4 millionin favorable movement in the Euro to U.S. Dollar exchange rate and (iv) $6.0 millionin inventory ordering patterns.

We continue to seek approval of TOBI® solution in other countries. Inventoryordering patterns of our wholesalers and distributors as well as reimbursementand government pressures, competition, foreign currency exchange rates and thelevel of rebates may influence future TOBI® product sales. In 

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December 2002, theU.S. Food and Drug Administration tentatively approved an abbreviated new drugapplication for an inhaled tobramycin for sale in the U.S. following expirationof the orphan drug status of the TOBI® solution in December 2004. Subsequently,the application was withdrawn and under terms of a settlement agreement reachedin October 2003, approval will not be sought to market this genericproduct until the 2014 expiration of our patent in the U.S. covering theformulation of TOBI® solution for inhalation.

*PROLEUKIN*®* (aldesleukin)**  *The decrease in PROLEUKIN® (aldesleukin) productsales in 2005 as compared with 2004 was primarily due to (i) $10.7 milliondue to a decrease in patient demand as a result of increased competition and (ii) $1.6million for a government rebate adjustment. These decreases were partiallyoffset by $6.6 million for price increases.

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

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

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

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

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.

**Royaltyand license fee revenues****  **Our biopharmaceuticals segment earns royalties on thirdparty sales of several products, including BETAFERON® interferon beta-1b and recombinantinsulin and glucagon products. Our biopharmaceuticals segment also earnslicense fees for technologies, such as hepatitis C virus-related patents, usedby third parties to develop therapeutic products.

*BETAFERON*®* interferon beta-1b**  *BETAFERON® product royalties were $60.0 million, $51.6million and $63.8 million in 2005, 2004 and 2003, respectively.

The increase in BETAFERON® product royalties in 2005 ascompared with 2004 was primarily due to (i) $5.4 million from an increasein demand and (ii) $3.9 million from price increases. These increases werepartially offset by $4.4 million from a shift of revenue from royalties toproduct sales as Schering began to sell product manufactured by us inadditional European markets.

The decrease in 2004 as compared with 2003 wasprimarily due to $16.6 million 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.

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As discussed in “Product sales—*BETASERON**® interferon beta-1b*” above, we begansupplying BETAFERON® product, which was previously supplied byBoehringer Ingelheim, to Schering in the fourth quarter 2002 for certainadditional European markets. This resulted in a shift of revenue recognizedunder this agreement to product sales, with a decrease in royalty revenues,beginning in the fourth quarter 2002. In 2003, Schering extended its supplyagreement with Boehringer Ingelheim through 2008. The magnitude of the shift ofrevenue in the future will be contingent on our production capacity, Schering’sminimum purchase 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 royaltieswill be influenced by demand, price changes and foreign currency exchangerates.

*NovoNordisk**  *Weearn royalty revenues on insulin and glucagon product sales by Novo Nordisk AS.We recognized $3.8 million, $4.4 million and $8.5 million in 2005,2004 and 2003, respectively, under these arrangements. Patents related to theproduction of insulin and glucagons began expiring in late 2003, and as aresult, there were significant reductions in royalty revenue in 2005 and 2004recognized under these arrangements. We expect royalties under thesearrangements to continue to decrease as certain U.S. patents expire in 2006 and2007.

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 using our technology. However, we have no assurancethat the licensees will meet their development objectives or commercialize aproduct using our technology. In addition, our ability to generate additionalroyalty and license fee revenues may depend, in part, on our ability to marketand capitalize on our technologies.

**Other revenues**

*Contractmanufacturing revenues**  *Ourbiopharmaceuticals segment recognized contract manufacturing revenues of $17.1million, $10.3 million and $13.5 million in 2005, 2004 and 2003,respectively. The fluctuations in 2005 as compared with 2004 and in 2004 ascompared with 2003 resulted from the level of activity and the timing ofcontract manufacturing activities.

*Biogenand 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. There can be no assurance thatwe will be successful in obtaining additional revenues or that these revenueswill not decline.

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**Grossprofit margin****  **Thebiopharmaceutical gross profit margin in 2005 was consistent with the grossprofit margin in 2004. The effect of price increases were offset by costsassociated with a planned increase in idle time for manufacturing facilitiesand ongoing process improvement efforts.

The biopharmaceutical gross profit margin in 2004 wasconsistent with the gross profit margin in 2003. The effect of price increaseswere offset by the lower royalties from the contractual change in the royaltyrate related to the sale of BETASERON® product and the increased costs associatedwith the pre-filled diluent syringe for BETASERON® product.

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 of intangible assets acquired in businesscombinations and assets purchases.”

Biopharmaceutical gross profit margin may fluctuatesignificantly in future periods due to production yields, increased cost toproduce the BETASERON® interferon beta-1b pre-filled diluentsyringe and as the biopharmaceutical product and customer mix changes.

**Researchand development expenses****  **The decrease in research and development expenses in2005 as compared with 2004 was primarily due to (i) a $14.2 milliondecrease in expenses related to the SILCAAT trial, as discussed below, (ii) a $5.0million decrease in expenses for the development of PULMINIQTM (cyclosporine, USP) inhalation solutionand (iii) a $3.0 million decrease related to the discontinueddevelopment of tezacitabine in the first quarter of 2004 based on an analysisof the data from a Phase II trial in patients with gastro esophageal cancer. Thesedecreases are partially offset by increased expenditures of (i) $8.6million for the progression of phase I clinical studies of our oncologycompound CHIR-258 (small molecule), (ii) $5.3 million for activitiesrelated to the development of tifacogin, (iii) $1.1 million fordevelopment activities related to CUBICIN® (daptomycin) for treatment of complicated skin andsoft tissue infections, (iv) $1.6 million related to the development ofnew processes and performance of test runs related to installed equipment ofour existing manufacturing facilities to support the supply of BETAFERON® interferon beta-1bto Schering and (vi) $1.5 million for development of tobramycin inhalationpowder.

The increase in research and development spending in2004 as compared with 2003 was primarily the result of (i) $30.7 millionfrom activities related to the development of tifacogin, as discussed below, (ii) $15.2million from development of our early-stage oncology compounds CHIR-258(small molecule) and CHIR 12.12 (an antibody) and (iii) $7.1 million frompre-registration activities for PULMINIQTM (cyclosporine, USP) inhalationsolution for the increase in survival and prevention of chronic rejection inpatients receiving allogenic lung transplants, in combination with standardimmunosuppressive therapy. These increases were partially offset by (i) areduction of $13.5 million due to the discontinued development oftezacitabine in the first quarter of 2004 based on an analysis of the data froma Phase II trial in patients with gastroesophageal cancer, (ii) a declineof $9.2 million in spending due to discontinuance of development of PA-2794,(iii) a decline of $7.8 million due to a decline in expenses related tothe development of new processes and the performance of test runs related toinstalled equipment of our existing manufacturing facilities to support thesupply of BETAFERON® interferon beta-1b to Schering and (iv) a netdecline of $5.2 million in spending related to the pre-registration activitiesof CUBICIN® (daptomycin) 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 our assessment of no futurebenefit from the trial.

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In March 2004, we 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 our share being 70% and XOMA’s share being 30%. Weagreed to make an initial payment of $10.0 million, which was paid as of December 31,2004, and classified as prepaid research and development expense. The prepaidexpense is being amortized on a straight-line basis over a five-year period ofbenefit. Amortized research and development expense of $1.5 million and $2.0million were recorded for the years ended December 31, 2004 and 2005,respectively. We agreed to make a loan facility of up to $50.0 millionavailable to XOMA, starting on January 1, 2005 to fund 75% of XOMA’s shareof development expenses. Under this arrangement, we made $12.1 million in loanadvances to XOMA as of December 31, 2005. Interest payable by XOMA is duewhen the principal is due and is additive to the $50.0 million availableprincipal. Interest payable of $0.3 million was added to the outstandingbalance as of December 31, 2005. The loan advances were recorded at theestimated fair value based upon an interest rate for a similar loan facilityfrom a bank to a similar counterparty. The recorded amount will be accreted tofull face value over the life of the outstanding facility based on theeffective interest method. At December 31, 2005, $7.1 million was recordedas “Non-current notes receivable” in the Consolidated Balance Sheet for theseloan advances.

In October 2003, we entered into a licenseagreement with Cubist Pharmaceuticals, Inc. for the development andcommercialization of Cubist’s antibiotic CUBICIN® (daptomycin) in Western and Eastern Europe,Australia, New Zealand, India and certain Central American, South American andMiddle Eastern countries. In exchange for these development andcommercialization rights, we have agreed to pay Cubist up to $50.0 million.This $50.0 million includes $18.0 million, which was paid by us upfront in the fourth quarter 2003, $10.0 million of which was used topurchase restricted Cubist common stock at a 50 percent premium overmarket price and up to $32.0 million of additional payments to Cubist uponthe achievement of certain regulatory and sales milestones. We also agreed topay Cubist a tiered royalty on CUBICIN® marketed by us. We recorded $10.6 millionof the up front payment related to the purchase of in-process research anddevelopment, as research and development expense in 2003. In January 2006,European Commission granted marketing approval to us for CUBICIN®, a first-in-class IV antibiotic. Themarketing approval was granted in the 25 member states of the European Union,Iceland, Liechtenstein and Norway. Under the approval, CUBICIN® isindicated for the treatment of complicated skin and soft-tissue infections(cSSTI) caused by Gram-positive bacteria. The CUBICIN® antibiotic is also approved by the FDA for thetreatment of complicated skin and skin structure infections caused byGram-positive bacteria, and is marketed in the United States by CubistPharmaceuticals, Inc. CUBICIN® antibiotic is manufactured for us by CubistPharmaceuticals, Inc.

In October 2003, we acquired all of Pfizer, Inc.’s,formerly Pharmacia Corporation’s, interest in tifacogin, in return for whichPfizer will receive royalties on future sales of tifacogin. In the secondquarter 2004, we began enrolling patients in our Phase III trial for tifacoginas a treatment for patients with severe community-acquired pneumonia. In December 2005an independent Data Monitoring Committee completed an interim analysis ofclinical data from the study and recommended the continuation of the study.

In April 2003, we acquired exclusive worldwidedevelopment and commercial rights from Novartis for PULMINIQTM  (cyclosporine, USP) inhalationsolution, a therapy under evaluation for treatment of rejection and reductionof mortality in lung transplant recipients for $0.5 million, which was expensedas research and development costs in 2003. In 2004, we submitted a new drugapplication to the FDA for marketing approval of PULMINIQTM. On July 14, 2005, we receivedan action letter from the FDA stating that the company’s New Drug Application(NDA) for PULMINIQTM (cyclosporine, USP) inhalation 

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solution is “approvable” but,in light of the fact that the application was based on a single-center clinicaltrial with a small patient population, an additional pre-approval study wouldbe required to confirm the efficacy of the drug.

In the fourth quarter of 2002, we reached an agreementin principle to transfer responsibility for the SILCAAT trial, a Phase IIIstudy for recombinant human interleukin-2 (IL-2, aldesleukin), tothe National Institutes Allergy and Infectious Disease (NIAID) and theUniversity of Minnesota. Responsibility for the SILCAAT study was transferredto NIAID and University of Minnesota effective February 14, 2003. Underthe agreement, we funded $6.0 million and $12.0 million for the years ended December 31,2003 and 2004, respectively. There are no remaining funding obligations dueunder this agreement.

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 expenses****  **The increase in selling, general andadministrative expenses in 2005 as compared with 2004 was primarily due to (i) $9.1million for pre-launch costs for CUBICIN® (daptomycin), (ii) $1.1 million of pre-launchcosts for PULMINIQTM (cyclosporine, USP) inhalation solution and (iii) $0.6 milliondue to movement in the Euro to U.S. Dollar exchange rate. These increases werepartially offset by $5.1 million decline for various marketing andpromotional activities that have been discontinued.

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

**Amortization expense****  **Amortization expense was consistentin 2005, 2004 and 2003 and relates to the distribution rights acquired uponacquisition of Pulmopharm in the third quarter 2002 and intangible assets fromour acquisition of PathoGenesis Corporation in 2000, which we accounted forunder the purchase method of accounting and allocated a portion of the purchaseprice to purchased technologies, acquired intangible assets and goodwill.

***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.Notably, revenues earned from diagnostic products are included in our othersegment and revenues earned from blood screening are included in our BloodTesting segment. As a result, we have aggregated these items into an “Other”segment.

| ** **                                     | ** ** | ** **                                                    | ** ** | ** **        | ** ** | ** **        | ** ** | **$ Change** | ** ** | **% Change** | ** ** |
|------------------------------------------------|------------|---------------------------------------------------------------|------------|-------------------|------------|-------------------|------------|-------------------|------------|-------------------|------------|
| ** **                                     | ** ** | **Year Ended December 31,**                    | ** ** | **2005 vs.** | ** ** | **2004 vs.** | ** ** | **2005 vs.** | ** ** | **2004 vs.** | ** ** |
| ** **                                     | ** ** | **2005**                                                      | ** ** | **2004**          | ** ** | **2003**          | ** ** | **2004**          | ** ** | **2003**          | ** ** | **2004** | ** ** | **2003** | ** ** |
| ** **                                     | ** ** | **($ in 000’s, except percentages)** | ** ** |
| Royalty and  license fee  revenues             |       | $                                                             | 132,827    |              | $          | 123,608           |       | $                 | 74,290     |              | $          | 9,219 |   | $ | 49,318 |   |   | 7.5 | % |   |   | 66.4 | % |   |
| Selling, general  and administrative expenses  |       | $                                                             | 148,160    |              | $          | 116,933           |       | $                 | 86,867     |              | $          | 31,227 |   | $ | 30,066 |   |   | 26.7 | % |   |   | 34.6 | % |   |
| Purchased  in-process research and development |       | $                                                             | —     |              | $          | 9,629             |       | $                 | 45,300     |              | $          | (9,629 | ) | $ | (35,671 | ) |   | (100 | )% |   |   | (78.7 | )% |   |
| Interest expense                               |       | $                                                             | 30,615     |              | $          | 26,093            |       | $                 | 19,104     |              | $          | 4,522 |   | $ | 6,989 |   |   | 17.3 | % |   |   | 36.6 | % |   |
| Interest and other  income, net                |       | $                                                             | 86,692     |              | $          | 56,797            |       | $                 | 38,892     |              | $          | 29,895 |   | $ | 17,905 |   |   | 52.6 | % |   |   | 46.0 | % |   |

 

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**Royaltyand license fee revenues****  **Our other segment earns royalties on third party salesof, and license fees on, several products. The majority of royalty and licensefee revenues related to the use of our HCV and HIV-related patents fordiagnostic testing purposes by various third parties.

*Rochesettlement**  *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 the blood screening agreement.

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, which becamenon-refundable through 2005. During 2003, 2004 and 2005, we recognized $8.4million, $11.0 million and $13.9 million, respectively. The agreement alsoprovides for royalties on future sales related to Roche’s use of ourHCV-related patent in its*in vitro*diagnostic products. Royalty revenue increased in 2005 as compared with 2004,by $7.1 million or 13.8%. Royalty revenues increased in 2004 as compared with2003, by $4.4 million or 9.5%.

The HIV agreement with Roche provides for royalties onsales related to Roche’s use of our HIV-related patent in its*in vitro* diagnostic products. Royaltyrevenues recognized under this agreement decreased by $12.6 million in 2005 ascompared with 2004 and increased by $40.0 million in 2004 as compared with2003.  The decrease in 2005 as comparedwith 2004 was mainly due to the recognition of $35.6 million in 2004 ofdeferred royalties and license fees and a nonrefundable portion of a royaltypayment from the September 10, 2004 settlement. This was partially offsetby royalties of $26.5 million in 2005 from the September 10, 2004settlement. The increase in 2004 as compared with 2003 was mainly due to therecognition of $35.6 million in 2004 of deferred royalties and license fees anda nonrefundable portion of a royalty payment from the September 10, 2004settlement. The September 10, 2004 settlement agreement with Roche isdescribed in more detail below.

An HIV-related patent directed to nucleic acid testingmethods for HIV-1 was issued in the U.S. on March 13, 2003. Thispatent will expire seventeen years from the date of issuance. The issuance ofthe patent triggered a milestone payment to us 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. We had deferred recognition ofthe $10.0 million milestone payment, interest, royalties received androyalties accrued under the patent until the resolution of this dispute. On September 10,2004, we reached a settlement agreement with Roche. Under the terms of thesettlement agreement, the milestone payment along with any royalties receivedprior to March 31, 2004 became non-refundable. Accordingly, in 2004, werecognized $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 2005, we received a lump-sum payment of$78.0 million in lieu of royalties beyond January 1, 2005. Roche mayelect under the terms of the agreement to obtain a partial refund and revert topaying royalties on the sales of its products in North America. The amount ofsuch potential refund ranges between $64.0 million and $0.0 million.The amount of the refund available to Roche decreases in increments over thequarters of 2005 and 2006. As such, we are recognizing $64.0 million ofthe $78.0 million payment as revenue during 2005 and 2006. The remaining$14.0 million is non-refundable and was recognized as revenue in 2004, ofwhich $9.3 million has been recognized as revenue in our other segment and$4.7 million has been recognized as revenue in our Blood Testing segment. Currently,the applicable issued HCV-related patents expire in 2015 for the U.S. and 2010in Europe. The applicable issued HIV-related patent in Europe expired in October 2005.

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For 2005, we recognized an aggregate of $40.0 million,with $26.5 million of revenue from this settlement recognized in our othersegment and $13.5 million of revenue from this settlement recognized in ourBlood Testing segment. We expect to recognize the remaining $24.0 millionduring 2006.

Theimpact on revenues in 2005 and 2004 from these items from theSeptember 10, 2004 settlement with Roche is summarized below.

| ** **                                   | ** ** | **2005**                | ** ** | **2004**                        | ** ** |
|----------------------------------------------|------------|-------------------------|------------|---------------------------------|------------|
| ** **                                   | ** ** | **Other  Segment**      | ** ** | **Blood Testing  Segment** | ** ** | **Total** | ** ** | **Other  Segment** | ** ** | **Blood Testing  Segment** | ** ** | **Total** | ** ** |
| ** **                                   | ** ** | **(In thousands)** | ** ** | **(In thousands)**         | ** ** |
| Deferred revenues  recognized                |       |                    | $          | —                          |       |   |   | $ | — |   |   | $ | — |   | $ | 16,313 |   |   | $ | 5,453 |   |   | $ | 21,766 |   |
| Deferred license  fee recognized             |       |                    | —     |                            |       |   | — |   |   | — |   | 10,000 |   |   | — |   |   | 10,000 |   |
| Non-refundable  portion of Roche settlement  |       |                    | 26,500     |                            |       |   | 13,500 |   |   | 40,000 |   | 9,333 |   |   | 4,667 |   |   | 14,000 |   |
| Total royalty and  license fee revenue  |       |                    | $          | 26,500                          |       |   |   | $ | 13,500 |   |   | $ | 40,000 |   | $ | 35,646 |   |   | $ | 10,120 |   |   | $ | 45,766 |   |

 

*RochePCR 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 2005 and 2003.

*Bayer**  *A cross-license agreement providesfor royalties to us on HIV and hepatitis C virus products sold by BayerCorporation. Royalties increased $1.9 million in 2005 compared with 2004 due toincreased product sales by Bayer. Royalties were consistent in 2004 as comparedwith 2003.

*Centocor**  *In 2005, we recognized $11.3million of upfront payments and royalties from a settlement with Centocorrelating to certain patents.

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.

**Selling,general and administrative expenses****  **The increase in selling, general andadministrative expenses in 2005 as compared with 2004 was primarily due to(i) $9.7 million of costs associated with the proposed merger betweenChiron and Novartis AG, (ii) $8.7 million for higher employee relatedexpenses, (iii) $5.9 million for higher costs related to compliance withthe Sarbanes-Oxley Act, (iv) $4.5 million of additional legal costsassociated with the FLUVIRIN® vaccine-relateddevelopments discussed above under*“Influenza Virus Vaccines Recent Events,”*  and (v) $4.1 million in legal costsrelated to the defense of our patents and technology. These increases werepartially offset by lower facility costs of $7.1 million.

The increase in selling, general and administrativeexpenses in 2004 as compared with 2003 was primarily due to $12.1 million inlegal costs related to the FLUVIRIN® vaccine developments discussed above under “*Influenza Virus Vaccines Recent Events,*”$12.9 million in legal costs related to the defense of our patents andtechnology and $5.4 million from costs related to compliance with theSarbanes-Oxley Act. These increases were partially offset by the effect of a$4.0 million donation to Chiron Foundation in 2003 and $1.2 million of loweremployee related expenses.

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**Purchasedin-process research and development****  **Purchased in-process research anddevelopment charged to operations was $9.6 million and $45.3 million in 2004 and 2003, respectively. Therewas no such charge in 2005.

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 did not anticipate that there would 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. Wedid not anticipate that there would be any alternative future use for thein-process research and development. In valuing the purchased in-processresearch and development, we used probability-of-success-adjusted cash flowsand 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.

**Interestexpense****  **Theincrease in interest expense in 2005 as compared with 2004 primarily related tothe effect of twelve months versus six months of interest expense recognized onthe $385.0 million convertible debentures that were issued on June 22,2004, partially offset by the lower interest expense recognized on the LiquidYield Option Notes (LYONs), the majority of which were put to us by the debtholders in June 2004. The $385.0 million convertible debentures incurinterest at a higher rate than the LYONs.

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

**Interestand 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 $37.0 million, $23.4 million and $23.2 million in2005, 2004 and 2003, respectively.

The increase in interest income in 2005 as comparedwith 2004 primarily was due to higher average cash and investment balances andhigher average interest rates.

In 2005, 2004 and 2003, we recognized gains of $44.3million, $34.3 million and $9.4 million, respectively, related to the saleof certain equity securities. The increases in both 2005 and 2004 are primarilydue to the termination of certain equity forward contracts and the related saleof underlying securities.

In 2005 and 2004, we recognized losses attributable tothe impairment of equity securities of $1.3 million and $1.4 million,respectively. There were no losses attributable to impairment of equitysecurities in 2003.

In 2005, we recognized a $6.0 million settlementregarding a dispute with one of our competitors regarding certain Chironpatents.

In 2005, we recognized a $2.6 million insurancesettlement regarding a building fire at our Emeryville campus.

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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 and $2.0 million for 2003 and 2002 in 2004 and2003, respectively.

**Incometaxes****  **Theeffective tax rate for 2005 was 11.0% of pretax income from continuingoperations. The effective tax rate for 2004 was 28.2% of pretax income fromcontinuing operations, including the charge for purchased in process researchand development related to the Sagres acquisition, which was not taxdeductible, and 25.0% of pre-tax income excluding such charge. The effectivetax rate was higher in 2004 principally due to the impact of inter-companytransfers of certain product rights in 2004, which increased foreign incometaxes. There were no such transfers of product rights in 2005. Further, theeffective tax rate in 2005 also includes increased benefits from state taxcredits and certain foreign tax benefits which are, as a percentage of pre-taxincome, higher than would be the case with higher levels of pre-tax income fromFLUVIRIN® influenza vaccine sales. We do not considerthis tax rate to be indicative of our effective tax rate going forward. Theeffective tax rate may be affected in future periods by changes in management’sestimates with respect to our deferred tax assets and other items affecting theoverall tax rate.

**Discontinuedoperations****  **Ina strategic effort to focus on our core businesses of Blood Testing, vaccinesand biopharmaceuticals, we completed the sale of Chiron Diagnostics and ChironVision in 1998 and 1997, respectively.

There was no gain (loss) from discontinued operations,net of taxes in 2005.

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 reached a settlement agreement relating to certain claimsraised by Bayer under the Stock Purchase Agreement dated September 17,1998, between Chiron and Bayer for Chiron Diagnostics. Under this settlementagreement, we made a payment to Bayer in 2003. Pursuant to this settlement, werecorded a charge, net of adjustment to our previously provided reserve forindemnity 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. Werecognized an aggregate income tax benefit of $12.2 million in 2003 of which$9.0 million related to the settlement agreement between Bayer and $3.2 millionrelated to the reversal of valuation allowances against deferred taxes thatwere established at the time of the sale of Chiron Diagnostics.

**NewAccounting Standards****  **InDecember 2004, the Financial Accounting Standards Board (FASB) issuedStatement of Financial Accounting Standards No. 123 (revised 2004),*Share-Based Payment* (SFAS 123(R)), whichrequires the cost resulting from all share-based payment transactions to berecognized in the consolidated financial statements. That cost will be measuredbased on the fair value of the equity instruments issued or on the fair valueof liabilities incurred. Under SFAS 123(R), the fair-value-based method forrecognition or disclosure of compensation expense will be applied using themodified prospective application transition method or the modifiedretrospective application transition method. We 

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currently measurecompensation expense for our stock-based employee compensation under theintrinsic method. Current option values determined using theBlack-Scholes-Merton formula, used for purposes of proforma disclosure, may notbe indicative of results from the valuation methodologies we finally adopt. Theeffective date of SFAS 123(R) is the first reporting period beginningafter June 15, 2005. However, on April 14, 2005, the Securities andExchange Commission (SEC) announced the adoption of a new rule that delaysthe effective date of SFAS 123(R) for registrants, such as Chiron, thatare not small business issuers. The SEC’s new rule allows calendar yearnon-small business issuers to implement SFAS 123(R) at the beginning of2006, which makes SFAS 123(R) effective for Chiron in the first quarter of2006.

We are currently evaluating the transition methods,option valuation methodologies and assumptions in light of SFAS 123(R) and,therefore, cannot estimate the impact of our adoption at this time, although weexpect that our adoption will have a material impact on our consolidated financialstatements.

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%. ThroughDecember 31, 2005, we have not provided deferred taxes on foreign earningsbecause such earnings are intended to be indefinitely reinvested outside theU.S. We did not repatriate any accumulated earnings from outside the U.S. ineither 2004 or 2005.

**Liquidity and Capital Resources**

Our capital requirementshave generally been funded by cash flow from operations, borrowings fromcommercial banks and issuance of convertible debt securities and common stock.Our cash, cash equivalents and investments in marketable debt securities, whichtotaled $1,408.8 million at December 31, 2005, are invested in adiversified portfolio of fixed income securities, including money marketinstruments, corporate notes and bonds, and government agency securities issuedby financial institutions and other issuers with strong credit ratings. Bypolicy, the amount of credit exposure to any one institution is limited.Investments are generally not collateralized and primarily mature within threeyears.

In December 2005, wereceived net proceeds of $300.0 million, following the sale of 6,896,552 newlyissued shares of our common stock at a price of $43.50 per share to asubsidiary of Novartis. Under provisions of the 1994 Subscription Agreementwith Novartis, as amended, Chiron exercised its right on October 30, 2005,to have Novartis purchase the shares.

The recent eventsregarding FLUVIRIN® vaccine,as discussed above under “Management’s Discussion and Analysis of FinancialCondition and Results of Operations—*InfluenzaVirus Vaccines Recent Events,*” will continue to impact our cash flowgoing forward. As we continue to implement our remediation plan, our effortswill entail additional cash payments, which will be material. The MHRA’slifting of our license suspension is conditioned upon the understanding thatour commitment to remediation will continue.

In addition, we haveincurred and expect to continue to incur substantial expense relating to theshareholder class action and derivative private lawsuits and other claims arisingout of or related to these developments regarding FLUVIRIN® vaccine. The results of any suchinvestigations, proceedings or disputes could have a material adverse effect onour cash flow.

Our previous inability tosupply FLUVIRIN® vaccinehas led to loss of market share and may lead to loss of additional market sharein future seasons. Following the announcement of our FLUVIRIN® license suspension, competitorsannounced plans to introduce influenza vaccine products in the United Statesand sought expedited regulatory approval to do so. Even though the licensesuspension has been lifted, and we returned to the U.S. market for the 2005-2006influenza season, some of our customers may continue to choose to purchaseinfluenza vaccine from other providers as their products become available inthe 

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UnitedStates. Delays in start-up procedures for ramping up to full production andnormal manufacturing issues inherent in the complexity of influenza vaccineproduction, have adversely affected the amount of FLUVIRIN® vaccine that we are ableto produce for the 2005-2006 influenza season and may result in furtherloss of market share. Loss of market share could have a material adverse effecton cash flow.

The recent events regarding BEGRIVACTM vaccine, asdiscussed above under “Management’s Discussion and Analysis of FinancialCondition and Results of Operations—*InfluenzaVirus Vaccines Recent Events,*” may impact our cash flow goingforward. We were unable to supply any BEGRIVACTM vaccine doses for the 2005-2006influenza season, which eliminated any cash flows we would have received fromthe sale of BEGRIVACTM vaccine. Our inability to supply BEGRIVACTM vaccine asplanned to non-U.S. markets may also lead to loss of market share in futureseasons. Loss of market share could have a material adverse effect on cashflow. In addition, while we are in the process of implementing remedialmeasures to address the product sterility issue, including facility modifications,our remediation efforts will entail cash payments for additional capital andother expenditures, which could be material. If we are unable to returnBEGRIVACTM influenza vaccine to the market, it could have a material adverseeffect on our cash flow.

In addition, certain distributors and other partieswith whom we had contracted to supply influenza vaccine may make claims againstus as a result of Chiron not supplying influenza vaccine. Any such claims maycause us to incur substantial expense and require significant time andattention from our management. The results of any such claims could have amaterial adverse effect on our cash flow.

For additional information concerning the risks weface as a result of these influenza vaccine developments, see “Factors That May AffectFuture Results—*Developments with respect toinfluenza vaccines over the past year may harm our business and results of**operations*.” For additionalinformation on the private lawsuits and other claims, see Part I, Item 3. “LegalProceedings” 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 31,2005, there remains $80.1 million outstanding in aggregate principal amount atmaturity with a current accreted balance of $48.3 million. At the option of theholders, we may be required to purchase all, or a portion, of the remainingLYONs on June 12, 2006 at $608.04 for each note with face value of $1,000.If the holders require us to purchase all, or a portion, of the LYONs, we maychoose to pay the purchase price in cash, Chiron common shares, or anycombination of the two. Our intent is to settle the purchase price in cash. Accordingly,$48.3 million is included in the current portion of long-term debt in theConsolidated Balance Sheet at December 31, 2005.

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 senior, unsecured obligations and rank equal in rightof payment with all of our existing and future unsecured and unsubordinatedindebtedness.

Under the terms of the Investment Agreement, Novartisagreed to guarantee certain of our obligations under revolving creditfacilities through January 1, 2008, the date on which the guarantee willexpire. The principal amount of indebtedness under the guaranteed creditfacilities outstanding at any one time may not exceed a specified cap. That capwas $402.5 million. In November 1996, we and Novartis agreed that we 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 our common stock requiredto be purchased by a Novartis affiliate, at our request, 

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under the SubscriptionAgreement, would be reduced by an equal amount. The maximum amount Novartis isrequired to guarantee pursuant to the terms of the Investment Agreement has beenreduced by $109.8 million following an election by us in December 2005, toexercise our subscription rights under the Investment Agreement, decreasing thecap to $592.7 million. Through February 2006, Novartis guaranteed a $100.0million U.S. credit facility for our benefit for which there were no borrowingsoutstanding at December 31, 2005 and $173.3 million of our capital leasecommitments. The U.S. credit facility has since expired and at our election wasnot renewed and is thus no longer guaranteed by Novartis. As a result of theseguarantees and the conversion of $9.8 million of bonds in 2000 into shares ofour common stock, there remains approximately $417.7 million of the guaranteeavailable following the exercise of our subscription rights and our subsequentelection to increase the amount Novartis may be required to guarantee to themaximum borrowing amount.

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 cash utilized for our stock repurchase program and ourcontractual obligations of $402.9 millionin the next twelve months as discussed in the contractual obligation tablebelow. We also believe that our cash, cash equivalents and marketable debtsecurities, together with funds provided by operations and lease arrangements,will be sufficient to meet our contractual obligations of $1.5 billionarising after twelve months as discussed in the Contractual Obligations tablebelow. In addition, we believe we could access additional funds from the debtand capital markets should the need arise. As noted above, if we are unable tomaintain FLUVIRIN®vaccine in the market and return BEGRIVACTM influenza vaccine to the market,whether through loss of regulatory approvals, market share or otherwise, itwould have a material adverse effect on our cash flow.

**Sources and Uses of Cash**

We had cash and cash equivalents of $291.4 million and$209.5 million at December 31, 2005 and 2004, respectively.

**Operatingactivities**   In 2005, net cash provided byoperating activities was $249.2 million as compared with $170.7 million in2004. The increase in cash provided by operating activities was primarily dueto higher income from continuing operations before depreciation, amortizationand other non-cash charges, mainly due to higher FLUVIRIN® vaccine sales of $96.5 million (compared toFLUVIRIN® vaccine sales of $2.3 million in 2004 from the2003-2004 influenza season), following the lifting of our licensesuspension to manufacture FLUVIRIN® influenza virus vaccine in our Liverpoolfacility. This subsequently allowed us to resume shipment of the product forthe 2005-2006 influenza season. Cash provided by operating activitiesalso increased due to (i) a $78.0 million lump-sum payment received inlieu of royalties beyond January 1, 2005 as part of the Roche settlementreached on September 10, 2004, (ii) increased sales of our travelvaccines, PROCLEIX® productsales and TOBI® tobramycin, partially offset by decreases insales of our pediatric and other vaccines and (iii) an increase in othercurrent liabilities at December 31, 2005 as compared with December 31,2004. These increases were partially offset by (i) costs associated withour remediation efforts for our Liverpool plant and legal costs related to theFLUVIRIN® vaccinedevelopments, (ii) the lost contribution of sales of BEGRIVACTM (there wereno sales of BEGRIVACTM vaccine in 2005 compared to sales of $52.7 million in2004), (iii) increased selling, general and administrative expenses in2005 primarily due to Novartis transaction-related costs, the pre-launchprogram for CUBICIN® daptomycin in Europe, higher employee-relatedcosts, compliance with the Sarbanes-Oxley Act and higher FLUVIRIN® vaccine-related legal costs, (iv) alarger increase in accounts receivable at December 31, 2005 as comparedwith the increase in accounts receivable at December 31, 2004, and (v) asmaller increase in accounts payable, accrued expenses and income taxes payableat December 31, 2005 as compared with December 31, 2004.

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In 2004, net cash provided by operating activities was$170.7 million as compared with $413.9 million in 2003. The decreasein cash provided by operating activities was primarily due to lower income fromcontinuing operations before depreciation, amortization and other non-cashcharges, which decreased mainly due to the suspension of our license tomanufacture FLUVIRIN® influenza virus vaccine in our Liverpoolfacility which prevented the release of any of the product during the 2004-2005influenza season. Cash provided by operating activities also decreased due to (i) increasedselling, general and administration expenses in 2004 primarily due to themovement of the Euro and British Pound exchange rates, twelve months ofselling, general and administrative expenses from PowderJect in 2004 comparedto approximately six months in 2003 and increased legal costs, (ii) lowerroyalty payments of BETASERON® and BETAFERON® interferon beta-1b due to a decline inthe royalty rate by five percentage points pursuant to our contractualarrangement with Schering, and lower royalty payments received under the Rocheroyalty arrangements in 2004 compared with 2003 and (iii) $14.4 millionof cash 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.

**Investingactivities**   In 2005, net cash used in investingactivities consisted of purchases of investments in marketable debt securitiesof $1,163.2 million, capital expenditures of $200.0 million, issuance of notesreceivable of $12.1 million, purchases of equity securities and interests inaffiliated companies of $4.9 million, cash paid for acquisitions net of cashacquired of $4.8 million, and other uses of cash of $13.3 million. Included innet cash paid for acquisitions was $4.0 million for previously accrued costs inconnection with acquisition costs related to the acquisition of PowderJect and$0.8 million of cash paid for the acquisition of Sagres. Cash used ininvesting activities was offset by proceeds from maturities of investments inmarketable debt securities of $610.5 million, proceeds from sales ofinvestments in marketable debt securities of $226.5 million, proceeds from thesale of equity securities and interests in affiliated companies of $36.9million and proceeds from the sale of assets of $0.2 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 influenzavaccines primary manufacturing facility in Liverpool, United Kingdom. The newmanufacturing facility will replace a portion of the existing influenzavaccines manufacturing facilities in Liverpool, United Kingdom and isanticipated to be available in 2009 for the manufacture of influenza vaccines,subject to regulatory approval. In December 2003, we entered into a 25-yearlease for the building. As of December 31, 2005, we have incurred $23.0 millionfor the capital improvements portion of the project.

The purchases of equity securities and interests inaffiliated companies in 2005 consisted of equity contributions under severalventure capital funds including a $1.6 million capital contribution under two2003 limited partnership agreements, a $0.6 million capital contribution undera 2002 limited partnership agreement, a $2.1 million capital contribution undera 2001 limited partnership agreement and a $0.6 million capital contributionunder a 2000 limited partnership agreement.

In 2003, we became a limited partner of Burrill LifeSciences Capital Fund, L.P. We agreed to pay $10.0 million oversix years, of which $4.7 million has been paid through December 31,2005 for a 5.14% ownership. In 2003, we became a limited partner of ForwardVenture V, L.P. We agreed to pay $5.0 million over five years, of which$0.6 million has been paid through December 31, 2005, for a 3.45%ownership. In 2002, we became a limited partner of TPG Biotechnology Partners,L.P. We agreed to pay $5.0 million over ten years, of which$2.8 million has been paid through December 31, 2005, for a 2.83%ownership. In 2001, we became a limited partner of Forward Venture IV, L.P. Weagreed to pay 

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$15.0 million overten years, of which $13.1 million has been paid through December 31,2005, for a 6.35% ownership. In 2000, we became a limited partner of BurrillBiotechnology Capital Fund, L.P. We agreed to pay $25.0 million over fiveyears, of which $21.7 million has been paid through December 31,2005, for a 23.26% ownership.

In 2004, net cash used in investing activitiesconsisted of purchases of investments in marketable debt securities of$796.9 million, capital expenditures of $183.7 million, cash paid foracquisitions net of cash acquired of $34.9 million, other uses of cash of$10.7 million and purchases of equity securities and interests in affiliatedcompanies of $6.6 million. Included in net cash paid for acquisitions was$8.2 million for previously accrued costs in connection with the acquisition ofPowderJect, $15.5 million of cash delivered on the divestiture of certainoperations in Wisconsin, the U.K., and Sweden and $11.2 million of cashpaid for the acquisition of Sagres. Cash used in investing activities wasoffset by proceeds from sales of investments in marketable debt securities of$431.1 million, proceeds from maturities of investments in marketable debtsecurities of $286.5 million, proceeds from the sale of 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.

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 partnershipagreement. In addition, we contributed $0.3 million to our 51%-owned jointventure Indian subsidiary in 2004.

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 activitieswas offset by proceeds from sales of investments in marketable debt securitiesof $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, United Kingdom that develops and commercializesvaccines. We acquired all of the outstanding shares of common stock ofPowderJect for a total purchase price of approximately $938.6 million. As partof the acquisition of PowderJect, we assumed the debt of PowderJect includingconvertible notes with a face value of 35.0 million British pounds (fair valueof $57.0 million at July 8, 2003). We repaid the convertible notes duringthe third quarter 2003 and the payment is included in “Repayment of debt andcapital leases” in the Consolidated Statement 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.

**Financingactivities****  **In2005, net cash provided by financing activities consisted of$300.0 million of proceeds from the issuance of common stock (discussedbelow), $72.9 million of proceeds from the re-

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issuance of treasury stockand $1.7 million of borrowings from a government agency. Cash provided byfinancing activities was partially offset by $1.0 million for the repayment ofdebt and capital leases.

On October 30, 2005, we exercised our right tohave Novartis purchase newly issued shares of our common stock under provisionsof our 1994 Subscription Agreement with Novartis, as amended. On December 8,2005, we announced that we had sold 6,896,552 newly issued shares of our commonstock at a price of $43.50 per share to a subsidiary of Novartis, for $300.0million in the aggregate, following receipt of necessary regulatory approvals.

In 2004, net cash used in financing activitiesconsisted of $383.0 million for the repayment of debt and capital leases,$135.0 million for the acquisition of treasury stock and $8.4 million forthe payment of debt issuance costs. Cash used in financing activities wasoffset by $385.0 million of proceeds from issuance of convertibledebentures due 2034 (discussed above), $69.1 million of proceeds from thereissuance of treasury stock and $5.6 million of borrowings from a governmentagency.

