**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**Washington,D.C. 20549**

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FORM 10-Q

**(Mark one)**

**x**                              QUARTERLYREPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACTOF 1934.

**Forthe quarterly period ended June 30, 2005**

**OR**

**o**                                 TRANSITIONREPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACTOF 1934.

**Forthe transition period from                             to                             **

**CommissionFile Number: 0-12798**

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CHIRON CORPORATION

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

 

**(510) 655-8730**

(Registrant’s telephonenumber, including area code)

**Not Applicable**

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

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Indicate by check mark whetherthe registrant (1) has filed all reports required to be filed by Section 13or 15(d) of the Securities Exchange Act of 1934 during the preceding12 months (or for such shorter period that the registrant was required tofile such reports), and (2) has been subject to such filing requirementsfor the past 90 days.

Yes x    No o

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

Yes x    No o

Indicatethe number of shares outstanding of each of the issuer’s classes of commonstock, as of the latest practicable date.

| Title of Class                 | ** ** | **Outstanding at August 3, 2005** |
|--------------------------------|------------|-------------------------------------------------------|
| Common Stock,  $0.01 par value |       | 187,879,648                                           |

 

 

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**CHIRON CORPORATIONTABLE OF CONTENTS**
|                                                                                                                                                                    | ** ** | **Page No.** |
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------|
| **PART I.   FINANCIAL  INFORMATION**                                                                                                                |       |              |   |   |
| **ITEM  1.   Financial  Statements (Unaudited)**                                                                                                         |       |              |   |   |
| Condensed  Consolidated Balance Sheets at June 30, 2005 and December 31, 2004                                                                                 |       |              | 3 |   |
| Condensed  Consolidated Statements of Operations for the three and six months ended June 30, 2005  and 2004                |       |              | 5 |   |
| Condensed Consolidated Statements of  Comprehensive Income (loss) for the three and six months ended June 30,  2005 and 2004                        |       |              | 6 |   |
| Condensed  Consolidated Statements of Cash Flows for the six months ended June 30,  2005 and 2004                     |       |              | 7 |   |
| Notes  to Condensed Consolidated Financial Statements                                                                                                              |       |              | 8 |   |
| **ITEM 2.   Management’s  Discussion and Analysis of Financial Condition and Results of Operations**        |       |              | 21 |   |
| **ITEM 3.   Quantitative  and Qualitative Disclosures About Market Risk**                                                                                |       |              | 56 |   |
| **ITEM 4.   Controls and  Procedures**                                                                                                                   |       |              | 56 |   |
| **PART II.   OTHER  INFORMATION**                                                                                                                   |       |              |   |   |
| **ITEM 1.   Legal  Proceedings**                                                                                                                         |       |              | 58 |   |
| **ITEM 2.   Unregistered  Sales of Equity Securities and Use of Proceeds**                                                                               |       |              | 60 |   |
| **ITEM 3.   Defaults Upon  Senior Securities**                                                                                                           |       |              | 60 |   |
| **ITEM 4.   Submission of  Matters to a Vote of Security Holders**                                                                                       |       |              | 60 |   |
| **ITEM 5.   Other  Information**                                                                                                                         |       |              | 60 |   |
| **ITEM 6.   Exhibits**                                                                                                                                   |       |              | 61 |   |
| **SIGNATURES**                                                                                                                                                     |       |              | 63 |   |

 

2

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**Item1.**                        FinancialStatements

**CHIRON CORPORATIONCONDENSED CONSOLIDATEDBALANCE SHEETS(Unaudited)(In thousands, except share data)**
| ** **                                                       | ** ** | **June 30,  2005** | ** ** | ** December 31,   2004** | ** ** |
|------------------------------------------------------------------|------------|-------------------------|------------|-----------------------------------------|------------|
| **ASSETS**                                                       |       |                    |       |                                    |       |   |   |
| Current assets:                                                  |       |                    |       |                                    |       |   |   |
| Cash and cash equivalents                                        |       | $                       | 184,308    |                                    |       | $ | 209,509 |   |   |
| Short-term investments in marketable debt securities             |       | 399,675                 |       |                                    | 394,112    |   |   |
| Total cash, cash equivalents and short-term  investments         |       | 583,983                 |       |                                    | 603,621    |   |   |
| Accounts receivable, net of allowances                           |       | 338,168                 |       |                                    | 402,094    |   |   |
| Inventories, net of reserves                                     |       | 238,894                 |       |                                    | 221,154    |   |   |
| Assets held for sale                                             |       | 1,226                   |       |                                    | —     |   |   |
| Current net deferred income tax asset                            |       | 61,537                  |       |                                    | 71,287     |   |   |
| Derivative financial instruments                                 |       | 4,224                   |       |                                    | 4,969      |   |   |
| Other current assets                                             |       | 107,428                 |       |                                    | 90,898     |   |   |
| Total current assets                                             |       | 1,335,460               |       |                                    | 1,394,023  |   |   |
| Non-current  investments in marketable debt securities           |       | 435,287                 |       |                                    | 409,421    |   |   |
| Property, plant,  equipment and leasehold improvements, at cost: |       |                    |       |                                    |       |   |   |
| Land and buildings                                               |       | 379,539                 |       |                                    | 379,861    |   |   |
| Laboratory, production and office equipment                      |       | 661,774                 |       |                                    | 637,394    |   |   |
| Leasehold improvements                                           |       | 133,140                 |       |                                    | 125,858    |   |   |
| Construction-in-progress                                         |       | 227,310                 |       |                                    | 225,482    |   |   |
|                                                             |       | 1,401,763               |       |                                    | 1,368,595  |   |   |
| Less accumulated depreciation and amortization                   |       | (593,385                | )          |                                    | (569,180   | ) |   |
| Property, plant, equipment and leasehold  improvements, net      |       | 808,378                 |       |                                    | 799,415    |   |   |
| Purchased  technologies, net                                     |       | 205,879                 |       |                                    | 216,037    |   |   |
| Goodwill                                                         |       | 821,016                 |       |                                    | 861,394    |   |   |
| Other intangible  assets, net                                    |       | 403,081                 |       |                                    | 457,707    |   |   |
| Investments in  equity securities and affiliated companies       |       | 61,635                  |       |                                    | 100,951    |   |   |
| Non-current notes  receivable                                    |       | 12,459                  |       |                                    | 7,500      |   |   |
| Other non-current  assets                                        |       | 58,290                  |       |                                    | 59,055     |   |   |
|                                                             |       | $                       | 4,141,485  |                                    |       | $ | 4,305,503 |   |   |

 