In 2003, net cash provided by financing activitiesconsisted of $500.0 million of proceeds from the issuance of convertibledebentures due 2033 (discussed below), $123.6 million of proceeds from thereissuance of treasury stock (related to stock option exercises),$2.1 million of proceeds from put options sold to reduce the costs of ourshare repurchase program, and $1.2 million from borrowings from agovernment agency in Italy. Cash provided by financing activities was offset by$207.7 million for the acquisition of treasury stock, $62.5 millionfor the repayment of debt and capital leases, $10.7 million for thepayment of issuance costs on the convertible debentures and $2.4 millionfor the net repayment of short-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.

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 millionshares of Chiron common stock through December 31, 2004. Through December 31,2004, we made purchases of 2.9 million shares at a cost of $126.5 millionand the 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. There were no share repurchases in 2005.

In March 2004, we entered into a worldwide,exclusive, multi-product, collaborative arrangement with XOMA Ltd. for thedevelopment and commercialization of antibody products for the treatment of cancer.Under the terms of the arrangement, the parties agreed to jointly research,develop, and commercialize multiple antibody product candidates. Under thearrangement, the parties agreed to share development and commercializationexpenses, including preclinical and clinical development, manufacturing andworldwide marketing costs, as well as revenues, generally on a 70-30basis, with our share being 70% and XOMA’s share being 30%. We agreed to makean initial payment of $10.0 million, which was paid as of December 31,2004, and to make a loan facility of up to $50.0 million available toXOMA, starting on January 1, 2005 to fund 75% of XOMA’s share ofdevelopment expenses. Under this arrangement, we made $12.1 million in loanadvances to XOMA as of December 31, 2005.

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

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***Contractual Obligations***

Ourcontractual obligations as of December 31, 2005 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) |       | $                                   | 940,292    |   | $ | 49,347 |   | $ | 2,284 |   | $ | 2,155 |   | $ | 886,506 |   |
| Capital lease  obligations(2)                 |       | 165,794                             |       | 2,624 |   | 5,248 |   | 157,922 |   | — |   |
| Other non-current  liabilities(3)             |       | 112,828                             |       | — |   | 18,364 |   | 6,648 |   | 87,816 |   |
| Operating  leases(4)                          |       | 200,816                             |       | 32,191 |   | 51,151 |   | 36,311 |   | 81,163 |   |
| Purchase obligations:                         |       |                                |       |   |   |   |   |   |   |   |   |
| Technology services agreement(5)              |       | 39,600                              |       | 9,600 |   | 19,200 |   | 10,800 |   | — |   |
| Purchase orders(6)                            |       | 74,200                              |       | 74,200 |   | — |   | — |   | — |   |
| Supply  agreement(7)                          |       | 128,100                             |       | 18,300 |   | 36,600 |   | 36,600 |   | 36,600 |   |
| Plant  expansion(8)                           |       | 19,200                              |       | 4,800 |   | 9,600 |   | 4,800 |   | — |   |
| Berna biotech(9)                              |       | 800                                 |       | 800 |   | — |   | — |   | — |   |
| Capital  commitments(10)                      |       | 43,868                              |       | 41,299 |   | 2,569 |   | — |   | — |   |
| Infonet(11)                                   |       | 2,100                               |       | 1,200 |   | 900 |   | — |   | — |   |
| Letters of  credit(12)                        |       | 14,825                              |       | 14,825 |   | — |   | — |   | — |   |
| Research and  development arrangements(13)    |       | 60,800                              |       | 50,200 |   | 10,600 |   | — |   | — |   |
| Insurance-related  items(14)                  |       | 21,269                              |       | 21,269 |   | — |   | — |   | — |   |
| Manufacturing and  supply agreement(15)  |       | 17,500                              |       | 12,000 |   | 5,500 |   | — |   | — |   |
| Supply  agreement(16)                         |       | 11,900                              |       | 5,950 |   | 5,950 |   | — |   | — |   |
| Burrill Life  Sciences Capital Fund, L.P.(17) |       | 5,300                               |       | 5,300 |   | — |   | — |   | — |   |
| Forward Venture V  L.P(18)                    |       | 4,400                               |       | 4,400 |   | — |   | — |   | — |   |
| TPG Biotechnology  Partners, L.P(19)          |       | 2,200                               |       | 2,200 |   | — |   | — |   | — |   |
| Forward Ventures  IV L.P(20)                  |       | 1,900                               |       | 1,900 |   | — |   | — |   | — |   |
| Burrill  Biotechnology Capital Fund L.P(21)   |       | 3,300                               |       | 3,300 |   | — |   | — |   | — |   |
| Contract  manufacturing agreement(22)         |       | 20,488                              |       | 6,308 |   | 7,880 |   | 6,300 |   | — |   |
| Revolving credit  agreement(23)               |       | 2,500                               |       | 2,500 |   | — |   | — |   | — |   |
| Loan facility(24)                             |       | 37,900                              |       | 37,900 |   | — |   | — |   | — |   |
| Managed services  agreement(25)               |       | 467                                 |       | 467 |   | — |   | — |   | — |   |
| Total                                         |       | $                                   | 1,932,347  |   | $ | 402,880 |   | $ | 175,846 |   | $ | 261,536 |   | $ | 1,092,085 |   |

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   (1)  On June 22, 2004, we issued $385.0 million aggregateprincipal amount of convertible debentures, which mature on June 30, 2034(2034 Debentures). The convertible debentures accrue interest at a rate of2.75% 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 ourexisting and future unsecured and unsubordinated indebtedness.

The holders of the 2034 Debentures may require us 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.

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On July 30, 2003, we issued $500.0 millionaggregate principal amount of convertible debentures, which mature on August 1,2033 (2033 Debentures). The convertible debentures accrue interest at a rate of1.625% per year and interest is payable on February 1 and August 1commencing February 1, 2004. The debentures are senior, unsecuredobligations of Chiron and rank equal in right of payment with all of ourexisting and future unsecured and unsubordinated indebtedness.

The holders of the 2033 Debentures may require us 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.

In June 2001, we issued zero coupon Liquid YieldOption Notes (LYONs) with a face value of $730.0 million and a yield tomaturity of 2.0%. The LYONs were carried net of an original issue discount of$328.2 million, which was being accreted to interest expense over the lifeof the LYONs using the effective interest method. On June 12, 2004,certain LYONs holders, at their option, tendered $649.9 million inaggregate principal amount at maturity for purchase by us. The purchase pricefor the LYONs was $584.31 in cash per $1,000 in principal amount at maturity.The aggregate purchase price for all the LYONs validly surrendered for purchasewas $379.7 million. At December 31, 2005, there remains outstanding$80.1 million in aggregate principal amount at maturity and an accreted balanceof $48.3 million for the LYONs. The LYONs are uncollateralized andunsubordinated, and rank equal in right of payment to our existing and futureuncollateralized and unsubordinated indebtedness.

At the option of the holders, we may be required topurchase all, or a portion, of the remaining LYONs on June 12, 2006 at$608.04 for each note with face value of $1,000. Accordingly, $48.3 million isincluded in the current portion of long-term debt in the Consolidated BalanceSheet at December 31, 2005, and in the “Less than 1 year” column in thetable of Contractual Obligations, above.

We had various other notes payable totaling $7.0million at December 31, 2005.

Long-term debt, other than the LYONs, has beenreflected in the table above at its stated maturity dates for presentationpurposes only. On specified dates, our repayment obligation could occur earlierthan the maturity dates presented above because holders of the debentures havethe 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 newlease as 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. When the leaseagreement includes a residual value guarantee, we use the following method toestimate amortization of the leased asset. First we determine the amount thatmay become payable to the lessor at the end of the lease term due to a declinein the estimated fair value of the leased asset below the lessor’s totalinvestment of $173.3 million. The leased asset is then amortized using astraight-line method to an amount such that the capital lease liability, net ofthe book value of the amortized leased asset at the end of the lease termequals the amount payable to the lessor. We estimated the fair value of theR&D Property at the end of the lease term will be approximately$168.9 million. The fair value at the end of the lease term was estimatedusing the cost approach in which appraised value at lease inception is modifiedby estimates for 

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building cost appreciationand building component depreciation through the six-year lease term. Thisvaluation requires significant estimates and assumptions. We believe the fairvalue assigned is based on reasonable assumptions. Aggregate amortization ofthe leased asset over the term of the lease is estimated to be approximately$6.0 million. For the years ended December 31, 2005, 2004 and 2003, $1.0million, $1.0 million and $0.5 million, respectively, were recorded asamortization expense for the 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, we canchoose to either purchase the facility from the lessors or sell the facility toa third party. This option accelerates if we default on our lease payments orin the event of other defined events. If we choose to purchase the facilityfrom the lessors the specified purchase consideration under the lease agreementis $173.3 million. Novartis has guaranteed (under provisions of the InvestmentAgreement) payments on this lease commitment, including payment of the residualvalue guarantee, to a maximum of $175.0 million.

   (3)  Other non-current liabilities as recorded in the ConsolidatedBalance Sheet as of December 31, 2005.

   (4)  We lease laboratory, office and manufacturing facilities, land andequipment under noncancelable operating leases, which expire through 2015.

   (5)  Effective August 1, 2003, Chiron and IBM Corporation amendedand restated the previous ten-year information technology services agreementwhich was effective on July 1, 1998. Under this revised agreement, IBMagreed to provide us with a full range of information services until March 31,2010. We can now terminate this agreement, subject to certain terminationcharges. At December 31, 2005, minimum future payments to IBM are expectedto be approximately $39.6 million. Payments to IBM are subject to adjustmentdepending upon the levels of services and infrastructure equipment provided byIBM, as well as inflation.

   (6)  We had noncancelable purchase orders for ongoing operations of$74.2 million at December 31, 2005.

   (7)  In connection with the production of our influenza vaccineproducts, we must purchase large quantities of incubated fertile chicken eggs.Currently, for FLUVIRIN® influenza 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 10.6 million British Pounds ($18.3 million at December 31, 2005) eachyear from that supplier through 2012, subject to our right to terminate thisagreement earlier upon payment of a termination fee. To ensure that theincubation of the eggs is the appropriate standard for vaccine manufacturing,we acquired assets of the primary incubation facility from the egg supplier in December 2005.

   (8)  In 2003, our Board of Directors approved $50.7 million inexpenditures for a 25-year building lease and $42.2 million forcapital improvements, both of which are part of a $97.0 million projectfor expansion and replacement of our influenza vaccines primary manufacturingfacility in Liverpool, United Kingdom. The new manufacturing facility willreplace a portion of the existing influenza vaccines manufacturing facilitiesin Liverpool, United Kingdom and is anticipated to be available in 2009 for themanufacture of influenza vaccines, subject to regulatory approval. In December 2003,we entered into a 25-year lease for the building. As of December 31,2005, we have incurred $23.0 million for the capital improvements portionof the project.

   (9)  In April 2001, Chiron, Rhein Biotech N.V. (now part of BernaBiotech) and GreenCross Vaccine Corporation entered into a collaboration toresearch and develop certain pediatric combination vaccine products for saleoutside of Europe and North America. The collaboration agreement requirescapital commitments from Chiron, Berna Biotech and Green Cross Vaccine. Our 

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commitment isapproximately 34.6 million Euro ($41.0 million at December 31, 2005)for the expansion of our Italian manufacturing facilities, of which we hadincurred costs of 33.9 million Euro ($40.2 million), as of December 31,2005. This agreement began in the fourth quarter 2001 and is expected tocontinue through 2006.

(10) We had various other firm purchase and capital project commitmentstotaling approximately $43.9 million at December 31, 2005.

(11) In 2003, we entered into a four-year Communication ServicesAgreement with Infonet USA Corporation. The contract requires a minimum monthlypayment of $0.1 million and our commitment at December 31, 2005,totaled $2.1 million.

(12) At December 31, 2005, we had $14.8 million committed underletters of credit, which are required by German law, related to ongoing legalproceedings in Germany.

(13) We participate in a number of research and development arrangementswith other pharmaceutical and biotechnology companies to research, develop andmarket certain technologies and products. We and our 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, 2005, aggregate annual noncancelablefunding commitments under collaborative arrangements are as follows:  2006—$32.0 million and 2007—$10.0 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 31,2005, aggregate milestone payments that may become due under thesenoncancelable collaborative arrangements totaled $9.4 million. These milestonepayments are due upon the achievement of various technical milestones,completion of trials and regulatory filings. From the inception of thesecontracts through December 31, 2005, costs incurred under thesecollaborative arrangements totaled $71.5 million.

In addition to these collaboration arrangements, wehave entered into contracts where we are responsible for all the costs relatedto research and development activities. At December 31, 2005, aggregateannual noncancelable commitments under these contracts are as follows: 2006—$4.3million and 2007—$0.6 million. At December 31, 2005, aggregate milestonepayments that may become due under these noncancelable arrangements totaled$4.5 million. These milestone payments are due upon the achievement of varioustechnical milestones, completion of trials and regulatory filings. Frominception of these contracts through December 31, 2005, costs incurredunder these contracts totaled $9.5 million.

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

(14) We had various performance bonds and insurance-related letters ofcredit in the amount of $21.3 million available at December 31, 2005.There are no amounts outstanding under these letters of credit at December 31,2005.

(15) Effective February 2003, Chiron and Baxter PharmaceuticalSolutions LLC executed an eight-year manufacturing and supply agreement. Underthis agreement, Baxter agreed to perform certain manufacturing procedures andsupply us with a key component for a certain biopharmaceutical product. We havecertain minimum purchase obligations under this agreement and are required topay the difference, if any, between the actual quantity purchased and theminimum purchase obligation. We can terminate this agreement after the thirdyear with eighteen month’s notice. At December 31, 2005, our minimumpurchase obligation under this agreement over the next eighteen months isexpected to be $17.5 million.

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(16) Effective October 2002, Chiron and Medical Associates Network, Inc.,Medimop Medical Projects, Ltd. and Medimop Medical ProjectsNorth, Ltd. (referred to as Med Parties in this section) executed afive-year supply agreement. Under this agreement, the Med Parties agreed toprovide us with a presentation device for certain pharmaceutical products. Weagreed to fund the Med Parties up to $1.5 million through 2003 to acquirethe tools and equipment to manufacture the presentation device, of which wehave paid $1.5 million as of December 31, 2005. In addition, under thisagreement, we have minimum purchase requirements. Our minimum purchaseobligation for the next two years is approximately $11.9 million. We canterminate the agreement subject to twelve-months notification. If we do notterminate the agreement by December 31, 2007, the agreement will beautomatically renewed for an additional twelve months.

(17) In 2003, we became a limited partner of Burrill Life SciencesCapital Fund, L.P. We agreed to pay $10.0 million over six years, ofwhich $4.7 million has been paid through December 31, 2005 for a5.14% ownership. The partnership agreement does not allocate the contributionacross future years; therefore we have included the remaining contributions in ‘lessthan 1 year’ for presentation purposes.

(18) In 2003, we became a limited partner of Forward Venture V, L.P. Weagreed to pay $5.0 million over five years, of which $0.6 million hasbeen paid through December 31, 2005, for a 3.45% 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.

(19) In 2002, we became a limited partner of TPG Biotechnology Partners,L.P. We agreed to pay $5.0 million over ten years, of which$2.8 million has been paid through December 31, 2005, for a 2.83%ownership. The partnership agreement does not allocate the contribution acrossfuture years; therefore, we have included the remaining contributions in ‘lessthan 1 year’ for presentation purposes.

(20) In 2001, we became a limited partner of Forward Venture IV, L.P. Weagreed to pay $15.0 million over ten years, of which $13.1 millionhas been paid through December 31, 2005, for a 6.35% 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.

(21) In 2000, we became a limited partner of Burrill BiotechnologyCapital Fund, L.P. We agreed to pay $25.0 million over five years, ofwhich $21.7 million has been paid through December 31, 2005, for a23.26% ownership. The partnership agreement does not allocate the contributionacross future years; therefore, we have included the remaining contributions in‘less than 1 year’ for presentation purposes.

(22) Effective June 2003, Chiron and SynCo B.V., a related party,executed a seven and a half-year contract manufacturing agreement. Under thisagreement, SynCo agreed to provide services related to the production ofcertain of our vaccine products for the European and U.S. markets commencing in2004. We have a firm binding order for products to be delivered by SynCo in2006 under this agreement. Our minimum purchase obligation under thisagreement, which depends on the quantities purchased by us in years 2007through 2010, inflation and movement in the Euro to U.S. Dollar exchange rate,is expected to be approximately $20.5 million over the remaining term ofthe agreement.

(23) In August 2003, we entered into a $2.5 million revolvingcredit agreement with Nektar Therapeutics to support the financing ofequipment, facility improvements and other capital expenditures related to themanufacture of clinical supplies in support of a program to develop a drypowder formulation of TOBI® tobramycin. Each advance made under this revolvingline of credit matures on the sixth 

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anniversary of the initialadvance. As of December 31, 2005, Nektar Therapeutics has not drawn fromthe revolving line of credit.

(24) In March 2004, we 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 our share being 70% and XOMA’s share being 30%. Weagreed to make an initial payment of $10.0 million, which was paid as of December 31,2004, and to make a loan facility of up to $50.0 million available toXOMA, starting on January 1, 2005 to fund 75% of XOMA’s share ofdevelopment expenses. Under this arrangement, we made $12.1 million in loanadvances to XOMA as of December 31, 2005. Interest payable by XOMA is duewhen the principal is due and is additive to the $50.0 million availableprincipal. Interest payable of $0.3 million was added to the outstandingbalance as of December 31, 2005. The loan advances are recorded at theirfair value based upon an interest rate for a similar loan facility from a bankto a similar counterparty. The recorded amount will be accreted to full facevalue over the life of the outstanding facility based on the effective interestmethod. At December 31, 2005, $7.1 million was recorded as “Non-currentnotes receivable” in the Consolidated Balance Sheet for these loan advances. 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.

(25) Effective June 2002, Chiron and VWRInternational, Inc. executed a seven-year managed services agreement.Under this agreement, VWR agreed to provide us with purchasing and deliveryservices. Effective June 2005, we amended this agreement for a new termthrough 2012. We can terminate this agreement at any time with six month’snotice. If we do not terminate this agreement, payments to VWR are expected tobe approximately $6.5 million, of which approximately $0.5 million was paid in2005. Under the amendment, we have the option to renew the agreement for anadditional three years at the end of the new termination date in 2012.

***Borrowing Arrangements***

Our $100.0 million revolving, committed,uncollateralized credit facility with a major financial institution expired in February 2006and was not renewed at our election. This facility had been guaranteed byNovartis AG under a November 1994 Investment Agreement. There were noborrowings outstanding under this credit facility at December 31, 2005 and2004. In July 2003, we entered into a new six-year lease to rent a researchand development facility in Emeryville, California. Under provisions of the November 1994Investment Agreement, Novartis AG guaranteed payments on this lease commitmentto a maximum of $175.0 million.

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Under the terms of the Investment Agreement, Novartisagreed to guarantee certain of our obligations under revolving creditfacilities through January 1, 2008, the date on which the guarantee willexpire. The principal amount of indebtedness under the guaranteed creditfacilities outstanding at any one time may not exceed a specified cap. That capwas $402.5 million. In November 1996, we and Novartis agreed that we 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 our common stock requiredto be purchased by a Novartis affiliate, at our request, under the SubscriptionAgreement, would be reduced by an equal amount. The maximum amount Novartis isrequired to guarantee pursuant to the terms of the Investment Agreement hasbeen reduced by $109.8 million following an election by us in December 2005,to exercise our subscription rights under the Investment Agreement, decreasingthe cap to $592.7 million.  We alsoagreed to enter into a separate agreement with Novartis for each obligationguaranteed by Novartis under which we agree to reimburse Novartis for anypayments made or out-of-pocket expenses incurred by Novartis in connection withthe guarantee (each, a “Reimbursement Agreement”). Our obligations under theReimbursement Agreements are, at the request of Novartis, to be fully securedby collateral (which means guaranteed by assets pledged by us) acceptable toNovartis. As discussed above, through February 2006, Novartis guaranteed a$100.0 million U.S. credit facility for our benefit for which there were noborrowings outstanding at December 31, 2005 and $173.3 million of ourcapital lease commitments. The U.S. credit facility has since expired and atour election was not renewed and is thus no longer guaranteed by Novartis. As aresult of these guarantees and the conversion of $9.8 million of bonds in 2000into shares of our common stock, there remains approximately $417.7 million ofthe guarantee available following the exercise of our subscription rights andour subsequent election to increase the amount Novartis may be required toguarantee to the maximum borrowing amount.

We also have variouscredit facilities available outside the U.S. There were no outstandingborrowings under these facilities at December 31, 2005 and 2004. Onefacility is maintained for our 51%-owned Indian subsidiary, and allows fortotal borrowings of 200 million Indian Rupees ($4.4 million at December 31,2005). There were no outstanding borrowings under this facility at December 31,2005 and 2004.

**Off-Balance Sheet Arrangements**

As of December 31,2005 and 2004, we do not have any off-balance sheet arrangements.

**Market Risk Management**

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.”

**FactorsThat 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 Form 10-Kand in other periodic reports, press releases, presentations and otherstatements issued by us from time to time reflect our current beliefs andexpectations concerning objectives, plans, strategies, future performance andother future events. The following discussion highlights some of the factors,many of which are beyond our control, which could cause actual results todiffer materially.

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*Chiron will besubject to business uncertainties and contractual restrictions in connectionwith the proposed merger with Novartis.*

Uncertainty about the proposed merger with Novartisand its possible effect on employees, customers and other constituencies  have had an adverse effect on Chiron. Theseuncertainties have impaired our ability to attract, retain and motivate keypersonnel, and have caused customers, suppliers, partners and others that dealwith us to seek to change existing business relationships. Retention of certainemployees has been challenging during the pendency of the merger, as employeesexperience uncertainty about their future roles after the merger or theprospects of Chiron if the merger does not occur. If key employees continue todepart because of issues relating to the uncertainty and difficulty ofintegration or a desire not to remain with Novartis after the merger or withChiron if the merger is not consummated, our business could be harmed. Inconnection with the proposed merger, some distributors, customers and strategicpartners could delay or defer decisions, which could negatively impactrevenues, earnings and cash flows of Chiron.

In addition, the mergeragreement restricts us from taking specified actions without the consent ofNovartis, including making certain capital expenditures, entering into materialcontracts and other matters. These restrictions may prevent us from pursuingattractive business opportunities that may arise prior to the completion of themerger and may impede our growth and limit the development of our projects,which could negatively impact revenues, earnings and cash flows of Chiron.

*Developments withrespect to influenza vaccines over the past year may harm our business andresults of operations.*

In October 2004, the U.K. regulatory body, theMedicines and Healthcare products Regulatory Agency, or MHRA, suspended ourlicense to manufacture FLUVIRIN® vaccine at our Liverpool, U.K.facility. As a result of the suspension of our license, we did not release anyFLUVIRIN® vaccineduring the 2004-2005 influenza season. On March 2, 2005, the MHRAnotified us that it had lifted the license suspension, giving Chiron clearanceto initiate full production of FLUVIRIN® vaccine, conditioned on the understanding thatChiron’s commitment to its remediation plan will continue and will be subjectto further inspections by the MHRA. On October 17, 2005, we initiateddelivery and release of FLUVIRIN® vaccineto customers in the United States for the 2005-2006 influenza season. Asof such time, we had received all necessary approvals from the U.S. Food andDrug Administration (FDA) and MHRA to start supplying FLUVIRIN® vaccine to the U.S. market.

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, after havingpreviously commenced an informal inquiry, the Securities and ExchangeCommission, or SEC, notified us that it would commence a formal investigationinto whether we or our employees violated any federal securities laws inconnection with these developments regarding FLUVIRIN® vaccine, and Chiron subsequentlyreceived subpoenas from the SEC requesting production of certain documentsrelating to our Liverpool facility and FLUVIRIN® vaccine. In February 2006, theSEC notified us that it had decided to terminate its investigation, and that noenforcement action had been recommended against the company. We also received avoluntary request for information from the United States House ofRepresentatives, Energy and Commerce Committee, Subcommittee on Oversight andInvestigations requesting production of certain documents. Numerous documentshave been collected and produced in response to these requests, and several witnesseshave been interviewed by the U.S. Attorney’s Office, the SEC staff andCongressional staff. Additional investigations regarding these matters mayarise.

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In addition, we and certain of our officers anddirectors 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® vaccine, which are described in Part I,Item 3, “Legal Proceedings”. Certain distributors and other parties withwhom we had contracted to supply FLUVIRIN® vaccine are considering or have communicated claimsagainst us as a result of our inability to supply FLUVIRIN® vaccine, and additional parties maydo so in the future. On January 27, 2005, the U.S. Centers for DiseaseControl and Prevention, or CDC, terminated its contracts with Chiron for thesupply of FLUVIRIN® vaccinefor default on the basis of Chiron’s failure to supply such vaccine to the U.S.government for the 2004-2005 influenza season. The CDC has reserved theright to hold Chiron liable for any excess costs it may have incurred inreplacing any FLUVIRIN® vaccinethat Chiron failed to deliver and further has reserved all other remediesprovided under the contract. It is not possible to predict whether any of theseclaims will be pursued and, if so, whether those claims will be upheld.Investigations, litigation and disputes have caused us to incur substantialexpense and have required significant time and attention from our managementand will continue to do so in the future and could result in civil actionand/or criminal proceedings against Chiron. The results of any suchinvestigations, proceedings or disputes could have a material adverse effect onour consolidated financial position and results of operations and/or cash flow.

Although the MHRA has lifted its suspension of ourlicense to manufacture FLUVIRIN® vaccine, we expect to incuradditional expenses in connection with ongoing FLUVIRIN® vaccine matters, which could bematerial, including in connection with (1) our continuing remediationefforts at our Liverpool facility; and (2) responding to private lawsuitsand other claims and investigations that exist or 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.

BEGRIVACTM vaccine is manufactured at our facility inMarburg, Germany. In July 2005, we reported that we would be unable tosupply any BEGRIVACTM vaccine doses for the 2005-2006 influenza season dueto a product sterility issue and wrote off our existing product inventoryresulting in charges of $18.0 million to cost of sales for the year ended December 31,2005. Investigation of the product sterility issue has been completed andimplementation of remedial measures and facility modifications is underway. Ourinability to supply BEGRIVACTM vaccine as planned to non-U.S. markets for the2005-2006 influenza season or, if remedial efforts are delayed or notsuccessful, future seasons could have a material adverse affect on our businessand results of operations. In addition, it is possible that distributors andother parties with whom we had contracted to supply influenza vaccine may makeclaims against us as a result of Chiron not supplying influenza vaccine. Anysuch claims may cause us to incur substantial expense and require significanttime and attention from our management. The results of any such claims couldhave a material adverse effect on our consolidated financial position andresults of operations and/or cash flow.

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. In addition, we did not releaseany BEGRIVACTM vaccine during the 2005-2006 influenza season. Additionalissues with respect to influenza vaccines could cause us to have to recognizean impairment charge with respect to the goodwill, certain other intangibleassets and property, including without limitation the Liverpool plant resultingfrom the PowderJect acquisition and the new influenza vaccines manufacturingfacility under construction in Liverpool, which could have a material adverseeffect on our results of operations.

Our previous inability tosupply influenza vaccines has led to loss of market share and may lead to lossof additional market share in future seasons. Following the announcement of ourFLUVIRIN® licensesuspension, competitors announced plans to introduce influenza vaccine productsin the United States and 

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soughtexpedited regulatory approval to do so. Even though the license suspension hasbeen lifted, some of our customers may continue to choose to purchase influenzavaccine from other providers as their products become available in the UnitedStates. Loss of market share in the United States or foreign markets could havea material adverse effect on our business and results of operations. Delays instart-up procedures for ramping up to full production and normal manufacturingissues inherent in the complexity of influenza vaccine production, adverselyaffected the amount of FLUVIRIN® vaccine that we were able to producefor the 2005-2006 influenza season and may result in further loss ofmarket share.

*If we fail toobtain or maintain the regulatory approvals we need to market our products orsubstantial changes in the regulatory environment occur, our business maysuffer.*

We must obtain andmaintain regulatory approval in order to market most of our products. Generally,these approvals are on a product-by-product and country-by-country basis. Inthe case of influenza vaccines, the failure to obtain or maintain our licenses,or delays imposed by regulatory actions, could lead to the loss of our entireinventory during any given season since each year’s vaccines are manufacturedto meet specific strains of influenza. In the case of therapeutic products, aseparate approval is required for each therapeutic indication. Productcandidates that appear promising based on early, and even large-scale, clinicaltrials may not receive regulatory approval. Furthermore, the results ofclinical trials often are susceptible to varying interpretations that maydelay, limit or prevent approval or result in the need for additionalpre-marketing or post-marketing studies. In addition, regulations may beamended from time to time. Revised regulations may require us to reformulateproducts on a country or regional basis, obtain additional regulatoryapprovals, or accept additional risks that our products will not maintainmarket acceptance or be eligible for third party insurance coverage. Increasedregulatory scrutiny and restrictions regarding marketing practices for productsthat are subject to government reimbursement may impact the sales of suchproducts. There is no guarantee that we will be able to meet conditions toobtain or maintain regulatory approval or to satisfy new regulatoryrequirements and may suffer a loss of revenue as a result.

*If our focus on theresearch and development of emerging technologies does not result in thecreation 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 nottranslate into success in large-scale clinical trials (which are designed toshow efficacy), often for reasons that are not fully understood. Further,success in clinical trials will likely lead to increased investment, adverselyaffecting short-term profitability, to bring such products to market. And evenafter a product is approved and launched, general usage or post-marketingstudies may identify safety or other previously unknown problems with theproduct which may result in regulatory approvals being suspended, limited tonarrow indications or revoked, or which may otherwise prevent successfulcommercialization.

*Our products arecomplex and difficult to manufacture on a large-scale basis, which could causeus to delay product launches, experience shortages of products or prevent usfrom offering products on a volume basis.*

Most of our products are biologics and manufacturingbiologic products is complex. A biologic product generally cannot besufficiently characterized (in terms of its physical and chemical properties)to 

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rely on assaying of thefinished product alone to ensure that the product will perform in the intendedmanner. Accordingly, it is essential to be able to both validate and controlthe manufacturing process, that is, to show that the process works and that theproduct is made strictly and consistently in compliance with that process.Slight deviations anywhere in the manufacturing process, including qualitycontrol, labeling and packaging, may result in unacceptable changes in theproducts that may result in lot failures or product recalls, or liability to athird party to the extent we are contract manufacturing products in ourfacilities for such third party. Manufacturing processes which are used toproduce the smaller quantities of material needed for research and developmentpurposes may not be successfully scaled up to allow production of commercialquantities at reasonable cost or at all. All of these difficulties arecompounded when dealing with novel biologic products that require novelmanufacturing processes. Additionally, manufacturing is subject to extensivegovernment regulation. Even minor changes in the manufacturing process requireregulatory approval, which, in turn, may require further clinical studies. Forsome of our products, we rely on others to supply raw materials and tomanufacture those products according to regulatory requirements.

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,collaborative partners, licensees and clinical trial sites.

*If we are unable tosuccessfully compete in the highly competitive healthcare industry, ourbusiness could be harmed.*

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

·       The possibility that thecompetitor may have launched its product first;

·       The competitor may havegreater access to certain raw materials;

·       The competitor may havemore efficient manufacturing processes;

·       The competitor may adaptmore quickly to technological change;

·       The competitor may havegreater marketing capabilities;

·       The competitive product mayhave therapeutic or other advantages; or

·       New competitors may enterinto markets where we currently have significant competitive 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.

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*Our work on newvaccines for pandemic preparedness exposes us to special risks that we may beunable to control.*

We continue to incur significant expenses inresearching, developing and manufacturing new vaccines for pandemicpreparedness. To date, these vaccines have undergone limited clinical testingand are not approved for use outside of clinical trials. In the event of apandemic, countries may opt to use our pandemic vaccines without full clinicaltrials. Although there is some effort to limit product liability exposure formanufacturers of pandemic vaccines, we cannot be assured that any attempts tolimit liability exposure, whether legislatively or contractually, willsufficiently address our risks or be adopted in all countries.

In addition, a pandemic orthe perceived risk of a pandemic could result in countries taking actions toprotect their citizens that could affect our ability to control the productionand export of pandemic vaccines or otherwise impose burdensome regulations onour business. For example, our manufacturing locations may be subject topossible seizure by governments in the event of a pandemic. Countries may alsorequire that we grant compulsory licenses to allow competitors to manufactureproducts that are covered by our patents. Although we have entered intoagreements to provide vaccine to certain countries where our manufacturingfacilities are located, we cannot give any assurance that these agreements willprevent actions that decrease our sales or otherwise harm our business.

*Conflicts with ordecisions by third parties we collaborate with could harm our business.*

An important part of ourbusiness strategy depends upon collaborations with third parties, includingresearch collaborations and joint efforts to develop, commercialize newproducts and manufacture, market and distribute existing products. Ascircumstances change, Chiron and our strategic partners may develop conflictingpriorities or other conflicts of interest or decide not to extend existingcollaborations. We may experience significant delays and incur significantexpenses in resolving these conflicts and may not be able to resolve thesematters on acceptable terms. Even without conflicts of interest, we maydisagree with our strategic partners as to how best to realize the valueassociated with a current product or a product in development. In some cases,the strategic partner may have responsibility for formulating and implementingkey strategic or operational plans. In addition, merger and acquisitionactivity within the pharmaceutical and biotechnology industries may affect ourstrategic partners, causing them to reprioritize their efforts related to theresearch collaborations and other joint efforts with us. Decisions by corporatepartners on key clinical, regulatory, marketing (including pricing), inventorymanagement and other issues may prevent successful commercialization of theproduct or otherwise impact our profitability.

*If any of our thirdparty suppliers or manufacturers cannot adequately meet our needs, our businesscould be harmed.*

We use raw materials and other supplies that generallyare available from multiple commercial sources. Certain manufacturingprocesses, however, use materials that are available from sole sources, or thatare in short supply, or are difficult for the supplier to produce and certifyin accordance with our specifications. From time to time, concerns are raisedwith respect to potential contamination of biological materials that aresupplied to us. These concerns can further tighten market conditions formaterials that may be in short supply or available from limited sources. Moreover,regulatory approvals to market our products may be conditioned upon obtainingcertain materials from specified sources. Our ability to substitute materialfrom an alternate source may be delayed pending regulatory approval of suchalternate source. Although we work to mitigate the risks associated withrelying on sole suppliers, there is a possibility that material shortages couldimpact production.

We purchase bulk powdered tobramycin, the primarybasic raw material in TOBI® tobramycin, fromtwo of the principal worldwide suppliers of the drug. We anticipate that eitherone of these suppliers alone 

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will be able to supplysufficient quantities to meet current needs; however, there can be no assurancethat these suppliers will be able to meet future demand in a timely andcost-effective manner. As a result, our operations could be adversely affectedby an interruption or reduction in the supply of bulk tobramycin powder.

We have entered into contracts with third parties forthe production and packaging of TOBI® tobramycin. Over time, we can use alternativeproduction and packaging sources. However, if the contracted third partiesbecome unable to produce or package sufficient quantities of TOBI® solution due to work stoppages or otherfactors, our operations could be disrupted until alternative sources aresecured. We have entered into contracts with third parties for the packaging ofthe pre-filled diluent syringe for BETASERON® interferon beta-1b. Over time, we canuse alternative packaging sources. However, if the contracted third partiesbecome unable to produce or package sufficient quantities of the pre-filleddiluent syringe for BETASERON® interferon beta-1b due to work stoppages orother factors, our operations could be disrupted until alternative sources aresecured.

In connection with the production of our influenzavaccine products, we must purchase large quantities of incubated fertilechicken eggs. Currently, for FLUVIRIN® influenza vaccine, we purchase those eggs froma single supplier in the United Kingdom and, pursuant to the contract with thatsupplier, we have agreed to make specified purchases from that supplier through2012, subject to our right to terminate this agreement earlier upon payment ofa termination fee. To ensure that the incubation of the eggs is of theappropriate standard for vaccine manufacturing, we acquired the assets of theprimary incubation facility from the egg supplier in December 2005. Avianinfluenza has resulted in the massive death or culling of domestic poultry incertain regions, primarily Southeast Asia. If our suppliers were to fail tosupply eggs in sufficient quantities or quality, including as a result of anyoutbreak of avian influenza or other issues related to the chickens, ourbusiness would be materially 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 PROCLEIX® WNV Assay, currently in use on an investigational-usebasis in the U.S., and the PROCLEIX® HIV-1/HCV Assay and PROCLEIX® ULTRIO® Assay. The related instrument systemsare sourced from third party suppliers. Currently, Gen-Probe is the onlymanufacturer of nucleic acid testing products using Transcription-MediatedAmplification technology. In immunodiagnostics, under our joint businesscontractual arrangements with Ortho-Clinical Diagnostics, we manufacture bulkreagents and antigens and confirmatory test kits sold in the clinicaldiagnostics and blood screening fields. While we and our partners work tomitigate the risks associated with being a key provider, there can be noassurance that our partner, Gen-Probe, will be able to provide sufficientquantities of the PROCLEIX® WNV Assay, PROCLEIX® HIV-1/HCVAssay and PROCLEIX® ULTRIO® Assay or that wewill be able to manufacture sufficient bulk reagents and antigens andconfirmatory test kits for immunodiagnostic products. Our difficulties ordelays or those of our partners’ could cause a public health concern for theblood supply, as well as increase costs and cause loss of revenue or marketshare.

*If we cannot obtainnecessary licenses to third party patents for the manufacture or sale of ourproducts, we may have to withdraw from the market or delay the introduction ofthe 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 

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licenses.If we do not or cannot obtain these licenses, products may be withdrawn fromthe market or delays could be encountered in market introduction while anattempt is made to design around these patents, or we could find that thedevelopment, manufacture or sale of such products is foreclosed. We could alsoincur substantial costs in licensing or challenging the validity and scope ofthese patents.

*Because most of ourproducts are based on technologies that are unfamiliar to the healthcare community,they may not be accepted by healthcare providers and patients, which could harmour 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 to healthcareproviders and patients. Such guidelines or recommendations can be veryinfluential and may adversely affect the usage of our products directly (forexample, by recommending a decreased dosage of our product in conjunction witha concomitant therapy or a government entity withdrawing its recommendation toscreen blood donations for certain viruses) or indirectly (for example, byrecommending a competitive product over our product).

*If we are unable toavoid significant exposure to product liability claims, our business could beharmed.*

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 these products.If we are sued for any injury caused by our products, we could suffer asignificant 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.

*Sales of ourproducts and profitability may be adversely affected by pricing policies andapplicable laws and the availability and amount of reimbursement from thirdparties, such as the government and insurance companies.*

In the U.S., Europe andother significant markets, sales of our products and our profitability may beaffected by the pricing policies and applicable laws of, and the availabilityand amount of reimbursement from, the government or other third parties, suchas insurance companies. It is difficult to predict the pricing andreimbursement status of newly approved, novel biotechnology products, and itmay be challenging to meet the current pricing and reimbursement policies forexisting products, which may be complex, subject to change and limit ourrevenues. In certain foreign markets, governments have issued more extensiveregulations relating to the pricing and profitability of pharmaceuticalcompanies, which can be expected to limit our revenues from certain products.There have been proposals in the U.S. (at both the federal and state level) toimplement such controls. If the United States Congress enacts legislativeproposals addressing parallel importation currently being deliberated, revenuesfrom certain products may be affected further by this change in U.S. policy.The growth of managed care in the U.S. also has placed pressure on the pricing ofhealthcare products. These pressures can be expected to continue.

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*If we marketproducts in a manner that violates state, federal or foreign laws that governpharmaceuticals and health care products, including FDA, FTC, and health carefraud and abuse laws, we may be subject to civil or criminal penalties,including the potential for exclusion from federal, state and foreign programs.*

The federal laws and regulations administered by theFDA and FTC place restrictions on the promotion of medical products. FDA lawand regulations prohibit the marketing and promotion of unapproved drug anddevice products and unapproved uses of approved drug and device products. FTCand FDA also place restrictions on the promotion of approved drugs and devicesto ensure that marketing material is not false or misleading. In addition tothese restrictions on the marketing of pharmaceutical products withoutregulatory approval, other types of state and federal health care fraud andabuse laws have been applied in recent years to restrict certain marketingpractices in the healthcare industry, and to otherwise determine theeligibility of pharmaceutical manufacturers to have their products reimbursedby Medicare, Medicaid, and other federal and state programs. These laws includeanti-kickback statutes, false claims statutes, and others. In addition, theforeign business operations of Chiron are impacted by certain United Stateslaws and regulations. These include prohibitions on payments to foreignofficials and restrictions on exports to certain foreign nations or commercewith certain debarred parties. Likewise, various foreign laws may restrict themanner in which healthcare products are marketed in other countries.

The federal anti-kickback statute prohibits, amongother things, knowingly offering, paying, soliciting, or receiving remunerationto induce or in return for purchasing, ordering, recommending, or arranging forthe purchase, order, or lease of any health care item reimbursable underMedicare, Medicaid, or other federally funded health care programs. Thisstatute has been interpreted broadly to apply to arrangements between drugmanufacturers on one hand and prescribers, purchasers, pharmacies, GroupPurchasing Organizations, and pharmacy benefit and formulary managers on theother, along with such indirect purchasers as health plans. Although there area number of statutory exemptions and regulatory safe harbors protecting certainactivities from prosecution, the exemptions and safe harbors are drawnnarrowly. Activities that fall outside of a safe harbor are not necessarilyillegal, but practices that involve direct or indirect remuneration intended toinduce prescribing, purchasing, or recommending of products may be subject togovernmental scrutiny if they do not qualify for an exemption or safe harbor.Our practices may not in all cases meet all of the criteria for safe harborprotection from anti-kickback liability.

Federal false claims laws generally prohibit a personfrom knowingly presenting, or causing to be presented, a false claim forpayment to the federal government, or knowingly making, or causing to be made,a false statement to have a false claim paid. Recently, several pharmaceuticaland other health care companies have been subject to investigative and enforcementactivity under these laws, including qui tam suits filed by “whistleblowers,”for a variety of alleged inappropriate promotional and marketingactivities, such as providing free product to customers with the expectationthat the customers would bill federal programs for the product; engaging in “off-label”promotion that caused claims to be submitted to federal and state programs fornon-covered off-label uses; and submitting inflated “best price” and otherwiseincorrect pricing data for Medicaid rebate or other price reporting purposes.In some cases, the manufacturers have been alleged to have aided and abetted inthe submission of false claims. In addition, state Attorneys General andprivate class action plaintiffs have filed civil suits under the federal RICOstatute and a variety of state consumer protection laws claiming thatpharmaceutical companies reported inflated average wholesale prices to pricingservices used by the federal programs to set reimbursement rates, and that as aresult, Medicare beneficiaries, Medicaid programs and private payers overpaidfor drugs. Still other manufacturers have been subject to enforcement activityfor alleged violations of such federal statutes as the Prescription DrugMarketing Act, involving pharmaceutical sampling practices. The majority ofstates also have statutes or regulations similar to the federal anti-kickbacklaw and false claims laws, which apply to items and services, reimbursed underMedicaid and other state programs, or, in several states, apply regardless ofthe payor.

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Sanctions under federal,state and foreign laws may include civil monetary penalties, exclusion of amanufacturer’s products from reimbursement under government programs, criminalfines, and imprisonment. Because of the breadth of these laws and thenarrowness of the safe harbors, it is possible that some of our businessactivities could be subject to challenge under one or more of such laws.

*Our mishandling ofhazardous materials could result in substantial 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 notprevent competition or generate revenues.*

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 products withoutbeing required to undertake the lengthy and expensive development efforts madeby us and without having to pay royalties or otherwise compensate us for theuse of the invention. We have no assurance that patents and patent applicationsowned or licensed to us will provide substantial protection. Important legalquestions remain to be resolved as to the extent and scope of available patentprotection for biotechnology products and processes in the U.S. and otherimportant markets. We do not know how many of our pending patent applicationswill be granted, or the effective coverage of those that are granted. In theU.S. and other important markets, the issuance of a patent is neitherconclusive as to its validity nor the enforceable scope of its claims. We haveengaged in significant litigation to determine the scope and validity ofcertain of our patents and expect to continue to do so. An adverse outcome oflitigation could result in the reduction or loss of royalty revenues. Engagingin patent litigation against one party may place significant royalty revenuesreceived 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 length of time necessaryto resolve patent litigation successfully may allow infringers to gainsignificant market advantage. Third parties may be able to design around thepatents and develop competitive products that do not use the inventions coveredby our patents. Many countries, including certain countries in Europe, havecompulsory licensing laws under which a patent owner may be compelled to grantlicenses to third parties (for example, the third party’s product is needed tomeet a threat to public health or safety in that country, or the patent ownerhas failed to “work” the invention in that country, or the third party haspatented improvements). In addition, most countries limit the enforceability ofpatents against government agencies or government contractors. In thesecountries, the patent owner may be limited to monetary relief and may be unableto enjoin infringement, which could materially diminish the value of thepatent. In addition, royalty revenues may decline as patents expire.

*If our efforts tointegrate acquired or licensed businesses or technologies into our business arenot successful, our business could be harmed.*

As part of ourbusiness strategy, we expect to continue to grow our business throughin-licensing, collaborations or acquisitions of products or companies. Thefailure to adequately address the financial, operational or legal risks raisedby such transactions could harm our business. Financial aspects related tothese transactions may alter our financial position, reported operating resultsor stock price, and include:

·       Use of cash resources;

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·       Potentially dilutiveissuances of equity securities;

·       The incurrence of debt andcontingent liabilities, impairment losses or restructuring charges;

·       Large write-offs and difficultiesin assessment of the relative percentages of in-process research anddevelopment expense that can be immediately written off as compared to theamount which must be amortized over the appropriate life of the asset;

·       Amortization expensesrelated to other intangible assets; and

·       Impairment of the value oftangible and intangible assets resulting from management’s decision todiscontinue a line of business or product previously acquired by Chiron or fromchanges in business conditions.

Operational risksthat could harm our existing operations or prevent realization of anticipatedbenefits from such transactions include:

·       Challenges associated withmanaging an increasingly diversified business and international business;

·       Difficulties in assimilatingthe operations, products, technology, information systems or personnel of theacquired company;

·       Diversion of management’sattention from other business concerns;

·       Inability to maintainuniform standards, controls, procedures and policies;

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

·       Subsequent loss of keypersonnel.

Legal risks may include requirements to obtain theconsent of our stockholders or a third party, or the approval of variousregulatory authorities.

If such efforts tointegrate acquired or licensed businesses or technologies into our business arenot successful, our business could be harmed.

*If we cannotinitiate and maintain revenue-generating relationships with third parties, wemay not be able to grow our revenues in the 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.

*Our internationalsales and operations involve additional risks that could increase our expenses,adversely affect our operating results and require increased time and attentionof our management.*

We derive asubstantial portion of revenue from sales outside of the U.S. and havesignificant research, development, manufacturing and marketing operationsoutside of the U.S. Our planned growth is contingent upon the successfulexpansion of our international revenue. These international operations aresubject to risks in addition to those faced by our U.S. operations, including:

·       Fluctuations in currencyexchange rates and economic instability such as higher interest rates andinflation;

·       Difficulties in hedgingforeign currency transaction exposures;

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·       Difficulties in staffing,managing, training and operating our international operations;

·       Difficulties incoordinating the activities of our geographically dispersed and culturallydiverse operations;

·       Costs and delays associatedwith coordinating operations in multiple languages;

·       Potential loss ofproprietary information due to laws that may be less protective of ourintellectual property rights; and

·       Exposure to different andevolving legal standards (particularly with respect to product marketing,pricing and competition).

*Our level of debtcould limit cash flow available for our operations and could adversely affectour ability to service our debt or obtain additional financing, if necessary.*

As of December 31,2005, our total debt including current portion, was $940.3 million. Our levelof debt could restrict our operations and make it more difficult for us tosatisfy our obligations under the 2033 and the 2034 convertible debentures (the“debentures”). Among other things, our level of debt may:

·       Limit our ability to obtainadditional financing for working capital, capital expenditures, strategicacquisitions and general corporate purposes;

·       Require us to dedicate allor a substantial portion of our cash flow to service our debt, which willreduce funds available for other business purposes, such as capitalexpenditures or acquisitions;

·       Limit our flexibility inplanning for or reacting to changes in the markets in which we compete;

·       Place us at a competitivedisadvantage relative to our competitors with less leverage;

·       Render us more vulnerableto general adverse economic and industry conditions; and

·       Make it more difficult forus to satisfy our financial obligations, including those relating to thedebentures and our other debt obligations.

We and our subsidiaries may still be able to incursubstantially more debt. The terms of the indenture governing the debenturesand the agreements governing our other debt permit additional borrowings. Ourincurrence of additional debt could further exacerbate the risks describedabove.

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,obtain additional financing, sell some of our assets or operations, reduce ordelay capital 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 relationshipwith Novartis AG could limit our ability to enter into transactions or pursueopportunities in conflict with Novartis and could cause the price of our commonstock to decline.*

On October 30, 2005,we entered into a merger agreement with Novartis AG and Novartis Corporation,pursuant to which Chiron would become a wholly owned subsidiary of NovartisCorporation if the proposed merger is consummated. Apart from the transactionscontemplated by the merger agreement, we have an alliance with Novartis AG, alife sciences company headquartered in Basel, 

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Switzerland.Under a series of agreements between Chiron and Novartis, which will continuein force while our merger with Novartis is pending or if the merger is notcompleted, and as a result of subsequent stock issuances by Chiron, Novartis’ownership interest in Chiron was approximately 43.9% as of December 31,2005. The governance agreement between Chiron and Novartis contains provisionsthat require the approval of Novartis before we enter into certain corporatetransactions. These transactions generally include significant debt or equityissuances, debt or equity repurchases, most mergers and acquisitions, thepayment of cash dividends, amendments to Chiron’s certificate of incorporationor by-laws, and other transactions that would adversely impact the rights ofNovartis, or discriminate against Novartis, as a Chiron stockholder. Inaddition, a majority of the independent directors must approve any materialtransactions between Chiron and Novartis. These provisions may limit ourability to enter into transactions with third parties otherwise viewed asbeneficial to Chiron. In addition, as discussed under “*Chiron will be subject to business uncertainties andcontractual restrictions in connection with the proposed merger with Novartis*,”our merger agreement with Novartis contains additional and more restrictivelimitations on our operations while the merger agreement is in effect. All ofour shares owned by Novartis are eligible for sale in the public market subjectto compliance with the applicable securities laws. We have agreed that, uponNovartis’ request, we will file one or more registration statements under theSecurities Act in order to permit Novartis to offer and sell shares of ourcommon stock, including shares that Novartis was required to purchase from uspursuant to the exercise of our subscription rights under the subscriptionagreement. 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 pricecould be volatile.*

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

·       Developmentswith respect to the proposed merger with Novartis;

·       Fluctuations in earningsfrom period to period;

·       Results of clinical trialsconducted by us or by our competitors;

·       Announcements by us or ourcompetitors regarding product development efforts, including the status ofregulatory approval applications;

·       Impact from the recentinfluenza vaccines developments;

·       The outcome of legalproceedings, including claims filed by us against third parties to enforce ourpatents and claims filed by third parties against us relating to patents heldby the third parties;

·       The launch of competingproducts;

·       The resolution of (orfailure to resolve) disputes with strategic partners;

·       Corporate restructuring byus;

·       Adoption of new U.S orforeign laws;

·       The sale of a substantialnumber of shares held by our existing stockholders;

·       Licensing activities by us;and

·       The acquisition or sale byus of products, products in development or businesses.

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 

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and maybe affected by, among other things, the types of events that affect our stock.Changes in the market price of these securities may impact our profitability.

*We are subject totaxation in a number of jurisdictions and changes to the corporate tax rate andlaws of any of these jurisdictions could increase the amount of corporate taxeswe have to pay.*

We pay taxes principally in the U.S., Germany, Italy,and the United Kingdom. All of these jurisdictions have in the past and may inthe future make changes to their corporate tax rates and other tax laws, whichcould increase our future tax provision. Specifically, on October 22,2004, the American Jobs Creation Act of 2004 (the Act) was signed into law. TheAct includes an elimination of the tax benefit of the Extraterritorial IncomeExclusion over 2005 and 2006.

We have negotiated a number of rulings regardingincome and other taxes that are subject to periodic review and renewal. If suchrulings are not renewed or are substantially modified, income taxes payable inparticular jurisdictions could increase. While we believe that all material taxliabilities are reflected properly in our balance sheet, we are presently underaudit in several jurisdictions and may be subject to further audits in thefuture, and we have no assurance that we will prevail in all cases in the eventthe taxing authorities disagree with our interpretations of the tax law. Inaddition, we have assumed liabilities for all income taxes incurred prior tothe sales of our former subsidiaries, including PowderJect Vaccines, Inc.,SBL Vaccin AB, and PowderJect Research Limited. Future levels of research anddevelopment spending, capital investment and export sales will impact ourentitlement to related tax credits and benefits which have the effect oflowering our effective tax rate.

In the fourth quarter of2005, the German tax authorities released draft administrative guidance relatedto 2003 legislation regarding certain intercompany debt arrangements. Webelieve that the 2003 legislation as written permits a tax deduction for theinterest expense accrued on certain intercompany loans related to ouroperations in Germany. However, if the 2005 draft administrative guidance isfinalized as introduced, intercompany interest expense of approximately $32.0million per year could be disallowed for the years 2004 and forward, whichwould have a material adverse impact on our reported effective tax rate. Wehave not provided for any additional tax since we believe it is currently notprobable of payment as this guidance is in draft form and is subject tosignificant revision.

*The ability to usecertain deferred tax assets is dependent upon future profitability in theVaccines business.*

A material portion of ourdeferred tax assets are due to tax loss carryforwards and other deferred taxbenefits incurred in the Vaccines business in the UK and Italy, primarily dueto reduced FLUVIRIN® influenza vaccine sales and continuingresearch and development expenses. The ability to use these deferred tax assetsis dependent upon us earning sufficient future profits in these jurisdictions. Ifmanagement determines that profits will not be earned in the tax periods beforewhich such losses expire, then a valuation allowance could be required and asubstantial tax expense may result.

*Our earningsresults may be inconsistent and cause volatility in our stock price.*

Our operatingresults may vary considerably from quarter to quarter. Any number of factorsmay affect our quarterly operating results. These factors include, but are notlimited to the following:

·       Inventory managementpractices, including wholesale ordering patterns;

·       The level of pre-clinicaland clinical trial-related activities;

·       Seasonality of certainvaccine products;

·       The tender driven nature ofcertain vaccine products;

·       The nature of ourcollaborative, royalty and license arrangements and other revenue sources;

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·       Foreign currency exchangerate fluctuations;

·       Effectivetax rate fluctuations; and

·       The level of productreserves due to various issues, including seasonality patterns, excess andobsolete inventory, and production yields.

*Ourresults in any one quarter are not necessarily indicative of results to beexpected for a full year.*

*Revisions toaccounting standards, financial reporting and corporate governance requirementsand tax laws result in changes to our standard practices and will impact ourresults and could require a significant expenditure of time, attention andresources, especially by senior management.*

We must follow accounting standards, financialreporting and corporate governance requirements and tax laws set by thegoverning bodies and lawmakers in the U.S. and other countries where we dobusiness. From time to time, these governing bodies and lawmakers implement newand revised rules and laws. These new and revised accounting standards,financial reporting and corporate governance requirements and tax laws mayrequire changes to our financial statements, the composition of our board ofdirectors, the composition, responsibility and manner of operation of various board-levelcommittees, the information filed by us with the governing bodies and enforcementof tax laws against us. Implementing changes required by such new standards,requirements or laws likely will require a significant expenditure of time,attention and resources, especially by our senior management. It is impossibleto completely predict the impact, if any, on Chiron of future changes toaccounting standards, financial reporting and corporate governance requirementsand tax laws.

It is possible that theapplication of certain current accounting standards may change due to environmentalfactors, which may necessitate a change in our standard practice related tothese accounting standards. In particular, effective January 1, 2006 weare required to adopt SFAS No. 123(R), which requires 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 123(R) to materially impact our results of operations.

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

**Foreign Currency Risk**

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. To mitigate foreign currency exchange risks, we enter into foreigncurrency forward contracts and purchase foreign currency option contracts. Wedo not use any of these derivative instruments for trading or speculativepurposes. The total notional amount of these derivative financial instrumentsat December 31, 2005 and 2004 was $178.2 million and $131.3 million,respectively.

We use foreign currency forward contracts to hedge thegains and losses generated by the re-measurement of certain assets andliabilities denominated in foreign currencies. Typically, these contracts havematurities of three months or less. At December 31, 2005, our transactionexposures amounted to $178.6 million and were offset by foreign currencyforward contracts with a notional amount of $178.2 million. The unrealizedgain on outstanding foreign currency forward contracts was $2.6 million at December 31,2005. The notional amount of the foreign currency forward contracts was$131.3 million at December 31, 2004. The unrealized loss onoutstanding foreign currency forward contracts was $10.4 million at December 31,2004. Based on exposures at December 31, 2005, a 10% movement against ourportfolio of transaction exposures and hedge contracts would result in a gainor loss of approximately 

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$0.04 million. A 10%movement in the value of the U.S. Dollar versus our portfolio of transactionexposures has not occurred in the last 12 quarters. Foreign currency gains(losses) from continuing operations, including the impact of hedging, were $1.5million, $(0.4) million and $5.5 million in 2005, 2004 and 2003,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 decrease in the value of the U.S. Dollar vis-à-vis both these currencies willlikely have a negative impact on our financial results. We may selectivelyhedge anticipated currency exposures by purchasing foreign currency optioncontracts and forward contracts. We may also purchase British Pound denominatedfixed income securities to hedge our short British Pound exposure. At December 31,2005, we had purchased 11.2 million British Pound denominated fixed incomesecurities. When we use options, we usually purchase out-of-the-money foreigncurrency option contracts to limit hedging costs. At December 31, 2005 and2004, we had no outstanding option contracts. Based on estimated exposures andexisting hedges at December 31, 2005 and based on historical patterns ofexchange rate movements, a value-at-risk analysis estimates that there is a 95%probability that our portfolio of anticipated currency exposures will result ina loss of less than $12.7 million over the next 12 months. We may enter intoforeign currency forwards or options, or we may buy additional British Pounddenominated fixed income securities 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$1,408.8 million at December 31, 2005. As of that date, we also had $173.3million of floating rate obligations tied to the London Inter-Bank Offered Rate(LIBOR). We have a “natural hedge” against this exposure as a result of ourportfolio holdings in floating rate fixed income securities tied to LIBOR. Theanalysis below describes the impact of changes in interest rates to us and isbased on a net investment portfolio of $1,235.5 million.

The analysis assumes an immediate parallel increase ordecrease in interest rates of 150-basis points and examines the impact tous over the next twelve months. An immediate increase in interest rates of 150-basispoints results in interest income of $63.4 million over the subsequent 12-monthperiod. Similarly, a 150-basis point decrease results in reportedinterest income of $38.8 million. Also, an immediate increase in interestrates of 150-basis points results in a decrease in the portfolio marketvalue of $7.7 million. Fluctuations in the value of our investment securitiescaused by changes in interest rates (gains or losses on the carrying value) arerecorded in other comprehensive income, and are realized only if we sell the underlyingsecurities.

A larger than 150-basispoint movement in short-term interest rates has occurred twice 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 three of the lastten years, and a 0-50 basis point movement has occurred in four of thelast ten years.

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**Equity Securities Risk**

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 hedged a portion of ourexposure through forward sales contracts. The forward sales contractssubstantially offset any changes in value of the securities held and, ineffect, neutralize the impact of market valuation shifts on the hedgedportfolio. The notional amount of our forward sales contracts at December 31,2005 was $12.9 million. The unrealized gain on outstanding forward salescontracts was $1.5 million at December 31, 2005. The notional amount ofour forward sales contracts at December 31, 2004 was $41.5 million. Theunrealized gain on outstanding forward sales contracts was $4.8 million at December 31,2004. In the future, we may use additional hedging strategies in order tomitigate the potential adverse impact from changes in the market value of stockprices. We have no assurance that impairment losses will not have a materialadverse impact on our future results of operations. We recorded charges of $1.3million, $1.4 million, and $0.0 million in 2005, 2004, and 2003respectively, to write down certain available-for-sale equity securities thatwe deemed to have been impaired. At December 31, 2005, if the market priceof our equity investments, including warrants, decreased by 10%, the marketvalue of the equity portfolio would decrease by $1.5 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 transactions with financial institutions and otherissuers with strong credit ratings, which reduce the risk of loss due tononpayment or deterioration in credit rating.

**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)   Evaluationof disclosure controls and procedures**   As of the end ofthe period covered by this Annual Report, Chiron carried out an evaluationunder the supervision and with the participation of Chiron’s management,including Chiron’s CEO and CFO, of the effectiveness of the design andoperation of Chiron’s disclosure controls and procedures. Based on thatevaluation, Chiron’s management, including the CEO and CFO, concluded that asof December 31, 2005 Chiron’s disclosure controls and procedures wereeffective to ensure that information required to be disclosed by the Company inreports that it files or submits under the Exchange Act is recorded, processed,summarized and reported within the time periods specified in SEC rules andforms.

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**(b)   Management’sannual report on internal control 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 31,2005. 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.*Based on theassessment using those criteria, management concluded that, as of December 31,2005, our internal control over financial reporting was effective.

Ernst &Young LLP, an independent registered public accounting firm that has auditedour consolidated financial statements included herein, has issued anattestation report on our assessment of internal control over financialreporting.

**(c)   Reportof the independent registered public accounting firm on internal control overfinancial reporting**

The Board of Directors and Stockholders of ChironCorporation

We have audited management’s assessment, included in “Management’sannual report on internal control over financial reporting” above, that ChironCorporation maintained effective internal control over financial reporting asof December 31, 2005, based on criteria established in Internal Control—IntegratedFramework issued by the Committee of Sponsoring Organizations of the TreadwayCommission (the COSO criteria). Chiron Corporation’s management is responsiblefor maintaining effective internal control over financial reporting and for itsassessment of the effectiveness of internal control over financial reporting. Ourresponsibility is to express an opinion on management’s assessment and anopinion on the effectiveness of the company’s internal control over financialreporting based on our audit.

We conducted our audit 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 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 of financialstatements in accordance with generally accepted accounting principles, andthat receipts and expenditures of the company are being made only in accordancewith authorizations of management and directors of the company; and (3) providereasonable assurance regarding prevention or timely detection of unauthorizedacquisition, use, or disposition of the company’s assets that could have amaterial effect on the financial statements.

Because of its inherentlimitations, internal control over financial reporting may not prevent ordetect misstatements. Also, projections of any evaluation of effectiveness tofuture periods are subject to the risk 

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thatcontrols may become inadequate because of changes in conditions, or that thedegree of compliance with the policies or procedures may deteriorate.

In our opinion, management’sassessment that Chiron Corporation maintained effective internal control overfinancial reporting as of December 31, 2005, is fairly stated, in allmaterial respects, based on the COSO criteria. Also, in our opinion, ChironCorporation maintained, in all material respects, effective internal controlover financial reporting as of December 31, 2005, based on the COSOcriteria.

We also have audited, inaccordance with the standards of the Public Company Accounting Oversight Board(United States), the consolidated balance sheets of Chiron Corporation as of December 31,2005 and 2004, and the related consolidated statements of operations,comprehensive income (loss), stockholders’ equity and cash flows for each ofthe three years in the period ended December 31, 2005 of ChironCorporation and our report dated March 14, 2006 (except for Note 20,as to which the date is March 16, 2006) expressed an unqualified opinionthereon.

|  |   | /s/ Ernst &  Young LLP |
|--|--------|---------------------------------|

Palo Alto, California

March 14, 2006

**(d)   Changes ininternal controls  **As of December 31, 2004 theCompany’s assessment of the effectiveness of its internal control overfinancial reporting identified three material weaknesses in the Company’sinternal control over financial reporting. During the fourth quarter of fiscalyear 2005, and in connection with the preparation of our consolidated financialstatements for the year ended December 31, 2005, we implemented additionalcontrols and procedures relating to the annual tax provision process to addressthe material weakness that had been identified in 2004. Such additionalcontrols and procedures included, among others:

·       Theimplementation of new analytical tools in order to enhance the analysis andcalculation of the tax provision and other tax accounts

·       Additionaltraining of personnel responsible for the tax provision process

As of December 31,2005, the Company had remediated the controls that led to the prior year’smaterial weaknesses, which pertained to both the design and operatingeffectiveness of controls relating to revenue recognition at our vaccinessubsidiary in Germany, the annual income tax provision and the timelydetermination of the appropriate accrual for legal services.

Except as discussed above,there were no changes in the company’s internal control over financialreporting during its most recently completed fiscal quarter that havematerially affected or are reasonably likely to materially affect its internalcontrol over financial reporting, as defined in Rule 13a-15(f) underthe Exchange Act.

**ITEM 9B.**       OTHERINFORMATION

Not applicable.

**PART III**

**ITEM10.**         DIRECTORS AND EXECUTIVEOFFICERS OF THE REGISTRANT

We incorporate theinformation required for this item by reference to our definitive ProxyStatement for our 2006 Annual Meeting. We intend to file our Proxy Statementwith the Securities and Exchange Commission within 120 days of December 31,2005. See the sections entitled “Election of Directors,” “Section 16(a) BeneficialOwnership Reporting Compliance” and “Corporate Governance Matters” in the 

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ProxyStatement. For information on our executive officers, refer to the sectionentitled “Executive Officers of the Registrant” which appears at the end of Part Iof 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 the section entitled “Stock Ownership” in the Proxy Statement.

**EquityCompensation Plan Information**

Thetable below shows the securities authorized for issuance under Chiron’s equitycompensation plans in effect at December 31, 2005. Chiron does notmaintain any equity compensation plans that have not been approved by itsstockholders.

| ** **                                                  | ** ** | **(a)**                                                                                                                                              | ** ** | **(b)**                                                                                                          | ** ** | **(c)**                                                                                                                                                                                                          | ** ** |
|-------------------------------------------------------------|------------|------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------------------------------------------------------------------------------------------------|------------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|
| ** **                                                  | ** ** | **Number of 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     |       |                                                                                                                                                 | 27,775,631 | (1)(2)(3)                                                                                                        |       |                                                                                                                                                                                                             | $          | 39.87 |   |   |   | 16,707,840 | (4) |   |
| Equity  compensation plans not approved by security holders |       |                                                                                                                                                 | —     |                                                                                                             |       |                                                                                                                                                                                                             | —     |   |   |   | — |   |   |
| Total                                                       |       |                                                                                                                                                 | 27,775,631 |                                                                                                             |       |                                                                                                                                                                                                             |       |   |   |   | 16,707,840 |   |   |

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(1)          Excludes purchase rightsaccruing under the Purchase Program component of the 2004 Stock CompensationPlan (the “Stock Plan”); the Stock Plan has a shareholder approved reserve of79.2 million shares of which up to 6,400,000 shares may be issued underthe Purchase Program. Under the Purchase Program as in effect on December 31,2005, each eligible employee may purchase up to 2,700 shares of commonstock during a 3 month offering period; shares are purchased during theoffering period at quarterly intervals on the last business day of March, June,September and December each year; common stock will be purchased onthe eligible employee’s behalf at a purchase price equal to ninety percent(90%) of the fair market value per share of common stock on the purchase date;and the fair market value is equal to the average of the high and low sellingprices of the common stock as reported on the Nasdaq National Market on thepurchase date.

(2)          Includes 839,705 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 56,386 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$31.38. At the time of the acquisition, Chiron granted substitute options for207,293 shares with a weighted average exercise price of $30.12.

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(4)          Consists of sharesavailable for future issuance under the Stock Plan. As of December 31,2005, 10,869,919 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 calendaryear by an amount equal to the lesser of (i) one percent (1.0%) of thenumber of Chiron Common Equivalent Shares outstanding as of the end of thepreceding fiscal year or (ii) 3 million shares. “Chiron Common EquivalentShares” are the total number of shares of common stock outstanding plus thetotal number of shares of common stock issuable upon conversion or exercise ofoutstanding warrants, 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 theinformation required for this item by reference to our Proxy Statement. See thesection entitled “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 informationincorporated by references in Items 10, 11, 12, 13 and 14 of this Form 10-K,our definitive Proxy 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 documents are filed as part of this report:

**1.   Indexto Consolidated Financial Statements**

| ** **                                                                                                                     | ** ** | **Page  Number** | ** ** |
|--------------------------------------------------------------------------------------------------------------------------------|------------|------------------|------------|
| Report of Independent Registered Public Accounting  Firm on Consolidated Financial Statements                                  |       | F-1              |       |
| Consolidated  Balance Sheets at December 31, 2005 and 2004                                                                |       | F-2  – F-3  |       |
| Consolidated Statements of Operations for each of the  three years in the period ended December 31, 2005                  |       | F-4              |       |
| Consolidated Statements of Comprehensive Income (Loss)  for each of the three years in the period ended December 31, 2005 |       | F-5              |       |
| Consolidated Statements of Stockholders’ Equity for  each of the three years in the period ended December 31, 2005   |       | F-6              |       |
| Consolidated  Statements of Cash Flows for each of the three years in the period ended  December 31, 2005                 |       | F-7  – F-8  |       |
| Notes to Consolidated Financial Statements                                                                                     |       | F-9 – F-83  |       |

 

**2.   Indexto Financial Statement Schedules**

| ** **                                                             | ** ** | **Page  Number** | ** ** |
|------------------------------------------------------------------------|------------|------------------|------------|
| Schedule II, Valuation and  Qualifying Accounts and Reserves |       | F-84             |       |

 

We omitted allother schedules because those schedules are not applicable, not required orbecause the required information is included in the Consolidated FinancialStatements or accompanying notes.

(b)   Exhibits.   The Exhibits listed below arefiled as part of this report.

| Exhibit   Number | ** ** | **Exhibit**                                                                                                                                                                                                                                                                                                           | ** ** |
|------------------|------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|
| 2.01             |       | Agreement and Plan of  Merger, dated as of October 30, 2005, among Novartis Corporation,  Novartis Biotech Partnership, Inc., Chiron and Novartis AG, incorporated  by reference to Exhibit 2.01 of Chiron’s current report on Form 8-K  filed with the Commission on November 1, 2005. |       |
| 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 St1ate of Delaware on May 22, 1996, incorporated by  reference to Exhibit 3.04 of Chiron’s report on Form 10-Q for  the 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 filed with the Commission on  March 10, 2005.                                                                                                                       |       |

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| 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 period ended June 30, 2001.                                                                                                                                                  |   |
|--------|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|
| 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 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 period ended June 30, 2001),  incorporated by reference to Exhibit 4.03 of Chiron’s report on Form 10-Q  for the 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 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 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 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 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 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 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 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 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 period ended September 30, 1994),  incorporated by reference to Exhibit 10.104 of Chiron’s report on  Form 10-Q for the 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 10.200Reserved                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 |       |
| *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 period ended September 30, 1994), incorporated by reference to  Exhibit 10.201 of Chiron’s report on Form 10-Q for the 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 period  ended June 30, 1994), incorporated by reference to Exhibit 10.202  of Chiron’s report on Form 10-Q for the 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 the period ended September 30, 1993),  incorporated by reference to Exhibit 10.203 of Chiron’s report on  Form 10-K for fiscal year 1998.                                                                                                                                                                                                                           |       |
| *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.                                                                                                                                                                                                                                                                                                                                                    |       |

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| *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 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 period ended March 31,  2003, incorporated by reference to Exhibit 10.211 of Chiron’s report on  Form 10-Q for the 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 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 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 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 period  ended April 2, 1995.                                                                                                      |   |
| *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 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 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 filed with the Commission on  December 15, 1998.                                                                                                              |   |

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| *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 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 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 the 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 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.”)                           |   |
| *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 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 period ended June 30, 2001.                                                                                                                                                                                           |   |

106

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| *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 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 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 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 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 period ended June 30,  2003.                 |     |
| *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 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 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 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 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.                         |     |

107

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| *10.329  |     | Future Blood Screening  Assay—ULTRIO 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 period ended September 30, 2004.                                                                                               |     |
| *10.331  |     | Modified Blood Screening  Instrument—eSAS 2 Addendum Amending the Agreement entered into as of  June 11, 1998, between Chiron and Gen-Probe, Incorporated, effective as  of January 1, 2002, incorporated by reference to Exhibit 10.331 of  Chiron’s report on Form 10-Q for the period ended March 31,  2005. |     |
| *10.332  |     | Amendment No. 6 to  Agreement with Gen-Probe Incorporated, entered into effective as of  January 1, 2004, incorporated by reference to Exhibit 10.332 of  Chiron’s report on Form 10-Q for the period ended March 31,  2005.                                                                                         |     |
| 10.333   | * * | Amendment No. 7 to  Agreement with Gen-Probe Incorporated dated May 20, 2005.                                                                                                                                                                                                                                                            | * * |
| 10.334   |     | Amendment No. 8 to  Agreement with Gen-Probe Incorporated, entered into effective as of  February 8, 2006.                                                                                                                                                                                                                               |     |
| 10.335   |     | 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 filed with the Commission on  January 13, 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 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 filed with the Commission on  December 15, 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 Commission on January 14, 2002.                                        |     |
| 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 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 period ended June 30, 2002.                                                                                          |     |

108

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| **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 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  period ended June 30, 2002.*       |     |
| **10.507 | * * | Chiron Executive Officer  Severance Plan.                                                                                                                                                                                                                                                         | * * |
| **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 period  ended June 30, 2004.                                                                                      |     |
| **10.509 | * * | Description of Chiron’s  2005 Executive Officers Variable Compensation Program.                                                                                                                                                                                                              | * * |
| **10.510 |     | Form of Deferred  Share Units Grant for Executive Officers, Chiron 2004 Stock Compensation  Plan.                                                                                                                                                                                            |     |
| 10.511   |     | Audit Committee Charter,  as amended and restated as of September 14, 2005, incorporated by  reference to Exhibit 10.511 of Chiron’s report on Form 10-Q  for the period ended September 30, 2005.                                                                       |     |
| **10.512 | * * | Change-in-Control  Severance Plan (Tier II—Executive Committee Members).                                                                                                                                                                                                                     | * * |
| **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.                               |     |
| **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 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 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  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 period ended June 30, 2004.                                                                                                                                  |     |

109

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| **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 Commission on December 9, 2004.                                                                                                                                                                                                                                                                   |   |
|----------|--------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|
| **10.522 |   | Amendment No. 1 to  Chiron 2004 Stock Compensation Plan, effective December 1, 2005.                                                                                                                                                                                                                                                                                                                                                                                                        |   |
| 10.523   |   | 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 |   | Change-in-Control  Severance Plan (Tier I—Chief Executive Officer).                                                                                                                                                                                                                                                                                                                                                                                                                         |   |
| **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  January 17, 2001, with an effective date of January 22, 2001, and  Addendum dated January 11, 2001, between Gene W. Walther and Chiron.                                                                                                                                                                                                                                                                                                                   |   |
| 10.612   |   | Reserved                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         |   |
| **10.613 |   | Letter Agreement dated  January 25, 1999, between Chiron and David V. Smith, incorporated by  reference to Exhibit 10.613 of Chiron’s report on Form 10-K  for fiscal year 2004.                                                                                                                                                                                                                                                                                             |   |
| **10.614 |   | Compromise Agreement  dated February 18, 2005, between John A. Lambert and Chiron,  incorporated by reference to Exhibit 10.614 of Chiron’s report on  Form 10-Q for the period ended March 31, 2005.                                                                                                                                                                                                                                                                   |   |
| **10.615 |   | Letter Agreement dated  February 28, 2005 (agreed to on March 4, 2005), between Jack  Goldstein and Chiron, incorporated by reference to Exhibit 10.615 of  Chiron’s report on Form 10-Q for the period ended March 31,  2005.                                                                                                                                                                                                                                     |   |
| 10.616   |   | Through 10.619 Reserved                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |   |
| **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 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 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.                                                                                                                                                                                                                                                                                                |   |

110

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| **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 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 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 period ended September 30, 2004.                                                                                                                                                                                           |   |
| **10.628 |   | Letter agreement dated  October 20, 2005, between Howard H. Pien and Chiron, incorporated by  reference to Exhibit 99.1 of Chiron’s current report on Form 8-K  filed with the Commission on October 26, 2005.                                                                                                                                                                                                   |   |
| 10.629   |   | 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  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 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  period ended June 30, 1999.   |   |
| 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 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 period ended June 30, 1999.                                       |   |

111

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| 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 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 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 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 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 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.                                                                                                                                                                                                                                                                      |   |
| 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 period ended September 30, 1999.                                                                                                                                                                                                                                             |   |

112

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| *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 period ended July 2,  1995.                                                                  |   |
| 10.719.1 |   | Reimbursement Agreement  dated as of May 20, 1996, between Ciba-Geigy Limited, a Swiss  corporation, and Chiron, incorporated by reference to Exhibit 10.95 of  Chiron’s report on Form 10-Q for the period ended June 30,  1996.                                                                   |   |
| 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 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 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.                        |   |
| **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 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 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 period  ended June 30, 2003.                                                                                                                             |   |

113

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| 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. |   |
|--------|--------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|
| 10.731 |   | 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 115 and 116 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 requested orgranted with respect to certain portions of the Exhibit.