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

3

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**CHIRON CORPORATIONCONDENSED CONSOLIDATEDBALANCE SHEETS (Continued)(Unaudited)(In thousands, except share data)**
| ** **                                                                                                            | ** ** | **June 30,  2005** | ** ** | ** December 31,   2004** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------|------------|-------------------------|------------|-----------------------------------------|------------|
| **LIABILITIES  AND STOCKHOLDERS’ EQUITY**                                                                        |       |                    |       |                                    |       |   |   |
| Current liabilities:                                                                                                  |       |                    |       |                                    |       |   |   |
| Accounts payable                                                                                                      |       | $                       | 119,320    |                                    |       | $ | 129,942 |   |   |
| Accrued compensation and related expenses                                                                             |       | 72,119                  |       |                                    | 79,113     |   |   |
| Derivative financial instruments                                                                                      |       | —                  |       |                                    | 10,395     |   |   |
| Current portion of long-term debt and capital lease                                                                   |       | 1,577                   |       |                                    | 2,687      |   |   |
| Current portion of unearned revenue                                                                                   |       | 51,961                  |       |                                    | 35,651     |   |   |
| Income taxes payable                                                                                                  |       | 793                     |       |                                    | 16,363     |   |   |
| Other current liabilities                                                                                             |       | 178,542                 |       |                                    | 160,293    |   |   |
| Total current liabilities                                                                                             |       | 424,312                 |       |                                    | 434,444    |   |   |
| Long-term debt                                                                                                        |       | 938,248                 |       |                                    | 936,652    |   |   |
| Long-term portion  of capital lease                                                                                   |       | 156,828                 |       |                                    | 156,952    |   |   |
| Non-current  derivative financial instruments                                                                         |       | —                  |       |                                    | 156        |   |   |
| Non-current net  deferred income tax liability                                                                        |       | 37,108                  |       |                                    | 60,427     |   |   |
| Non-current  unearned revenue                                                                                         |       | 31,568                  |       |                                    | 26,175     |   |   |
| Other non-current  liabilities                                                                                        |       | 71,225                  |       |                                    | 79,643     |   |   |
| Minority interest                                                                                                     |       | 10,258                  |       |                                    | 9,350      |   |   |
| Total liabilities                                                                                                     |       | 1,669,547               |       |                                    | 1,703,799  |   |   |
| Commitments and  contingencies                                                                                        |       |                    |       |                                    |       |   |   |
| Stockholders’ equity:                                                                                            |       |                    |       |                                    |       |   |   |
| Common stock                                                                                                          |       | 1,917                   |       |                                    | 1,917      |   |   |
| Additional paid-in capital                                                                                            |       | 2,536,828               |       |                                    | 2,527,709  |   |   |
| Deferred stock compensation                                                                                           |       | (17,759                 | )          |                                    | (13,825    | ) |   |
| Accumulated deficit                                                                                                   |       | (44,861                 | )          |                                    | (11,843    | ) |   |
| Accumulated other comprehensive income                                                                                |       | 186,248                 |       |                                    | 330,491    |   |   |
| Treasury stock, at cost (3,917,000 shares at  June 30, 2005 and 4,804,000 shares at December 31, 2004) |       | (190,435                | )          |                                    | (232,745   | ) |   |
| Total stockholders’ equity                                                                                       |       | 2,471,938               |       |                                    | 2,601,704  |   |   |
|                                                                                                                  |       | $                       | 4,141,485  |                                    |       | $ | 4,305,503 |   |   |

 

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

4

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**CHIRON CORPORATIONCONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS(Unaudited)(In thousands, except per share data)**
| ** **                                                                                       | ** ** | **Three Months Ended  June 30,** | ** ** | **Six Months Ended  June 30,** | ** ** |
|--------------------------------------------------------------------------------------------------|------------|-------------------------------------------------|------------|-----------------------------------------------|------------|
| ** **                                                                                       | ** ** | **2005**                                        | ** ** | **2004**                                      | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **                                                                                       | ** ** | ** **                                      | ** ** | **Restated**                                  | ** ** | ** ** | ** ** | **Restated** | ** ** |
| Revenues:                                                                                        |       |                                            |       |                                          |       |   |   |   |   |
| Product sales, net                                                                               |       | $                                               | 303,575    |                                          | $          | 281,221 |   | $ | 580,738 |   | $ | 562,287 |   |
| Revenues from joint business arrangement                                                         |       | 31,003                                          |       | 28,532                                        |       | 67,061 |   | 58,893 |   |
| Collaborative agreement revenues                                                                 |       | 3,453                                           |       | 3,828                                         |       | 7,980 |   | 10,343 |   |
| Royalty and license fee revenues                                                                 |       | 76,522                                          |       | 55,196                                        |       | 156,583 |   | 109,988 |   |
| Other revenues                                                                                   |       | 4,204                                           |       | 10,975                                        |       | 13,751 |   | 17,913 |   |
| Total revenues                                                                                   |       | 418,757                                         |       | 379,752                                       |       | 826,113 |   | 759,424 |   |
| Operating  expenses:                                                                             |       |                                            |       |                                          |       |   |   |   |   |
| Cost of sales (excludes amortization expense related  to acquired developed products)            |       | 177,569                                         |       | 129,228                                       |       | 340,529 |   | 255,929 |   |
| Research and development                                                                         |       | 107,472                                         |       | 100,326                                       |       | 217,311 |   | 198,736 |   |
| Selling, general and administrative                                                              |       | 128,492                                         |       | 106,857                                       |       | 260,400 |   | 211,597 |   |
| Amortization expense of intangible assets acquired  in business combinations and asset purchases |       | 20,613                                          |       | 21,179                                        |       | 41,876 |   | 42,511 |   |
| Other operating expenses                                                                         |       | 2,056                                           |       | 4,644                                         |       | 9,202 |   | 6,760 |   |
| Total operating expenses                                                                         |       | 436,202                                         |       | 362,234                                       |       | 869,318 |   | 715,533 |   |
| (Loss) income  from operations                                                                   |       | (17,445                                         | )          | 17,518                                        |       | (43,205 | ) | 43,891 |   |
| Interest expense                                                                                 |       | (8,094                                          | )          | (6,452                                        | )          | (15,173 | ) | (12,377 | ) |
| Interest and  other income, net                                                                  |       | 26,298                                          |       | 19,809                                        |       | 47,745 |   | 35,883 |   |
| Minority interest                                                                                |       | (662                                            | )          | (459                                          | )          | (1,192 | ) | (1,079 | ) |
| Income (loss)  from continuing operations before income taxes                                    |       | 97                                              |       | 30,416                                        |       | (11,825 | ) | 66,318 |   |
| Provision for  (benefit of) income taxes                                                         |       | 48                                              |       | 7,604                                         |       | (2,932 | ) | 16,579 |   |
| Income (loss)  from continuing operations                                                        |       | 49                                              |       | 22,812                                        |       | (8,893 | ) | 49,739 |   |
| Gain from  discontinued operations, net of taxes                                                 |       | —                                          |       | 12,459                                        |       | — |   | 25,304 |   |
| Net income (loss)                                                                                |       | $                                               | 49         |                                          | $          | 35,271 |   | $ | (8,893 | ) | $ | 75,043 |   |
| Basic earnings  (loss) per share:                                                                |       |                                            |       |                                          |       |   |   |   |   |
| Income (loss) from continuing operations                                                         |       | $                                               | —     | *                                             | $          | 0.12 |   | $ | (0.05 | ) | $ | 0.26 |   |
| Net income (loss)                                                                                |       | $                                               | —     | *                                             | $          | 0.19 |   | $ | (0.05 | ) | $ | 0.40 |   |
| Diluted earnings  (loss) per share:                                                              |       |                                            |       |                                          |       |   |   |   |   |
| Income (loss) from continuing operations                                                         |       | $                                               | —     | *                                             | $          | 0.12 |   | $ | (0.05 | ) | $ | 0.26 |   |
| Net income (loss)                                                                                |       | $                                               | —     | *                                             | $          | 0.18 |   | $ | (0.05 | ) | $ | 0.39 |   |

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*                    Less than$0.01 per share.

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

5

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**CHIRON CORPORATIONCONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVEINCOME (LOSS)(Unaudited)(In thousands)**
| ** **                                                                                                                                                                                                                                                                                                     | ** ** | **Three Months Ended  June 30,** | ** ** | **Six Months Ended  June 30,** | ** ** |
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------------------------------|------------|-----------------------------------------------|------------|
| ** **                                                                                                                                                                                                                                                                                                     | ** ** | **2005**                                        | ** ** | **2004**                                      | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **                                                                                                                                                                                                                                                                                                     | ** ** | ** **                                      | ** ** | **Restated**                                  | ** ** | ** ** | ** ** | **Restated** | ** ** |
| Net income (loss)                                                                                                                                                                                                                                                                                              |       | $                                               | 49         |                                          | $          | 35,271 |   | $ | (8,893 | ) | $ | 75,043 |   |
| Other comprehensive  loss:                                                                                                                                                                                                                                                                                     |       |                                            |       |                                          |       |   |   |   |   |
| Change in foreign currency translation adjustment  during the period                                                                                                                                                                                                                                           |       | (73,577                                         | )          | (15,784                                       | )          | (124,139 | ) | (37,412 | ) |
| Unrealized losses  from investments:                                                                                                                                                                                                                                                                           |       |                                            |       |                                          |       |   |   |   |   |
| Net unrealized holding gains (losses) arising during  the period, net of tax (provision) benefit of ($367) and $4,610 for the  three months ended June 30, 2005 and 2004, respectively, and $1,679 and  $2,112 for the six months ended June 30, 2005 and 2004,  respectively              |       | 742                                             |       | 6,267                                         |       | (2,449 | ) | 7,544 |   |
| Reclassification adjustment for net gains included  in net income(loss), net of tax provision of $5,356 and $2,965 for  the three months ended June 30, 2005 and 2004, respectively, and $10,909 and  $9,353 for the six months ended June 30, 2005 and 2004,  respectively |       | (8,668                                          | )          | (11,361                                       | )          | (17,655 | ) | (14,629 | ) |
| Net unrealized losses from investments                                                                                                                                                                                                                                                                         |       | (7,926                                          | )          | (5,094                                        | )          | (20,104 | ) | (7,085 | ) |
| Other comprehensive loss                                                                                                                                                                                                                                                                                       |       | (81,503                                         | )          | (20,878                                       | )          | (144,243 | ) | (44,497 | ) |
| Comprehensive income  (loss)                                                                                                                                                                                                                                                                                   |       | $                                               | (81,454    | )                                             | $          | 14,393 |   | $ | (153,136 | ) | $ | 30,546 |   |

 

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

6

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**CHIRON CORPORATIONCONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS(Unaudited)(In thousands)**
| ** **                                                                     | ** ** | **Six Months Ended  June 30,** | ** ** |
|--------------------------------------------------------------------------------|------------|-----------------------------------------------|------------|
| ** **                                                                     | ** ** | **2005**                                      | ** ** | **2004** | ** ** |
| ** **                                                                     | ** ** | ** **                                    | ** ** | **Restated** | ** ** |
| Net cash provided  by operating activities                                     |       | $                                             | 94,688     |   | $ | 74,730 |   |
| Cash flows from  investing activities:                                         |       |                                          |       |   |   |
| Purchases of investments in marketable debt  securities                        |       | (499,322                                      | )          | (218,815 | ) |
| Proceeds from sales of investments in marketable  debt securities              |       | 141,410                                       |       | 353,595 |   |
| Proceeds from maturities of investments in  marketable debt securities         |       | 318,129                                       |       | 154,526 |   |
| Capital expenditures                                                           |       | (97,802                                       | )          | (93,770 | ) |
| Purchases of equity securities and interests in  affiliated companies          |       | (2,467                                        | )          | (4,349 | ) |
| Proceeds from sale of equity securities and  interests in affiliated companies |       | 17,851                                        |       | 16,277 |   |
| Cash paid for acquisitions, net of cash acquired                               |       | (2,122                                        | )          | (19,548 | ) |
| Proceeds from (issuance of) notes receivable                                   |       | (4,959                                        | )          | 1,000 |   |
| Other, net                                                                     |       | (4,706                                        | )          | (217 | ) |
| Net cash provided by (used in) investing activities                            |       | (133,988                                      | )          | 188,699 |   |
| Cash flows from  financing activities:                                         |       |                                          |       |   |   |
| Repayment of debt and capital leases                                           |       | (351                                          | )          | (380,035 | ) |
| Payments to acquire treasury stock                                             |       | —                                        |       | (71,726 | ) |
| Proceeds from re-issuance of treasury stock                                    |       | 18,355                                        |       | 45,001 |   |
| Proceeds from issuance of debt                                                 |       | 1,002                                         |       | 2,317 |   |
| Payment of bond issuance costs                                                 |       | —                                        |       | (7,766 | ) |
| Proceeds from issuance of convertible debentures                               |       | —                                        |       | 385,000 |   |
| Net cash provided by (used in) financing activities                            |       | 19,006                                        |       | (27,209 | ) |
| Effect of exchange rate changes on cash and cash  equivalents                  |       | (4,907                                        | )          | (5,467 | ) |
| Net (decrease) increase in cash and cash equivalents                           |       | (25,201                                       | )          | 230,753 |   |
| Cash and cash  equivalents at beginning of the period                          |       | 209,509                                       |       | 364,270 |   |
| Cash and cash  equivalents at end of the period                                |       | $                                             | 184,308    |   | $ | 595,023 |   |

 

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

7

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

**Note** 1—Basisof Presentation

The information presented in the CondensedConsolidated Financial Statements at June 30, 2005, and for the three andsix months ended June 30, 2005 and 2004, is unaudited but includes all adjustments,consisting only of normal recurring adjustments, which Chiron Corporationbelieves to be necessary for fair presentation of the periods presented.

The Condensed ConsolidatedBalance Sheet amounts at December 31, 2004, have been derived from auditedfinancial statements. Historically, Chiron’s operating results have variedconsiderably from period to period due to the nature of Chiron’s collaborative,royalty and license arrangements and the seasonality of certain vaccineproducts. In addition, the mix of products sold and the introduction of newproducts will affect comparability from quarter to quarter. As a consequence,Chiron’s interim results in any one quarter are not necessarily indicative ofresults to be expected for a full year. This information should be read inconjunction with Chiron’s audited Consolidated Financial Statements as of andfor the year ended December 31, 2004, which are included in the AnnualReport on Form 10-K filed by Chiron with the Securities and ExchangeCommission, or SEC.

*Principles ofConsolidation*

The Condensed ConsolidatedFinancial Statements include the accounts of Chiron and its majority-ownedsubsidiaries. For consolidated majority-owned subsidiaries in which Chiron ownsless than 100%, Chiron records minority interest in the Condensed ConsolidatedFinancial Statements to account for the ownership interest of the minorityowner. Investments in limited partnerships and interests in which Chiron has anequity interest of 50% or less are accounted for using either the equity orcost method. All significant intercompany accounts and transactions have beeneliminated in consolidation.