      **  Indicates management contract or compensatory plan, contract orarrangement.

114

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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,  2006 | By:                    | /s/ HOWARD H. PIEN |
|                       |                   | Howard H. Pien |
|                       |                   | *Chief Executive Officer;  Chairman of the Board* |

 

**POWER OF ATTORNEY**

**KNOW ALL MEN BY THESE 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.Without limiting the generality of the foregoing power and authority, thepowers granted include the power and authority to sign the names of theundersigned officers 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 |          | Chief Executive  Officer and Chairman of the |       | March 16, 2006  |
| Howard  H. Pien     |          | Board (Principal  Executive Officer)         |       |                 |
| /s/ DAVID V.  SMITH |          | Vice President,  Chief Financial Officer     |       | March 16,  2006 |
| David V. Smith      |          | (Principal Financial and Accounting Officer) |       |                 |
| /s/ RAYMUND  BREU   |          | Director                                     |       | March 16,  2006 |
| Raymund Breu        |          |                                         |       |                 |

115

----

 
| /s/ VAUGHN  D. BRYSON       |   | Director |   | March 16,  2006 |
|-----------------------------|--------|----------|--------|----------------------|
| Vaughn D. Bryson            |   |     |   |                 |
| /s/ LEWIS W.  COLEMAN       |   | Director |   | March 16,  2006 |
| Lewis W. Coleman            |   |     |   |                 |
| /s/ PIERRE E.  DOUAZE       |   | Director |   | March 16,  2006 |
| Pierre E. Douaze            |   |     |   |                 |
| /s/ J. RICHARD  FREDERICKS  |   | Director |   | March 16,  2006 |
| J. Richard Fredericks       |   |     |   |                 |
| /s/ PAUL L.  HERRLING       |   | Director |   | March 16,  2006 |
| Paul L. Herrling            |   |     |   |                 |
| /s/ DENISE M.  O’LEARY |   | Director |   | March 16,  2006 |
| Denise M. O’Leary      |   |     |   |                 |
| /s/ EDWARD E.  PENHOET      |   | Director |   | March 16, 2006  |
| Edward  E. Penhoet          |   |     |   |                 |
| /s/ PIETER J.  STRIJKERT    |   | Director |   | March 16,  2006 |
| Pieter J.  Strijkert        |   |     |   |                 |

 

116

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**Reportof Independent Registered Public Accounting Firm on Consolidated FinancialStatements**

**TheBoard of Directors and Stockholders of Chiron Corporation**

We have audited the accompanying consolidated balancesheets of Chiron Corporation as of December 31, 2005 and 2004, and therelated consolidated statements of operations, comprehensive income (loss),stockholders’ equity and cash flows for each of the three years in the periodended December 31, 2005. Our audits also included the financial statementschedule listed in the Index at Item 15(a). These financial statements andschedule are the responsibility of Chiron Corporation’s management. Ourresponsibility is to express an opinion on these financial statements andschedule based on our 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 as of December 31, 2005 and 2004, and theconsolidated results of its operations and its cash flows for each of the threeyears in the period ended December 31, 2005, 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 31,2005, based on criteria established in Internal Control—Integrated Frameworkissued by the Committee of Sponsoring Organizations of the Treadway Commissionand our report dated March 14, 2006**expressed anunqualified opinion thereon.

|   | /s/ Ernst & Young LLP |
|--------|--------------------------------|

 

Palo Alto, CaliforniaMarch 14, 2006,except for Note 20, as to which the date isMarch 16, 2006

F-1

----

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

| ** **                                                                                          | ** ** | **December 31,** | ** ** |
|-----------------------------------------------------------------------------------------------------|------------|-----------------------|------------|
| ** **                                                                                          | ** ** | **2005**              | ** ** | **2004** | ** ** |
| **ASSETS**                                                                                          | ** ** | ** **            | ** ** | ** ** | ** ** |
| Current assets:                                                                                     |       |                  |       |   |   |
| Cash and cash equivalents                                                                           |       | $                     | 291,435    |   | $ | 209,509 |   |
| Short-term investments in marketable debt securities                                                |       | 394,639               |       | 394,112 |   |
| Total cash, cash equivalents and short-term  investments                                            |       | 686,074               |       | 603,621 |   |
| Accounts receivable, net of allowances of $33,691 in  2005 and $38,039 in 2004                      |       | 475,718               |       | 402,094 |   |
| Current portion of notes receivable                                                                 |       | 7,500                 |       | — |   |
| Inventories, net of reserves of $78,165 in 2005 and  $71,609 in 2004                                |       | 231,666               |       | 221,154 |   |
| Assets held for sale                                                                                |       | 1,921                 |       | — |   |
| Current net deferred income tax asset                                                               |       | 62,414                |       | 71,287 |   |
| Derivative financial instruments                                                                    |       | 5,774                 |       | 4,969 |   |
| Other current assets                                                                                |       | 120,785               |       | 90,898 |   |
| Total current assets                                                                                |       | 1,591,852             |       | 1,394,023 |   |
| Non-current  investments in marketable debt securities                                              |       | 722,717               |       | 409,421 |   |
| Property, plant,  equipment and leasehold improvements, at cost                                     |       |                  |       |   |   |
| Land and buildings                                                                                  |       | 379,525               |       | 379,861 |   |
| Laboratory, production and office equipment                                                         |       | 692,163               |       | 637,394 |   |
| Leasehold improvements                                                                              |       | 138,515               |       | 125,858 |   |
| Construction-in-progress                                                                            |       | 307,648               |       | 225,482 |   |
|                                                                                                |       | 1,517,851             |       | 1,368,595 |   |
| Less accumulated depreciation and amortization                                                      |       | (629,048              | )          | (569,180 | ) |
| Property, plant, equipment and leasehold improvements,  net                                         |       | 888,803               |       | 799,415 |   |
| Purchased  technologies, net of accumulated amortization of $136,414 in 2005 and  $117,048 in 2004  |       | 195,779               |       | 216,037 |   |
| Goodwill                                                                                            |       | 808,285               |       | 861,394 |   |
| Other intangible  assets, net of accumulated amortization of $285,359 in 2005 and $249,469 in  2004 |       | 361,671               |       | 457,707 |   |
| Investments in  equity securities and affiliated companies                                          |       | 57,454                |       | 100,951 |   |
| Non-current notes  receivable                                                                       |       | 7,118                 |       | 7,500 |   |
| Non-current net  deferred income tax asset                                                          |       | 65,627                |       | — |   |
| Other non-current  assets                                                                           |       | 48,173                |       | 59,055 |   |
|                                                                                                |       | $                     | 4,747,479  |   | $ | 4,305,503 |   |

 

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,** | ** ** |
|------------------------------------------------------------------------------------------------------------------------|------------|-----------------------|------------|
| ** **                                                                                                             | ** ** | **2005**              | ** ** | **2004** | ** ** |
| **LIABILITIES  AND STOCKHOLDERS’ EQUITY**                                                                         |       |                  |       |   |   |
| Current liabilities                                                                                                    |       |                  |       |   |   |
| Accounts payable                                                                                                       |       | $                     | 117,855    |   | $ | 129,942 |   |
| Accrued compensation and related expenses                                                                              |       | 93,916                |       | 79,113 |   |
| Derivative financial instruments                                                                                       |       | —                |       | 10,395 |   |
| Current portion of long-term debt and capital lease                                                                    |       | 49,594                |       | 2,687 |   |
| Current portion of unearned revenue                                                                                    |       | 46,592                |       | 35,651 |   |
| Income taxes payable                                                                                                   |       | 72,207                |       | 16,363 |   |
| Other current liabilities                                                                                              |       | 184,600               |       | 160,293 |   |
| Total current liabilities                                                                                              |       | 564,764               |       | 434,444 |   |
| Long-term debt                                                                                                         |       | 890,945               |       | 936,652 |   |
| Long-term portion  of capital lease                                                                                    |       | 156,661               |       | 156,952 |   |
| Non-current  derivative financial instruments                                                                          |       | —                |       | 156 |   |
| Non-current net  deferred income tax liability                                                                         |       | —                |       | 60,427 |   |
| Non-current  unearned revenue                                                                                          |       | 27,359                |       | 26,175 |   |
| Other non-current  liabilities                                                                                         |       | 112,828               |       | 79,643 |   |
| Minority interest                                                                                                      |       | 10,779                |       | 9,350 |   |
| Total liabilities                                                                                                      |       | 1,763,336             |       | 1,703,799 |   |
| 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; 198,579,000 outstanding in 2005 and 191,682,000 in 2004 |       | 1,986                 |       | 1,917 |   |
| Restricted common stock, $0.01 par value; 500,000  shares authorized; none outstanding                                 |       | —                |       | — |   |
| Additional paid-in capital                                                                                             |       | 2,850,547             |       | 2,527,709 |   |
| Deferred stock compensation                                                                                            |       | (10,345               | )          | (13,825 | ) |
| Retained earnings (Accumulated deficit)                                                                                |       | 104,114               |       | (11,843 | ) |
| Accumulated other comprehensive income                                                                                 |       | 126,273               |       | 330,491 |   |
| Treasury stock, at cost (1,982,000 shares in 2005  and 4,804,000 shares in 2004)                                       |       | (88,432               | )          | (232,745 | ) |
| Total stockholders’ equity                                                                                        |       | 2,984,143             |       | 2,601,704 |   |
|                                                                                                                   |       | $                     | 4,747,479  |   | $ | 4,305,503 |   |

 

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

F-3

----

**CHIRON CORPORATION CONSOLIDATED STATEMENTSOF OPERATIONS (In thousands, except per share data)**

| ** **                                                                                       | ** ** | **Year Ended December 31,** | ** ** |
|--------------------------------------------------------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                                                                       | ** ** | **2005**                                   | ** ** | **2004** | ** ** | **2003** | ** ** |
| Revenues:                                                                                        |       |                                       |       |   |   |   |   |
| Product sales, net                                                                               |       | $                                          | 1,421,494  |   | $ | 1,268,303 |   | $ | 1,345,833 |   |
| Revenues from joint business arrangement                                                         |       | 136,701                                    |       | 118,246 |   | 108,298 |   |
| Collaborative agreement revenues                                                                 |       | 13,084                                     |       | 18,044 |   | 18,562 |   |
| Royalty and license fee revenues                                                                 |       | 317,006                                    |       | 289,561 |   | 250,142 |   |
| Other revenues                                                                                   |       | 31,394                                     |       | 29,201 |   | 43,526 |   |
| Total revenues                                                                                   |       | 1,919,679                                  |       | 1,723,355 |   | 1,766,361 |   |
| Operating expenses:                                                                              |       |                                       |       |   |   |   |   |
| Cost of sales (excludes amortization expense related  to acquired developed products)            |       | 732,100                                    |       | 675,944 |   | 571,897 |   |
| Research and development                                                                         |       | 433,891                                    |       | 431,128 |   | 409,806 |   |
| Selling, general and administrative                                                              |       | 501,193                                    |       | 459,502 |   | 380,388 |   |
| Amortization expense of intangible assets acquired  in business combinations and asset purchases |       | 66,206                                     |       | 84,503 |   | 56,365 |   |
| Purchased in-process research and development                                                    |       | —                                     |       | 9,629 |   | 45,300 |   |
| Impairment loss on acquired intangible assets                                                    |       | 15,658                                     |       | — |   | — |   |
| Other operating expenses                                                                         |       | 20,515                                     |       | 12,844 |   | 11,532 |   |
| Total operating expenses                                                                         |       | 1,769,563                                  |       | 1,673,550 |   | 1,475,288 |   |
| Income from  operations                                                                          |       | 150,116                                    |       | 49,805 |   | 291,073 |   |
| Loss on disposal  of assets                                                                      |       | (1,108                                     | )          | (3,247 | ) | (224 | ) |
| Interest expense                                                                                 |       | (30,615                                    | )          | (26,093 | ) | (19,104 | ) |
| Interest and  other income, net                                                                  |       | 86,692                                     |       | 56,797 |   | 38,892 |   |
| Minority interest                                                                                |       | (2,221                                     | )          | (1,968 | ) | (1,753 | ) |
| Income from  continuing operations before income taxes                                           |       | 202,864                                    |       | 75,294 |   | 308,884 |   |
| Provision for income  taxes                                                                      |       | 22,394                                     |       | 21,231 |   | 88,546 |   |
| Income from  continuing operations                                                               |       | 180,470                                    |       | 54,063 |   | 220,338 |   |
| Gain from  discontinued operations, net of taxes                                                 |       | —                                     |       | 24,854 |   | 6,975 |   |
| Net income                                                                                       |       | $                                          | 180,470    |   | $ | 78,917 |   | $ | 227,313 |   |
| Basic earnings per share:                                                                        |       |                                       |       |   |   |   |   |
| Income from continuing operations                                                                |       | $                                          | 0.96       |   | $ | 0.29 |   | $ | 1.18 |   |
| Net income                                                                                       |       | $                                          | 0.96       |   | $ | 0.42 |   | $ | 1.22 |   |
| Diluted earnings per  share:                                                                     |       |                                       |       |   |   |   |   |
| Income from continuing operations                                                                |       | $                                          | 0.94       |   | $ | 0.28 |   | $ | 1.15 |   |
| Net income                                                                                       |       | $                                          | 0.94       |   | $ | 0.41 |   | $ | 1.19 |   |

 

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

F-4

----

**CHIRON CORPORATIONCONSOLIDATED STATEMENTSOF COMPREHENSIVE INCOME (LOSS)(In thousands)**

| ** **                                                                                                                                                   | ** ** | **Year Ended December 31,** | ** ** |
|--------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                                                                                                                                   | ** ** | **2005**                                   | ** ** | **2004** | ** ** | **2003** | ** ** |
| Net income                                                                                                                                                   |       | $                                          | 180,470    |   | $ | 78,917 |   | $ | 227,313 |   |
| Other  comprehensive income (loss):                                                                                                                          |       |                                       |       |   |   |   |   |
| Change in foreign  currency translation adjustment during the period                                                                                         |       | (176,104                                   | )          | 131,812 |   | 155,782 |   |
| Unrealized gains  (losses) from investments:                                                                                                                 |       |                                       |       |   |   |   |   |
| Net unrealized  holding gains arising during the period, net of tax provision of $1,660,  $3,293 and $5,551 in 2005, 2004 and 2003, respectively             |       | 2,687                                      |       | 2,460 |   | 12,378 |   |
| Reclassification  adjustment for net gains included in net income, net of tax provision of  $16,962, $12,780 and $3,654 in 2005, 2004 and 2003, respectively |       | (27,332                                    | )          | (20,184 | ) | (5,716 | ) |
| Net unrealized  gains (losses) from investments                                                                                                              |       | (24,645                                    | )          | (17,724 | ) | 6,662 |   |
| Minimum pension  liability adjustment, net of tax benefit (provision) of $729, $1,374 and  ($167) in 2005, 2004 and 2003, respectively                       |       | (3,469                                     | )          | 101 |   | (1,003 | ) |
| Other  comprehensive income (loss)                                                                                                                           |       | (204,218                                   | )          | 114,189 |   | 161,441 |   |
| Comprehensive income  (loss)                                                                                                                                 |       | $                                          | (23,748    | ) | $ | 193,106 |   | $ | 388,754 |   |

 

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

F-5

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**CHIRON CORPORATIONCONSOLIDATED STATEMENTSOF STOCKHOLDERS’ EQUITY(In thousands)**

| ** **                                                         | ** ** | ** **            | ** ** | ** **  | ** ** | ** **     | ** ** | ** **       | ** ** | **Retained**      | ** ** | **Accumulated**         | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
|--------------------------------------------------------------------|------------|-----------------------|------------|-------------|------------|----------------|------------|------------------|------------|-------------------|------------|-------------------------|------------|------------|------------|------------|------------|------------|------------|
| ** **                                                         | ** ** | ** **            | ** ** | ** **  | ** ** | **Additional** | ** ** | **Deferred**     | ** ** | **Earnings**      | ** ** | **Other**               | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                                                         | ** ** | **Common Stock** | ** ** | **Paid-in** | ** ** | **Stock**      | ** ** | **(Accumulated** | ** ** | **Comprehensive** | ** ** | **Treasury Stock** | ** ** | ** ** | ** ** |
| ** **                                                         | ** ** | **Shares**            | ** ** | **Amount**  | ** ** | **Capital**    | ** ** | **Compensation** | ** ** | **Deficit)**      | ** ** | **Income (Loss)**  | ** ** | **Shares** | ** ** | **Amount** | ** ** | **Total**  | ** ** |
| 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 |   |
| Stock issued from  exercise of right under agreement with Novartis |       |                  | 6,897      |        |       |           | 69         |             |       |              | 299,931    |                    |       |       | —     |       |       |       | —     |   |   |   | — |   |   |   | — |   |   | — |   | 300,000 |   |
| Exercise of stock  options                                         |       |                  | —     |        |       |           | —     |             |       |              | (1,170     | )                       |       |       | —     |       |       |       | (56,529    | ) |   |   | — |   |   |   | 2,530 |   |   | 123,370 |   | 65,671 |   |
| Tax benefits from  employee stock plans and other                  |       |                  | —     |        |       |           | —     |             |       |              | 21,011     |                    |       |       | —     |       |       |       | —     |   |   |   | — |   |   |   | — |   |   | — |   | 21,011 |   |
| Employee stock  purchase plan                                      |       |                  | —     |        |       |           | —     |             |       |              | —     |                    |       |       | —     |       |       |       | (7,984     | ) |   |   | — |   |   |   | 292 |   |   | 20,943 |   | 12,959 |   |
| Forfeitures of  deferred stock compensation                        |       |                  | —     |        |       |           | —     |             |       |              | (5,136     | )                       |       |       | 5,136      |       |       |       | —     |   |   |   | — |   |   |   | — |   |   | — |   | — |   |
| Deferred stock  compensation                                       |       |                  | —     |        |       |           | —     |             |       |              | 8,202      |                    |       |       | (8,202     | )          |       |       | —     |   |   |   | — |   |   |   | — |   |   | — |   | — |   |
| Amortization of  deferred stock compensation                       |       |                  | —     |        |       |           | —     |             |       |              | —     |                    |       |       | 6,546      |       |       |       | —     |   |   |   | — |   |   |   | — |   |   | — |   | 6,546 |   |
| Foreign currency translation  adjustment                           |       |                  | —     |        |       |           | —     |             |       |              | —     |                    |       |       | —     |       |       |       | —     |   |   |   | (176,104 | ) |   |   | — |   |   | — |   | (176,104 | ) |
| Net unrealized  loss from investments                              |       |                  | —     |        |       |           | —     |             |       |              | —     |                    |       |       | —     |       |       |       | —     |   |   |   | (24,645 | ) |   |   | — |   |   | — |   | (24,645 | ) |
| Minimum pension  liability adjustment                              |       |                  | —     |        |       |           | —     |             |       |              | —     |                    |       |       | —     |       |       |       | —     |   |   |   | (3,469 | ) |   |   | — |   |   | — |   | (3,469 | ) |
| Net income                                                         |       |                  | —     |        |       |           | —     |             |       |              | —     |                    |       |       | —     |       |       |       | 180,470    |   |   |   | — |   |   |   | — |   |   | — |   | 180,470 |   |
| Balances at  December 31, 2005                                |       |                  | 198,579    |        |       |           | $          | 1,986            |       |              |       | $                       | 2,850,547  |       |       |       | $          | (10,345    | )          |   |   | $ | 104,114 |   |   |   | $ | 126,273 |   |   |   | (1,982 | ) |   | $ | (88,432 | ) | $ | 2,984,143 |   |

 

The accompanying Notes to Consolidated Financial Statements areintegral to this statement.

F-6

 

----

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

| ** **                                                                                               | ** ** | **Year Ended December 31,** | ** ** |
|----------------------------------------------------------------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                                                                               | ** ** | **2005**                                   | ** ** | **2004** | ** ** | **2003** | ** ** |
| Cash flows from operating activities:                                                                    |       |                                       |       |   |   |   |   |
| Net income                                                                                               |       | $                                          | 180,470    |   | $ | 78,917 |   | $ | 227,313 |   |
| Adjustments to  reconcile net income to net cash provided by operating activities:                       |       |                                       |       |   |   |   |   |
| Depreciation and amortization                                                                            |       | 173,693                                    |       | 185,921 |   | 145,723 |   |
| Amortization of marketable debt securities                                                               |       | 6,265                                      |       | 8,682 |   | 8,883 |   |
| Amortization of deferred stock compensation                                                              |       | 6,546                                      |       | 7,612 |   | 6,997 |   |
| Accelerated vesting of stock options                                                                     |       | —                                     |       | 2,563 |   | — |   |
| Amortization of discount on Liquid Yield Option  Notes                                                   |       | 952                                        |       | 4,316 |   | 8,330 |   |
| Amortization of bond issuance costs on Liquid Yield  Option Notes and convertible debentures        |       | 3,580                                      |       | 4,433 |   | 4,252 |   |
| Amortization of discount on notes receivable                                                             |       | 3,418                                      |       | — |   | — |   |
| Purchased in-process research and development                                                            |       | —                                     |       | 9,629 |   | 45,300 |   |
| Impairment loss on acquired intangible assets                                                            |       | 15,658                                     |       | — |   | — |   |
| Impairment loss on tangible assets                                                                       |       | 2,559                                      |       | — |   | — |   |
| Loss on disposal of assets                                                                               |       | 1,108                                      |       | 3,247 |   | 224 |   |
| Gain from discontinued operations                                                                        |       | —                                     |       | (24,854 | ) | (6,975 | ) |
| Net (gain) loss on sale of marketable debt  securities                                                   |       | 307                                        |       | (99 | ) | (895 | ) |
| Net gain on sale of equity securities                                                                    |       | (44,290                                    | )          | (34,265 | ) | (9,370 | ) |
| Gain on sale of interests in affiliated companies                                                        |       | —                                     |       | (4,183 | ) | (2,012 | ) |
| Other-than-temporary loss on investments                                                                 |       | 1,267                                      |       | 1,431 |   | — |   |
| Equity in loss of equity method investments                                                              |       | 2,518                                      |       | 3,726 |   | 2,325 |   |
| Minority interest                                                                                        |       | 2,221                                      |       | 1,968 |   | 1,753 |   |
| Changes in  reserves (product returns, other accounts receivable allowance and  inventory reserves) |       | 54,421                                     |       | 69,053 |   | 27,209 |   |
| Deferred income taxes                                                                                    |       | (91,602                                    | )          | (73,298 | ) | (14,808 | ) |
| Other, net                                                                                               |       | 112                                        |       | (149 | ) | 294 |   |
| Changes,  excluding effect of acquisitions and dispositions, to:                                         |       |                                       |       |   |   |   |   |
| Accounts receivable                                                                                      |       | (102,556                                   | )          | (31,517 | ) | (69,956 | ) |
| Inventories                                                                                              |       | (50,981                                    | )          | (55,375 | ) | 31,726 |   |
| Other current assets                                                                                     |       | (5,308                                     | )          | (22,120 | ) | (20,584 | ) |
| Derivative financial instruments                                                                         |       | (2,646                                     | )          | (603 | ) | (674 | ) |
| Other non-current assets                                                                                 |       | (1,697                                     | )          | (13,689 | ) | (3,105 | ) |
| Accounts payable, accrued expenses and income taxes  payable                                             |       | 49,693                                     |       | 94,541 |   | 28,168 |   |
| Current portion of unearned revenue                                                                      |       | 7,730                                      |       | (14,314 | ) | 12,795 |   |
| Other current liabilities                                                                                |       | 28,303                                     |       | (16,219 | ) | (9,877 | ) |
| Non-current unearned revenue                                                                             |       | 5,773                                      |       | (16,502 | ) | (13,350 | ) |
| Other non-current liabilities                                                                            |       | 1,728                                      |       | 1,804 |   | 14,179 |   |
| Net cash provided  by operating activities                                                               |       | $                                          | 249,242    |   | $ | 170,656 |   | $ | 413,865 |   |

 

F-7

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

 

| ** **                                                                     | ** ** | **Year Ended December 31,** | ** ** |
|--------------------------------------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                                                     | ** ** | **2005**                                   | ** ** | **2004** | ** ** | **2003** | ** ** |
| Cash flows from  investing activities:                                         |       |                                       |       |   |   |   |   |
| Purchases of investments in marketable debt  securities                        |       | $                                          | (1,163,164 | ) | $ | (796,942 | ) | $ | (920,768 | ) |
| Proceeds from sales of investments in marketable  debt securities         |       | 226,528                                    |       | 431,082 |   | 793,161 |   |
| Proceeds from maturities of investments in  marketable debt securities         |       | 610,494                                    |       | 286,487 |   | 420,469 |   |
| Proceeds from (issuance of) notes receivable                                   |       | (12,121                                    | )          | 1,479 |   | 750 |   |
| Capital expenditures                                                           |       | (199,972                                   | )          | (183,691 | ) | (139,399 | ) |
| Proceeds from sales of assets                                                  |       | 168                                        |       | 3,042 |   | — |   |
| Purchases of equity securities and interests in  affiliated companies          |       | (4,921                                     | )          | (6,622 | ) | (14,240 | ) |
| Proceeds from sale of equity securities and  interests in affiliated companies |       | 36,855                                     |       | 38,675 |   | 12,646 |   |
| Cash paid for acquisitions, net of cash acquired                               |       | (4,796                                     | )          | (34,899 | ) | (815,420 | ) |
| Other, net                                                                     |       | (13,272                                    | )          | (10,706 | ) | (887 | ) |
| Net cash used in investing activities                                          |       | (524,201                                   | )          | (272,095 | ) | (663,688 | ) |
| Cash flows from  financing activities:                                         |       |                                       |       |   |   |   |   |
| Net repayment of short-term borrowings                                         |       | —                                     |       | — |   | (2,436 | ) |
| Repayment of debt and capital leases                                           |       | (1,005                                     | )          | (382,958 | ) | (62,454 | ) |
| Borrowings from a government agency                                            |       | 1,728                                      |       | 5,560 |   | 1,243 |   |
| Payment of issuance costs on convertible debentures                            |       | —                                     |       | (8,437 | ) | (10,684 | ) |
| Payments to acquire treasury stock                                             |       | —                                     |       | (135,007 | ) | (207,689 | ) |
| Proceeds from re-issuance of treasury stock                                    |       | 72,946                                     |       | 69,143 |   | 123,625 |   |
| Proceeds from issuance of convertible debentures                               |       | —                                     |       | 385,000 |   | 500,000 |   |
| Proceeds from put options                                                      |       | —                                     |       | — |   | 2,144 |   |
| Proceeds from issuance of common stock                                         |       | 300,000                                    |       | — |   | — |   |
| Net cash provided by (used in) financing activities                            |       | 373,669                                    |       | (66,699 | ) | 343,749 |   |
| Effect of  exchange rate changes on cash and cash equivalents                  |       | (16,784                                    | )          | 13,377 |   | 22,394 |   |
| Net increase (decrease) in cash and cash equivalents                           |       | 81,926                                     |       | (154,761 | ) | 116,320 |   |
| Cash and cash  equivalents at beginning of the year                            |       | 209,509                                    |       | 364,270 |   | 247,950 |   |
| Cash and cash  equivalents at end of the year                                  |       | $                                          | 291,435    |   | $ | 209,509 |   | $ | 364,270 |   |

 

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, 2005**

**Note 1—The Company and Summary of SignificantAccounting Policies**

*The Company andBasis of Presentation*

Chiron Corporation is a global biopharmaceuticalcompany that develops, manufactures and markets therapeutic products for theprevention and treatment of infectious disease and products for the treatmentof cancer utilizing innovations in biology and chemistry. Chiron participatesin three global healthcare markets: (i) Blood Testing; (ii) adult andpediatric vaccines; and (iii) biopharmaceuticals, with an emphasis on thetreatment of cancer and infectious disease.

On December 29, 1997, Chiron completed the saleof its ophthalmics business, Chiron Vision, to Bausch & LombIncorporated, and on November 30, 1998, Chiron completed the sale of itsin vitro diagnostics business, Chiron Diagnostics, to Bayer Corporation. Chiron’sConsolidated Statements of Operations reflect the settlement agreement with theIRS, the settlement agreement with Bayer Corporation, the reversal of valuationallowances against deferred tax assets that were established at the time ofsale, and the expiration of certain contractual obligations in the gain fromdiscontinued operations, net of taxes (see Note 4).

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

On July 2, 2004, Chiron acquired SagresDiscovery, a privately held company headquartered in Davis, California, whichfocuses on the discovery and validation of targets with potential applicationto the development of cancer therapeutics. Chiron included Sagres’ operatingresults in its consolidated operating results beginning on July 2, 2004(see Note 5). Sagres is part of Chiron’s biopharmaceuticals segment.

On October 30, 2005,Chiron entered into an Agreement and Plan of Merger (the “Merger Agreement”)with Novartis Corporation, Novartis Biotech Partnership, Inc. (“NovartisBiotech”), an indirect wholly owned subsidiary of Novartis AG (“Novartis”) andan indirect subsidiary of Novartis Corporation, and Novartis, as guarantor.Pursuant to the terms of the Merger Agreement, Novartis Biotech will merge withand into Chiron, with Chiron as the surviving corporation and becoming anindirect subsidiary of Novartis Corporation and an indirect wholly ownedsubsidiary of Novartis. Upon completion of the merger, each share of Chironcommon stock not held by Novartis or any of its subsidiaries, Chiron or any ofits subsidiaries or a stockholder of Chiron who perfects appraisal rights, willbe converted into the right to receive $45.00 per share in cash, withoutinterest. The merger is subject to stockholder approval and satisfaction ofother customary conditions, including governmental and regulatory approvals. OnFebruary 6, 2006, the European Commission adopted a decision pursuant to Article 6(1)(b) ofthe Council Regulation (EC) No. 139/2004 declaring the combinationcompatible with the common market. This follows approval by the U.S. FederalTrade Commission in December 2005 and clearance by the Committee onForeign Investment in the United States under Exon-Florio in January 2006. Chiron expects that the transaction willbe completed in the second quarter of 2006. This is a “going private”transaction. If the merger is completed, Chiron’s shareholders will be paid$45.00 per 

F-9

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**CHIRON CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) DECEMBER 31, 2005**

**Note 1—TheCompany and Summary of Significant Accounting Policies (Continued)**

share incash; Novartis will own Chiron’s entire equity interest; Chiron’s shareholderswill no longer have any interest in Chiron’s future earnings or growth; Chironwill no longer be a public company; Chiron’s common stock will no longer betraded on the National Association of Securities Dealers Automatic QuotationSystem, or Nasdaq; and Chiron may no longer be required to file periodic and otherreports with the Securities and Exchange Commission, or SEC.

*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 of 50%or less are accounted for using either the equity or cost method. Allsignificant intercompany accounts and transactions have been eliminated inconsolidation.

Chiron’smost significant consolidated majority-owned subsidiaries and respectiveownership percentages are 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 Blood Testing  (Bermuda) 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 Estimatesand Reclassifications*

The preparation of financial statements requiresmanagement to make estimates, assumptions and judgments that affect thereported amounts of assets, liabilities, revenues and expenses, and relateddisclosures of contingent assets and liabilities. On an on-going basis, managementevaluates its estimates, including those related to investments; inventories;derivatives; capital leases; intangible assets; goodwill; purchased in-processresearch and development; product discounts, rebates and returns; bad debts;collaborative, royalty and license arrangements; restructuring; pension andother post-retirement benefits; income taxes; and litigation and othercontingencies. Chiron bases its estimates on historical experience and onvarious other assumptions that are believed to be reasonable under thecircumstances, the results of which form the basis for making judgments aboutthe carrying values of assets and liabilities that are not 

F-10

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**CHIRON CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) DECEMBER 31, 2005**

**Note 1—TheCompany and Summary of Significant Accounting Policies (Continued)**

readily apparent fromother sources. Actual results may differ from those estimates under differentassumptions or conditions.

Chiron’s BloodTesting segment includes Chiron’s one-half share in the pretax operatingearnings generated by the joint business contractual arrangement withOrtho-Clinical Diagnostics, Inc., a Johnson & Johnson company.Chiron accounts separately for research and development and manufacturing costreimbursements and certain product sale revenues received from Ortho-ClinicalDiagnostics but relating to the joint business contractual arrangement. Chiron’sjoint business arrangement with Ortho-Clinical Diagnostics is a contractualarrangement and is not a separate and distinct legal entity. Through Chiron’s jointbusiness contractual arrangement with Ortho-Clinical Diagnostics, Chiron sellsa line of immunodiagnostic tests to detect hepatitis viruses and retrovirusesand provides 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. affiliatesales on 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 $3.2 million for revenues from thejoint business contractual arrangement for the year ended December 31,2003.

In 2005, certain manufacturing and inspectionequipment had no future use and Chiron has committed to a plan to sell thisequipment and expects to complete the sale of this equipment within one year. Chironis actively marketing this equipment, which is available for immediate sale. Thisequipment is classified as “Assets held for sale” in the Consolidated BalanceSheet at December 31, 2005. Certain of this equipment, with a carryingvalue of $1.4 million at December 31, 2005, was sold in January 2006for the same amount.

Certain previouslyreported amounts have been reclassified to conform to the current yearpresentation. The impact of such reclassifications was not material.

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

All highly-liquid investments with maturities of threemonths or less from the date of purchase are considered to be cash equivalents.Cash equivalents and short-term investments in marketable debt securitiesconsist principally of money market instruments, corporate notes and bonds andgovernment agency securities. Non-current investments in marketable debtsecurities consist principally of corporate notes and bonds and governmentagency securities with maturities greater than one year. The cost of securitiessold is based on the specific identification method for debt securities and onthe average cost method for equity securities.

F-11

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**CHIRON CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) DECEMBER 31, 2005**

**Note 1—TheCompany and Summary of Significant Accounting Policies (Continued)**

Chiron has classified its investments in debt andequity securities as available-for-sale. Available-for-sale securities arerecorded at fair value based upon year-end quoted market prices. Unrealizedgains and losses, deemed as temporary in nature, are reported as a separatecomponent of comprehensive income or loss.

Chiron periodicallyreviews its debt and equity securities by comparing the market value to thecarrying value of the security. For equity investments, impairment, if any, isbased on the excess of the carrying value over the market value. If impairmentis considered other-than-temporary, the security’s cost is written down tomarket value through earnings. Generally, Chiron believes that an investment isimpaired if its market value has been below its carrying value for each tradingday during the preceding six-month period. However, in determining whetherimpairment is considered to be other-than-temporary, Chiron considers allavailable factors in its evaluation. These factors include but are not limitedto (i) whether the issuer of the securities is experiencing depressed anddeclining earnings in relation to competitors, erosion of market share, anddeteriorating financial position, (ii) whether the issuer is experiencingfinancial difficulties 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 our debtsecurities to maturity.

*Inventories*

Inventories are stated at the lower of cost or marketusing the moving weighted-average cost method. Chiron periodically reviews thecomposition of inventories in order to identify obsolete, slow-moving orotherwise unsalable items. Inventory reserves are primarily maintained 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 expected market value,if lower than cost.

As a result of the developments with respect toFLUVIRIN® vaccine discussed in “Note 14—Commitments andContingencies,” Chiron wrote-off the entire inventory of FLUVIRIN® product in 2004, resulting in a $91.3 millioncharge to cost of sales in 2004.

As discussed in “Note 14—Commitments andContingencies,” in July 2005, Chiron reported that it would be unable tosupply any BEGRIVACTM vaccine doses for the 2005-2006 influenza season dueto a product sterility issue and wrote off its existing product inventoryresulting in charges of $18.0 million to cost of sales in 2005.

F-12

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**CHIRON CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) DECEMBER 31, 2005**

**Note 1—TheCompany and Summary of Significant Accounting Policies (Continued)**

Inventories, net ofreserves, consisted of the following at December 31:

| ** **      | ** ** | **2005**                | ** ** | **2004** | ** ** |
|-----------------|------------|-------------------------|------------|----------|------------|
| ** **      | ** ** | **(In thousands)** | ** ** |
| Finished goods  |       | $                       | 60,640     |     | $          | 59,206 |   |
| Work-in-process |       | 129,457                 |       | 116,660  |       |
| Raw materials   |       | 41,569                  |       | 45,288   |       |
|            |       | $                       | 231,666    |     | $          | 221,154 |   |

 

*DerivativeFinancial 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.

*Foreign CurrencyHedging*

A significant portion of Chiron’s operations consists ofmanufacturing and sales activities in western European countries. As a result,Chiron’s financial results may be affected by changes in the foreign currencyexchange rates of those countries.

Chiron may selectively hedge anticipated currencyexposures by purchasing foreign currency option contracts and forwardcontracts, which are designated as cash flow hedges and typically expire withintwelve months. Changes in the fair value of these contracts are recorded incomprehensive income and are recognized in earnings when the forecastedtransaction occurs. When the contracts expire, any amounts recorded incomprehensive income are reclassified to earnings.

Because the critical terms of the derivativeinstrument and the underlying exposure are the same, Chiron expects thatchanges in the fair value of the underlying exposure will be offset completelyby changes in the fair value of the derivative instrument, both at inceptionand on an ongoing basis. The critical terms are reviewed quarterly. All timevalue changes are deemed ineffective and are recognized immediately inearnings. Hedge ineffectiveness was not material for the years ended December 31,2005, 2004 and 2003.

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 

F-13

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**CHIRON CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) DECEMBER 31, 2005**

**Note 1—TheCompany and Summary of Significant Accounting Policies (Continued)**

largelyby changes upon remeasurement of the underlying assets and liabilities. Thesecontracts usually have maturities of three months or less.

*Equity SecuritiesHedging*

Chiron has exposure to equity price risk because ofits investments in equity securities. Typically, these securities are obtainedthrough collaboration agreements with other pharmaceutical and biotechnologypartners. Changes in share prices affect the value of Chiron’s equityinvestment portfolio.

Chiron selectively enters into forward salescontracts, which are designated as fair value hedges and normally expire withintwo years. At the inception of the hedge, the difference between the cost andthe fair value of the equity security remains in comprehensive income.Subsequent changes in the fair value of the forward sales contracts and the underlyingequity security are recognized in earnings. When forward sales contracts matureand the underlying equity security is sold, any amounts previously recorded incomprehensive income related to the underlying equity security sold arereclassified to earnings.

Chiron recognized a gainof $44.3 million related to the termination of thirteen fair value hedges andthe sale of the underlying shares for the year ended December 31, 2005.This gain was recorded in “Interest and other income, net” in the ConsolidatedStatement of Operations for the year ended December 31, 2005. Chironrecognized a gain of $34.3 million related to the termination of ten fairvalue hedges and the sale of the underlying shares for the year ended December 31,2004. This gain was recorded in “Interest and other income, net” in theConsolidated Statement of Operations for the year ended December 31, 2004.Chiron recognized a gain of $9.4 million related to the termination ofthree fair value hedges and the sale of the underlying shares for the yearended December 31, 2003. This gain was recorded in “Interest and otherincome, net” in the Consolidated Statement of Operations for the year ended December 31,2003.

*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 $99.0 million,$92.2 million and $75.9 million in 2005, 2004 and 2003, 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 31,2005, 2004 and 2003 was $4.1 million, $3.3 million and $1.7 million,respectively.

*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 

F-14

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**CHIRON CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) DECEMBER 31, 2005**

**Note 1—TheCompany and Summary of Significant Accounting Policies (Continued)**

more ofthe fair value of the leased property. All other leases are classified asoperating leases. Capital leases are recorded as assets and liabilities at thelower of the present value of the minimum lease payments at the beginning ofthe lease term or the fair value of the leased property at the inception of thelease. When the lease agreement includes a residual value guarantee, Chironuses the following method to estimate amortization of the leased asset. FirstChiron determines the amount that may become payable to the lessor at the endof the lease term due to a decline in the estimated fair value of the leasedasset below the lessor’s total investment. The leased asset is then amortizedusing a straight-line method to an amount such that the capital leaseliability, net of the book value of the amortized leased asset at the end ofthe lease term equals the amount payable to the lessor. When the leaseagreement does not include a residual value guarantee, the amount of the leasedasset is amortized on a straight-line basis over the lease term.

*Computer SoftwareCosts 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 $28.2 million, $30.2 million and$14.7 million at December 31, 2005, 2004 and 2003, respectively.Depreciation and amortization expense disclosed under *Property, Plant, Equipment and Leasehold Improvements*,above, includes amortization expense related to costs of computer software forinternal use of $17.3 million, $12.0 million and $7.6 million in2005, 2004 and 2003, respectively.

*Intangible andOther Long-Lived Assets*

Intangible assets consist principally of purchasedtechnologies, developed product technologies and patents. Purchasedtechnologies and patents are amortized on a straight-line basis over theirestimated useful lives, ranging from 3 to 17 years. Developed producttechnologies are amortized using either the estimated sales method over10 years or on a straight-line basis over 1 to 15 years. Chironperiodically reviews the useful lives of its intangible and long-lived assets,which may result in future adjustments to the amortization periods. Chiron hasno intangible assets with indefinite useful lives. Amortization expense,including amortization of bond issuance costs, for the years ended December 31,2005, 2004 and 2003 was $78.3 million, $98.1 million and$74.1 million, respectively. Amortization of purchased technologies,developed product technologies and the majority of trademarks was included in “Amortizationexpense of intangible assets acquired in business combinations and assetpurchases” and amortization of patents was included primarily in “Research anddevelopment” in the Consolidated Statements of Operations.

Effective January 1, 2002, goodwill (includingassembled workforce) and intangible assets with indefinite useful lives are nolonger amortized, but instead, are tested for impairment at least annually. Anyimpairment loss from the annual test will be recognized as part of operations. Chironperformed its annual impairment test for goodwill in the third quarter 2005, asof July 1, 2005, which indicated no impairment. In 2004, Chiron performedits annual 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 andContingencies,” Chiron considered the impact of the FLUVIRIN® vaccinedevelopments on goodwill. Chiron performed an interim impairment test forvaccines goodwill as of December 31, 2004 given those developments. Basedon either the annual 

F-15

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**CHIRON CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) DECEMBER 31, 2005**

**Note 1—TheCompany and Summary of Significant Accounting Policies (Continued)**

or interim analysis,Chiron had no indication of an impairment loss in 2004. Chiron performed itsannual impairment test in 2003, which indicated no impairment.

Long-lived assets to beheld and used are reviewed for impairment when events or changes incircumstances indicate that the carrying amount of such assets may not berecoverable. Determination of recoverability is based on an estimate ofundiscounted future cash flows resulting from the use of the asset and itseventual disposition. In the event that such cash flows are not expected to besufficient to recover the carrying amount of the assets, the assets are writtendown to their estimated fair values. Long-lived assets to be disposed of bysale are reported at the lower of the carrying value or the fair value lesscosts to sell. Long-lived assets to be disposed of other than by sale will havetheir useful lives and salvage value revised to reflect the cease of use in thefuture.

*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, 2005 and 2004.

*ComprehensiveIncome (Loss)*

Chironhas displayed the detailed changes in the components of comprehensive income(loss) in the Consolidated Statements of Comprehensive Income (Loss).Accumulated other comprehensive income balances by component were as follows(in thousands):

| ** **                               | ** ** | **Foreign  Currency  Translation  Adjustment** | ** ** | **Net Unrealized  Gains (Losses)  from  Investments** | ** ** | **Minimum  Pension  Liability  Adjustment** | ** ** | **Accumulated  Other  Comprehensive  Income** | ** ** |
|------------------------------------------|------------|------------------------------------------------|------------|-----------------------------------------------------------------|------------|---------------------------------------------|------------|-----------------------------------------------|------------|
| 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 |   |   |
| Period change                            |       | (176,104                                       | )          |                                                            | (24,645    | )                                           |       |                                          | (3,469     | ) |   |   | (204,218 | ) |   |
| Balance, net, at  December 31, 2005 |       | $                                              | 123,483    |                                                            |       | $                                           | 8,760      |                                          |       |   | $ | (5,970 | ) |   |   | $ | 126,273 |   |   |

 

In 2005, 2004 and 2003, all of the undistributedearnings of all Chiron foreign subsidiaries were considered to be permanentlyreinvested. As such, no tax effect was provided on the foreign currencytranslation component of comprehensive income for 2005, 2004 and 2003.