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

During our 2004 year-endfinancial statement review, we determined that certain sales of the travelvaccine recorded as revenues in the second quarter of 2004 should not have beenrecorded as revenue at that time, and that portions of those sales should havebeen recorded as revenues in the third and fourth quarters of 2004 and possiblyin later quarters. As a result, we restated the financial statements includedin our Quarterly Reports on Form 10-Q for such quarters and filed amendedForm 10-Q’s for such quarters on April 6, 2005.

*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,management evaluates its estimates, including those related to investments;inventories; derivatives; capital leases; intangible assets; goodwill;purchased in-process research and development; product discounts, rebates andreturns; bad debts; collaborative, royalty and license arrangements;restructuring; pension and other post-retirement benefits; income taxes; andlitigation and other contingencies. Chiron bases its estimates on historicalexperience and on various other assumptions that are believed to be reasonable underthe circumstances, the results of 

8

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

**Note 1—Basisof Presentation (Continued)**

which form the basis formaking judgments about the carrying values of assets and liabilities that arenot readily apparent from other sources. Actual results may differ from thoseestimates under different assumptions or conditions.

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

Chiron currently owns certain manufacturing andinspection equipment which is no longer useful and became available for sale in2005. Chiron has committed to a plan to sell these assets and is activelymarketing these assets. These assets are classified as “Assets held for sale”in the Condensed Consolidated Balance Sheet at June 30, 2005.

Certain previouslyreported amounts have been reclassified to conform to the current yearpresentation.

*Stock-BasedCompensation*

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

9

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

**Note 1—Basisof Presentation (Continued)**

The following tableillustrates the effect on net income (loss) and related net income (loss) pershare, had compensation cost for the stock-based employee compensation beendetermined based upon the fair value method:
| ** **                           | ** **                                                                                                                            | **Three Months Ended  June 30,**                    | ** ** | **Six Months Ended  June 30,** | ** ** |
|--------------------------------------|---------------------------------------------------------------------------------------------------------------------------------------|--------------------------------------------------------------------|------------|-----------------------------------------------|------------|
| ** **                           | ** **                                                                                                                            | **2005**                                                           | ** ** | **2004**                                      | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **                           | ** **                                                                                                                            | ** **                                                         | ** ** | **Restated**                                  | ** ** | ** ** | ** ** | **Restated** | ** ** |
| ** **                           | ** **                                                                                                                            | **(in thousands, except per share data)** | ** ** |
| Net income (loss):                   |                                                                                                                                  |                                                               |       |                                          |       |   |   |   |   |
| As reported                          |                                                                                                                                  | $                                                                  | 49         |                                          | $          | 35,271 |   | $ | (8,893 | ) | $ | 75,043 |   |
| Add:                                 | Stock-based employee  compensation expense included in reported net income (loss), net of related  tax   effects                 |                                                               | 1,014      |                                          | 1,349      |   | 2,075 |   | 2,689 |   |
| Less:                                | Total stock-based  employee compensation expense determined under fair value based method for  all awards, net of related tax effects |                                                               | 19,062     |                                          | 22,769     |   | 35,736 |   | 44,277 |   |
|                                 | Pro forma                                                                                                                             |                                                               | $          | (17,999                                       | )          | $ | 13,851 |   | $ | (42,554 | ) | $ | 33,455 |   |
| Basic net income (loss) per share:   |                                                                                                                                  |                                                               |       |                                          |       |   |   |   |   |
| As reported                          |                                                                                                                                  | $                                                                  | —     | *                                             | $          | 0.19 |   | $ | (0.05 | ) | $ | 0.40 |   |
| Pro forma                            |                                                                                                                                  | $                                                                  | (0.10      | )                                             | $          | 0.07 |   | $ | (0.23 | ) | $ | 0.18 |   |
| Diluted net income (loss) per share: |                                                                                                                                  |                                                               |       |                                          |       |   |   |   |   |
| As reported                          |                                                                                                                                  | $                                                                  | —     | *                                             | 0.18       |   | $ | (0.05 | ) | $ | 0.39 |   |
| Pro forma                            |                                                                                                                                  | $                                                                  | (0.10      | )                                             | $          | 0.07 |   | $ | (0.23 | ) | $ | 0.18 |   |

----

*                    Lessthan $0.01 per share.

**Note 2—New Accounting Standards**

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-basedpayment transactions to be recognized in the consolidated financial statements.That cost will be measured based on the fair value of the equity instrumentsissued or on the fair value of liabilities incurred. Under SFAS 123(R),the fair-value-based method for recognition or disclosure of compensationexpense will be applied using the modified prospective application transitionmethod or the modified retrospective application transition method. Chironcurrently measures compensation expense for its stock-based employeecompensation under the intrinsic method. We are currently evaluating transitionmethods, option valuation methodologies and assumptions in light ofSFAS 123(R) and, therefore, cannot estimate the impact of ouradoption at this time, although we expect that its adoption will have amaterial impact on Chiron’s consolidated financial statements. Current optionvalues determined using the Black-Scholes-Merton formula, used for purposes ofproforma disclosure, may not be indicative of results from the valuationmethodologies Chiron finally adopts. The effective date of SFAS 123(R) isthe first reporting period beginning after June 15, 2005. However, on April 14,2005, the 

10

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

**Note 2—NewAccounting Standards (Continued)**

Securities and ExchangeCommission (SEC) announced the adoption of a new rule that delays theeffective 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 beginningof 2006, which makes SFAS 123(R) effective for Chiron in the firstquarter of 2006.

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

**Note 3—Inventories**

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

Inventories,net of reserves, consisted of the following:
| ** **          | ** ** | **June 30,  2005** | ** ** | **December 31,  2004** | ** ** |
|---------------------|------------|-------------------------|------------|-----------------------------|------------|
| ** **          | ** ** | **(in thousands)** | ** ** |
| Finished goods |       | $                       | 68,698     |                        |       | $ | 59,206 |   |   |
| Work-in-process     |       | 117,901                 |       |                        | 116,660    |   |   |
| Raw materials       |       | 52,295                  |       |                        | 45,288     |   |   |
|                |       | $                       | 238,894    |                        |       | $ | 221,154 |   |   |

 

**Note 4—Income Taxes**

The effective tax rate was24.8% and 25.0% of pretax income (loss) from continuing operations for the sixmonths ended June 30, 2005 and 2004, respectively. The effective tax ratemay be affected in future periods by changes in management’s estimates withrespect to our deferred tax assets and other items affecting the overall taxrate.

11

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

**Note 5—Comprehensive Income (Loss)**

For the three and sixmonths ended June 30, 2005 and 2004, the foreign currency translationcomponent of comprehensive income (loss) relates to permanent investments innon-U.S. subsidiaries and, accordingly, was not adjusted for income taxes.

**Note 6—Treasury Stock**

Treasury stock is statedat cost. Gains on reissuance of treasury stock are credited to “Additionalpaid-in capital.” Losses on reissuance of treasury stock are charged to “Additionalpaid-in capital” to the extent of available net gains on reissuance of treasurystock. Otherwise, losses are charged to “Accumulated deficit.” Chiron chargedlosses of $10.5 million and $24.1 million for the three and six monthsended June 30, 2005, respectively, and $4.7 million and $30.1 million forthe three and six months ended June 30, 2004, respectively, to “Accumulateddeficit” in the Condensed Consolidated Balance Sheets.