F-16

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**CHIRON CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) DECEMBER 31, 2005**

**Note 1—The Company andSummary of Significant Accounting Policies (Continued)**

*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 “Retained earnings (Accumulateddeficit).” For the years ended December 31, 2005, 2004 and 2003, Chironcharged losses of $64.5 million, $44.1 million and $52.7 million,respectively, to “Retained earnings (Accumulated deficit)” in the ConsolidatedBalance Sheets.

*Revenue Recognition*

Chiron recognizes revenue from the sale of itsproducts, revenues from a joint business contractual arrangement, collaborativeagreement revenues, royalty and license fee revenues and other revenues, whichprimarily consist of contract manufacturing and grant revenues. Chironrecognizes revenue when there is persuasive evidence that an arrangementexists, delivery has occurred or services have been rendered, the price isfixed or determinable, and collectibility is reasonable assured.

“Product sales, net” primarily consist of revenuesrecognized upon shipment of products to customers. Chiron’s Blood Testingsegment recognizes revenues related to nucleic acid testing product sales,which primarily consist of revenue derived from the sale and use of assays,revenue derived from the sale, lease or rental of equipment and revenue fromproviding field service for the instruments, which are not material. Revenue isrecorded based upon the reported results obtained from the customer from theuse of assays to screen donations or upon sale and delivery of the assays,depending on the underlying contract. In the case of equipment sales or leases,revenue is recorded upon transfer of risk of loss and title to the instrument,which is generally upon shipment or ratably over the life of the lease term,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 recognizesrevenues upon shipment to its marketing partner, Schering, and additionalrevenues upon Schering’s subsequent sale of BETASERON® tocustomers. Upon shipment to Schering, Chiron recognizes the contractuallydetermined fixed amount of the fee to which Chiron is entitled because at thispoint, there is persuasive evidence of an arrangement, delivery has occurred,the price due from Schering is fixed or determinable and collectibility isreasonably assured. Upon receiving the contractual reporting of relevantcustomer sales from Schering, Chiron recognizes the incremental portion of thefee related to Schering’s shipments to its customers because this portion ofthe fee is not determinable until receipt of the related sales reports.Provisions for discounts and rebates to customers, and returns and otherrelated product sales are recorded. Provisions for rebates to customers andreturns and other adjustments are based upon analyses of historical rebates andreturns. Provisions for discounts are based upon a set percentage of theprevious month’s sales, which are driven by contractual agreements.

“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-

F-17

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**CHIRON CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) DECEMBER 31, 2005**

**Note 1—TheCompany and Summary of Significant Accounting Policies (Continued)**

based instrument systemsto automate test performance and data collection. In addition, Chiron andOrtho-Clinical Diagnostics jointly hold the immunodiagnostic rights to Chiron’shepatitis and retrovirus technology and receive royalties from the sales ofhepatitis C virus and HIV tests by licensees.

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 toOrtho-Clinical Diagnostics, are recorded in product sales, with thecorresponding costs recorded in cost of sales. Reimbursements fromOrtho-Clinical Diagnostics for research costs incurred by Chiron are recordedin collaborative agreement revenues and the related research expenses arerecorded in research and development expenses. In addition to these productrevenues and reimbursements, Chiron shares in the defined pre-tax operatingearnings of the Ortho-Clinical Diagnostics joint business activity at apre-determined percentage (50%), as defined in the agreement, rather than froman ownership interest in an entity. Chiron receives contractually definedprofit sharing payments from Ortho-Clinical Diagnostics on a quarterly basis.

“Collaborative agreement revenues” are earned andrecognized based upon work performed or upon the attainment of specifiedmilestones. Under contracts where Chiron recognizes revenue based upon researchand development work performed, the revenues amounted to $7.2 million,$8.0 million and $9.0 million in 2005, 2004 and 2003, respectively.These amounts were recorded in “Collaborative agreement revenues” in theConsolidated Statements of Operations.

“Royalty and license fee revenues” consist of productroyalty payments and fees under license agreements and are recognized whenearned. Chiron estimates royalty revenues based on previous period royaltiesreceived or on product sales forecast information provided by the third partylicensee. In the subsequent quarter, Chiron records an adjustment equal to thedifference between those royalty revenues recorded in the previous quarter andthe contractual reporting of the third party’s actual product sales for thatperiod. Up-front refundable fees are deferred and recognized as revenues uponthe later of when they become nonrefundable or when performance obligations arecompleted. Up-front nonrefundable fees where Chiron has no continuingperformance obligations are recognized as revenues when collection isreasonably assured. In situations where continuing performance obligationsexist, up-front nonrefundable fees are deferred and amortized ratably over theperformance period. Milestones, if any, related to scientific or technicalachievements are recognized in income when the milestone is accomplished.

“Other revenues” primarilyconsist of fees for manufacturing and grants and contracts from governmentagencies and are recognized when earned. Other revenues include revenue fromgrants and contracts where Chiron recognizes revenue based upon research anddevelopment work performed, which amounted to $9.1 million, $12.9 million and$7.8 million in 2005, 2004 and 2003, respectively.

*ContractManufacturing Revenues and Expenses*

Contract manufacturingrevenues and expenses are recognized upon meeting the criteria for substantialperformance and acceptance as defined in the contract and recorded in “Otherrevenues” and “Other operating expenses,” respectively, in the ConsolidatedStatements of Operations.

F-18

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**CHIRON CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) DECEMBER 31, 2005**

**Note 1—TheCompany and 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 “Cost of sales” in the Consolidated Statements of Operations uponsale of product.

*Researchand Development Expense and Purchased In-Process Research and Development*

Research and developmentcosts are charged to expense when incurred. Major components of research anddevelopment expenses consist of personnel costs, including salaries andbenefits, clinical studies performed by investigators and contract researchorganizations (CROs), materials and supplies, and overhead allocationsconsisting of certain administrative and facilities 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 of 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 the National Institutes Allergy and Infectious Disease (NIAID)and the University of Minnesota. Responsibility for the SILCAAT study wastransferred to NIAID and University of Minnesota effective February 14,2003.

F-19

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**CHIRON CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) DECEMBER 31, 2005**

**Note 1—TheCompany and Summary of Significant Accounting Policies (Continued)**

Under the agreement, we funded $6.0 million and $12.0million for the years ended December 31, 2003 and 2004, respectively. Thereare no remaining funding obligations due under this agreement. In the fourthquarter of 2004, Chiron determined that there was not sufficient potentialfuture value to Chiron to warrant continued recognition of expense over theoriginal trial period. Accordingly, in the fourth quarter 2004 Chiron recordedan expense of $6.0 million representing the unamortized expense balance 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, 2005, 2004 and 2003 were $22.1million, $24.1 million and $20.2 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-Based Compensation*

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

F-20

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**CHIRON CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) DECEMBER 31, 2005**

**Note 1—TheCompany 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:

| ** **                                                                                                                                            | ** ** | **2005**                                                           | ** ** | **2004** | ** ** | **2003** | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------------------------------------------------------|------------|----------|------------|----------|------------|
| ** **                                                                                                                                            | ** ** | **(In thousands, except per share data)** | ** ** |
| Net income  (loss):                                                                                                                                   |       |                                                               |       |     |       |     |       |
| As reported                                                                                                                                           |       | $                                                                  | 180,470    |     | $          | 78,917   |       | $ | 227,313 |   |
| Add: Stock-based  employee compensation expense included in reported net income, net of  related tax effects                                     |       | 3,850                                                              |       | 4,703    |       | 5,571    |       |
| Less: Total  stock-based employee compensation expense determined under fair value based  method for all awards, net of related tax effects |       | 68,952                                                             |       | 86,801   |       | 100,849  |       |
| Pro forma                                                                                                                                             |       | $                                                                  | 115,368    |     | $          | (3,181   | )          | $ | 132,035 |   |
| Basic net income  (loss) per share:                                                                                                                   |       |                                                               |       |     |       |     |       |
| As reported                                                                                                                                           |       | $                                                                  | 0.96       |     | $          | 0.42     |       | $ | 1.22 |   |
| Pro forma                                                                                                                                             |       | $                                                                  | 0.61       |     | $          | (0.02    | )          | $ | 0.71 |   |
| Diluted net  income (loss) per share:                                                                                                                 |       |                                                               |       |     |       |     |       |
| As reported                                                                                                                                           |       | $                                                                  | 0.94       |     | $          | 0.41     |       | $ | 1.19 |   |
| Pro forma                                                                                                                                             |       | $                                                                  | 0.60       |     | $          | (0.02    | )          | $ | 0.69 |   |

 

*Foreign CurrencyTranslation*

Thefinancial statements of Chiron’s foreign subsidiaries and equity investmentsare generally measured using the local currency. Accordingly, the assets andliabilities of Chiron’s foreign subsidiaries and equity investments aretranslated into U.S. dollars using the exchange rates in effect at the end ofthe period. Revenues and expenses are translated using the average exchangerates for the period. Adjustments resulting from currency translations areincluded in comprehensive income.

*Concentration ofRisk*

Financial instruments, which potentially expose Chironto concentrations of credit risk, consist primarily of cash, investments (suchas debt and equity securities), derivatives and trade accounts receivable.Chiron invests cash, which is not required for immediate operating needs, in adiversified portfolio of financial instruments issued by financial institutionsand 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. Chiron has notexperienced any losses due to counterparty default.

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.

F-21

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**CHIRON CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) DECEMBER 31, 2005**

**Note 1—TheCompany and Summary of Significant Accounting Policies (Continued)**

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, fromtwo of the principal worldwide suppliers of the drug. Chiron anticipates thateither one of these suppliers alone will be able to supply sufficientquantities to meet current needs; however, there can be no assurance that thesesuppliers will be able to meet future demand in a timely and cost-effectivemanner. As a result, Chiron’s operations could be adversely affected by aninterruption or reduction in the supply of bulk tobramycin powder.

Chiron has entered into contracts with third partiesfor the production and packaging of TOBI® tobramycin. Over time, Chiron can usealternative production and packaging sources. However, if the contracted thirdparties become unable to produce or package sufficient quantities of TOBI® solution due to work stoppages or otherfactors, its operations could be disrupted until alternative sources aresecured. Chiron has entered into contracts with third parties for the packagingof the pre-filled diluent syringe for BETASERON® interferon beta-1b. Over time, Chironcan use alternative packaging sources. However, if the contracted third partiesbecome unable to produce or package sufficient quantities of the pre-filleddiluent syringe for BETASERON® interferon beta-1b due to work stoppages orother factors, its operations could be disrupted until alternative sources aresecured.

In connection with the production of Chiron’sinfluenza vaccine products, Chiron must purchase large quantities of incubatedfertile chicken eggs. Currently, for FLUVIRIN® influenza vaccine, Chiron purchases those eggsfrom a single supplier in the United Kingdom and, pursuant to the contract withthat supplier, Chiron has agreed to make specified purchases from that supplierthrough 2012, subject to its right to terminate this agreement earlier uponpayment of a termination fee. To ensure that the incubation of the eggs is ofthe appropriate standard for vaccine manufacturing, Chiron acquired the assetsof the primary incubation facility from the egg supplier in December 2005.Avian influenza has resulted in the massive death or culling of domestic poultryin certain regions, primarily Southeast Asia. If Chiron’s suppliers were tofail to supply eggs in sufficient quantities or quality, including as a resultof any outbreak of avian influenza or other issues related to the chickens,Chiron’s business would be materially affected.

Chiron is a key providerfor the blood screening field of nucleic acid testing and immunodiagnostics. Innucleic acid testing, Chiron relies on its collaborative partner, Gen-Probe, tomanufacture the PROCLEIX® WNV Assay, currently in use on aninvestigational-use basis in the U.S., and the PROCLEIX® HIV-1/HCV Assay and PROCLEIX® ULTRIO® Assay. The relatedinstrument systems are sourced from third party suppliers. Currently, Gen-Probeis the only manufacturer of nucleic acid testing products using TranscriptionMediated Amplification technology. In immunodiagnostics, under Chiron’s jointbusiness contractual arrangement with Ortho-Clinical Diagnostics, Chironmanufactures bulk reagents and antigens and confirmatory test kits sold in theclinical diagnostics and blood screening 

F-22

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**CHIRON CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) DECEMBER 31, 2005**

**Note 1—TheCompany and Summary of Significant Accounting Policies (Continued)**

fields.While Chiron and Chiron’s partners work to mitigate the risks associated withbeing a key provider, there can be no assurance that Chiron’s partner,Gen-Probe, will be able to provide sufficient quantities of the PROCLEIX® WNV Assay, PROCLEIX® HIV-1/HCVAssay and PROCLEIX® ULTRIO® Assay or thatChiron will be able to manufacture sufficient bulk reagents and antigens andconfirmatory test kits for immunodiagnostic products. Chiron’s difficulties ordelays or those of Chiron’s partners’ could cause a public health concern forthe blood supply, as well as increase costs and cause loss of revenue or marketshare.

*New AccountingStandards*

In December 2004, the Financial AccountingStandards Board (FASB) issued Statement of Financial Accounting Standards No. 123(revised 2004),*Share-Based Payment*(SFAS 123(R)), which requires the cost resulting from all share-based paymenttransactions to be recognized in the consolidated financial statements. Thatcost will be measured based on the fair value of the equity instruments issuedor on the fair value of liabilities incurred. Under SFAS 123(R), thefair-value-based method for recognition or disclosure of compensation expensewill be applied using the modified prospective application transition method orthe modified retrospective application transition method. Chiron currentlymeasures compensation expense for its stock-based employee compensation underthe intrinsic method. Current option values determined using theBlack-Scholes-Merton formula, used for purposes of proforma disclosure, may notbe indicative of results from the valuation methodologies Chiron finallyadopts. The effective date of SFAS 123(R) is the first reporting periodbeginning after June 15, 2005. However, on April 14, 2005, theSecurities and Exchange Commission (SEC) announced the adoption of a new rule thatdelays the effective date of SFAS 123(R) for registrants, such asChiron, that are not small business issuers. The SEC’s new rule allowscalendar year non-small business issuers to implement SFAS 123(R) at thebeginning of 2006, which makes SFAS 123(R) effective for Chiron in thefirst quarter of 2006.

Chiron is currently evaluating the transition methods,option valuation methodologies and assumptions in light of SFAS 123(R) and,therefore, cannot estimate the impact of its adoption at this time, althoughChiron expects that its adoption will have a material impact on itsconsolidated financial statements.

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%.Through December 31, 2005, Chiron has not provided deferred taxes onforeign earnings because such earnings are intended to be indefinitelyreinvested outside the U.S. Chiron did not repatriate any accumulated earningsfrom outside the U.S. in either 2004 or 2005.

F-23

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**CHIRON CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) DECEMBER 31, 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; (iv) convertible notesand debentures, which are included under the if-converted method, ifapplicable, and (v) contingently issuable shares under an agreement withNovartis when the necessary conditions have been satisfied at the end of thereporting period.

On October 30, 2005, Chiron exercised its rightunder an agreement with Novartis (as successor to Ciba-Geigy), dated as of November 20,1994, as amended, to require Novartis or its affiliate to purchase shares ofits common stock for an aggregate purchase price of $300.0 million at a pershare purchase price of $43.50. On December 8, 2005, Chiron closed on asale of $300.0 million in newly issued shares of its common stock at a price of$43.50 per share to a subsidiary of Novartis. For purposes of calculatingdiluted earnings per share, the issued shares of this transaction areconsidered outstanding from October 30, 2005. As a result, the calculationof diluted earnings per share for 2005 included an additional 1.1 millionshares.

Contingently convertible debt instruments (“CoCos”)are included in diluted earnings per share, if dilutive. For the years ended December 31,2005 and 2003, Chiron’s $500.0 million contingently convertible debentures due2033 (“2033 Debentures”) were included in the computation of diluted earningper share. For the year ended December 31, 2004, the 2033 Debentures wereexcluded from the computations of diluted earnings per share, as the inclusionof these CoCos would be antidilutive. For the years ended December 31,2005 and 2004, Chiron’s $385.0 million contingently convertible debentures due2034 (“2034 Debentures”) were excluded from the computations of dilutedearnings per share, as the inclusion of these CoCos would be antidilutive.

F-24

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**CHIRON CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) DECEMBER 31, 2005**

**Note 2—EarningsPer 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:

| ** **                                                                                       | ** ** | **2005**                                                           | ** ** | **2004** | ** ** | **2003** | ** ** |
|--------------------------------------------------------------------------------------------------|------------|--------------------------------------------------------------------|------------|----------|------------|----------|------------|
| ** **                                                                                       | ** ** | **(In thousands, except per share data)** | ** ** |
| Income (Numerator):                                                                              |       |                                                               |       |     |       |     |       |
| Income from continuing operations                                                                |       | $                                                                  | 180,470    |     | $          | 54,063   |       | $ | 220,338 |   |
| Plus: Interest on the 2033 Debentures, net of taxes                                              |       | 6,357                                                              |       | 3⁄4   |       | 2,638    |       |
| Income from continuing operations, plus impact from  assumed conversions.                        |       | $                                                                  | 186,827    |     | $          | 54,063   |       | $ | 222,976 |   |
| Shares  (Denominator):                                                                           |       |                                                               |       |     |       |     |       |
| Weighted-average common shares outstanding                                                       |       | 188,448                                                            |       | 187,545  |       | 186,835  |       |
| Effect of  dilutive securities:                                                                  |       |                                                               |       |     |       |     |       |
| Additional shares from exercise of right under  agreement with Novartis                          |       | 1,061                                                              |       | 3⁄4   |       | 3⁄4   |       |
| Stock options and equivalents.                                                                   |       | 1,887                                                              |       | 2,657    |       | 4,339    |       |
| Put options                                                                                      |       | 3⁄4                                                             |       | 3⁄4   |       | 1        |       |
| 2033 Debentures.                                                                                 |       | 7,308                                                              |       | 3⁄4   |       | 2,740    |       |
| Weighted-average common shares outstanding, plus  impact from assumed conversions and issuances. |       | 198,704                                                            |       | 190,202  |       | 193,915  |       |
| Basic earnings per share from continuing operations.                                             |       | $                                                                  | 0.96       |     | $          | 0.29     |       | $ | 1.18 |   |
| Diluted earnings  per share from continuing operations                                           |       | $                                                                  | 0.94       |     | $          | 0.28     |       | $ | 1.15 |   |

 

F-25

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**CHIRON CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) DECEMBER 31, 2005**

**Note 2—EarningsPer Share (Continued)**

The following table setsforth the computation for basic and diluted earnings per share on net incomefor the years ended December 31:

| ** **                                                                                       | ** ** | **2005**                                                           | ** ** | **2004** | ** ** | **2003** | ** ** |
|--------------------------------------------------------------------------------------------------|------------|--------------------------------------------------------------------|------------|----------|------------|----------|------------|
| ** **                                                                                       | ** ** | **(In thousands, except per share data)** | ** ** |
| Income  (Numerator):                                                                             |       |                                                               |       |     |       |     |       |
| Net income                                                                                       |       | $                                                                  | 180,470    |     | $          | 78,917   |       | $ | 227,313 |   |
| Plus: Interest on 2033 Debentures, net of taxes                                                  |       | 6,357                                                              |       | 3⁄4   |       | 2,638    |       |
| Net income, plus impact from assumed conversions.                                                |       | $                                                                  | 186,827    |     | $          | 78,917   |       | $ | 229,951 |   |
| Shares (Denominator):                                                                            |       |                                                               |       |     |       |     |       |
| Weighted-average common shares outstanding                                                       |       | 188,448                                                            |       | 187,545  |       | 186,835  |       |
| Effect of dilutive securities:                                                                   |       |                                                               |       |     |       |     |       |
| Additional shares from exercise of right under an  agreement with Novartis                       |       | 1,061                                                              |       | 3⁄4   |       | 3⁄4   |       |
| Stock options and equivalents.                                                                   |       | 1,887                                                              |       | 2,657    |       | 4,339    |       |
| Put options                                                                                      |       | 3⁄4                                                             |       | 3⁄4   |       | 1        |       |
| 2033 Debentures..                                                                                |       | 7,308                                                              |       | 3⁄4   |       | 2,740    |       |
| Weighted-average common shares outstanding, plus  impact from assumed conversions and issuances. |       | 198,704                                                            |       | 190,202  |       | 193,915  |       |
| Basic earnings per share from net income.                                                        |       | $                                                                  | 0.96       |     | $          | 0.42     |       | $ | 1.22 |   |
| Diluted earnings  per share from net income                                                      |       | $                                                                  | 0.94       |     | $          | 0.41     |       | $ | 1.19 |   |

 

Stock options to purchase 18.2 million shares,13.4 million shares and 7.3 million shares with exercise pricesgreater than the average market prices of common stock were outstanding duringthe years ended December 31, 2005, 2004 and 2003, 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 of cash and shares of Chiron’s common stock, if any, to be receivedby a holder converting $1,000 principal amount of the debentures (“ConversionValue”) will be determined by multiplying the applicable conversion rate by aweighted average price. Chiron will deliver the Conversion Value to debentureholders as follows: (1) an amount in cash (“Principal Return”) equal to the lesser of (a) the aggregateConversion Value of the debentures to be converted and (b) the aggregateprincipal amount of the debentures to be converted and (2) if theaggregate Conversion Value of the debentures to be converted is greater thanthe Principal Return, an amount in shares (“Net Shares”) equal to the aggregateConversion Value less the Principal Return (“Net Share Amount”). The number ofNet Shares to be paid will be determined by dividing the Net Share Amount by aweighted average price. If dilutive, common shares to be added to the dilutedshares 

F-26

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**CHIRON CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) DECEMBER 31, 2005**

**Note 2—EarningsPer Share (Continued)**

outstanding would be determinedby the net share settlement of the 2034 Debentures. For the years ended December 31,2005 and 2004, the assumed conversion of the 2034 Debentures was not dilutive.

For the years ended December 31,2005, 2004 and 2003, 0.6 million, 0.6 million and 5.2 million shares of commonstock issuable upon conversion of the Liquid Yield Option Notes (LYONs) wereexcluded from the computations of diluted earnings per share as their inclusionwould be antidilutive. During 2004, Chiron was required to purchase asignificant portion of the LYONs.

**Note 3—SupplementalCash Flow Information**

| ** **                                                             | ** ** | **2005**                | ** ** | **2004** | ** ** | **2003**  | ** ** |
|------------------------------------------------------------------------|------------|-------------------------|------------|----------|------------|-----------|------------|
| ** **                                                             | ** ** | **(In thousands)** | ** ** |
| Interest paid                                                          |       | $                       | 29,163     |     | $          | 18,771    |       | $ | 2,310 |   |
| Income taxes paid                                                      |       | $                       | 74,381     |     | $          | 51,651    |       | $ | 70,240 |   |
| Investing and  financing activities:                                   |       |                    |       |     |       |      |       |
| Acquisitions:                                                          |       |                    |       |     |       |      |       |
| Cash acquired                                                          |       | $                       | —     |     | $          | —    |       | $ | 92,178 |   |
| Fair value of all other assets acquired                                |       | —                  |       | 11,327   |       | 1,074,668 |       |
| Liabilities assumed                                                    |       | —                  |       | (724     | )          | (141,110  | )          |
| Income taxes payable                                                   |       | —                  |       | —   |       | (17,741   | )          |
| Net deferred tax asset (liability)                                     |       | —                  |       | 1,420    |       | (60,170   | )          |
| Cash payable for asset purchase                                        |       | —                  |       | (780     | )          | —    |       |
| Acquisition costs not yet paid as of  December 31, 2004 and 2003. |       | —                  |       | (22      | )          | (40,930   | )          |
| Total cash paid                                                        |       | $                       | —     |     | $          | 11,221    |       | $ | 906,895 |   |
| Capital lease                                                          |       | $                       | —     |     | $          | —    |       | $ | 157,500 |   |
| Non-cash capital  expenditures                                         |       | $                       | 36,618     |     | $          | —    |       | $ | — |   |

 

**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 from discontinued operations,net of taxes” consisted of the following for the years ended December 31:

| ** **                                                   | ** ** | **2004**                | ** ** | **2003** | ** ** |
|--------------------------------------------------------------|------------|-------------------------|------------|----------|------------|
| ** **                                                   | ** ** | **(In thousands)** | ** ** |
| Reversal of  reserves (net charge) for indemnity obligations |       | $                       | —     |     | $          | (5,222 | ) |
| Gain resulting  from IRS settlement                          |       | 12,459                  |       | —   |       |
| Reversal of  income tax reserves from Bayer settlement       |       | 12,395                  |       | —   |       |
| Income tax  benefit                                          |       | 3⁄4                  |       | 12,197   |       |
|                                                         |       | $                       | 24,854     |     | $          | 6,975 |   |

 

There was no gain (loss) from discontinued operations,net of taxes for the year ended December 31, 2005.

F-27

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**CHIRON CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) DECEMBER 31, 2005**

**Note 4—DiscontinuedOperations (Continued)**

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, Chiron 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 inexcess following this settlement.  Thissettlement resulted in a net gain of $12.4 million in 2004. This net gainprimarily relates to a tax benefit as a result of the settlement payment toBayer.

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

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 $7.6million, offset by an income tax benefit of $9.0 million, resulting in a netgain of $1.4 million in 2003.

Chiron recognized an income tax benefit of $12.2million in 2003. This tax benefit related to the settlement agreement betweenBayer, as discussed above and the reversal of valuation allowances againstdeferred tax assets that were established at the time of the sale of ChironDiagnostics.

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.

**Note 5—Acquisitions**

**SagresDiscovery**   On July 2, 2004, Chiron acquiredSagres Discovery (“Sagres”), a privately held company headquartered in Davis,California, which focuses on the discovery and validation of targets withpotential application to the development of cancer therapeutics. Chironacquired Sagres for a purchase price of $12.0 million.

F-28

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**CHIRON CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) DECEMBER 31, 2005**

**Note 5—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 purchase priceand allocation thereof based on estimated fair values are summarized in thefollowing table (in thousands). The purchase price reflects acquisition costs,which include contractual severance, direct acquisition costs and facility exitcosts.

| Consideration and  acquisition costs:               |   |   |   |
|-----------------------------------------------------|--------|--------|--------|
| Cash paid for asset purchase                        |   | $      | 10,893 |   |
| Acquisition costs paid as of December 31, 2005 |   | 1,130  |   |
| Total purchase price                                |   | $      | 12,023 |   |
| Allocation of purchase price:                       |   |   |   |
| Assets acquired                                     |   | $      | 1,698  |   |
| Liabilities assumed                                 |   | (724   | )      |
| Deferred tax assets                                 |   | 1,420  |   |
| Purchased in-process research and development       |   | 9,629  |   |
| Total purchase  price                               |   | $      | 12,023 |   |

 

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 it charged to earnings in 2004.

For acquisition costs related to Sagres, Chiron paid$1.1 million in 2004. These payments are reflected in the ConsolidatedStatement of Cash Flows as a component of “Cash paid for acquisitions, net ofcash 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 carry forwards of approximately $27.9 million and$21.2 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’s net operatingloss carryforwards is expected to expire unutilized.

**PowderJect****  **On July 8, 2003, Chironacquired PowderJect, a company based in Oxford, United Kingdom that developsand commercializes vaccines. Chiron acquired all of the outstanding shares ofcommon stock of PowderJect for 550 pence per ordinary share, which, includingestimated acquisition costs, resulted in a total purchase price ofapproximately $938.6 million. During 2004 and 2005, 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, United Kingdom andcertain vaccines operations in Sweden. The divestiture of these operationsincluded the disposition of net assets of $14.7 million (which included$15.5 million of cash), deferred taxes of $9.4 million, and exitliabilities of 

F-29

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**CHIRON CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) DECEMBER 31, 2005**

**Note 5—Acquisitions(Continued)**

$21.6 million.The net impact of the divestiture resulted in an increase to goodwill of$2.5 million in the second quarter 2004. Also, during the second quarterof 2004, Chiron adjusted the previously recorded obligation related to anassumed defined benefit plan, which resulted in an increase to goodwill 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.

·       Duringthe fourth quarter 2005, Chiron revised estimates of certain pre-acquisition incometax liabilities, which resulted in an increase to goodwill of $14.6 million andan increase to income tax payable of $14.6 million. These amounts adjustgoodwill as opposed to tax expense as the amounts relate to tax liabilitiesbefore the date of acquisition.

As a result of the above adjustments, the purchaseprice was revised from $947.8 million at December 31, 2003 to $938.6million at December 31, 2004. Goodwill was revised from $503.0 million at December 31,2003 to $520.9 million at December 31, 2004 and to $535.5 million at December 31,2005.

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-30

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**CHIRON CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) DECEMBER 31, 2005**

**Note 5—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, 2005                    |   | 28,855  |    |
| Estimated acquisition costs not yet paid as of  December 31, 2005 |   | 19,596  |    |
| 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.                                                              |   | 535,525 |    |
| Acquired intangible assets.                                            |   | 335,500 |    |
| Other assets.                                                          |   | 4,876   |    |
| Income taxes payable                                                   |   | (32,376 | )       |
| 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 aportion of the purchase price to purchased in-process research and development,which it charged to earnings in 2003. Purchased in-process research anddevelopment represented the valuation of acquired, to-be-completed researchprojects. Purchased in-process research and development was determined usingthe income approach, which is based on the premise that the value of a securityor asset is the present value of the future earning capacity that is availablefor distribution to the subject investors in the security or asset. In valuingthe purchased 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 believesthat the fair value assigned to purchased in-process research and developmentis based on reasonable assumptions. To assist in determining the value of thepurchased in-process research and development, a third-party valuation wasobtained as of the acquisition date.

F-31

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**CHIRON CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) DECEMBER 31, 2005**

**Note 5—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 agreementwere being amortized on a straight-line basis over 1 to 4 years. Theweighted average amortization period for these intangible assets was2 years. The distribution rights were fully amortized after one year andthe acquired intangible asset associated with the contract manufacturingagreement was written off in 2005 (as discussed in Note 8). Developed producttechnologies are being amortized using either the estimated sales method over10 years or on a straight-line basis over 1 to 15 years. The weightedaverage amortization period for these intangible assets is 11 years. Theweighted average amortization period for total acquired intangible assets is10 years.

Income taxes payable of $32.4 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 costsrelated to PowderJect, Chiron paid $4.0 million, $8.2 million and$16.7 million in 2005, 2004 and 2003, respectively. The net assets fromthe divestiture in 2004 of certain research operations in Madison, Wisconsinand Oxford, United Kingdom and certain vaccines operations in Sweden included$15.5 million of cash. For the acquisition of PowderJect, cash paid for commonstock and options on common stock was $890.2 million for 2003. Thesepayments 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, 2005, 2004 and 2003, respectively.

**Note 6—Restructuringand Reorganization**

For the years ended December 31, 2005, 2004 and2003, Chiron recorded net restructuring and reorganization charges of $0.3****million, $2.5 million and$1.7 million, respectively. The charges, included in “Selling, general andadministrative” and “Research and development” in the Consolidated Statementsof Operations, consisted of termination and other employee-related costsrecognized in connection with the reorganization of Chiron’s Seattle facilityand the closure of its Basel, Switzerland research facilities and Amsterdammanufacturing facilities. Termination notices were provided for all thefacilities. Of the 27 positions for elimination at the Seattle and Basel,Switzerland facilities, 27 were terminated at December 31, 2004. Of the 15positions for elimination at the Amsterdam facility, 7 were terminated as of December 31,2004, 14 were terminated as of December 31, 2005 and 1 position wasretained.

As of December 31,2005 and 2004, $0.3 million and $1.1 million, respectively, in remainingrestructuring obligations were included in “Other current liabilities” in theConsolidated Balance Sheets.

**Note 7—RocheSettlement**

In October 2000, Chiron entered into threelicense agreements with F. Hoffman-La Roche Limited  (“Roche”) and severalof its affiliated companies related to the settlement of certain litigation inthe U.S. and certain other countries for use of Chiron’s hepatitis C virus andHIV nucleic acid testing intellectual property. Two agreements relate to*in vitro* diagnostics products. The thirdagreement relates to blood 

F-32

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**CHIRON CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) DECEMBER 31, 2005**

**Note 7—RocheSettlement (Continued)**

screening, which wassuperseded in May 2001 by two new agreements, one for hepatitis Cvirus 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. Thispatent will expire seventeen years from the date of issuance. The issuance ofthe patent 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 $10.0 million milestone payment, interest, royalties received androyalties accrued under the patent until the resolution of this dispute. On September 10,2004, Chiron reached a settlement agreement with Roche. Under the terms of thesettlement agreement, the milestone payment along with any royalties receivedprior to March 31, 2004 became non-refundable. Accordingly, in 2004,Chiron 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 Chiron’s othersegment and $5.5 million has been recognized as revenue in Chiron’s BloodTesting segment. In 2004, Chiron also recognized $0.8 million in intereston the license fee. Also, under the settlement agreement, in 2005, Chironreceived a lump-sum payment of $78.0 million in lieu of royalties beyond January 1,2005. Roche may elect under the terms of the agreement to obtain a partialrefund and revert to paying royalties on the sales of its products in NorthAmerica. The amount of such potential refund ranges between $64.0 millionand $0.0 million. The amount of the refund available decreases inincrements over the quarters of 2005 and 2006. As such, Chiron is recognizing$64.0 million of the $78.0 million payment as revenue during 2005 and 2006. Theremaining $14.0 million was nonrefundable and was recognized as revenue in2004, of which $9.3 million has been recognized as revenue in Chiron’sother segment and $4.7 million has been recognized as revenue in Chiron’sBlood Testing segment. In 2005, Chiron recognized an aggregate of $40.0million, with $26.5 million of revenue from this settlement recognized in itsother segment and $13.5 million of revenue from this settlement recognized inits Blood Testing segment. Chiron expects to recognize the remaining $24.0million during 2006. Revenues earned from diagnostic products are included inChiron’s other segment and revenues earned from blood screening are included inChiron’s Blood Testing segment.

Theimpact on revenues in 2005 and 2004 from these items from the September 10,2004 settlement agreement with Roche is summarized below.

| ** **                                  | ** ** | **2005**                | ** ** | **2004**                    | ** ** |
|---------------------------------------------|------------|-------------------------|------------|-----------------------------|------------|
| ** **                                  | ** ** | **Other  Segment**      | ** ** | **Blood  Testing  Segment** | ** ** | **Total** | ** ** | **Other  Segment** | ** ** | **Blood  Testing  Segment** | ** ** | **Total** | ** ** |
| ** **                                  | ** ** | **(In thousands)** | ** ** | **(In thousands)**     | ** ** |
| Deferred revenues  recognized               |       | $                       | —     |                        | $          | — |   | $ | — |   | $ | 16,313 |   | $ | 5,453 |   | $ | 21,766 |   |
| Deferred license  fee recognized            |       | —                  |       | —                      |       | — |   | 10,000 |   | — |   | 10,000 |   |
| Non-refundable  portion of Roche settlement |       | 26,500                  |       | 13,500                      |       | 40,000 |   | 9,333 |   | 4,667 |   | 14,000 |   |
| Total royalty and  license fee revenue      |       | $                       | 26,500     |                        | $          | 13,500 |   | $ | 40,000 |   | $ | 35,646 |   | $ | 10,120 |   | $ | 45,766 |   |

 

F-33

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**CHIRON CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) DECEMBER 31, 2005**

**Note 8—IntangibleAssets**

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

| ** **                                       | ** ** | **December 31, 2005** | ** ** | **December 31, 2004** | ** ** |
|--------------------------------------------------|------------|---------------------------------|------------|---------------------------------|------------|
| ** **                                       | ** ** | **Gross  Carrying  Value**      | ** ** | **Accumulated  Amortization**   | ** ** | **Net Carrying  Value** | ** ** | **Gross  Carrying  Value** | ** ** | **Accumulated  Amortization** | ** ** | **Net Carrying  Value** | ** ** |
| Purchased  technologies                          |       | $                               | 332,193    |                            |       | $ | 136,414 |   |   |   | $ | 195,779 |   |   | $ | 333,085 |   |   | $ | 117,048 |   |   |   | $ | 216,037 |   |   |
| Patents                                          |       | $                               | 142,694    |                            |       | $ | 79,923 |   |   |   | $ | 62,771 |   |   | $ | 132,385 |   |   | $ | 71,616 |   |   |   | $ | 60,769 |   |   |
| Trademarks                                       |       | 59,780                          |       |                            | 26,416     |   |   |   | 33,364 |   |   | 65,609 |   |   | 25,450 |   |   |   | 40,159 |   |   |
| Licenses and  technology rights                  |       | 52,456                          |       |                            | 43,267     |   |   |   | 9,189 |   |   | 47,745 |   |   | 34,079 |   |   |   | 13,666 |   |   |
| Developed product  technologies                  |       | 320,674                         |       |                            | 101,023    |   |   |   | 219,651 |   |   | 374,025 |   |   | 77,253 |   |   |   | 296,772 |   |   |
| Customer  relationships                          |       | 27,270                          |       |                            | 12,272     |   |   |   | 14,998 |   |   | 31,234 |   |   | 12,421 |   |   |   | 18,813 |   |   |
| Know how(1)                                      |       | 12,385                          |       |                            | 7,482      |   |   |   | 4,903 |   |   | 14,185 |   |   | 7,548 |   |   |   | 6,637 |   |   |
| Databases                                        |       | 7,100                           |       |                            | 2,485      |   |   |   | 4,615 |   |   | 7,100 |   |   | 2,012 |   |   |   | 5,088 |   |   |
| Other(2)                                         |       | 24,671                          |       |                            | 12,491     |   |   |   | 12,180 |   |   | 34,893 |   |   | 19,090 |   |   |   | 15,803 |   |   |
| Total other  intangible assets              |       | $                               | 647,030    |                            |       | $ | 285,359 |   |   |   | $ | 361,671 |   |   | $ | 707,176 |   |   | $ | 249,469 |   |   |   | $ | 457,707 |   |   |
| Total intangible assets  subject to amortization |       | $                               | 979,223    |                            |       | $ | 421,773 |   |   |   | $ | 557,450 |   |   | $ | 1,040,261 |   |   | $ | 366,517 |   |   |   | $ | 673,744 |   |   |

----

(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 $19.3 million and accumulated amortization of $7.4million were included in “Other” at December 31, 2005. Bond issuance costswith a gross carrying value of $29.4 million and accumulated amortization of$13.8 million were included in “Other” at December 31, 2004.

Aggregateamortization expense is as follows (in thousands):

| For the year  ended December 31, 2003 (reported)  |   | $ | 69,836 |   |
|--------------------------------------------------------|--------|---|--------|--------|
| For the year  ended December 31, 2004 (reported)  |   | $ | 98,180 |   |
| For the year  ended December 31, 2005 (reported)  |   | $ | 79,189 |   |
| For the year  ended December 31, 2006 (estimated) |   | $ | 67,957 |   |
| For the year  ended December 31, 2007 (estimated) |   | $ | 74,187 |   |
| For the year  ended December 31, 2008 (estimated) |   | $ | 75,040 |   |
| For the year  ended December 31, 2009 (estimated) |   | $ | 73,857 |   |
| For the year ended  December 31, 2010 (estimated) |   | $ | 72,977 |   |

 

F-34

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**CHIRON CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) DECEMBER 31, 2005**

**Note 8—IntangibleAssets (Continued)**

The changes in thecarrying value of goodwill by reporting unit consisted of the following (inthousands):

| ** **                            | ** ** | **Biopharmaceuticals** | ** ** | **Vaccines** | ** ** | **Total** | ** ** |
|---------------------------------------|------------|------------------------|------------|--------------|------------|-----------|------------|
| 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 |   |
| Effect of exchange rate changes       |       |                   | —     |         |       | (67,744   | )          | (67,744 | ) |
| Revision of tax benefits(4)           |       |                   | —     |         |       | 14,635    |       | 14,635 |   |
| Balance as of  December 31, 2005 |       |                   | $          | 192,186      |       |      | $          | 616,099 |   | $ | 808,285 |   |

----

(3)          SFAS No. 109,*Accounting for Income Taxes,* requiresthat the realization of acquired tax benefits subject to valuation allowance beapplied to goodwill.