**Note 7—Earnings (Loss) Per Share**

Basic earnings per share is based upon theweighted-average number of common shares outstanding. Diluted earnings pershare is based upon the weighted-average number of common shares and dilutivepotential common shares outstanding. Dilutive potential common shares couldresult from (i) the assumed exercise of outstanding stock options andequivalents, which are included under the treasury-stock method; (ii) performancebased share rights awards to the extent that dilutive shares are assumedissuable; (iii) the assumed exercise of outstanding put options, which areincluded under the reverse treasury-stock method; and (iv) convertiblenotes and debentures, which are included under the if-converted method, ifapplicable. Due to rounding, quarterly amounts may not sum to full yearamounts.

Contingently convertible debt instruments (“CoCos”)are included in diluted earnings per share, if dilutive. For the three and sixmonths ended June 30, 2005 and 2004, Chiron’s $500.0 million contingentlyconvertible debentures due 2033 (“2033 Debentures”) and Chiron’s $385.0 millioncontingently convertible debentures due 2034 (“2034 Debentures”) were excludedfrom the computations of diluted earnings per share as the inclusion of each ofthese CoCos would be antidilutive.

12

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

**Note 7—Earnings(Loss) Per Share (Continued)**

The following table setsforth the computations for basic and diluted earnings (loss) per share onincome (loss) from continuing operations (in thousands, except per share data):
| ** **                                                                             | ** ** | **Three Months Ended  June 30,** | ** ** | **Six Months Ended  June 30,** | ** ** |
|----------------------------------------------------------------------------------------|------------|-------------------------------------------------|------------|-----------------------------------------------|------------|
| ** **                                                                             | ** ** | **2005**                                        | ** ** | **2004**                                      | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **                                                                             | ** ** | ** **                                      | ** ** | **Restated**                                  | ** ** | ** ** | ** ** | **Restated** | ** ** |
| Income (loss)  (Numerator):                                                            |       |                                            |       |                                          |       |   |   |   |   |
| Income (loss) from continuing operations                                               |       | $                                               | 49         |                                          | $          | 22,812 |   | $ | (8,893 | ) | $ | 49,739 |   |
| Shares (Denominator):                                                                  |       |                                            |       |                                          |       |   |   |   |   |
| Weighted-average common shares outstanding                                             |       | 187,532                                         |       | 188,275                                       |       | 187,321 |   | 187,952 |   |
| Effect of  dilutive securities:                                                        |       |                                            |       |                                          |       |   |   |   |   |
| Stock options and equivalents                                                          |       | 1,436                                           |       | 2,710                                         |       | — |   | 3,450 |   |
| Weighted-average common shares outstanding,  plus impact from assumed conversions |       | 188,968                                         |       | 190,985                                       |       | 187,321 |   | 191,402 |   |
| Basic earnings  (loss) per share                                                       |       | $                                               | —     | *                                             | $          | 0.12 |   | $ | (0.05 | ) | $ | 0.26 |   |
| Diluted earnings (loss)  per share                                                     |       | $                                               | —     | *                                             | $          | 0.12 |   | $ | (0.05 | ) | $ | 0.26 |   |

----

*                    Less than$0.01 per share.

Thefollowing table sets forth the computations for basic and diluted earnings(loss) per share on net income (loss) (in thousands, except per share data):
| ** **                                                                        | ** ** | **Three Months Ended  June 30,** | ** ** | **Six Months Ended  June 30,** | ** ** |
|-----------------------------------------------------------------------------------|------------|-------------------------------------------------|------------|-----------------------------------------------|------------|
| ** **                                                                        | ** ** | **2005**                                        | ** ** | **2004**                                      | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **                                                                        | ** ** | ** **                                      | ** ** | **Restated**                                  | ** ** | ** ** | ** ** | **Restated** | ** ** |
| Income (loss)  (Numerator):                                                       |       |                                            |       |                                          |       |   |   |   |   |
| Net income (loss)                                                                 |       | $                                               | 49         |                                          | $          | 35,271 |   | $ | (8,893 | ) | $ | 75,043 |   |
| Shares  (Denominator):                                                            |       |                                            |       |                                          |       |   |   |   |   |
| Weighted-average common shares outstanding                                        |       | 187,532                                         |       | 188,275                                       |       | 187,321 |   | 187,952 |   |
| Effect of dilutive securities:                                                    |       |                                            |       |                                          |       |   |   |   |   |
| Stock options and equivalents                                                     |       | 1,436                                           |       | 2,710                                         |       | — |   | 3,450 |   |
| Weighted-average common shares outstanding, plus  impact from assumed conversions |       | 188,968                                         |       | 190,985                                       |       | 187,321 |   | 191,402 |   |
| Basic earnings  (loss) per share                                                  |       | $                                               | —     | *                                             | $          | 0.19 |   | $ | (0.05 | ) | $ | 0.40 |   |
| Diluted earnings (loss)  per share                                                |       | $                                               | —     | *                                             | $          | 0.18 |   | $ | (0.05 | ) | $ | 0.39 |   |

----

*                    Less than$0.01 per share.

Stock options to purchase 21.0 million shares and11.8 million shares with exercise prices greater than the average marketprices of common stock were outstanding during the three months ended June 30,2005 

13

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

**Note 7—Earnings(Loss) Per Share (Continued)**

and 2004, respectively,and 22.0 million shares and 7.6 million shares, respectively, for the sixmonths ended June 30, 2005 and 2004. These options were excluded from therespective computations of diluted earnings per share, as their inclusion wouldbe 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 three and six months ended June 30,2005 and 2004, 7.3 million shares of common stock issuable upon conversion ofthe 2033 Debentures were excluded from the computations of diluted earnings pershare as their inclusion would be antidilutive.

If the 2034 Debentures are tendered for conversion,the value (“Conversion Value”) of cash and shares of Chiron’s common stock, ifany, to be received by a holder converting $1,000 principal amount of thedebentures will be determined by multiplying the applicable conversion rate bya weighted average price. Chiron will deliver the Conversion Value to debentureholders as follows: (1) an amount in cash (“Principal Return”) equal tothe lesser of (a) the aggregate Conversion Value of the debentures to beconverted and (b) the aggregate principal amount of the debentures to beconverted and (2) if the aggregate Conversion Value of the debentures tobe converted is greater that the Principal Return, an amount in shares (“NetShares”) equal to the aggregate Conversion Value less the Principal Return (“NetShare Amount”). The number of Net Shares to be paid will be determined bydividing the Net Share Amount by a weighted average price. If dilutive, commonshares to be added to the diluted shares outstanding would be determined by thenet share settlement of the 2034 Debentures. For the three and six months endedJune 30, 2005 and 2004, the assumed conversion of the 2034 Debentures wasnot dilutive.

In addition, for the three and six months ended June 30,2005, 0.6 million shares of common stock issuable upon conversion of the LiquidYield Option Notes were excluded from the computations of diluted earnings pershare as their inclusion would be antidilutive. For the three and six monthsended June 30, 2004, 4.1 million and 6.2 million shares of common stockissuable upon conversion of the Liquid Yield Option Notes were excluded fromthe computations of diluted earnings per share as their inclusion would beantidilutive.

All potential common shareshave been excluded from the computation of diluted loss per share for the sixmonths ended June 30, 2005, as their inclusion would be antidilutive.These potential common shares included stock options to purchase 1.3 millionshares of common stock, 0.6 million shares of common stock issuable uponconversion of the Liquid Yield Option Notes and 7.3 million shares issuableupon conversion of the Convertible Debentures.