(4)          During the fourthquarter 2005, Chiron revised estimates of certain pre-acquisition income taxliabilities, which resulted in an increase to goodwill of $14.6 million and anincrease to income tax payable of $14.6 million.

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

Certain developed product technologies from Chiron’sacquisition of PowderJect are amortized under the estimated sales method, whichconsiders forecasted FLUVIRIN® sales during eachinfluenza season through the remaining period of the benefit. Relatedamortization was $34.2 million and $48.2 million for the years ended December 31,2005 and 2004, respectively, reflecting updated forecasted FLUVIRIN® sales.

In the third quarter of 2005, Chiron recognized animpairment loss of $14.5 million on acquired intangible assets from Chiron’sacquisition of PowderJect related to ARILVAXTM, a yellow fever vaccine. Thisimpairment loss was due to a focus of resources towards the influenza market,resulting in a reduction of the expected activity for ARILVAXTM. ARILVAXTMremains in Chiron’s portfolio of trademarks and Chiron may re-enter the yellowfever vaccine market in the future with this product.

In the fourth quarter of2005, Chiron recognized an impairment loss of $1.1 million on acquiredintangible assets from Chiron’s acquisition of PowderJect related to a contractmanufacturing agreement. The contract manufacturing agreement is included inthe caption “Licenses and technology rights” in the table above.

**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 

F-35

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**CHIRON CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) DECEMBER 31, 2005**

**Note 9—Researchand Development Arrangements (Continued)**

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, 2005, aggregate annual noncancelablefunding commitments under collaborative arrangements are as follows:  2006 - $32.0 million and 2007 - $10.0million. There are no noncancelable funding commitments under collaborativearrangements thereafter. Chiron may also be required to make payments tocertain collaborative partners upon the achievement of specified milestones. AtDecember 31, 2005, aggregate milestone payments that may become due underthese noncancelable collaborative arrangements totaled $9.4 million. Thesemilestone payments are due upon the achievement of various technicalmilestones, completion of trials and regulatory filings. From the inception ofthese contracts through December 31, 2005, costs incurred under thesecollaborative arrangements totaled $71.5 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, 2005,aggregate annual noncancelable commitments under these contracts are asfollows: 2006—$4.3 million and 2007—$0.6 million. At December 31, 2005,aggregate milestone payments that may become due under these noncancelablearrangements totaled $4.5 million. These milestone payments are due upon theachievement of various technical milestones, completion of trials andregulatory filings. From inception of these contracts through December 31,2005, costs incurred under these contracts totaled $9.5 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 jointly research,develop, and commercialize multiple antibody product candidates. Under thearrangement, the parties agreed to share development and commercializationexpenses, including preclinical and clinical development, manufacturing andworldwide marketing costs, as well as revenues, generally on a 70-30basis, with Chiron’s share being 70% and XOMA’s share being 30%. Chiron agreedto make an initial payment of $10.0 million, which was paid as of December 31,2004, and classified as prepaid research and development expense. The prepaidexpense is being amortized on a straight-line basis over a five-year period ofbenefit. Amortized research and development expense of $1.5 million and $2.0million were recorded for the years ended December 31, 2004 and 2005, respectively.Chiron agreed to make a loan facility of up to $50.0 million available toXOMA, starting on January 1, 2005 to fund 75% of XOMA’s share ofdevelopment expenses. Under this arrangement, Chiron made $12.1 million in loanadvances to XOMA as of December 31, 2005. Interest payable by XOMA is duewhen the principal is due and is additive to the $50.0 million availableprincipal. Interest payable of $0.3 million was added to the outstandingbalance as of December 31, 2005. The loan advances are recorded at theirfair value based upon an interest rate for a similar loan facility from a bankto a similar counterparty. The recorded amount will be accreted to full facevalue over the life of the outstanding facility based on the effective interestmethod. At December 31, 2005, $7.1 million was recorded as “Non-currentnotes receivable” in the Consolidated Balance Sheet for these loan advances.

In October 2003, Chiron entered into a licenseagreement with Cubist Pharmaceuticals, Inc. for the development andcommercialization of Cubist’s antibiotic CUBICIN® (daptomycin) in Western and Eastern Europe,Australia, New Zealand, India and certain Central American, South American andMiddle Eastern countries. In exchange for these development and commercializationrights, 

F-36

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**CHIRON CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) DECEMBER 31, 2005**

**Note 9—Researchand Development Arrangements (Continued)**

Chiron agreed to payCubist up to $50.0 million. This $50.0 million includes$18.0 million, which was paid by Chiron up front in the fourth quarter2003, $10.0 million of which was used to purchase restricted Cubist commonstock at a 50 percent premium over market price, and up to$32.0 million of additional payments to Cubist upon the achievement ofcertain regulatory and sales milestones. Chiron is also obligated to pay Cubista tiered royalty on CUBICIN® marketed  by Chiron. Chiron recorded $10.6 millionof the up front payment related to the purchase of in-process research anddevelopment as research and development expense in 2003 and $6.7 millionand $0.7 million of the up front payment as an equity investment and prepaidresearch and development, respectively. The marketable equity investment wasrecorded at fair value. This agreement is cancelable by Chiron at any time withtwelve months written notice. As of December 31, 2005, Chiron has not paidany amount in regard to milestones or royalties. In 2004, Chiron adjusted thepreviously recorded equity investment for an “other than temporary” write-downof $1.4 million. There was no such “other than temporary” write-down recordedin 2005. The equity investment was recorded at $11.3 million and $6.3 million,the fair value as of December 31, 2005 and 2004, respectively. The prepaidresearch and development was fully expensed as of December 31, 2005. In January 2006,European Commission granted marketing approval to Chiron for CUBICIN®, a first-in-class IVantibiotic. The marketing approval was granted in the 25 member states of theEuropean Union, Iceland, Liechtenstein and Norway. Under the approval, CUBICIN® is indicated for the treatment of complicatedskin and soft-tissue infections (cSSTI) caused by Gram-positive bacteria. TheCUBICIN® antibiotic is also approved by the FDA for thetreatment of complicated skin and skin structure infections caused byGram-positive bacteria, and is marketed in the United States by CubistPharmaceuticals, Inc. CUBICIN® antibiotic is manufactured for Chiron byCubist Pharmaceuticals, Inc. This marketing approval by the EuropeanCommission in January 2006 triggered a milestone payment of $2.0 millionpayable by Chiron to Cubist Pharmaceuticals, Inc.

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 recordedin the Consolidated Balance Sheet as “Current portion of notes receivable” atDecember 31, 2005 and “Non-current notes receivable” at December 31,2004. The note, which bears interest at the prime rate (7.25% atDecember 31, 2005 and 5.25% at December 31, 2004), is due withaccrued interest on December 31, 2006 and will be forgiven (principal andaccrued interest) if the U.S. Food and Drug Administration approves any productcovered by the patent and license agreement for marketing in the U.S. prior toDecember 31, 2006. Chiron may pay additional milestone payments to Scios ifcertain development objectives are met. In addition, Chiron may pay Scios royaltiesof 4% on future net product sales of the product under the patent and licenseagreement. Subsequently, in March 2005, Chiron has entered into a licenseagreement with Kaken Pharmaceutical Co. Ltd. (“Kaken’’), under which Kakenwould compensate Chiron for the principal and accrued interest of thepromissory note otherwise receivable from Scios, if Kaken obtains FDA approvalof a New Drug Application for a licensed product prior to December 31,2006.

F-37

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**CHIRON CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) DECEMBER 31, 2005**

**Note 9—Research andDevelopment Arrangements (Continued)**

Occasionally, Chironinvests in equity securities of its corporate partners. The price of thesesecurities is subject to significant volatility. Chiron performs periodicreviews for temporary or other-than-temporary impairment of its securities andrecords adjustments to the carrying values of those securities accordingly.Chiron recognized losses attributable to the other-than-temporary impairment ofcertain of these equity securities of $1.3 million and $1.4 million in2005 and 2004, respectively. There was no such loss in 2003.

**Note 10—Related PartyTransactions**

*Relationship withNovartis AG*

On October 30, 2005, Chiron entered into anAgreement and Plan of Merger (the “Merger Agreement”) with NovartisCorporation, Novartis Biotech Partnership, Inc. (“Novartis Biotech”), anindirect wholly owned subsidiary of Novartis AG (“Novartis”) and an indirectsubsidiary of Novartis Corporation, and Novartis, as guarantor. Pursuant to theterms of the Merger Agreement, Novartis Biotech will merge with and intoChiron, with Chiron as the surviving corporation and becoming an indirectsubsidiary of Novartis Corporation and an indirect wholly owned subsidiary ofNovartis. Upon completion of the merger, each share of Chiron common stock notheld by Novartis or any of its subsidiaries, Chiron or any of its subsidiariesor a stockholder of Chiron who perfects appraisal rights, will be convertedinto the right to receive $45.00 per share in cash, without interest. Themerger is subject to stockholder approval and satisfaction of other customaryconditions, including governmental and regulatory approvals. On February 6,2006, the European Commission adopted a decision pursuant to Article 6(1)(b) ofthe Council Regulation (EC) No. 139/2004 declaring the combinationcompatible with the common market. This follows approval by the U.S. FederalTrade Commission in December 2005 and clearance by the Committee onForeign Investment in the United States under Exon-Florio in January 2006. Chironexpects that the transaction will be completed in the second quarter of 2006.

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 ChironVaccines Company and Chiron S.p.A. (formerly The Biocine Company and BiocineS.p.A.). As a result of dilution stemming primarily from the issuance of commonstock under Chiron’s employee stock option and stock purchase plans, and inconnection with certain acquisitions, as of December 31, 2005, Novartisheld approximately 43.9% 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. In connection with those transactions, Chiron and Novartis enteredinto certain agreements, which are described below.

F-38

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**CHIRON CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) DECEMBER 31, 2005**

**Note 10—RelatedParty Transactions (Continued)**

*The GovernanceAgreement*

*Standstill.**  *Under the Governance Agreement,Novartis has agreed not to increase its ownership interest in Chiron above 55%unless:

(i)    a majorityof the independent 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)   theincrease in Novartis’ ownership interest is the result of an action by Chiron(such as the re-purchase of outstanding common stock or the sale of common stockto Novartis or its subsidiaries); or

(iii)  theacquisition is part of a “buy-out transaction,” in which Novartis acquires allof Chiron’s outstanding capital stock in accordance with certain procedures setforth in the Governance Agreement.

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 has 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 (as defined in the Governance Agreement), acting solelyon behalf of Chiron’s stockholders other than Novartis, would consider theproposal, and with approval of a majority of independent directors, may acceptit subject to stockholder approval. If the independent directors do not acceptthe proposal, Novartis may request binding arbitration to determine the thirdparty sale value. The independent directors may delay the arbitration for aperiod of up to one year under certain circumstances. Upon determination of thethird party sale value by arbitration, Novartis may either proceed with theproposed buy-out transaction at the third party sale value determined byarbitration or withdraw its proposed buy-out transaction in accordance withterms set forth in the Governance Agreement. If Novartis withdraws its proposedbuy-out transaction following the determination of third party sale value byarbitration, Novartis cannot withdraw any subsequent proposal that results in asecond arbitration to determine the third party sale value of Chiron. Inconnection with the signing of the Merger Agreement, the Chiron Board (with theNovartis directors having recused themselves), including all of the independentdirectors as defined in the Governance Agreement, unanimously approved theMerger Agreement and the transactions contemplated thereby and recommended thatChiron’s stockholders adopt the Merger Agreement. As part of the negotiation ofthe Merger Agreement, Novartis also agreed to condition the closing of themerger on the adoption of the Merger Agreement by a majority of our outstandingshares not held by Novartis and its subsidiaries.

*ProxySolicitations and Voting Trusts.**  *The Governance Agreement furtherprovides that unless and until Novartis and its subsidiaries own all of Chiron’scapital stock, they will not solicit proxies or initiate or encouragestockholders to initiate proposals, nor will they encourage any persons withrespect to the voting 

F-39

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**CHIRON CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) DECEMBER 31, 2005**

**Note 10—RelatedParty Transactions (Continued)**

of equity securities ofChiron or enter into any voting trust or similar arrangement to vote any ofChiron’s equity securities.

*Anti-dilutionProvisions.**  *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 CorporateTransactions.**  *TheGovernance Agreement provides that as long as Novartis owns at least 40% ofChiron’s outstanding voting stock, Chiron may not engage in certain corporatetransactions without Novartis’ approval. These transactions generally include:

·       significantdebt or equity issuances,

·       debtor equity repurchases,

·       mergersand acquisitions involving consideration exceeding $125 million,

·       thepayment of cash dividends,

·       amendmentsto Chiron’s restated certificate of incorporation or bylaws, and

·       othertransactions that might adversely impact the rights of Novartis, ordiscriminate against Novartis, as a Chiron stockholder.

In addition, amajority of the directors of Chiron’s Board who have been designated byNovartis must approve certain other corporate transactions as described in theGovernance Agreement. The transactions generally include:

·       thepayment of cash dividends,

·       theissuance of equity securities, other than common stock or options to purchasecommon stock, to any employee of Chiron,

·       amendmentsto Chiron’s Bylaws,

·       thepayment of certain kinds of consideration in connection with an acquisition,and

·       theissuance of certain kinds of debt or equity securities other than common stock,nonvoting preferred stock and debt securities that are convertible into commonstock or nonvoting preferred stock.

*TransactionsBetween Chiron and Novartis.**  *In addition, under the Governance Agreement, amajority 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 or any of its affiliates thatis described in Item 404 of Regulation S-K promulgated by the SEC.

F-40

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**CHIRON CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) DECEMBER 31, 2005**

**Note 10—RelatedParty Transactions (Continued)**

*Nominationof Directors and Voting of 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, subject toNovartis’ right to designate three directors. The number of directors whomNovartis may designate declines if Novartis’ ownership interest in Chirondeclines to less than 30%. Chiron’s 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 Novartis directors (also referred to asinvestor directors); and if Novartis’ percentage interest of Chiron’soutstanding capital stock is less than 40%, the committee will be comprised ofthree independent directors and one investor director. A majority of theindependent directors designate the independent directors who serve on theNominating and Corporate Governance Committee, and a majority of the investordirectors designate the investor directors who serve on the committee. A quorumof the Nominating and Corporate Governance Committee required for any actionrequires the attendance of at least two independent directors and both investordirector members. The Nominating and Corporate Governance Committee acts bymajority vote of the entire committee; provided, however, that as long asNovartis’ percentage interest is at least 40%, no action to nominate a directormay be taken by the committee that is opposed by both of the investordirectors. Beginning in the year 2006, as long as Novartis owns at least 49% ofChiron’s outstanding capital stock, the investor directors of the committeewill have the deciding vote with respect to nomination of any directors,meaning the vote of the two investor directors will control over the vote ofthe independent directors.

*Measurement Standards.**  *The Governance Agreement furtherprovides that the Board will set and approve Measurement Standards to evaluateChiron’s performance for each fiscal year. The Measurement Standards arederived from Chiron’s annual financial and operating performance goals, andinclude quantitative items such as revenue, earnings per share and stock priceappreciation targets, as well as qualitative items such as research anddevelopment, commercial and corporate milestones. If the applicable MeasurementStandards are not met for any fiscal year, the Governance Agreement providesthat a committee comprised of the three investor directors, three independentdirectors and one management director, called the Strategic Planning Committee,will be created. The purpose of the committee will be to prepare and recommendto the Board a remedial plan intended to restore Chiron to compliance with theMeasurement Standards. In addition, until the Measurement Standards are met fora subsequent 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 

F-41

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**CHIRON CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) DECEMBER 31, 2005**

**Note 10—RelatedParty Transactions (Continued)**

failure to releaseany FLUVIRIN® vaccine for the 2004-2005 influenzaseason. While the Board took steps consistent with the role of the StrategicPlanning Committee, directing the preparation of and approving a remedial planto bring Chiron back to compliance with applicable Measurement Standards, theBoard did not establish a Strategic Planning Committee. Chiron met theMeasurement Standards for 2005.

*The InvestmentAgreement*

*BankDebt 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 was $402.5 million. In November 1996,Chiron and Novartis agreed that Chiron could increase the maximum borrowingamount under the guaranteed credit facilities by up to $300.0 million, for amaximum borrowing amount under the cap of $702.5 million. In exchange forthis increase, the amount of Chiron’s common stock required to be purchased bya Novartis affiliate, at Chiron’s request, under the Subscription Agreement,would be reduced by an equal amount. The maximum amount Novartis is required toguarantee pursuant to the terms of the Investment Agreement has been reduced by$109.8 million following an election by Chiron in December 2005, toexercise its subscription rights under the Investment Agreement, decreasing thecap to $592.7 million.  Chiron alsoagreed to enter into a separate agreement with Novartis for each obligationguaranteed by Novartis under which Chiron agrees to reimburse Novartis for anypayments made or out-of-pocket expenses incurred by Novartis in connection withthe guarantee (each, a “Reimbursement Agreement”). Chiron’s obligations underthe Reimbursement Agreements are, at the request of Novartis, to be fullysecured by collateral (which means guaranteed by assets pledged by Chiron)acceptable to Novartis. Through February 2006, Novartis guaranteed a $100.0million U.S. credit facility for Chiron’s benefit for which there were noborrowings outstanding at December 31, 2005 and $173.3 million ofChiron’s capital lease commitments. The U.S. credit facility has since expiredand at Chiron’s election was not renewed and is thus no longer guaranteed byNovartis. As a result of these guarantees and the conversion of $9.8 million ofbonds in 2000 into shares of Chiron common stock, there remains approximately$417.7 million of the guarantee available following the exercise of itssubscription rights and its subsequent election to increase the amount Novartismay be required to guarantee to the maximum borrowing amount.

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 and 2003,****Novartismade no payments to eligible option holders in connection with the surrenderfor cancellation of such options. These options expired in 2004.

*TheLimited Liability Company Agreement (also known as the “R &D FundingAgreement”).**  *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, in December 1995, or the 

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**CHIRON CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) DECEMBER 31, 2005**

**Note 10—RelatedParty Transactions (Continued)**

“R &D FundingAgreement.” The R&D Funding Agreement provided that Novartis would purchaseinterests in a limited liability company as a means of providing this funding.In December 2000, this agreement was amended to provide that, through December 31,2001, at Chiron’s request, Novartis would fund up to 100% of the developmentcosts incurred between January 1, 1995 and December 31, 2000 on theseprojects. The amount of funding that Novartis was obligated to provide wassubject to an aggregate limit of $265.0 million. Novartis funded $265.0 millionover the term of this agreement. Although Novartis’ agreement to purchaseinterests expired on December 31, 2001, there are certain royalty andco-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 HerpesSimplex Virus-thymidine kinase (“HSV-tk”). In exchange for providing thefunding, Novartis has certain rights, as described below, in certain adult andpediatric vaccines, Insulin-Like Growth Factor-1, Factor VIII and HSV-tkknown as the “Products.”

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.Novartis also has co-promotional rights, in countries other than in NorthAmerica and Europe, for certain adult vaccines. Under the R&D FundingAgreement, Chiron is obligated to pay royalties on the designated Products fora minimum of ten years from the later of October 1, 2001 or the date ofthe first commercial sale of individual Products covered by the amended R&DFunding Agreement. For the years ended December 31, 2005, 2004 and 2003,****Chiron recorded royalties to Novartis of$0.9 million, $0.6** **millionand $2.4 million, respectively, which are recorded in “Cost of sales” inthe Consolidated Statement of Operations.

*TheCooperation and Collaboration Agreement.**  *Chiron also agreed to work withNovartis to collaborate in research and development, marketing andmanufacturing, and to give each party access to the other party’s technologyand reciprocal “most-favored nation” rights for certain licenses. The agreementprovides a means by which Chiron or Novartis may specifically propose tocollaborate with the other party in an area of research and development, yetretain a 90-day right of first negotiation with respect to that area.Neither Chiron nor Novartis has the right to enter into any material researchand development collaboration related to Chiron’s strategic mission with anythird party if it is anticipated that the third party’s only contribution tothe collaboration will be funding, unless Chiron or Novartis has first offeredto the other party an opportunity to collaborate on the same terms as offeredby that third party. The restrictions do not apply to collaborations that arenot funded commercially, such as grants, or financing arrangements with thirdparties where the third party receives a return on the financed amount. Also,under the Cooperation and Collaboration Agreement, Novartis and Chiron have: (i) areciprocal right of first refusal to market certain products developed by theother party or which the other party has the right to market, and (ii) areciprocal right of first negotiation to manufacture certain products developedby the other party or which the other party has the right to manufacture.

*MarketPrice Option Agreement.**  *Under this agreement, Chiron granted to an affiliateof Novartis an option to purchase newly issued shares of equity securitiesdirectly from Chiron at fair market value. Under the terms of this agreement,known as the Market Price Option Agreement, Novartis has the right 

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**CHIRON CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) DECEMBER 31, 2005**

**Note 10—RelatedParty Transactions (Continued)**

to purchase from Chironshares of newly issued common stock in an amount which, when added to othershares held directly or indirectly by Novartis, would not increase Novartis’aggregate ownership above 55% of Chiron’s then outstanding common stock.Novartis may exercise this option at any time. Novartis also may exercise theoption repeatedly, with a minimum purchase equal to $1.0 million each time.Novartis may not exercise the option if it owns shares representing less than30% of the aggregate number of votes entitled to be voted at an election ofdirectors of Chiron. In addition, one of the following “exercise conditions”must be satisfied: (i) Novartis is restricted by law from purchasingequity securities from any person other than Chiron (including any restrictionresulting from Novartis’ possession of non-public material informationconcerning Chiron); (ii) there is insufficient liquidity in the openmarket to permit Novartis to purchase the number of shares it desires, eitherwithin the time period it desires or without unduly affecting the price of theshares; or (iii) Novartis’ ownership interest in Chiron at that time isbelow 50% and it wishes (and is permitted under then applicable standstillprovisions of the Governance Agreement) to increase its ownership interest toabove 50% (although if this is the only exercise condition that is satisfied,Novartis is not permitted to purchase shares that would increase its ownershipinterest above 51%).

*Subscription Agreement.*   Under a Subscription Agreement with Novartis, Chiron has the right torequire Novartis to purchase common stock directly from Chiron at fair marketvalue, up to a maximum initial subscription amount of $500.0 million. Thesubscription amount will be reduced in certain circumstances, as described inthe Subscription Agreement, and is also subject to reduction by the amount ofany increase if the amount Novartis is required to guarantee under theInvestment Agreement is increased above $402.5 million. In November 1996,Chiron and Novartis agreed that Chiron could increase the maximum borrowingamount under the guaranteed credit facilities by up to $300.0 million, asdiscussed under “Bank Debt Guarantee” above. As a result, if the bank debtguarantee is increased by $300.0 million, the maximum subscription amountwould be decreased to $200.0 million. However, as described below, Chironexercised its right to require Novartis to purchase shares of Chiron commonstock valued at $300.0 million and the sale of those shares was completed on December 8,2005. The subscription agreement expired in January 2006. Other than the6,896,552 shares purchased on December 8, 2005 pursuant to Chiron’sexercise of its subscription right and shares acquired upon conversion of $9.8million of bonds in 2000, Novartis has not purchased any securities from Chiron(including the 2.75% Convertible Debentures issued in June 2004, the1.625% Convertible Debentures issued in July 2003 and the Liquid YieldOption Notes issued in June 2001) pursuant to the Market Price OptionAgreement or the Subscription Agreement.

On October 30, 2005,Chiron gave notice to Novartis that it was exercising its right under the SubscriptionAgreement to require Novartis (or an affiliate) to purchase shares of Chironcommon stock for an aggregate purchase price of $300.0 million at $43.50 pershare (equivalent to 6,896,552 shares). Chiron and Novartis Biotech consummatedthe acquisition of these shares on December 8, 2005 as a result of which,Novartis and its subsidiaries collectively own approximately 43.9% of Chiron’soutstanding common stock at December 31, 2005.

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**CHIRON CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) DECEMBER 31, 2005**

**Note 10—RelatedParty Transactions (Continued)**

*The April 2003Agreement*

In April 2003, Chironacquired exclusive worldwide development and commercial rights from Novartisfor PULMINQTM 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 in2003. In 2004, Chiron submitted a new drug application to the FDA for marketingapproval of PULMINIQTM,which triggered a milestone amount of $1.0 million to Novartis that wasexpensed as research and development expenses in 2004. On July 14, 2005, Chironreceived an action letter from the FDA stating that Chiron’s New DrugApplication (NDA) for PULMINIQTM (cyclosporine, USP) inhalation solution is “approvable”but, in light of the fact that the application was based on a single-centerclinical trial with a small patient population, an additional pre-approvalstudy would be required to confirm the efficacy of the drug. Chiron incurredadditional research and development expenses of $0.2 million, $0.8 million and $0.7 million in 2003, 2004and 2005 respectively, for Novartis contract manufacturing services related toPULMINIQTM production.

*ContractManufacturing Agreement with Novartis Pharma AG for Diamorphine*

As of March 1, 2005,Chiron entered into a contract manufacturing and supply agreement with NovartisPharma AG for the production and manufacture of Diamorphine by Novartis forsale by Chiron in the United Kingdom. Under the terms of the agreement, Chironagrees to order, and Novartis Pharma agrees to process and supply, a minimumquantity of Diamorphine. Novartis Pharma will purchase all components at itsown cost and may, at Chiron’s request, use reasonable efforts to increasecapacity. For the year ended December 31, 2005, Chiron purchased $1.3million of Diamorphine from Novartis Pharma under the agreement. The agreementwill remain in effect until June 30, 2006, unless it is earlierterminated.

*DistributionAgreement with Novartis Pharma GmbH for Vaccines*

Chironis party to a Distribution Agreement with Novartis Pharma GmbH, dated as of July 1,2005, as amended, pursuant to which Novartis Pharma GmbH serves as the exclusivedistributor for certain Chiron vaccines in Austria. Under the terms of theagreement, Novartis agrees to purchase on an annual basis a minimum quantity ofeach vaccine distributed under the agreement. For the year ended December 31,2005, Novartis Pharma GmbH purchased from Chiron $2.3 million under theagreement. The agreement will remain in effect until July 1, 2008, andthereafter will renew automatically for an additional period of one year,unless it is earlier terminated.

*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.

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**CHIRON CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) DECEMBER 31, 2005**

**Note 10—RelatedParty Transactions (Continued)**

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) and 1.2 million Euro ($1.3 million) for the yearsended December 31, 2004 and 2003 respectively.

As of December 31, 1999, Chiron exercised itsoption to lease certain equipment under the same terms as the office andwarehouse lease. For the year ended December 31, 2003, Chiron incurredexpenses of 0.04 million Euro ($0.04 million). Also, at the option ofSynCo, Chiron may provide various administrative services to SynCo. As of December 31,2005, no such administrative services were being provided. At the option ofChiron, SynCo may provide various manufacturing and quality control services toChiron. In July 2001, Chiron and SynCo entered into another agreement, toinclude the manufacture of certain vaccine products through January 1,2004 upon Chiron’s request. For the year ended December 31, 2003, Chironincurred expenses of approximately $2.5 million, which was included in “Costof Sales” in the Consolidated Statements of Operations, related to suchmanufacture of certain vaccine products.

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 2006 under this agreement. Chiron’s minimum purchaseobligation under this agreement, which depends on the quantities purchased byChiron in years 2007 through 2010, inflation and movement in the Euro to U.S.Dollar exchange rate, is expected to be approximately $20.5 million overthe remaining term of the agreement. For the years ended December 31, 2005and 2004, Chiron incurred expenses of approximately $1.1 million and$1.3 million, respectively, which was included in “Cost of Sales” in theConsolidated Statements of Operations, related to such manufacture of certainvaccine products.

Simultaneouslyin June 2003, Chiron and SynCo B.V. executed an FDA compliance agreement.Under this agreement, Chiron will fund certain costs required to bring SynCo’sAmsterdam manufacturing facility into compliance to support approval by theU.S. Food and Drug Administration to manufacture certain vaccine products forthe U.S. market. Under this agreement, Chiron paid 4.7 million Euro ($5.5 million)for the year ended December 31, 2003. In 2004, the agreement wasterminated and Chiron recorded an obligation of 4.5 million Euro ($5.4million) as of December 31, 2004. As at December 31, 2005, thereremains 1.3 million Euro ($1.5 million) as a payable to SynCo underthis agreement. All costs for this contract were recorded in “Research anddevelopment” in the Consolidated 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, 2005and 2004, our equity investment in ZymeQuest was $0.0 million and $0.5 million,

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**CHIRON CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) DECEMBER 31, 2005**

**Note 10—RelatedParty Transactions (Continued)**

respectively,and is included in “Investments in equity securities and affiliated companies,”in the Consolidated Balance Sheets. As of December 31, 2005, Chiron hasdevelopment funding commitments with ZymeQuest of $10.0 million, which has beenincluded under non-cancelable funding commitments under collaborativeagreements in “Note 9—Research and Development Arrangements.”

**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 and receiveroyalties from the sales of hepatitis C virus and HIV tests by licensees.

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 toOrtho-Clinical Diagnostics, are recorded in product sales, with thecorresponding costs recorded in cost of sales. Reimbursements fromOrtho-Clinical Diagnostics for research costs incurred by Chiron and therelated research expenses are separately recorded. In addition to these productrevenues and reimbursements, Chiron shares in the defined pre-tax operatingearnings of the Ortho-Clinical Diagnostics joint business activity at apre-determined percentage (50%), as defined in the agreement, rather than froman ownership interest in an entity. Chiron receives contractually definedprofit sharing payments from Ortho-Clinical Diagnostics on a quarterly basis.

Chiron records its shareof earnings from the joint business contractual arrangement on a one-month lagusing estimates provided by Ortho-Clinical Diagnostics. Profit sharingdistributions are payable to Chiron within 90 days after the end of each quarter.At December 31, 2005 and 2004, $85.2 million and $41.3 million,respectively, were due from Ortho-Clinical Diagnostics for profit sharing andreimbursement of costs. In 2005, 2004 and 2003, Chiron’s 50% share of theearnings from the joint business contractual arrangement, which was recorded in“Revenues from joint business arrangement,” was $136.7 million,$118.2 million and $108.3 million, respectively. Revenues recognizedunder the cost reimbursement portion of the arrangement in 2005, 2004 and 2003were $31.3 million, $27.8 million and $28.4 million, respectively,for product sales and $7.2 million, $8.0 million and$9.0 million, respectively, for collaborative research. The cost of salesassociated with the product sales recognized related to this arrangement in2005, 2004 and 2003 were $31.6 million, $28.5 million and$29.0 million, respectively. Research and development costs incurred forcollaborative research related to this arrangement in 2005, 2004 and 2003 were$7.3 million, $8.3 million and $10.0 million, respectively.

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**CHIRON CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) DECEMBER 31, 2005**

**Note 12—Fair Value ofFinancial Instruments**

*MarketableSecurities*

Available-for-salesecurities consisted of the following at December 31: 

| ** **              | ** ** | **2005**                | ** ** | **2004**                | ** ** |
|-------------------------|------------|-------------------------|------------|-------------------------|------------|
| ** **              | ** ** | **Adjusted  Cost**      | ** ** | **Unrealized  Gains**   | ** ** | **Unrealized  Losses** | ** ** | **Fair  Value** | ** ** | **Adjusted  Cost** | ** ** | **Unrealized  Gains** | ** ** | **Unrealized  Losses** | ** ** | **Fair  Value** | ** ** |
| ** **              | ** ** | **(In thousands)** | ** ** | **(In thousands)** | ** ** |
| U.S. Government         |       | $                       | 155,609    |                    |       | $ | 58 |   |   |   | $ | (546 | ) |   | $ | 155,121 |   | $ | 163,855 |   |   | $ | — |   |   |   | $ | (634 | ) |   | $ | 163,221 |   |
| State Debt              |       | 101,812                 |       |                    | —     |   |   |   | (1,062 | ) |   | 100,750 |   | 125,848 |   |   | 22 |   |   |   | (277 | ) |   | 125,593 |   |
| Foreign Government Debt |       | 2,075                   |       |                    | —     |   |   |   | — |   |   | 2,075 |   | — |   |   | — |   |   |   | — |   |   | — |   |
| Corporate Debt.         |       | 846,922                 |       |                    | 127        |   |   |   | (1,060 | ) |   | 845,989 |   | 486,806 |   |   | 144 |   |   |   | (1,263 | ) |   | 485,687 |   |
| Other                   |       | 13,421                  |       |                    | —     |   |   |   | — |   |   | 13,421 |   | 29,032 |   |   | — |   |   |   | — |   |   | 29,032 |   |
|                    |       | 1,119,839               |       |                    | 185        |   |   |   | (2,668 | ) |   | 1,117,356 |   | 805,541 |   |   | 166 |   |   |   | (2,174 | ) |   | 803,533 |   |
| Equity                  |       | 11,781                  |       |                    | 14,748     |   |   |   | (158 | ) |   | 26,371 |   | 25,879 |   |   | 45,743 |   |   |   | (100 | ) |   | 71,522 |   |
|                    |       | $                       | 1,131,620  |                    |       | $ | 14,933 |   |   |   | $ | (2,826 | ) |   | $ | 1,143,727 |   | $ | 831,420 |   |   | $ | 45,909 |   |   |   | $ | (2,274 | ) |   | $ | 875,055 |   |

 

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 $9.2 million and $30.6 millionat December 31, 2005 and 2004, respectively. For hedged securities,subsequent offsetting changes in the fair value of the forward sales contractand the underlying equity security are recognized in earnings.

Available-for-salesecurities were classified in the Consolidated Balance Sheets as follows at December 31:

| ** **                                                                                                                       | ** ** | **2005**                | ** ** | **2004** | ** ** |
|----------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------|------------|----------|------------|
| ** **                                                                                                                       | ** ** | **(In thousands)** | ** ** |
| Short-term  investments in marketable debt securities                                                                            |       | $                       | 394,639    |     | $          | 394,112 |   |
| Non-current  investments in marketable debt securities.                                                                          |       | 722,717                 |       | 409,421  |       |
| Investments in  marketable equity securities, included in “Investments in equity securities  and affiliated companies” |       | 26,371                  |       | 71,522   |       |
|                                                                                                                             |       | $                       | 1,143,727  |     | $          | 875,055 |   |

 

The cost and estimated fair value ofavailable-for-sale debt securities by contractual maturity consisted of thefollowing at December 31, 2005:

| ** **                | ** ** | **Adjusted  Cost**      | ** ** | **Fair  Value** | ** ** |
|---------------------------|------------|-------------------------|------------|-----------------|------------|
| ** **                | ** ** | **(In thousands)** | ** ** |
| Due in one year  or less  |       | $                       | 389,846    |            | $          | 394,639 |   |
| Due in one to  five years |       | 729,993                 |       | 722,717         |       |
|                      |       | $                       | 1,119,839  |            | $          | 1,117,356 |   |

 

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**CHIRON CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) DECEMBER 31, 2005**

**Note 12—FairValue of Financial Instruments (Continued)**

Chiron had no tradingsecurities at December 31, 2005 and 2004.

*Other FinancialInstruments*

Thecarrying amounts and fair values of other financial instruments, were asfollows at December 31:

| ** **                                                  | ** ** | **2005**                | ** ** | **2004**            | ** ** |
|-------------------------------------------------------------|------------|-------------------------|------------|---------------------|------------|
| ** **                                                  | ** ** | **Carrying  Amount**    | ** ** | **Fair Value** | ** ** | **Carrying  Amount** | ** ** | **Fair Value** | ** ** |
| ** **                                                  | ** ** | **(In thousands)** | ** ** |
| Liquid Yield  Option Notes                                  |       | $                       | 48,288     |                | $          | 47,570 |   | $ | 47,336 |   | $ | 46,980 |   |
| Convertible  Debentures maturing in 2033                    |       | 500,000                 |       | 486,875             |       | 500,000 |   | 467,500 |   |
| Convertible  Debentures maturing in 2034                    |       | 385,000                 |       | 383,110             |       | 385,000 |   | 375,568 |   |
| Other notes  payable (see Note 13)                          |       | 5,945                   |       | 5,945               |       | 4,316 |   | 4,316 |   |
| *Derivative financial instruments:*                         |       |                    |       |                |       |   |   |   |   |
| Equity forward sales contracts (asset)                      |       | 3,163                   |       | 3,163               |       | 4,969 |   | 4,969 |   |
| Foreign currency forward contracts (asset)                  |       | 2,611                   |       | 2,611               |       | — |   | — |   |
| Foreign currency forward contracts (liability)              |       | —                  |       | —              |       | 10,395 |   | 10,395 |   |
| Foreign currency  forward contracts (non-current liability) |       | —                  |       | —              |       | 156 |   | 156 |   |
|                                                             |            |                         |            |                     |            |  |  |  |  |  |  |  |  |

 

The fair value estimates provided above were based oninformation available at December 31, 2005 and 2004. 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.

The fair value of LiquidYield Option Notes, Convertible Debentures maturing in 2033 and ConvertibleDebentures maturing in 2034 were based on the market price at the close ofbusiness on the last day of the fiscal year. Changes in the fair value of thesenotes have no effect on our financial position. The carrying value of othernotes payable approximated fair value due to the market based nature of theseinstruments. The fair values of the equity forward sales contracts and theforeign currency forward contracts were based on estimated market prices,determined by a broker. Included in current assets and current liabilities werecertain other financial instruments whose carrying values approximated fairvalue due to the short-term nature of such 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, 2005, 2004 and 2003 included net gains of $0.6million, $0.5 million and $0.5 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.

F-49

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**CHIRON CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) DECEMBER 31, 2005**

**Note 12—Fair Value ofFinancial Instruments (Continued)**

*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 $1.5 million, $(0.4) million and $5.5 millionin 2005, 2004 and 2003, 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 cashinterest feature of the Liquid Yield Option Notes is considered an embeddedderivative. The value of the embedded derivative is reassessed at each balancesheet date, and any change from the prior balance sheet date is reflectedcurrently in earnings. The change in the value of the embedded derivatives wasnot material for the years ended December 31, 2005, 2004 and 2003,respectively.

*Unrealized Losses*

Chiron’sunrealized loss position consisted of the following at December 31, 2005:

| ** **                                                                 | ** ** | **Unrealized loss position  for less than 12 months  prior to 12/31/05** | ** ** | **Unrealized loss position  for 12 months or longer  prior to 12/31/05** | ** ** | **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. |       | $                                                                                                                | 52,095     |                                                                                                             |       | $                    | (304       | ) |   | $ | 57,050 |   |   | $ | (242 | ) |   | $ | 109,145 |   |   | $ | (546 | ) |   |
| Municipal bonds                                                            |       | 62,355                                                                                                           |       |                                                                                                             | (550       | )                    |       | 37,698 |   |   | (512 | ) |   | 100,053 |   |   | (1,062 | ) |   |
| Corporate bonds                                                            |       | 419,265                                                                                                          |       |                                                                                                             | (974       | )                    |       | 18,428 |   |   | (86 | ) |   | 437,693 |   |   | (1,060 | ) |   |
| Subtotal, debt securities                                                  |       | 533,715                                                                                                          |       |                                                                                                             | (1,828     | )                    |       | 113,176 |   |   | (840 | ) |   | 646,891 |   |   | (2,668 | ) |   |
| Common Stock.                                                              |       | 437                                                                                                              |       |                                                                                                             | (158       | )                    |       | — |   |   | — |   |   | 437 |   |   | (158 | ) |   |
| Total temporarily  impaired securities                                     |       | $                                                                                                                | 534,152    |                                                                                                             |       | $                    | (1,986     | ) |   | $ | 113,176 |   |   | $ | (840 | ) |   | $ | 647,328 |   |   | $ | (2,826 | ) |   |
|                                                                            |            |                                                                                                                  |            |                                                                                                                  |            |                      |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

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.

F-50

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**CHIRON CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) DECEMBER 31, 2005**

**Note 13—DebtObligations**

Long-termdebt consisted of the following at December 31:

| ** **                                                                                      | ** ** | **2005**                | ** ** | **2004** | ** ** |
|-------------------------------------------------------------------------------------------------|------------|-------------------------|------------|----------|------------|
| ** **                                                                                      | ** ** | **(In thousands)** | ** ** |
| Convertible  Debentures maturing in 2034                                                        |       | $                       | 385,000    |     | $          | 385,000 |   |
| Convertible  Debentures maturing in 2033                                                        |       | 500,000                 |       | 500,000  |       |
| Liquid Yield  Option Notes, net of unamortized discount of $31,842 in 2005 and $32,794 in  2004 |       | 48,288                  |       | 47,336   |       |
| Other notes  payable                                                                            |       | 7,004                   |       | 6,757    |       |
| Current portion  of Liquid Yield Option Notes                                                   |       | (48,288                 | )          | —   |       |
| Current portion  of other notes payable                                                         |       | (1,059                  | )          | (2,441   | )          |
|                                                                                            |       | $                       | 890,945    |     | $          | 936,652 |   |

 

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

If the debentures are tendered for conversion, thevalue of cash and shares of Chiron’s common stock, if any, to be received by aholder converting $1,000 principal amount of the debentures (“Conversion Value”)will 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.

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.

F-51

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**CHIRON CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) DECEMBER 31, 2005**

**Note 13—DebtObligations (Continued)**

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.

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. Chiron expects that this event will occur as a result of its anticipatedmerger with Novartis.

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 Sheets at December 31, 2005 and 2004.

*Convertible DebenturesMaturing 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 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. TheFirst Supplemental Indenture modified certain provisions of the Indenturepertaining to the repurchase of the convertible debentures by Chiron at theoption of the holder at specified dates and under certain change in controltransactions, as discussed below. Under each of these modified provisions,Chiron has eliminated Chiron’s right to settle the repurchases with Chironcommon stock, so that all such repurchases shall 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 interestwill be 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.

F-52

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**CHIRON CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) DECEMBER 31, 2005**

**Note 13—DebtObligations (Continued)**

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. Chiron expects that this event will occur asa result of its anticipated merger with Novartis.

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 31,2005 and 2004.

*Liquid Yield OptionNotes*

In June 2001, Chiron issued zero coupon Liquid YieldOption Notes (LYONs) with a face value of $730.0 million and a yield tomaturity of 2.0%. The LYONs were carried net of an original issue discount of$328.2 million, which was being accreted to interest expense over the lifeof 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 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 31,2005, there remains outstanding $80.1 million in aggregate principalamount at maturity and an accreted balance of $48.3 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     |      |

 

F-53

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**CHIRON CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) DECEMBER 31, 2005**

**Note 13—DebtObligations (Continued)**

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. Since, at the optionof the holder, Chiron may be required to purchase all, or a portion, of theremaining LYONs on June 12, 2006, and Chiron’s intent is to settle thepurchase price in cash, the accreted balance of $48.3 million for the LYONs isincluded in the current portion of long-term debt in the Consolidated BalanceSheet at December 31, 2005.

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 expects that this eventwill occur as a result of its anticipated merger with Novartis.

Chiron may redeem all or a portion of the LYONs forcash at any time after June 12, 2006, at specified redemption prices.

The original bond issuancecosts of approximately $10.0 million were fully amortized as of December 31,2005.

*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 ($10.2 million at December 31,2005) for research purposes. Under these facilities, Chiron has an outstandingbalance of 5.9 million Euros ($7.0 million) as of December 31, 2005 withinterest rates that range from 2% to 6% and maturities that range from 2006 to 2013.Future maturities of other notes payable are as follows: 2006-$1.1 million;2007-$1.0 million; 2008-$1.3 million; 2009-$1.3 million; 2010-$0.9million and $1.4 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*

The $100.0 million revolving, committed,uncollateralized credit facility with a major financial institution expired in February 2006and was not renewed at Chiron’s election. This facility had been guaranteed byNovartis AG under a November 1994 Investment Agreement. There were noborrowings outstanding under this credit facility at December 31, 2005 and2004. In July 2003, Chiron entered into a new six-year lease to rent aresearch and development facility in Emeryville, California. Under provisions 

F-54

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**CHIRON CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) DECEMBER 31, 2005**

**Note 13—DebtObligations (Continued)**

of the November 1994Investment Agreement, Novartis AG guaranteed payments on this lease commitmentto a maximum of $175.0 million.

Under the terms of the Investment Agreement, Novartisagreed to guarantee certain Chiron obligations under revolving creditfacilities through January 1, 2008, the date on which the guarantee willexpire. The principal amount of indebtedness under the guaranteed creditfacilities outstanding at any one time may not exceed a specified cap. That capwas $402.5 million. In November 1996, Chiron and Novartis agreed thatChiron could increase the maximum borrowing amount under the guaranteed creditfacilities by up to $300.0 million, for a maximum borrowing amount under thecap of $702.5 million. In exchange for this increase, the amount of Chiron’scommon stock required to be purchased by a Novartis affiliate, at Chiron’srequest, under the Subscription Agreement, would be reduced by an equal amount.The maximum amount Novartis is required to guarantee pursuant to the terms ofthe Investment Agreement has been reduced by $109.8 million following anelection by Chiron in December 2005, to exercise its subscription rightsunder the Investment Agreement, decreasing the cap to $592.7 million.  Chiron also agreed to enter into a separateagreement with Novartis for each obligation guaranteed by Novartis under whichChiron agrees to reimburse Novartis for any payments made or out-of-pocketexpenses incurred by Novartis in connection with the guarantee (each, a “ReimbursementAgreement”). Chiron’s obligations under the Reimbursement Agreements are, atthe request of Novartis, to be fully secured by collateral (which meansguaranteed by assets pledged by Chiron) acceptable to Novartis. As discussedabove, through February 2006, Novartis guaranteed a $100.0 million U.S.credit facility for Chiron’s benefit for which there were no borrowingsoutstanding at December 31, 2005 and $173.3 million of Chiron’s capitallease commitments. The U.S. credit facility has since expired and at Chiron’selection was not renewed and is thus no longer guaranteed by Novartis. As aresult of these guarantees and the conversion of $9.8 million of bonds in 2000into shares of Chiron common stock, there remains approximately $417.7 millionof the guarantee available following the exercise of its subscription rightsand its subsequent election to increase the amount Novartis may be required toguarantee to the maximum borrowing amount.

Chiron also has variouscredit facilities available outside the U.S. There were no outstandingborrowings under these facilities at December 31, 2005 and 2004. Onefacility is maintained for our 51%-owned Indian subsidiary, and allows fortotal borrowings of 200 million Indian Rupees ($4.4 million at December 31,2005). There were no outstanding borrowings under this facility at December 31,2005 and 2004.

**Note 14—Commitmentsand Contingencies**

*Influenza virusvaccines*

In October 2004, the U.K. regulatory body, theMedicines and Healthcare products Regulatory Agency, or MHRA, suspended Chiron’slicense to manufacture FLUVIRIN® at Chiron’s Liverpool, U.K.facility. As a result of the suspension of Chiron’s license, Chiron did notrelease any FLUVIRIN® vaccine during the 2004-2005 influenzaseason. On March 2, 2005, the MHRA notified Chiron that it had lifted thelicense suspension, giving Chiron clearance to initiate full production ofFLUVIRIN® vaccine, conditioned on the understanding thatChiron’s commitment to its remediation plan will continue and will be subjectto further inspections by the MHRA. On October 17, 2005 Chiron initiateddelivery and release of FLUVIRIN® vaccine to customers in the United States forthe 2005-2006 influenza season. As of such 

F-55

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**CHIRON CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) DECEMBER 31, 2005**

**Note 14—Commitmentsand Contingencies (Continued)**

time, Chiron had receivedall necessary approvals from the U.S. Food and Drug Administration (FDA) andMHRA to start supplying FLUVIRIN® vaccine to the U.S. market.

Chiron received a grand jury subpoena issued by theU.S. Attorney’s Office for the Southern District of New York in October 2004requesting production of certain documents relating to FLUVIRIN® vaccine and the suspension by the MHRA ofChiron’s license. In February 2005, after having previously commenced aninformal inquiry, the Securities and Exchange Commission, or SEC, notifiedChiron that it would commence a formal investigation into whether Chiron or itsemployees violated any federal securities laws in connection with thesedevelopments regarding FLUVIRIN® vaccine, and Chiron subsequently receivedsubpoenas from the SEC requesting production of certain documents relating toits Liverpool facility and FLUVIRIN® vaccine. In February 2006, the SECnotified Chiron that it had decided to terminate its investigation, and that noenforcement action had been recommended against Chiron. Chiron also received avoluntary request for information from the United States House ofRepresentatives, Energy and Commerce Committee, Subcommittee on Oversight andInvestigations requesting production of certain documents. Numerous documentshave been collected and produced in response to these requests, and severalwitnesses have been interviewed by the U.S. Attorney’s Office, the SEC staffand Congressional staff. Additional investigations regarding these matters mayarise.

In addition, Chiron and certain of its officers anddirectors 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® vaccine. Certain distributors and otherparties with whom Chiron had contracted to supply FLUVIRIN® vaccine are considering or have communicatedclaims against Chiron as a result of Chiron’s 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, or CDC, terminated its contracts with Chiron for the supply ofFLUVIRIN® vaccine for default on the basis of Chiron’sfailure to supply such vaccine to the U.S. government for the 2004-2005influenza season. The CDC has reserved the right to hold Chiron liable for anyexcess costs it may have incurred in replacing any FLUVIRIN® vaccine that Chiron failed to deliver andfurther has reserved all other remedies provided under the contract. It is notpossible to predict whether any of these claims will be pursued and, if so,whether those claims will be upheld. Investigations, litigation and disputeshave caused Chiron to incur substantial expense and have required significanttime and attention from Chiron’s management and will continue to do so in thefuture and could result in civil action and/or criminal proceedings againstChiron. The results of any such investigations, proceedings or disputes couldhave a material adverse effect on Chiron’s consolidated financial position andresults of operations and/or cash flow.

Although the MHRA has lifted its suspension of Chiron’slicense to manufacture FLUVIRIN® vaccine, Chiron expects to incur additionalexpenses in connection with ongoing FLUVIRIN® vaccine matters, which could be material,including in connection with (1) Chiron’s continuing remediation effortsat its Liverpool facility; and (2) responding to private lawsuits and otherclaims and investigations that exist or may arise.

BEGRIVACTM vaccine ismanufactured at Chiron’s facility in Marburg, Germany. In July 2005,Chiron reported that it would be unable to supply any BEGRIVACTM vaccine dosesfor the 2005-2006 influenza season due to a product sterility issue andwrote off its existing product inventory resulting in charges of $18.0 millionto cost of sales for 2005. Investigation of the product sterility issue hasbeen 

F-56

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**CHIRON CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) DECEMBER 31, 2005**

**Note 14—Commitmentsand Contingencies (Continued)**

completedand implementation of remedial measures and facility modifications is underway.Chiron’s inability to supply BEGRIVACTM vaccine as planned to non-U.S. marketsfor the 2005-2006 influenza season or, if remedial efforts are delayed ornot successful, future seasons could have a material adverse affect on itsbusiness and results of operations. In addition, it is possible thatdistributors and other parties with whom Chiron had contracted to supplyinfluenza vaccine may make claims against Chiron as a result of Chiron notsupplying influenza vaccine. Any such claims may cause Chiron to incursubstantial expense and require significant time and attention from Chiron’smanagement. The results of any such claims could have a material adverse effecton Chiron’s consolidated financial position and results of operations and/orcash flow.

*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 Chiron’s influenzavaccines primary manufacturing facility in Liverpool, United Kingdom. The newmanufacturing facility will replace a portion of the existing influenzavaccines manufacturing facilities in Liverpool, United Kingdom and isanticipated to be available in 2009 for the manufacture of influenza vaccines,subject to regulatory approval. In December 2003, Chiron entered into a 25-yearlease for the building. As of December 31, 2005, Chiron has incurred $23.0 millionfor the capital improvements portion of the 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 34.6 million Euro($41.0 million at December 31, 2005) for the expansion of Chiron’s Italianmanufacturing facilities, of which Chiron had incurred costs of 33.9 millionEuro ($40.2 million), as of December 31, 2005. This agreement began in thefourth quarter 2001 and is expected to continue through 2006.

Chiron had various otherfirm purchase and capital project commitments totaling approximately $43.9 millionat December 31, 2005.

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**CHIRON CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) DECEMBER 31, 2005**

**Note 14—Commitmentsand Contingencies (Continued)**

*Operating Leases*

Chironleases laboratory, office and manufacturing facilities, land and equipmentunder noncancelable operating leases, which expire through 2015. Rent expense,net of sublease income, from continuing operations was $40.2 million,$41.1 million and $37.7 million in 2005, 2004 and 2003, respectively.Future minimum lease payments under these leases, net of future minimumpayments to be received under subleases, are as follows:

| ** ** | ** ** | **(In millions**) | ** ** |
|------------|------------|------------------------|------------|
| 2006       |       |                   | $          | 32.2 |   |   |
| 2007       |       |                   | 27.5       |   |   |
| 2008       |       |                   | 23.6       |   |   |
| 2009       |       |                   | 18.9       |   |   |
| 2010       |       |                   | 17.4       |   |   |
| Thereafter |       |                   | 81.2       |   |   |

 

There were no rentals tobe received under noncancelable subleases as of December 31, 2005.

*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 asset and the corresponding liability of$157.5 million on its balance sheet. This amount represents the present valueof minimum lease payments, including the residual value guarantee. The leaseprovides a $156.0 million residual value guarantee from Chiron to the lessorsin the event fair value of the R&D Property declines below the totalinvestment of $173.3 million made by the lessors in the R&D Property.Consequently, Chiron’s maximum payment obligation is $156.0 million upontermination of the lease on or before July 1, 2009. When the leaseagreement includes a residual value guarantee, Chiron uses the following methodto estimate amortization of the leased asset. First Chiron determines theamount that may become payable to the lessor at the end of the lease term dueto a decline in the estimated fair value of the leased asset below the lessor’stotal investment of $173.3 million. The leased asset is then amortized using astraight-line method to an amount such that the capital lease liability, net ofthe book value of the amortized leased asset at the end of the lease termequals the amount payable to the lessor. Chiron estimated the fair value of theR&D Property at the end of the lease term will be approximately$168.9 million. The fair value at the end of the lease term was estimatedusing the cost approach in which appraised value at lease inception is modifiedby estimates for building cost appreciation and building component depreciationthrough the six-year lease term.

This valuation requires significant estimates andassumptions. Chiron believes the fair value assigned is based on reasonableassumptions. Aggregate amortization of the leased asset over the term of thelease is estimated to be approximately $6.0 million. For the years ended December 31,2005, 2004 and 2003, $1.0 million, $1.0 million and $0.5 million,respectively, were recorded as amortization expense for the capital lease.

F-58

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**CHIRON CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) DECEMBER 31, 2005**

**Note 14—Commitmentsand Contingencies (Continued)**

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 $175.0 million.

Property,plant and equipment includes the following amounts for assets subject tocapital leases:

| ** **                     | ** ** | **2005**                | ** ** | **2004** | ** ** |
|--------------------------------|------------|-------------------------|------------|----------|------------|
| ** **                     | ** ** | **(In thousands)** | ** ** |
| Buildings                      |       | $                       | 157,500    |     | $          | 157,500 |   |
| Less accumulated  depreciation |       | (2,500                  | )          | (1,500   | )          |
|                           |       | $                       | 155,000    |     | $          | 156,000 |   |

 

Future minimum leasepayments and residual value guarantee under the capital lease obligations areas follows:

| ** **                                                               | ** ** | **(In thousands)** | ** ** |
|--------------------------------------------------------------------------|------------|-------------------------|------------|
| 2006                                                                     |       |                    | $          | 2,624 |   |   |
| 2007                                                                     |       |                    | 2,624      |   |   |
| 2008                                                                     |       |                    | 2,624      |   |   |
| 2009                                                                     |       |                    | 157,922    |   |   |
| Total minimum  lease payments and residual value guarantee               |       |                    | 165,794    |   |   |
| Amounts representing interest                                            |       |                    | (8,885     | ) |   |
| Present value of net  minimum lease payment and residual value Guarantee |       |                    | $          | 156,909 |   |   |

 

Theabove capital lease obligations have been reflected in the accompanyingconsolidated Balance Sheets as follows:

| ** **                          | ** ** | **2005**                | ** ** | **2004** | ** ** |
|-------------------------------------|------------|-------------------------|------------|----------|------------|
| ** **                          | ** ** | **(In thousands)** | ** ** |
| Current portion  of capital lease   |       | $                       | 248        |     | $          | 246 |   |
| Long-term portion  of capital lease |       | 156,661                 |       | 156,952  |       |
|                                |       | $                       | 156,909    |     | $          | 157,198 |   |

 

*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 

F-59

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**CHIRON CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) DECEMBER 31, 2005**

**Note 14—Commitmentsand Contingencies (Continued)**

agreements,which expired on December 31, 2001, Chiron was obligated to pay royaltieson sales of certain therapeutic products in the U.S. and certain diagnosticproducts worldwide, as well as a portion of license, distribution or other feeswith respect to such products, to the former limited partners of CetusHealthcare Limited Partnership. Under the Cetus Healthcare Limited PartnershipII purchase agreements, which expired on December 31, 2005, Chiron was obligatedto pay royalties and a portion of other income with respect to sales of certainproducts in Europe to the former limited partners of Cetus Healthcare LimitedPartnership II. Under these partnerships, Chiron paid royalties of $3.1million, $3.0 million and $2.8 million for the years ended December 31,2005, 2004 and 2003, 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 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 was paidas 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 fund75% of XOMA’s share of development expenses. Under this arrangement, Chironmade $12.1 million in loan advances to XOMA as of December 31, 2005. Interestpayable by XOMA is due when the principal is due and is additive to the $50.0million available principal. Interest payable of $0.3 million was added to theoutstanding balance as of December 31, 2005. The loan advances arerecorded at their fair value based upon an interest rate for a similar loanfacility from a bank to a similar counterparty. The recorded amount will beaccreted to full face value over the life of the outstanding facility based onthe effective interest method. At December 31, 2005, $7.1 million wasrecorded as “Non-current notes receivable” in the Consolidated Balance Sheetfor these loan advances.

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 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$20.5 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 after the third year with eighteen month’s notice. At December 31,2005, Chiron’s minimum purchase obligation under this agreement over the nexteighteen months is expected to be $17.5 million.

F-60

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**CHIRON CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) DECEMBER 31, 2005**

**Note 14—Commitmentsand Contingencies (Continued)**

In connection with the production of Chiron’sinfluenza vaccine products, Chiron must purchase large quantities of incubatedfertile chicken eggs. Currently, for FLUVIRIN® influenza vaccine, Chiron purchases those eggsand incubation services from a single supplier in the United Kingdom and,pursuant to the contract with that supplier, Chiron has agreed to makespecified purchases of 10.6 million British Pounds ($18.3 million at December 31,2005) each year from that supplier through 2012, subject to Chiron’s right toterminate this agreement earlier upon payment of a termination fee. To ensurethat the incubation of the eggs is the appropriate standard for vaccinemanufacturing, Chiron acquired assets of the primary incubation facility fromthe egg supplier in December 2005.

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 advance made under thisrevolving line of credit matures on the sixth anniversary of the initialadvance. As of December 31, 2005, Nektar Therapeutics has not drawn fromthe revolving line of credit.

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 agreed to fund the Med Parties up to $1.5 million through2003 to acquire the tools and equipment to manufacture the presentation device,of which Chiron has paid $1.5 million as of December 31, 2005. Inaddition, under this agreement, Chiron has minimum purchase requirements.Chiron’s minimum purchase obligation for the next two years is approximately$11.9 million. Chiron can terminate the agreement subject to twelve month’snotification. 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 with purchasing and delivery services. Effective June 2005,Chiron amended this agreement for a new term through 2012. Chiron can terminatethis agreement at any time with six month’s notice. If Chiron does notterminate this agreement, payments to VWR are expected to be approximately $6.5million, of which approximately $0.5 million was paid in 2005. Under theamendment, Chiron has the option to renew the agreement for an additional threeyears at the end of the new termination date in 2012.

In 2003, Chiron became a limited partner of BurrillLife Sciences Capital Fund, L.P. Chiron agreed to pay $10.0 million oversix years, of which $4.7 million has been paid through December 31,2005 for a 5.14% ownership. In 2003, Chiron became a limited partner of ForwardVenture V, L.P. Chiron agreed to pay $5.0 million over five years, ofwhich $0.6 million has been paid through December 31, 2005, for a3.45% ownership. In 2002, Chiron became a limited partner of TPG BiotechnologyPartners, L.P. Chiron agreed to pay $5.0 million over ten years, of which$2.8 million has been paid through December 31, 2005, for a 2.83%ownership. In 2001, Chiron became a limited partner of Forward Venture IV, L.P.Chiron agreed to pay $15.0 million over ten years, of which $13.1 millionhas been paid through December 31, 2005, for a 6.35% ownership. In 2000,Chiron became a limited partner of Burrill Biotechnology Capital Fund, L.P. 

F-61

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**CHIRON CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) DECEMBER 31, 2005**

**Note 14—Commitmentsand Contingencies (Continued)**

Chiron agreed to pay$25.0 million over five years, of which $21.7 million has been paidthrough December 31, 2005, 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, 2005 totaled $2.1 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,subject to certain termination charges. At December 31, 2005, minimumfuture payments to IBM are expected to be approximately $39.6 million. Paymentsto IBM are subject to adjustment depending upon the levels of services andinfrastructure equipment provided by IBM, as well as inflation.

At December 31, 2005 Chiron had $14.8 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 $21.3 millionavailable at December 31, 2005. There are no amounts outstanding underthese letters of credit at December 31, 2005.

Chiron had noncancelable purchase orders for ongoingoperations of $74.2 million at December 31, 2005.

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. Chiron’s self-insurance liability at December 31,2005, 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, 2005.

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 31,2005. 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 party tovarious 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 

F-62

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**CHIRON CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) DECEMBER 31, 2005**

**Note 14—Commitmentsand Contingencies (Continued)**

could have a materialadverse impact in any future period, management does not believe, based uponinformation known to it, that the final resolution of any of these ordinarycourse matters will have a material adverse effect upon Chiron’s consolidatedfinancial position and results of operations or cash flows.

Chiron’s tax filings are presently under examinationin several domestic and international tax jurisdictions. While there is noassurance that Chiron will prevail in all tax examinations in the event thetaxing authorities disagree with Chiron’s interpretation of the tax law, Chiron’smanagement does not believe, based upon information known to it, that the finalresolution of any of these audits will have a material adverse effect uponChiron’s consolidated financial position and results of operations or cashflows. Adequate provisions have been made for these tax examinations.

**Note 15—Stockholders’ Equity**

*Stock CompensationPlan*

The Chiron 2004 Stock Compensation Plan, as amendedand restated on February 13, 2004 (“Plan”), formerly the Chiron 1991 StockOption 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 Program,which 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, such stock options (which are included in the below tables) in2003. No stock options were awarded in 2005 and 2004 pursuant to the ExecutiveLong-Term Incentive Program. At December 31, 2005 and 2004, 893,400 stockoptions were exercisable under the Executive Long-Term Incentive Program. AtDecember 31, 2003, 380,200 stock options were exercisable under theExecutive Long-Term Incentive Program. Because they are granted with anexercise price equal to fair market value, Chiron does not record compensationexpense related to these stock options.

F-63

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**CHIRON CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) DECEMBER 31, 2005**

**Note 15—Stockholders’Equity (Continued)**

During 2005 and 2004, certain executives receivedperformance based share rights awards. These share rights awards entitle theparticipant to receive shares upon the attainment of certain pre-establishedperformance goals as established by the Compensation Committee of the Board ofDirectors. In accordance with Accounting Principles Board Opinion No. 25, *Accounting for Stock Issued to Employees*(Opinion No. 25), compensation expense related to these awards is based onthe extent to which the performance criteria are met. No such expense wasrecognized in 2005 or 2004. There were 151,000 and 122,000 performance basedshare rights awards granted in 2005 and 2004, respectively; no shares wereissued in 2005 or 2004 under such awards.

In 2005, the Compensation Committee awarded certainkey individuals an aggregate of 402,175 share rights that vest over four yearsof service, and also awarded 42,975 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 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. The intrinsic value of the share rights is recognizedratably over the related vesting periods. In 2005, 2004 and 2003, Chironrecognized $6.3 million, $7.6 million and $7.4 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.Pursuant to this program, eligible employees may purchase shares of Chironcommon stock over a 3-month offering period through payroll deductions. Atthe end of each quarter, funds deducted from participating employees’ salariesare used to purchase common stock at 90% of the fair market value per share onthe quarterly purchase date. Prior to April 1, 2005, the purchase pricewas 85% of the lower of market value at the quarterly purchase date or theemployees’ date of participation in the offering period. Purchases of sharesmade under the program (including purchases under the 1997 Employee StockPurchase Plan prior to its incorporation into the Plan) were 0.3 million,0.4 million and 0.3 million in 2005, 2004 and 2003, respectively. Up to6.4 million shares may be issued under the Purchase Program.

At December 31, 2005, 79.2 million shares ofChiron’s common stock have been reserved for issuance over the term of the Planand 16.7 million shares were available for future awards under the Plan.

The aggregate number ofshares of Chiron’s common stock that may be issued under the Plan will beincreased on the first trading day of January of each fiscal year(beginning in 2004) by the lesser of 1.0% of the number of Chiron commonequivalent shares outstanding as of the last day of the preceding fiscal yearor 3.0 million shares.

F-64

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**CHIRON CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) DECEMBER 31, 2005**

**Note 15—Stockholders’ Equity (Continued)**

A summary of stock optionand share right activity is as follows:

| ** **                                                                                                                | ** ** | **2005**   | ** ** | **2004**   | ** ** | **2003**   | ** ** |
|---------------------------------------------------------------------------------------------------------------------------|------------|------------|------------|------------|------------|------------|------------|
| Outstanding  options and share rights at January 1,                                                                  |       | 27,257,292 |       | 27,145,205 |       | 25,985,907 |       |
| Granted                                                                                                                   |       | 6,506,090  |       | 6,234,969  |       | 7,236,493  |       |
| Forfeited                                                                                                                 |       | (3,457,968 | )          | (3,858,974 | )          | (1,710,648 | )          |
| Exercised                                                                                                                 |       | (2,529,783 | )          | (2,263,908 | )          | (4,366,547 | )          |
| Outstanding  options and share rights at December 31,                                                                |       | 27,775,631 |       | 27,257,292 |       | 27,145,205 |       |
| Options  exercisable at December 31,                                                                                 |       | 15,434,082 |       | 14,953,563 |       | 12,913,430 |       |
| Weighted average  exercise price of:                                                                                      |       |       |       |       |       |       |       |
| Outstanding  options at December 31,                                                                                 |       | $          | 39.87      |       | $          | 40.85      |       | $ | 39.56 |   |
| Options granted                                                                                                           |       | $          | 32.25      |       | $          | 42.08      |       | $ | 43.11 |   |
| Options forfeited                                                                                                         |       | $          | 43.61      |       | $          | 43.78      |       | $ | 43.66 |   |
| Options exercised                                                                                                         |       | $          | 25.96      |       | $          | 23.74      |       | $ | 27.68 |   |
| Weighted-average  grant-date fair value of options granted during the year calculated pursuant  to SFAS No. 123      |       | $          | 9.53       |       | $          | 19.35      |       | $ | 24.47 |   |
| Weighted-average  grant-date fair value of share rights granted during the year calculated  pursuant to SFAS No. 123 |       | $          | 34.09      |       | $          | 45.29      |       | $ | 44.20 |   |

 

The weighted-averagegrant-date fair value of each option and share right grant was estimated usingthe Black-Scholes-Merton formula. In 2005, in anticipation of adopting SFAS 123(R) onJanuary 1, 2006, Chiron evaluated the variables used in theBlack-Scholes-Merton formula and as a result, adjusted its computation ofexpected life to be more representative of actual future exercising patternsand adjusted its computation of volatility to be more representative of futureexpected volatility. The weighted average assumptions used in the model were asfollows: expected volatility of 27%, 43% and 61% for 2005, 2004 and 2003,respectively; risk-free interest rates of 4.1%, 3.6% and 3.3% for 2005, 2004and 2003, respectively; and an average expected life of 4 years for 2005,5 years for 2004 and 6 years for 2003. No dividends were factoredinto the calculation in 2005, 2004 or 2003.

The following table summarizes information concerningoptions and share rights at December 31, 2005:

| ** **                                  | ** ** | **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 $38                               |       | 11,048,620      |       |                    | 7.30       |   |   |   | $ | 30.29 |   |   | 3,808,497 |   |   | $ | 28.97 |   |   |
| $38 to $42                                  |       | 4,896,912       |       |                    | 7.76       |   |   |   | 40.72 |   |   | 2,643,585 |   |   | 40.01 |   |   |
| $42 to $47                                  |       | 5,763,895       |       |                    | 6.07       |   |   |   | 45.03 |   |   | 4,699,229 |   |   | 45.21 |   |   |
| $47 to $57                                  |       | 6,066,204       |       |                    | 6.72       |   |   |   | 51.73 |   |   | 4,282,771 |   |   | 51.99 |   |   |
|                                        |       | 27,775,631      |       |                    | 7.00       |   |   |   | 39.87 |   |   | 15,434,082 |   |   | 42.20 |   |   |
|                                             |            |                 |            |                         |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

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**CHIRON CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) DECEMBER 31, 2005**

**Note 15—Stockholders’Equity (Continued)**

Purchase rights grantedunder the Purchase Program are not included in the table above. Theweighted-average grant-date fair value of these purchase rights was estimatedusing the Black-Scholes Merton formula and the following assumptions: expectedvolatility of 24%, 32% and 23% for 2005, 2004 and 2003, respectively; risk-freeinterest rates of 4.4%, 2.8% and 1.3% for 2005, 2004 and 2003, respectively;and an average expected life of one year for 2005, 2004 and 2003. No dividendswere factored into the calculation in 2005, 2004 and 2003, respectively. Theweighted-average fair value of the purchase rights granted were $7.98, $11.00and $11.18 per share in 2005, 2004 and 2003, 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 year ended December 31, 2003, Chironrecorded a premium of $2.1 million for contracts which expired, andpurchased 0.2 million shares in connection with the put option program. Asof December 31, 2005 and 2004, Chiron had no outstanding put options.

*Stock RepurchaseProgram*

Since 2001, Chiron’s Boardof Directors has authorized the repurchase of Chiron common stock on the openmarket to offset the dilution associated with the operation of the stock optionand employee stock purchase programs and the granting of share rights. On December 5,2003, the Board of Directors authorized Chiron to repurchase 5.0 millionshares of Chiron common stock through December 31, 2004. Through December 31,2004, Chiron made purchases of 2.9 million shares. On March 10, 2005, theBoard of Directors authorized Chiron to repurchase 5.0 million shares of Chironcommon stock through December 31, 2005. There were no share repurchases in2005.

**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 maintains aSupplemental Executive Retirement Plan that is closed to new employees and isgrandfathered under IRC 409A. Chiron also sponsors a Supplemental RetirementProgram, which allows certain levels of U.S. executives to defer up to 25% oftheir eligible compensation. These executives may also defer an additional 100%of their annual bonuses. Chiron matched employee contributions according tospecified formulas and contributed $12.6 million, $10.7 million, and$9.3 million in 2005, 2004 and 2003, respectively, related to these plans.

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**CHIRON CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) DECEMBER 31, 2005**

**Note 16—OtherEmployee Benefit Plans (Continued)**

*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:

| ** **                 | ** ** | **2005**                | ** ** | **2004** | ** ** | **2003** | ** ** |
|----------------------------|------------|-------------------------|------------|----------|------------|----------|------------|
| ** **                 | ** ** | **(In thousands)** | ** ** |
| Service cost               |       | $                       | 828        |     | $          | 571      |       | $ | 404 |   |
| Interest cost              |       | 914                     |       | 749      |       | 717      |       |
| Termination  benefits      |       | —                  |       | —   |       | 31       |       |
| Recognized  actuarial loss |       | 201                     |       | 135      |       | 45       |       |
|                       |       | $                       | 1,943      |     | $          | 1,455    |       | $ | 1,197 |   |

 

The measurement dates forthe plan obligation were December 31, 2005, 2004 and 2003. The change inthe projected benefit obligation, reconciliation of funded status and weightedaverage assumptions were as follows for the years ended December 31:

| ** **                                        | ** ** | **2005**                | ** ** | **2004** | ** ** | **2003** | ** ** |
|---------------------------------------------------|------------|-------------------------|------------|----------|------------|----------|------------|
| ** **                                        | ** ** | **(In thousands)** | ** ** |
| Change in projected  benefit obligation:          |       |                    |       |     |       |     |       |
| Projected benefit obligation at beginning of year |       | $                       | 18,720     |     | $          | 14,425   |       | $ | 12,310 |   |
| Service cost                                      |       | 828                     |       | 571      |       | 404      |       |
| Interest cost                                     |       | 914                     |       | 749      |       | 717      |       |
| Benefits paid                                     |       | (548                    | )          | (447     | )          | (380     | )          |
| Actuarial (gain) loss                             |       | 1,419                   |       | 1,573    |       | (742     | )          |
| Transfer                                          |       | —                  |       | —   |       | (563     | )          |
| Other                                             |       | 594                     |       | 311      |       | 286      |       |
| Foreign currency translation                      |       | (2,602                  | )          | 1,538    |       | 2,393    |       |
| Projected benefit obligation at end of year       |       | $                       | 19,325     |     | $          | 18,720   |       | $ | 14,425 |   |
| Reconciliation of  funded status:                 |       |                    |       |     |       |     |       |
| Funded status                                     |       | $                       | (19,325    | )        | $          | (18,720  | )          | $ | (14,425 | ) |
| Unrecognized actuarial loss                       |       | 4,509                   |       | 3,837    |       | 2,092    |       |
| Unrecognized prior service cost                   |       | (8,397                  | )          | (4,455   | )          | (2,952   | )          |
| Net amount  recognized                            |       | $                       | (23,213    | )        | $          | (19,338  | )          | $ | (15,285 | ) |
| Weighted average  assumptions:                    |       |                    |       |     |       |     |       |
| Discount rate                                     |       | 4.25                    | %          | 5.25     | %          | 5.00     | %          |
| Rate of  compensation increase                    |       | 2.25                    | %          | 2.50     | %          | 2.75     | %          |

 

F-67

----

**CHIRON CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) DECEMBER 31, 2005**

**Note 16—Other Employee Benefit Plans (Continued)**

The amounts recognized inthe Consolidated Balance Sheets were as follows at December 31:

| ** **                              | ** ** | **2005**                | ** ** | **2004** | ** ** | **2003** | ** ** |
|-----------------------------------------|------------|-------------------------|------------|----------|------------|----------|------------|
| ** **                              | ** ** | **(In thousands)** | ** ** |
| Accrued pension  cost                   |       | $                       | 14,816     |     | $          | 14,883   |       | $ | 12,333 |   |
| Accumulated other  comprehensive income |       | 8,397                   |       | 4,455    |       | 2,952    |       |
|                                    |       | $                       | 23,213     |     | $          | 19,338   |       | $ | 15,285 |   |

 

The accumulated benefitobligation was $22.4 million and $18.3 million at December 31, 2005 and2004, respectively.

*Contributions*

Chiron expects tocontribute $4.5 million to this pension plan in 2006.

*Estimated Future Benefit Payments*

| ** ** | ** ** | **Estimated Future  Benefit Payments at  December 31, 2005** | ** ** |
|------------|------------|---------------------------------------------------------------------------------------|------------|
| ** ** | ** ** | **(In thousands)**                                                               | ** ** |
| 2006       |       |                                                                                  | $          | 511 |   |   |
| 2007       |       |                                                                                  | 586        |   |   |
| 2008       |       |                                                                                  | 633        |   |   |
| 2009       |       |                                                                                  | 691        |   |   |
| 2010       |       |                                                                                  | 764        |   |   |
| 2011-2015  |       |                                                                                  | 4,985      |   |   |

 

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 of pensionableearnings if the defined benefit plan is in a deficit position. Thesecontributions are determined by a qualified independent actuary based on anannual valuation.

Thecomponents of net periodic pension costs for these defined benefit plans are asfollows for the years ended December 31:

| ** **                      | ** ** | **2005**                | ** ** | **2004** | ** ** | **2003** | ** ** |
|---------------------------------|------------|-------------------------|------------|----------|------------|----------|------------|
| ** **                      | ** ** | **(In thousands)** | ** ** |
| Service cost                    |       | $                       | 1,893      |     | $          | 1,896    |       | $ | 903 |   |
| Interest cost                   |       | 1,438                   |       | 1,396    |       | 606      |       |
| Expected return  on plan assets |       | (1,258                  | )          | (1,090   | )          | (422     | )          |
| Recognized  actuarial loss      |       | —                  |       | —   |       | 191      |       |
|                            |       | $                       | 2,073      |     | $          | 2,202    |       | $ | 1,278 |   |

 

F-68

----

**CHIRON CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) DECEMBER 31, 2005**

**Note 16—Other Employee Benefit Plans (Continued)**

The measurement dates forthe plan assets and the plan obligation were December 31, 2005, 2004 and2003. The change in the projected benefit obligations, change in the fair valueof plan assets, reconciliation of funded status and weighted averageassumptions of these defined benefit plans are as follows for the years ended December 31:

| ** **                                          | ** ** | **2005**                | ** ** | **2004** | ** ** | **2003**   | ** ** |
|-----------------------------------------------------|------------|-------------------------|------------|----------|------------|------------|------------|
| ** **                                          | ** ** | **(In thousands)** | ** ** |
| Change in  projected benefit obligation:            |       |                    |       |     |       |       |       |
| Projected benefit obligation at beginning of period |       | $                       | 27,617     |     | $          | 28,683     |       | $ | 22,685 |   |
| Service cost                                        |       | 1,893                   |       | 1,896    |       | 903        |       |
| Interest cost                                       |       | 1,438                   |       | 1,396    |       | 606        |       |
| Benefits paid                                       |       | (178                    | )          | (158     | )          | (60        | )          |
| Actuarial loss                                      |       | 8,447                   |       | 574      |       | 1,339      |       |
| Other                                               |       | —                  |       | —   |       | 1,012      |       |
| Divestiture(1)                                      |       | —                  |       | (6,649   | )          | —     |       |
| Foreign currency translation                        |       | (3,337                  | )          | 1,875    |       | 2,198      |       |
| Projected benefit obligation at end of year         |       | $                       | 35,880     |     | $          | 27,617     |       | $ | 28,683 |   |
| Change in the fair value of plan assets:            |       |                    |       |     |       |       |       |
| Fair Value of plan assets at beginning of period    |       | $                       | 17,165     |     | $          | 15,162     |       | $ | 10,679 |   |
| Actual return on plan assets                        |       | 3,857                   |       | 1,516    |       | 1,501      |       |
| Employee contributions                              |       | 373                     |       | 370      |       | 171        |       |
| Employer contributions                              |       | 1,296                   |       | 1,367    |       | 754        |       |
| Other                                               |       | —                  |       | —   |       | 976        |       |
| Benefits paid                                       |       | (178                    | )          | (178     | )          | (31        | )          |
| Divestiture(1)                                      |       | —                  |       | (2,216   | )          | —     |       |
| Foreign currency translation                        |       | (1,977                  | )          | 1,144    |       | 1,112      |       |
|                                                |       | $                       | 20,536     |     | $          | 17,165     |       | $ | 15,162 |   |
| Reconciliation of  funded status:                   |       |                    |       |     |       |       |       |
| Funded status                                       |       | $                       | (15,344    | )        | $          | (10,452    | )          | $ | (13,521 | ) |
| Unrecognized actuarial loss                         |       | 6,755                   |       | 638      |       | 8,636      |       |
| Net amount  recognized                              |       | $                       | (8,589     | )        | $          | (9,814     | )          | $ | (4,885 | ) |
| Weighted average assumptions:                       |       |                    |       |     |       |       |       |
| Discount rate                                       |       | 4.80                    | %          | 5.30     | %          | 5.25%-5.40 | %          |
| Rate of compensation increase                       |       | 4.30                    | %          | 4.30     | %          | 3.00       | %          |
| Expected  long-term rate of return on plan assets   |       | 6.76                    | %          | 7.38     | %          | 7.00%-7.75 | %          |

----

(1)          In 2004, Chiron divestedcertain research operations in Sweden, which included the associated pensionplan (Note 5). The remaining benefit plan is associated with operations in theUnited Kingdom.