**Note 8—Discontinued Operations**

In a strategic effort to focus on our core businessesof blood-testing, vaccines and biopharmaceuticals, we completed the sale ofChiron Diagnostics to Bayer Corporation, or Bayer, in 1998.

In the second quarter of 2004, Chiron and the IRSentered into a settlement agreement closing the open tax years 1996 to 1998. Pursuantto this settlement, Chiron recognized a tax benefit of approximately $12.5 millionfor the three and six months ended June 30, 2004.

14

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

**Note 8—DiscontinuedOperations (Continued)**

Chiron and Bayer wereinvolved in a dispute with respect to their respective rights to certainroyalty refunds receivable for which a settlement was reached in 2004. Underthis settlement agreement, Chiron made a settlement payment to Bayer in 2004.This settlement includes an agreement that all outstanding items with Bayerrelated to the sale of Chiron Diagnostics are resolved and no future indemnityobligations are required. Chiron released previously established reservesdeemed to be in excess following this settlement. This settlement resulted in anet gain of $12.8 million for the six months ended June 30, 2004.This net gain primarily relates to a tax benefit as a result of the settlementpayment to Bayer.

**Note 9—IntangibleAssets**

Intangibleassets subject to amortization consisted of the following (in thousands):
| ** **                                       | ** ** | **June 30, 2005** | ** ** | **December 31, 2004** | ** ** |
|--------------------------------------------------|------------|-----------------------------|------------|---------------------------------|------------|
| ** **                                       | ** ** | **Gross  Carrying  Value**  | ** ** | **Accumulated  Amortization**   | ** ** | **Net Carrying  Value** | ** ** | **Gross  Carrying  Value** | ** ** | **Accumulated  Amortization** | ** ** | **Net Carrying  Value** | ** ** |
| Purchased technologies                           |       | $                           | 332,325    |                            |       | $ | 126,446 |   |   |   | $ | 205,879 |   |   | $ | 333,085 |   |   | $ | 117,048 |   |   |   | $ | 216,037 |   |   |
| Patents                                          |       | $                           | 137,016    |                            |       | $ | 75,639 |   |   |   | $ | 61,377 |   |   | $ | 132,385 |   |   | $ | 71,616 |   |   |   | $ | 60,769 |   |   |
| Trademarks                                       |       | 60,512                      |       |                            | 25,106     |   |   |   | 35,406 |   |   | 65,609 |   |   | 25,450 |   |   |   | 40,159 |   |   |
| Licenses and  technology rights             |       | 44,172                      |       |                            | 32,335     |   |   |   | 11,837 |   |   | 47,745 |   |   | 34,079 |   |   |   | 13,666 |   |   |
| Developed product  technologies                  |       | 352,983                     |       |                            | 98,868     |   |   |   | 254,115 |   |   | 374,025 |   |   | 77,253 |   |   |   | 296,772 |   |   |
| Customer  relationships                          |       | 27,859                      |       |                            | 11,808     |   |   |   | 16,051 |   |   | 31,234 |   |   | 12,421 |   |   |   | 18,813 |   |   |
| Know how(1)                                      |       | 12,652                      |       |                            | 7,188      |   |   |   | 5,464 |   |   | 14,185 |   |   | 7,548 |   |   |   | 6,637 |   |   |
| Databases                                        |       | 7,100                       |       |                            | 2,248      |   |   |   | 4,852 |   |   | 7,100 |   |   | 2,012 |   |   |   | 5,088 |   |   |
| Other                                            |       | 24,700                      |       |                            | 10,721     |   |   |   | 13,979 |   |   | 34,893 |   |   | 19,090 |   |   |   | 15,803 |   |   |
| Total other intangible assets               |       | $                           | 666,994    |                            |       | $ | 263,913 |   |   |   | $ | 403,081 |   |   | $ | 707,176 |   |   | $ | 249,469 |   |   |   | $ | 457,707 |   |   |
| Total intangible assets  subject to amortization |       | $                           | 999,319    |                            |       | $ | 390,359 |   |   |   | $ | 608,960 |   |   | $ | 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.

15

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

**Note 9—IntangibleAssets (Continued)**

Aggregate futureamortization expense is expected to be as follows (in thousands):
| For the six  months ended June 30, 2005                           |   | $ | 48,447  |   |
|------------------------------------------------------------------------|--------|---|---------|--------|
| For the remaining  six months in the year ended December 31, 2005 |   | $ | 48,440  |   |
| For the year  ended December 31, 2005                             |   | $ | 96,887  |   |
| For the year  ended December 31, 2006                             |   | $ | 107,222 |   |
| For the year  ended December 31, 2007                             |   | $ | 105,456 |   |
| For the year  ended December 31, 2008                             |   | $ | 79,922  |   |
| For the year  ended December 31, 2009                             |   | $ | 54,899  |   |
| For the year ended  December 31, 2010                             |   | $ | 53,397  |   |

 

Thechanges in the carrying value of goodwill by reporting unit consisted of thefollowing (in thousands):
| ** **                            | ** ** | **Biopharmaceuticals** | ** ** | **Vaccines** | ** ** | **Total** | ** ** |
|---------------------------------------|------------|------------------------|------------|--------------|------------|-----------|------------|
| Balance as of  December 31, 2004 |       |                   | $          | 192,186      |       |      | $          | 669,208 |   | $ | 861,394 |   |
| Effect of exchange rate changes       |       |                   | —     |         |       | (40,378   | )          | (40,378 | ) |
| Balance as of  June 30, 2005     |       |                   | $          | 192,186      |       |      | $          | 628,830 |   | $ | 821,016 |   |

 

**Note 10—Segment Information**

Chiron is organized based on the products and servicesthat it offers. Under this organizational structure, there are three reportablesegments: (i) blood-testing, (ii) vaccines and (iii) biopharmaceuticals.The blood-testing segment consists of an alliance with Gen-Probe and Chiron’sone-half share in the pretax operating earnings generated by the joint businesscontractual arrangement with Ortho-Clinical Diagnostics. Chiron’s alliance withGen-Probe is focused on developing and commercializing nucleic acid testingproducts using Transcription-Mediated Amplification technology to screendonated blood and plasma products for viral infection. Chiron’s joint businessarrangement with Ortho-Clinical Diagnostics is operated under a contractualarrangement and is not a separate and distinct legal entity. Through Chiron’sjoint business contractual arrangement with Ortho-Clinical Diagnostics, Chironsells a line of immunodiagnostic tests to detect hepatitis viruses andretroviruses and provides supplemental tests and microplate andchemiluminescent instrument systems to automate test performance and datacollection. The blood-testing segment also earns royalties from third partiesbased on their sales of immunodiagnostic and nucleic acid testing probediagnostic products utilizing Chiron’s hepatitis C virus and HIV-relatedpatents, for use in blood screening and plasma fractionation markets. Thevaccines segment consists principally of adult and pediatric vaccines for viraland bacterial infections. Chiron sells these vaccines primarily in the U.S.,Germany, Italy, and the United Kingdom, as well as in other internationalmarkets. The vaccines segment is also involved in the development of novelvaccines and vaccination technology. The biopharmaceuticals segment consists oftherapeutic products and services, with an emphasis on the treatment of cancerand infectious and pulmonary diseases, using the development and acquisition oftechnologies related to therapeutic proteins, antibodies and small molecules.The biopharmaceuticals segment earns royalties on third party sales of severalproducts, including BETAFERON® interferon 

16

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

**Note 10—SegmentInformation (Continued)**

beta-1b, and earnslicense fees for technologies, such as hepatitis C virus-related patents, usedby third parties to develop therapeutic products.

Revenues and expenses associated with Chiron’sresearch and development activities specifically benefit each of the reportablesegments and, as such, have been included in the results of operations of therespective reportable segment.

Chiron views certain other revenues and expenses,particularly certain royalty and license fee revenues primarily related to HIVand hepatitis C virus related patents, and unallocated corporate expenses, asnot belonging to any one reportable segment. As a result, Chiron has aggregatedthese items into an “Other” segment.

The accounting policies of Chiron’s reportablesegments are the same as those described in Chiron’s Annual Report on Form 10-Kfor the year ended December 31, 2004. Chiron evaluates the performance ofits segments based on each segment’s income (loss) from continuing operations.

17

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

**Note 10—Segment Information**(Continued)

Thefollowing segment information excludes all significant intersegmenttransactions as these transactions are eliminated for management reportingpurposes (in thousands):
| ** **                                                          | ** ** | **Three Months Ended  June 30,** | ** ** | **Six Months Ended  June 30,** | ** ** |
|---------------------------------------------------------------------|------------|-------------------------------------------------|------------|-----------------------------------------------|------------|
| ** **                                                          | ** ** | **2005**                                        | ** ** | **2004**                                      | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **                                                          | ** ** | ** **                                      | ** ** | **Restated**                                  | ** ** | ** ** | ** ** | **Restated** | ** ** |
| *Revenues*                                                          |       |                                            |       |                                          |       |   |   |   |   |
| Blood-testing:                                                      |       |                                            |       |                                          |       |   |   |   |   |
| Product sales,  net:                                                |       |                                            |       |                                          |       |   |   |   |   |
| PROCLEIX® products                                        |       | $                                               | 66,104     |                                          | $          | 60,589 |   | $ | 130,535 |   | $ | 122,475 |   |
| Ortho-Clinical  Diagnostics                                         |       | 7,988                                           |       | 6,608                                         |       | 14,450 |   | 12,842 |   |
| Total product  sales, net                                           |       | 74,092                                          |       | 67,197                                        |       | 144,985 |   | 135,317 |   |
| Revenues from  joint business arrangement                           |       | 31,003                                          |       | 28,532                                        |       | 67,061 |   | 58,893 |   |
| Collaborative  agreement revenues                                   |       | 2,128                                           |       | 2,325                                         |       | 4,010 |   | 4,389 |   |
| Royalty and  license fee revenues                                   |       | 25,990                                          |       | 16,267                                        |       | 51,194 |   | 32,701 |   |
| Other revenues                                                      |       | 200                                             |       | 235                                           |       | 275 |   | 430 |   |
| Total  blood-testing revenues                                       |       | 133,413                                         |       | 114,556                                       |       | 267,525 |   | 231,730 |   |
| Vaccines:                                                           |       |                                            |       |                                          |       |   |   |   |   |
| Product sales,  net:                                                |       |                                            |       |                                          |       |   |   |   |   |
| Influenza vaccines                                                  |       | (492                                            | )          | 8,207                                         |       | 3,079 |   | 15,912 |   |
| Meningococcal  vaccines                                             |       | 13,605                                          |       | 5,016                                         |       | 22,758 |   | 9,565 |   |
| Travel vaccines                                                     |       | 45,014                                          |       | 26,261                                        |       | 88,773 |   | 49,271 |   |
| Pediatric and  other vaccines                                       |       | 39,127                                          |       | 47,619                                        |       | 69,620 |   | 98,802 |   |
| Total product  sales, net                                           |       | 97,254                                          |       | 87,103                                        |       | 184,230 |   | 173,550 |   |
| Collaborative  agreement revenues                                   |       | 999                                             |       | 1,214                                         |       | 3,241 |   | 5,180 |   |
| Royalty and  license fee revenues                                   |       | 769                                             |       | 25                                            |       | 2,185 |   | 2,675 |   |
| Other revenues                                                      |       | 2,480                                           |       | 5,914                                         |       | 5,756 |   | 9,556 |   |
| Total vaccines  revenues                                            |       | 101,502                                         |       | 94,256                                        |       | 195,412 |   | 190,961 |   |
| Biopharmaceuticals:                                                 |       |                                            |       |                                          |       |   |   |   |   |
| Product sales, net                                                  |       |                                            |       |                                          |       |   |   |   |   |
| BETASERON® interferon beta-1b                             |       | 38,132                                          |       | 31,626                                        |       | 64,766 |   | 61,762 |   |
| TOBI® tobramycin                                          |       | 56,600                                          |       | 51,342                                        |       | 109,535 |   | 103,866 |   |
| PROLEUKIN® aldesleukin                                    |       | 31,727                                          |       | 35,057                                        |       | 61,262 |   | 66,925 |   |
| Other                                                               |       | 5,770                                           |       | 8,896                                         |       | 15,960 |   | 20,867 |   |
| Total product  sales, net                                           |       | 132,229                                         |       | 126,921                                       |       | 251,523 |   | 253,420 |   |
| Collaborative  agreement revenues                                   |       | 326                                             |       | 289                                           |       | 729 |   | 774 |   |
| Royalty and  license fee revenues                                   |       | 19,792                                          |       | 15,183                                        |       | 38,418 |   | 32,480 |   |
| Other revenues                                                      |       | 1,524                                           |       | 4,826                                         |       | 7,720 |   | 7,927 |   |
| Total  biopharmaceuticals revenues                                  |       | 153,871                                         |       | 147,219                                       |       | 298,390 |   | 294,601 |   |
| Other:                                                              |       |                                            |       |                                          |       |   |   |   |   |
| Royalty and  license fee revenues                                   |       | 29,971                                          |       | 23,721                                        |       | 64,786 |   | 42,132 |   |
| Total revenues                                                      |       | $                                               | 418,757    |                                          | $          | 379,752 |   | $ | 826,113 |   | $ | 759,424 |   |
| *Income  (loss) from continuing operations:*                        |       |                                            |       |                                          |       |   |   |   |   |
| Blood-testing                                                       |       | $                                               | 70,776     |                                          | $          | 59,208 |   | $ | 145,135 |   | $ | 122,848 |   |
| Vaccines                                                            |       | (81,734                                         | )          | (46,313                                       | )          | (167,133 | ) | (96,352 | ) |
| Biopharmaceuticals                                                  |       | 2,597                                           |       | 8,777                                         |       | (3,511 | ) | 28,026 |   |
| Other                                                               |       | (9,084                                          | )          | (4,154                                        | )          | (17,696 | ) | (10,631 | ) |
| Segment (loss)  income from operations                              |       | (17,445                                         | )          | 17,518                                        |       | (43,205 | ) | 43,891 |   |
| Interest expense                                                    |       | (8,094                                          | )          | (6,452                                        | )          | (15,173 | ) | (12,377 | ) |
| Interest and other  income, net                                     |       | 26,298                                          |       | 19,809                                        |       | 47,745 |   | 35,883 |   |
| Minority interest                                                   |       | (662                                            | )          | (459                                          | )          | (1,192 | ) | (1,079 | ) |
| Income (loss) from  continuing operations before income taxes  |       | $                                               | 97         |                                          | $          | 30,416 |   | $ | (11,825 | ) | $ | 66,318 |   |

** **

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

**Note 11—Commitments and Contingencies**

In October 2004,the U.K. regulatory body, the Medicines and Healthcare products RegulatoryAgency, or MHRA, suspended Chiron’s license to manufacture FLUVIRIN®at our Liverpool, U.K. facility. Subsequently, Chiron received a warning letterfrom the Food and Drug Administration, or FDA, citing violations of goodmanufacturing practices. The FDA later informed Chiron that implementation andeffectiveness of our corrective actions and overall compliance would beevaluated in a subsequent inspection. As a result of the suspension of ourlicense, Chiron did not release any FLUVIRIN® vaccine during the 2004-2005influenza season.