F-69

----

**CHIRON CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) DECEMBER 31, 2005**

**Note 16—OtherEmployee Benefit Plans (Continued)**

The amounts recognized inthe Consolidated Balance Sheets for these benefit plans were as follows at December 31:

| ** **                              | ** ** | **2005**                | ** ** | **2004** | ** ** | **2003** | ** ** |
|-----------------------------------------|------------|-------------------------|------------|----------|------------|----------|------------|
| ** **                              | ** ** | **(In thousands)** | ** ** |
| Accrued pension  cost                   |       | $                       | 8,589      |     | $          | 9,814    |       | $ | 4,885 |   |
| Accumulated other  comprehensive income |       | —                  |       | —   |       | —   |       |
|                                    |       | $                       | 8,589      |     | $          | 9,814    |       | $ | 4,885 |   |

 

The accumulated benefitobligation was $28.8 million and $22.7 million at December 31, 2005 and2004, respectively.

** **

*Plan Assets*

| ** **         | ** ** | **Plan Assets at  December 31,** | ** ** |
|--------------------|------------|-------------------------------------------------|------------|
| ** **         | ** ** | **2005**                                        | ** ** | **2004** | ** ** | **2003** | ** ** |
| ** **         | ** ** | **(In thousands)**                         | ** ** |
| **Asset Category** |       |                                            |       |   |   |   |   |
| Equity securities  |       | $                                               | 18,208     |   | $ | 16,255 |   | $ | 12,823 |   |
| Debt securities    |       | 2,183                                           |       | 695 |   | 89 |   |
| Other              |       | 145                                             |       | 215 |   | 2,250 |   |
| Total              |       | $                                               | 20,536     |   | $ | 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 $3.3 million to this pension plan in 2006.

F-70

----

**CHIRON CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) DECEMBER 31, 2005**

**Note 16—OtherEmployee Benefit Plans (Continued)**

*Estimated Future Benefit Payments*

| ** ** | ** ** | **Estimated Future  Benefit Payments at  December 31, 2005** | ** ** |
|------------|------------|---------------------------------------------------------------------------------------|------------|
| ** ** | ** ** | **(In thousands)**                                                               | ** ** |
| 2006       |       |                                                                                  | $          | 109 |   |   |
| 2007       |       |                                                                                  | 167        |   |   |
| 2008       |       |                                                                                  | 311        |   |   |
| 2009       |       |                                                                                  | 521        |   |   |
| 2010       |       |                                                                                  | 599        |   |   |
| 2011-2015  |       |                                                                                  | 2,613      |   |   |

 

*Post EmploymentBenefits Other Than to Retirees*

In December 2003, the Board of Directors approvedan executive severance plan for its U.S. based executive officers, excludingthe Chairman, Chief Executive Officer and certain other executives withemployment agreements. The plan provides a single level of coverage for allexecutives who, as a result of workforce reduction or job elimination, losetheir positions with Chiron. The severance benefit is equivalent to 6 weekssalary and target bonus per year of service with a minimum payment of 26 weeksand maximum payment of 104 weeks severance, plus various insurance coverage.

In February 2001, the Board of Directors approveda change in control severance plan for its U.S. based executive officers. Theplan provides for three levels of coverage: Tier 1 is applicable to theChief Executive Officer and provides a change in control severance benefit ofthree times 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 U.S. based executives andprovides a change in control severance benefit equal to one time base salaryand bonus plus various insurance coverage.

Effective October 1, 1997 (restated October 15,1998), Chiron adopted the Chiron Corporation Severance Plan (amended andrestated December 2005), which provides certain post employment salary andemployee benefits to U.S. based employees who are involuntarily terminated as aresult of a workforce reduction or job elimination.

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 EmploymentBenefits*. Amounts accrued under these plans in 2005 and 2004 werenot material.

F-71

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**CHIRON CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) DECEMBER 31, 2005**

**Note 17—Non-OperatingIncome and Expense**

*Interestand Other Income, Net*

“Interest and otherincome, net” in the Consolidated Statements of Operations consisted of thefollowing for the years ended December 31:

| ** **                                                     | ** ** | **2005**                | ** ** | **2004** | ** ** | **2003** | ** ** |
|----------------------------------------------------------------|------------|-------------------------|------------|----------|------------|----------|------------|
| ** **                                                     | ** ** | **(In thousands)** | ** ** |
| Interest income                                                |       | $                       | 36,961     |     | $          | 23,359   |       | $ | 23,187 |   |
| Write-down of  equity securities (see Notes 1 and 9)      |       | (1,267                  | )          | (1,431   | )          | —   |       |
| Net gain (loss)  on sale of marketable debt securities         |       | (307                    | )          | 99       |       | 895      |       |
| Net gain on sale  of equity securities                         |       | 44,290                  |       | 34,265   |       | 9,370    |       |
| Gain on sale of  interests in affiliated companies (see below) |       | —                  |       | 4,183    |       | 2,012    |       |
| Patent settlement  (see below)                                 |       | 6,000                   |       | —   |       | —   |       |
| Net realized gain  (loss) on foreign exchange transactions     |       | 1,506                   |       | (360     | )          | 5,451    |       |
| Equity in loss of  equity method investments (see below)       |       | (2,518                  | )          | (3,726   | )          | (2,325   | )          |
| Other income                                                   |       | 2,027                   |       | 408      |       | 302      |       |
|                                                           |       | $                       | 86,692     |     | $          | 56,797   |       | $ | 38,892 |   |

 

In the second quarter of2005, Chiron recognized a $6.0 million settlement regarding a dispute with acompetitor regarding certain Chiron patents.

In December 1998,Chiron completed the sale of its 30% interest in General Injectibles &Vaccines, Inc. to Henry Schein, Inc. and received payment in full ofcertain advances made by Chiron to General Injectibles & Vaccines. Theagreement also provided for Chiron to receive additional payments, calculatedas a pre-determined percentage of the gross profit of products contributed byGeneral Injectibles & Vaccines to Henry Schein, through 2003. Chironreceived $4.2 million and $2.0 million in 2004 and 2003,respectively, which was included in gain on sale of interests in affiliatedcompanies.

As discussed in Note 1, Chiron is a limitedpartner in several venture capital funds. Chiron accounts for these investmentsunder the equity method of accounting pursuant to Emerging Issues Task ForceTopic No. D-46, “Accounting for Limited Partnership Investments.”

**Note 18—SegmentInformation**

Chiron is organized basedon the products and services that it offers. Under this organizationalstructure, there are three reportable segments: (i) Blood Testing, (ii) vaccinesand (iii) biopharmaceuticals. The Blood Testing segment consists of analliance with Gen-Probe and Chiron’s one-half share in the pretax operatingearnings generated by the joint business contractual arrangement withOrtho-Clinical Diagnostics. Chiron’s alliance with Gen-Probe is focused ondeveloping and commercializing nucleic acid testing products usingTranscription-Mediated Amplification technology to screen donated blood, plasmaproducts, organs and tissues 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 data 

F-72

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**CHIRON CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) DECEMBER 31, 2005**

**Note 18—SegmentInformation (Continued)**

collection. TheBlood Testing segment also earns royalties from third parties based on theirsales of immunodiagnostic and nucleic acid testing probe diagnostic productsutilizing Chiron’s hepatitis C virus and HIV-related patents, for use in bloodscreening and plasma fractionation markets. The vaccines segment consistsprincipally of adult and pediatric vaccines for viral and bacterial infections.Chiron sells these vaccines primarily in the U.S., Germany, Italy, and theUnited Kingdom, as well as in other international markets. The vaccines segmentis also involved in the development of novel vaccines and vaccinationtechnology. The biopharmaceuticals segment consists of therapeutic products andservices, with an emphasis on the treatment of cancer and infectious andpulmonary 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 for technologies, such as hepatitis C virus- relatedpatents, used by third parties to develop therapeutic products.

Revenues and expensesassociated with Chiron’s research and development activities specificallybenefit each of the reportable segments and, as such, have been included in theresults of operations of the respective reportable segment.

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

The accounting policies ofChiron’s reportable segments are the same as those described in Note 1—TheCompany and Summary of Significant Accounting Policies. Chiron evaluates theperformance of its segments based on each segment’s income (loss) fromcontinuing operations, excluding certain special items such as purchasedin-process research and development, which is shown as a reconciling item inthe table below.

F-73

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**CHIRON CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) DECEMBER 31, 2005**

**Note 18—SegmentInformation (Continued)**

The following segmentinformation excludes all significant intersegment transactions as thesetransactions are eliminated for management reporting purposes:

| ** **                                             | ** ** | **2005**                | ** ** | **2004** | ** ** | **2003**  | ** ** |
|--------------------------------------------------------|------------|-------------------------|------------|----------|------------|-----------|------------|
| *** ***                                           | ** ** | **(in thousands)** | ** ** |
| ***Revenues***                                         |       |                    |       |     |       |      |       |
| Blood Testing:                                         |       |                    |       |     |       |      |       |
| Product sales, net:                                    |       |                    |       |     |       |      |       |
| PROCLEIX® products                           |       | $                       | 273,407    |     | $          | 249,809   |       | $ | 200,066 |   |
| Ortho-Clinical  Diagnostics                            |       | 31,298                  |       | 27,844   |       | 28,391    |       |
| Total product  sales, net                              |       | 304,705                 |       | 277,653  |       | 228,457   |       |
| Revenues from  joint business arrangement              |       | 136,701                 |       | 118,246  |       | 108,298   |       |
| Collaborative  agreement revenues                      |       | 7,222                   |       | 8,044    |       | 9,012     |       |
| Royalty and  license fee revenues                      |       | 106,045                 |       | 89,192   |       | 75,407    |       |
| Other revenues                                         |       | 1,031                   |       | 979      |       | 466       |       |
| Total Blood  Testing revenues                          |       | 555,704                 |       | 494,114  |       | 421,640   |       |
| Vaccines:                                              |       |                    |       |     |       |      |       |
| Product sales, net:                                    |       |                    |       |     |       |      |       |
| Influenza vaccines                                     |       | 225,355                 |       | 153,413  |       | 332,428   |       |
| Meningococcal  vaccines                                |       | 43,361                  |       | 27,739   |       | 65,548    |       |
| Travel vaccines                                        |       | 147,507                 |       | 96,864   |       | 87,831    |       |
| Pediatric and  other vaccines                          |       | 164,308                 |       | 200,948  |       | 192,511   |       |
| Total product  sales, net                              |       | 580,531                 |       | 478,964  |       | 678,318   |       |
| Collaborative  agreement revenues                      |       | 4,328                   |       | 8,646    |       | 4,222     |       |
| Royalty and  license fee revenues                      |       | 5,184                   |       | 5,234    |       | 12,747    |       |
| Other revenues                                         |       | 12,058                  |       | 17,282   |       | 13,522    |       |
| Total vaccines  revenues                               |       | 602,101                 |       | 510,126  |       | 708,809   |       |
| Biopharmaceuticals:                                    |       |                    |       |     |       |      |       |
| Product sales, net:                                    |       |                    |       |     |       |      |       |
| BETASERON® interferon  beta-1b               |       | 142,238                 |       | 130,572  |       | 124,936   |       |
| TOBI® tobramycin                             |       | 232,624                 |       | 212,876  |       | 172,047   |       |
| PROLEUKIN® (aldesleukin)                     |       | 123,549                 |       | 129,377  |       | 115,075   |       |
| Other                                                  |       | 37,847                  |       | 38,861   |       | 27,000    |       |
| Total product sales,  net                              |       | 536,258                 |       | 511,686  |       | 439,058   |       |
| Collaborative  agreement revenues                      |       | 1,534                   |       | 1,354    |       | 5,328     |       |
| Royalty and  license fee revenues                      |       | 72,950                  |       | 71,527   |       | 87,698    |       |
| Other revenues                                         |       | 18,305                  |       | 10,940   |       | 29,538    |       |
| Total  biopharmaceuticals revenues                     |       | 629,047                 |       | 595,507  |       | 561,622   |       |
| Other:                                                 |       |                    |       |     |       |      |       |
| Royalty and  license fee revenues                      |       | 132,827                 |       | 123,608  |       | 74,290    |       |
| Total revenues                                         |       | $                       | 1,919,679  |     | $          | 1,723,355 |       | $ | 1,766,361 |   |
| *Income(loss) from continuing operations*              |       |                    |       |     |       |      |       |
| Blood Testing                                          |       | $                       | 300,047    |     | $          | 259,702   |       | $ | 214,444 |   |
| Vaccines                                               |       | (158,776                | )          | (214,776 | )          | 95,092    |       |
| Biopharmaceuticals                                     |       | 26,446                  |       | 9,423    |       | 39,343    |       |
| Other                                                  |       | (17,601                 | )          | 5,085    |       | (12,506   | )          |
| Segment income  from operations                        |       | 150,116                 |       | 59,434   |       | 336,373   |       |
| Operating expense  reconciling item:                   |       |                    |       |     |       |      |       |
| Purchased  in-process research and development         |       | —                  |       | (9,629   | )          | (45,300   | )          |
| Income from  operations                                |       | 150,116                 |       | 49,805   |       | 291,073   |       |
| Loss on disposal  of assets                            |       | (1,108                  | )          | (3,247   | )          | (224      | )          |
| Interest expense                                       |       | (30,615                 | )          | (26,093  | )          | (19,104   | )          |
| Interest and other  income, net                        |       | 86,692                  |       | 56,797   |       | 38,892    |       |
| Minority interest.                                     |       | (2,221                  | )          | (1,968   | )          | (1,753    | )          |
| Income from  continuing operations before income taxes |       | $                       | 202,864    |     | $          | 75,294    |       | $ | 308,884 |   |

 

F-74

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**CHIRON CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) DECEMBER 31, 2005**

**Note 18—SegmentInformation (Continued)**

***Segment Assets,Depreciation and Amortization Expenses and Capital Expenditures***

Chiron does not evaluatethe performance of and allocate resources to its reportable segments based onthe financial position of each reportable segment. Rather, Chiron evaluates theperformance of and allocates resources to its reportable segments based on (i) incomefrom continuing operations, including depreciation and amortization expenses,and (ii) capital expenditures.

Depreciation andamortization expenses for property, plant, equipment and leasehold improvementsand intangible assets, are included with other operating expenses. Depreciationand amortization expenses not specifically related to a reportable segment areallocated to each segment based upon each segment’s percentage of total selling,general and administrative expenses and research and development expenses.Depreciation and amortization expenses for each reportable segment were asfollows:

| ** **                                    | ** ** | **2005**                | ** ** | **2004** | ** ** | **2003** | ** ** |
|-----------------------------------------------|------------|-------------------------|------------|----------|------------|----------|------------|
| ** **                                    | ** ** | **(In thousands)** | ** ** |
| *Depreciation and amortization  expenses*     |       |                    |       |     |       |     |       |
| Blood Testing                                 |       | $                       | 6,628      |     | $          | 6,569    |       | $ | 7,881 |   |
| Vaccines                                      |       | 111,072                 |       | 127,732  |       | 83,473   |       |
| Biopharmaceuticals                            |       | 42,571                  |       | 41,192   |       | 44,859   |       |
| Other                                         |       | 13,422                  |       | 10,428   |       | 9,510    |       |
| Total  depreciation and amortization expenses |       | $                       | 173,693    |     | $          | 185,921  |       | $ | 145,723 |   |

 

Capital expenditures arespecifically identified by each reportable segment. Capital expenditures foreach reportable segment were as follows:

| ** **                  | ** ** | **2005**                | ** ** | **2004** | ** ** | **2003** | ** ** |
|-----------------------------|------------|-------------------------|------------|----------|------------|----------|------------|
| ** **                  | ** ** | **(In thousands)** | ** ** |
| *Capital  expenditures*     |       |                    |       |     |       |     |       |
| Blood Testing               |       | $                       | 2,425      |     | $          | 6,353    |       | $ | 2,449 |   |
| Vaccines                    |       | 148,213                 |       | 109,218  |       | 66,310   |       |
| Biopharmaceuticals          |       | 56,095                  |       | 52,828   |       | 197,872  |       |
| Other                       |       | 29,857                  |       | 15,292   |       | 30,268   |       |
| Total capital  expenditures |       | $                       | 236,590    |     | $          | 183,691  |       | $ | 296,899 |   |

 

Capital expenditures in 2005 for the “Vaccines”segment include a non-cash addition of $36.6 million where Chiron is thelessee but considered the owner of the asset during the construction period.Capital expenditures in 2003 for the “Biopharmaceuticals” segment include acapital lease addition of $157.5 million as discussed in Note 14.

*GeographicArea Information*

Revenues from product sales by geographic area arebased on the customers’ shipping locations rather than the customers’ countryof domicile. Collaborative agreement, license fee, revenues from the jointbusiness arrangement and other revenues by geographic area are based on thecountry of domicile of the 

F-75

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**CHIRON CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) DECEMBER 31, 2005**

**Note 18—SegmentInformation (Continued)**

counterparty to theagreement. Royalty revenues by geographic area are based on the location towhich the product earning the royalties is shipped.

| ** **     | ** ** | **2005**                | ** ** | **2004** | ** ** | **2003**  | ** ** |
|----------------|------------|-------------------------|------------|----------|------------|-----------|------------|
| ** **     | ** ** | **(In thousands)** | ** ** |
| *Revenues*     |       |                    |       |     |       |      |       |
| Domestic       |       | $                       | 941,110    |     | $          | 780,116   |       | $ | 865,878 |   |
| Belgium        |       | 74,545                  |       | 51,919   |       | 60,757    |       |
| Canada         |       | 31,338                  |       | 21,632   |       | 23,863    |       |
| France         |       | 57,416                  |       | 50,286   |       | 58,126    |       |
| Germany        |       | 222,034                 |       | 183,193  |       | 199,951   |       |
| Italy          |       | 74,219                  |       | 86,009   |       | 70,014    |       |
| Japan          |       | 38,764                  |       | 42,696   |       | 41,638    |       |
| United Kingdom |       | 54,113                  |       | 70,805   |       | 71,577    |       |
| Other          |       | 426,140                 |       | 436,699  |       | 374,557   |       |
| Total revenues |       | $                       | 1,919,679  |     | $          | 1,723,355 |       | $ | 1,766,361 |   |

 

| ** **               | ** ** | **2005**                | ** ** | **2004** | ** ** | **2003** | ** ** |
|--------------------------|------------|-------------------------|------------|----------|------------|----------|------------|
| ** **               | ** ** | **(In thousands)** | ** ** |
| *Long-lived  assets*     |       |                    |       |     |       |     |       |
| Domestic                 |       | $                       | 478,512    |     | $          | 446,683  |       | $ | 422,596 |   |
| Germany                  |       | 87,772                  |       | 79,509   |       | 50,926   |       |
| Italy                    |       | 171,564                 |       | 168,721  |       | 125,772  |       |
| United Kingdom           |       | 132,507                 |       | 87,566   |       | 76,279   |       |
| Other                    |       | 18,448                  |       | 16,936   |       | 14,177   |       |
| Total long-lived  assets |       | $                       | 888,803    |     | $          | 799,415  |       | $ | 689,750 |   |

 

*MajorCustomers*

One significant customer accounted for 10.6%, 10.6%and 10.7% of total revenues in 2005, 2004 and 2003, respectively. Chiron’sbiopharmaceuticals segment revenue included 32.4%, 30.8% and 33.7% of revenuesfrom the major customer in 2005, 2004 and 2003, respectively. Chiron’s BloodTesting, vaccines and other segments had no major customers in 2005, 2004 and2003.

**Note 19—IncomeTaxes**

For financial reportingpurposes, “Income from continuing operations before income taxes” included thefollowing components for the years ended December 31:

| ** **             | ** ** | **2005**                | ** ** | **2004** | ** ** | **2003** | ** ** |
|------------------------|------------|-------------------------|------------|----------|------------|----------|------------|
| ** **             | ** ** | **(In thousands)** | ** ** |
| Domestic income        |       | $                       | 314,559    |     | $          | 229,651  |       | $ | 170,964 |   |
| Foreign income  (loss) |       | (111,695                | )          | (154,357 | )          | 137,920  |       |
|                   |       | $                       | 202,864    |     | $          | 75,294   |       | $ | 308,884 |   |

 

F-76

----

**CHIRON CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) DECEMBER 31, 2005**

**Note 19—Income Taxes(Continued)**

*Components ofProvision for Income Taxes from Continuing Operations*

Significant components ofthe provision for income tax expense from continuing operations were as followsfor the years ended December 31:

| ** **                                             | ** ** | **2005**                | ** ** | **2004** | ** ** | **2003** | ** ** |
|--------------------------------------------------------|------------|-------------------------|------------|----------|------------|----------|------------|
| ** **                                             | ** ** | **(In thousands)** | ** ** |
| Current tax expense:                                   |       |                    |       |     |       |     |       |
| Domestic                                               |       | $                       | 94,194     |     | $          | 62,360   |       | $ | 89,502 |   |
| Foreign                                                |       | 19,802                  |       | 32,169   |       | 13,852   |       |
|                                                   |       | 113,996                 |       | 94,529   |       | 103,354  |       |
| Deferred tax expense  (benefit):                       |       |                    |       |     |       |     |       |
| Domestic                                               |       | 7,267                   |       | (13,567  | )          | (5,634   | )          |
| Foreign                                                |       | (98,869                 | )          | (59,731  | )          | (9,174   | )          |
|                                                   |       | (91,602                 | )          | (73,298  | )          | (14,808  | )          |
| Provision for income  taxes from continuing operations |       | $                       | 22,394     |     | $          | 21,231   |       | $ | 88,546 |   |

 

In 2005, 2004 and 2003,Chiron realized stock option tax benefits, recorded as an increase toadditional paid-in capital, of approximately $18.0 million, $14.9 millionand $33.1 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 andthat adequate provisions have been made for these tax examinations.

F-77

----

**CHIRON CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) DECEMBER 31, 2005**

**Note 19—IncomeTaxes (Continued)**

*RateReconciliation*

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:

| ** **                                                                            | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** |
|---------------------------------------------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Expected statutory tax  rate                                                          |       | 35.0     | %          | 35.0     | %          | 35.0     | %          |
| Increases (reductions)  in tax resulting from the following:                          |       |     |       |     |       |     |       |
| State taxes, net of  federal benefit                                                  |       | (2.8     | )%         | (10.8    | )%         | 0.9      | %          |
| Net impact of foreign  tax rates and credits                                          |       | (19.9    | )%         | (55.5    | )%         | (12.7    | )%         |
| Tax effect of  intercompany transaction involving transfer of product rights(1)  |       | —   | %          | 74.0     | %          | 1.9      | %          |
| Purchased in-process  research and development (see below)                            |       | —   | %          | 4.5      | %          | 5.1      | %          |
| Tax benefit attributed  to Extraterritorial Income Exclusion                          |       | (0.5     | )%         | (4.1     | )%         | (1.0     | )%         |
| Utilization of current  year research & development credits                  |       | (1.9     | )%         | (14.2    | )%         | (2.8     | )%         |
| Other                                                                                 |       | 1.1      | %          | (0.7     | )%         | 2.3      | %          |
| Actual tax rate on  income from continuing operations                                 |       | 11.0     | %          | 28.2     | %          | 28.7     | %          |

----

(1)          Tax effect ofintercompany transfers between Chiron’s subsidiaries represent current year taxexpense arising from the transfer of rights related to a product underdevelopment. The taxes payable by the selling subsidiary were expensed, as theoutcome of the related product development program, which has no futurealternative use, is uncertain.

Purchased in-process research and development chargein 2004 was a permanent difference associated with the acquisition of Sagres(Note 5). Purchased in-process research and development charge in 2003 was apermanent difference associated with the acquisition of PowderJect (Note 5).

*Summaryof 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.

Net deferred tax assets have been recognized based onmanagement’s estimates of future taxable income for U.S. and certain foreignjurisdictions in which Chiron’s operations have historically been profitable.

F-78

----

**CHIRON CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) DECEMBER 31, 2005**

**Note 19—IncomeTaxes (Continued)**

Significant components of Chiron’s deferred income taxassets and liabilities from continuing operations were as follows at December 31(including certain reclassifications to provide consistency):

| ** **                                         | ** ** | **2005**                | ** ** | **2004** | ** ** |
|----------------------------------------------------|------------|-------------------------|------------|----------|------------|
| ** **                                         | ** ** | **(In thousands)** | ** ** |
| Deferred income tax  assets:                       |       |                    |       |     |       |
| Capitalized research and development costs         |       | $                       | 20,739     |     | $          | 779 |   |
| Deferred revenue                                   |       | 14,960                  |       | 16,332   |       |
| Basis difference of equity investments             |       | 13,936                  |       | 26,824   |       |
| Reserves and expense accruals                      |       | 88,575                  |       | 62,950   |       |
| Net operating loss carryovers                      |       | 122,003                 |       | 114,416  |       |
| Business tax credit carryovers                     |       | 63,307                  |       | 43,508   |       |
| Depreciation and amortization                      |       | 1,988                   |       | 7,695    |       |
| Other deferred income tax assets                   |       | 8,610                   |       | 5,906    |       |
|                                               |       | 334,118                 |       | 278,410  |       |
| Less valuation allowance                           |       | (18,148                 | )          | (42,386  | )          |
|                                               |       | 315,970                 |       | 236,024  |       |
| Deferred income tax  liabilities:                  |       |                    |       |     |       |
| Intangible assets basis differences (amortization) |       | 124,984                 |       | 170,644  |       |
| Patent costs expensed for tax purposes             |       | 19,854                  |       | 16,267   |       |
| Contingent payment debt instruments                |       | 34,439                  |       | 18,889   |       |
| Tax effect of unrealized comprehensive income      |       | 5,577                   |       | 19,364   |       |
| Other                                              |       | 3,075                   |       | —   |       |
|                                               |       | 187,929                 |       | 225,164  |       |
| Net deferred  income tax asset                     |       | $                       | 128,041    |     | $          | 10,860 |   |

 

The above net deferredincome tax asset has been reflected in the accompanying Consolidated BalanceSheets as follows:

| ** **                     | ** ** | **2005**                | ** ** | **2004** | ** ** |
|--------------------------------|------------|-------------------------|------------|----------|------------|
| ** **                     | ** ** | **(In thousands)** | ** ** |
| Current asset                  |       | $                       | 62,414     |     | $          | 71,287 |   |
| Non-current asset  (liability) |       | 65,627                  |       | (60,427  | )          |
| Net deferred income tax  asset |       | $                       | 128,041    |     | $          | 10,860 |   |

 

Chiron has permanentlyinvested approximately $52.0 million of earnings of certain foreignsubsidiaries outside the U.S. As of December 31, 2005 additional U.S.taxes of approximately $4.0 million would accrue if these earnings wereremitted.

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%.Through December 31, 2005, Chiron has not provided deferred 

F-79

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**CHIRON CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) DECEMBER 31, 2005**

**Note 19—IncomeTaxes (Continued)**

taxes on foreignearnings because such earnings are intended to be indefinitely reinvestedoutside the U.S. Chiron did not repatriate any accumulated earnings fromoutside the U.S. in either 2004 or 2005.

The net increase (decrease) in the valuation allowancefor the years ended December 31, 2005, 2004 and 2003 was$(24.2) million, $7.2 million and $21.1 million, respectively, primarilyattributable to acquired net operating losses of PowderJect in 2003, as well asforeign net operating losses in 2003 and 2004 in jurisdictions where Chiron hasno history of taxable income. In 2005, the decrease was primarily attributableto liquidation of disposed PowderJect entities.

*TaxOperating Loss and Credit Carryforwards*

At December 31, 2005,Chiron had foreign net operating loss carryforwards of approximately$387.1 million. Of this, $70.1 million expires in 2010 and substantiallyall of the remainder is available to offset future taxable income withoutlimitation. $94.6 million of the foreign net operating loss carryforwards arealso subject to valuation allowances as the ability to use those carryforwardsis not considered to be more likely than not.

At December 31, 2005,Chiron had federal net operating loss carryforwards, attributable to theacquisition of Matrix Pharmaceutical of approximately $232.8 million. As theseloss carryforwards are limited under provisions of the Internal Revenue Code,$43.7 million of the losses are expected to be utilized to offset futuredomestic taxable income ratably through 2021.

At December 31, 2005,Chiron had federal net operating loss carryforwards attributable to theacquisition of Sagres of approximately $27.9 million. As these losscarryforwards are limited under provisions of the Internal Revenue Code, $2.9million of the losses are expected to be utilized to offset future domestictaxable income ratably through 2022.

At December 31, 2005,Chiron had a total of $131.7 million of state net operating loss carryforwards,which expire between 2013 and 2024. State net operating loss carryforwardsattributable to the acquisition of Matrix Pharmaceutical totaled approximately$49.2 million, of which, approximately $21.9 million, are available tooffset future state taxable income ratably through 2013. State net operatingloss carryforwards attributable to the acquisition of Sagres totaledapproximately $21.2 million, of which, approximately $1.4 million are availableto offset future state taxable income ratably through 2013. The availableutilization of the net operating losses is limited in any one year underprovisions of the state tax codes. As such, a significant portion of bothMatrix’s and Sagres’s state net operating loss carryforwards are expected toexpire unutilized.

At December 31, 2005, Chiron had state businesstax credit carryovers of $43.0 million, which are available to offsetfuture state tax liabilities without expiration, and foreign business taxcredit carryovers of $18.8 million without expiration.

**Note 20—SubsequentEvents**

**On March 16, 2006, Chiron announceda recall and withdrawal of MORUPAR®,its measles, mumps and rubella (MMR) vaccine. Chiron previously supplied MORUPAR® vaccine to customers in a limitednumber of developing countries, largely via the United Nations Children’s Fund(UNICEF) and the Pan American Health Organization (PAHO), and to Italy.  Resultsof pharmacovigilance surveillance in Italy**

F-80

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**CHIRON CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) DECEMBER 31, 2005**

**Note 20—SubsequentEvents (Continued)**

**suggestthat MORUPAR® vaccine may be associated with a higher reported rate of adverseevents following immunization than other MMR vaccine products.  Chiron expects to work with the World HealthOrganization (WHO) to assist it in conducting a risk-benefit analysis todetermine whether UNICEF or PAHO will require a limited quantity of theexisting inventory of MORUPAR® vaccine for their ongoing public healthprograms.  Chiron has written-off in 2005 approximately$6.0 million of MORUPAR® inventory as a result of the withdrawal andrecorded approximately $1.7 million of product returns reserves in 2005 inconnection with expected returns of 2005 product sales from the recall.**

**Note 21—QuarterlyFinancial Data (Unaudited)**

| ** **                                                                                                                       | ** ** | **2005**                                                           | ** ** |
|----------------------------------------------------------------------------------------------------------------------------------|------------|--------------------------------------------------------------------|------------|
| ** **                                                                                                                       | ** ** | **Dec. 31**                                                   | ** ** | **Sept. 30** | ** ** | **June 30** | ** ** | **Mar. 31** | ** ** |
| ** **                                                                                                                       | ** ** | **(In thousands, except per share data)** | ** ** |
| Total revenues                                                                                                                   |       | $                                                                  | 613,953    |   | $ | 479,613 |   | $ | 418,757 |   | $ | 407,356 |   |
| Gross margin from  net product sales (Cost of sales excludes amortization expense related to  acquired developed products)  |       | 252,486                                                            |       | 198,449 |   | 125,135 |   | 113,324 |   |
| Income (loss) from  continuing operations:                                                                                       |       |                                                               |       |   |   |   |   |   |   |
| Income (loss)                                                                                                                    |       | 138,052                                                            |       | 51,311 |   | 49 |   | (8,942 | ) |
| Basic income  (loss) per share                                                                                                   |       | 0.72                                                               |       | 0.27 |   | — | * | (0.05 | ) |
| Diluted income  (loss) per share                                                                                                 |       | 0.68                                                               |       | 0.27 |   | — | * | (0.05 | ) |
| Gain (loss) from  discontinued operations, net of taxes                                                                          |       | —                                                             |       | — |   | — |   | — |   |
| Net income (loss):                                                                                                               |       |                                                               |       |   |   |   |   |   |   |
| Income (loss)                                                                                                                    |       | 138,052                                                            |       | 51,311 |   | 49 |   | (8,942 | ) |
| Basic income  (loss) per share                                                                                                   |       | 0.72                                                               |       | 0.27 |   | — | * | (0.05 | ) |
| Diluted income (loss)  per share                                                                                                 |       | 0.68                                                               |       | 0.27 |   | — | * | (0.05 | ) |
|                                                                                                                                  |            |                                                                    |            |  |  |  |  |  |  |  |  |  |  |

----

*                    Lessthan $0.01 per share

| ** **                                                                                                                 | ** ** | **2004**                                                           | ** ** |
|----------------------------------------------------------------------------------------------------------------------------|------------|--------------------------------------------------------------------|------------|
| ** **                                                                                                                 | ** ** | **Dec. 31**                                                   | ** ** | **Sept. 30  Restated** | ** ** | **June 30  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) |       | 153,331                                                            |       | 134,505 |   | 151,320 |   | 153,203 |   |
| 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 |   |
| Gain (loss) from  discontinued operations, net of taxes                                                                    |       | —                                                             |       | (450 | ) | 12,459 |   | 12,845 |   |
| 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, 2005**

**Note 21—QuarterlyFinancial Data (Unaudited) (Continued)**

 

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.

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

*ContinuingOperations*

The recent developmentswith respect to FLUVIRIN® influenza vaccine, as discussed above,impacted our results of operations for the quarters in 2005 and 2004. Chiron’sFLUVIRIN® influenza vaccine returned to the U.S. market,as discussed in Note 14 above, in the fourth quarter of 2005 with $96.5 millionin sales. Chiron incurred FLUVIRIN® vaccine remediation costs of $16.0 million,$8.0 million, $3.0 million and $1.0 million in the first, second, third andfourth quarters of 2005, respectively. In 2005, the majority of legal costsassociated with the FLUVIRIN® vaccine-related developments were incurred inthe first and second quarters of 2005 for $10.0 million and $5.0 million,respectively. Chiron did not release any FLUVIRIN® product during the 2004-2005 influenzaseason. Chiron had no sales of FLUVIRIN® vaccine in 2004(other than $2.3 million in late 2003-2004 season sales). In the thirdquarter 2004, Chiron wrote-off the entire inventory of FLUVIRIN® vaccine, resulting in a $91.3 million chargeto cost of sales. In the fourth quarter 2004, Chiron incurred FLUVIRIN® vaccine remediation costs of $2.6 million andincurred legal expenses of $12.1 million related to FLUVIRIN®.

Chiron did not release anyBEGRIVACTM influenza vaccine during the 2005-2006 influenza season asdiscussed in Note 14 above, and Chiron had no BEGRIVACTM sales in the third andfourth quarters of 2005. BEGRIVACTM sales were $41.0 million and $12.0 millionin the third and fourth quarters of 2004, respectively. Chiron wrote-off theentire inventory of BEGRIVACTM resulting in charges of $15.0 million and $3.0million in the second and third quarters of 2005, respectively.

Certain developed producttechnologies from Chiron’s acquisition of PowderJect are amortized under theestimated sales method, which considers forecasted FLUVIRIN® sales during each influenza season through theremaining period of the benefit. Related amortization was $12.9 million, $12.8million, $4.3 million and $4.2 million in the first, second, third and fourthquarters of 2005, respectively, reflecting updated forecasted FLUVIRIN® sales. Related amortization was $11.3 million,$11.3 million, $12.3 million and $13.3 million in the first, second, third andfourth quarters of 2004, respectively.

In the third quarter of 2005, Chiron recognized animpairment loss of $14.5 million on acquired intangible assets from Chiron’sacquisition of PowderJect related to ARILVAXTM, a yellow fever vaccine. Thisimpairment loss was due to a focus of resources towards the influenza market,resulting in a reduction of the expected activity for ARILVAXTM. ARILVAXTMremains in Chiron’s portfolio of trademarks and Chiron may re-enter the yellowfever vaccine market in the future with this product. In the fourth quarter 

F-82

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**CHIRON CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) DECEMBER 31, 2005**

**Note 21—Quarterly Financial Data (Unaudited)(Continued)**

of 2005, Chironrecognized an impairment loss of $1.1 million on acquired intangible assetsfrom Chiron’s acquisition of PowderJect related to a contract manufacturingagreement.

On July 2, 2004,Chiron acquired Sagres and Chiron accounted for the acquisition as an assetpurchase and included Sagres’s operating results in its consolidated operatingresults beginning on July 2, 2004 (Note 5). Sagres is part of Chiron’sbiopharmaceuticals segment. Chiron allocated $9.6 million of the purchase priceto purchased-in-process research and development, which Chiron charged toearnings in the third quarter 2004.

In 2004, Chiron and Rochereached a settlement regarding our HIV patent in the U.S (Note 7). Thesettlement included a $78.0 million lump sum payment, of which $14.0 millionwas recognized in the third quarter 2004. In addition, the settlement resultedin $31.8 million of previously deferred royalties and license payments, whichwas recognized in the third quarter 2004. The impact of these revenue itemsfrom the Roche settlement was an approximate $0.18 increase in diluted earningsper share in the third quarter 2004. In the first quarter of 2005, Chironrecognized $16.0 million of the $78.0 million lump sum payment and $8.0 millionof this lump sum payment in each of the second, third and fourth quarters of2005.

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 remained 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 millionaggregate principal amount of convertible debentures, which mature on June 30,2034. The convertible debentures accrue interest at a rate of 2.75% per yearand interest is payable on June 30 and December 30 commencing on December 30,2004.

*DiscontinuedOperations (Note 4)*

There was no gain (loss)from discontinued operations in 2005.

“Gain from discontinuedoperations, net of taxes” included a settlement with Bayer Corporation,primarily relating to a tax benefit as a result of the settlement payment. Thissettlement resulted in a net gain of $12.8 million in the first quarter of2004.

“Gain from discontinued operations, net of taxes” alsoincluded a settlement agreement between Chiron and the IRS closing the open taxyears 1996 to 1998. This settlement resulted in a tax benefit of approximately$12.5 million in the second quarter 2004.

F-83

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**SCHEDULE II**

**CHIRONCORPORATIONVALUATION AND QUALIFYING ACCOUNTS AND RESERVESYEARS ENDED DECEMBER 31, 2005, 2004 and 2003**

| **Description**                           | ** ** | ** **              | ** ** | **Balance at  Beginning  of Year** | ** ** | **Charged to  Costs and  Expenses,  Net of Reversals** | ** ** | **Utilizations** | ** ** | **Balance at  End  of Year** | ** ** |
|-------------------------------------------|------------|-------------------------|------------|----------------------------------------------|------------|----------------------------------------------------------------------------|------------|------------------|------------|----------------------------------------|------------|
| ** **                                | ** ** | **(In thousands)** | ** ** |
| 2005:                                     |       |                    |       |                                         |       |                                                                       |       |             |       |                                   |       |   |   |   |   |   |   |
| Product returns                           |       |                    | $          | 17,405                                       |       |                                                                       |       | $                | 9,723      |                                   |       |   | $ | (8,860 | ) |   |   | $ | 18,268 |   |   |
| Other accounts  receivable allowance      |       |                    | 20,634     |                                         |       |                                                                       | 12,568     |             |       |                                   | (17,779    | ) |   |   | 15,423 |   |   |
| Inventory  reserves                       |       |                    | 71,609     |                                         |       |                                                                       | 32,130     |             |       |                                   | (25,574    | ) |   |   | 78,165 |   |   |
| Restructuring and  reorganization accrual |       |                    | 1,074      |                                         |       |                                                                       | 285        |             |       |                                   | (1,101     | ) |   |   | 258 |   |   |
| 2004:                                     |       |                    |       |                                         |       |                                                                       |       |             |       |                                   |       |   |   |   |   |   |   |
| Product returns                           |       |                    | 17,593     |                                         |       |                                                                       | 8,800      |             |       |                                   | (8,988     | ) |   |   | 17,405 |   |   |
| 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                           |       |                    | 9,363      |                                         |       |                                                                       | 10,280     |             |       |                                   | (2,050     | ) |   |   | 17,593 |   |   |
| 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 |   |   |
|                                           |            |                         |            |                                              |            |                                                                            |            |                  |            |                                        |            |  |  |  |  |  |  |  |  |  |  |  |  |

 

In addition to the charges reflected above for 2005,Chiron wrote-off the entire inventory of BEGRIVACTM product in 2005, resulting in a charge to cost ofsales of $18.0 million. Also in 2005, Chiron wrote-off certain FLUVIRIN® product, resulting in a charge tocost of sales of $19.1 million. In addition to the charges reflectedabove for 2004, Chiron wrote-off the entire inventory of FLUVIRIN® product in 2004, resulting in a $91.3 millioncharge to cost of sales.

F-84

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