On March 2,2005, the MHRA notified Chiron that it had lifted the license suspension,giving Chiron clearance to initiate full production of FLUVIRIN® vaccine, conditionedon the understanding that Chiron’s commitment to its remediation plan willcontinue and will be subject to further inspections by the MHRA. In July 2005,the FDA completed an on-site inspection of our Liverpool facility. Consistentwith FDA process, at the conclusion of the on-site inspection, Chiron receiveda list of observations on a Form 483. Chiron expects to complete itsresponse to these observations in early August 2005. If the FDA finds thatChiron has failed to adequately address the matters discussed in its priorwarning letter or any other serious violations, the FDA may modify Chiron’sU.S. license in an adverse manner, take action that could result in impositionof fines, require temporary or permanent cessation of future selling ofFLUVIRIN® vaccine or take other action that could reduce our abilityto market FLUVIRIN® vaccine. In addition to the facility inspection,Chiron will need to receive supplemental approvals for changes in our FLUVIRIN®vaccine from the MHRA and the FDA because of variations to our manufacturingprocess.

Chironreceived a grand jury subpoena issued by the U.S. Attorney’s Office for the SouthernDistrict of New York in October 2004 requesting production of certaindocuments relating to FLUVIRIN® vaccine and the suspension by theMHRA of Chiron’s license. In February 2005, after having previouslycommenced an informal inquiry, the Securities and Exchange Commission, or SEC,notified Chiron that it would commence a formal investigation into whetherChiron or Chiron employees violated any federal securities laws in connectionwith these developments regarding FLUVIRIN® vaccine, and Chironsubsequently received subpoenas from the SEC requesting production of certaindocuments relating to our Liverpool facility and FLUVIRIN® vaccine.Chiron also received a voluntary request for information from the United StatesHouse of Representatives, Energy and Commerce Committee, Subcommittee onOversight and Investigations requesting production of certain documents. Numerous documents have been collectedand produced in response to these requests, and several witnesses have beeninterviewed by the U.S. Attorney’s Office, the SEC staff and Congressionalstaff and additional interviews are anticipated. Additional investigationsregarding these matters may arise.

Inaddition, Chiron and certain of its officers and directors have also been namedas defendants in several putative shareholder class action and derivativelawsuits alleging various claims arising out of or relating to thesedevelopments regarding FLUVIRIN® vaccine. Certain distributors andother parties with whom Chiron had contracted to supply FLUVIRIN®vaccine are considering or have communicated claims against Chiron as a resultof our inability to supply FLUVIRIN® vaccine, and additional partiesmay do 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® vaccine for default on the basis of Chiron’s failureto supply such vaccine to the U.S. government for the 2004-2005 influenzaseason. The CDC has reserved the right to hold Chiron liable for any excesscosts it may have incurred in replacing any 

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

**Note 11—Commitmentsand Contingencies (Continued)**

FLUVIRIN®vaccine that Chiron failed to deliver and further has reserved all otherremedies provided under the contract. It is not possible to predict whether anyof these claims will be pursued and, if so, whether those claims will beupheld. Investigations, litigation and disputes have caused us to incursubstantial expense and have required significant time and attention fromChiron management and will continue to do so in the future and could result in civilaction and/or criminal proceedings against Chiron. The results of any suchinvestigations, proceedings or disputes could have a material adverse effect onChiron’s consolidated financial position and results of operations and/or cashflow.

Althoughthe MHRA has lifted its suspension of Chiron’s license to manufacture FLUVIRIN® vaccine, Chiron expects to incur additional expensesin connection with ongoing FLUVIRIN®vaccine matters, which could be material, including in connection with (1) ourcontinuing remediation efforts at our Liverpool facility; and (2) respondingto the U.S. Attorney for the Southern District of New York, the SEC, the UnitedStates House of Representatives, Energy and Commerce Committee, Subcommittee onOversight and Investigations and the private lawsuits and other claims andinvestigations that exist or may arise.

In July 2005, Chiron reportedthat it would be unable to supply any BEGRIVACTM vaccine doses for the 2005-2006influenza season due to a product sterility issue and wrote off its existingproduct inventory resulting in a $15.0 million charge to cost of sales for thethree and six months ended June 30, 2005. BEGRIVACTM vaccine is manufactured at Chiron’sfacility in Marburg, Germany. Chiron’s inability to supply BEGRIVACTM vaccine as plannedto non-U.S. markets for the 2005-2006 season or future seasons could havea material adverse affect on its business and results of operations. In addition, it is possible that distributors andother parties with whom Chiron had contracted to supply influenzavaccine may make claims against Chiron as aresult of Chiron not supplying influenza vaccine. Any such claims may cause Chiron to incur substantial expense and requiresignificant time and attention from Chiron management. The results of any suchclaims could have a material adverse effect on Chiron’s consolidated financialposition and results of operations and/or cash flow.

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

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

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**Item 2.**                        Management’s Discussion andAnalysis of Financial Condition and Results of Operations

***Forward-Looking Statements***

This Form 10-Qcontains forward-looking statements regarding our expectations, hopes orintentions regarding the future, including statements relating to sales growth,product development initiatives, new product marketing, acquisitions,competition, and licensing activities that involve risks and uncertainties andare subject to change. The forward-looking statements contained in this Form 10-Qreflect our current expectations on the date of this Form 10-Q. Actualresults, performance or outcomes may differ materially from currentexpectations. Our actual performance may differ from current expectations dueto many factors, including additional adverse developments resulting from thesuspension from October 5, 2004 through March 2, 2005 of our UKlicense to manufacture FLUVIRIN® influenza virus vaccine, theannouncement of such suspension and the litigation and investigations relatingto those matters, the outcome of clinical trials, regulatory review andapprovals, manufacturing capabilities, intellectual property protections anddefenses, litigation, stock price and interest rate volatility, marketingeffectiveness and the severity of the 2005-2006 influenza season. Inparticular, there can be no assurance that we will increase sales of existingproducts, successfully develop and receive approval to market new products, orachieve market acceptance for such new products. No assurances can be giventhat additional issues with respect to BEGRIVACTM or FLUVIRIN®vaccines or our manufacturing generally will not arise in the future, that wewill be able to cover vaccine shortfalls, or that we will successfully addressmatters raised in a warning letter from the U.S. Food and Drug Administrationwith respect to our FLUVIRIN® vaccine manufacturing facility orresume sale of FLUVIRIN® vaccine for the 2005-2006 influenza seasonor BEGRIVACTM vaccine for the 2006-2007 influenza season. In addition, we mayface additional competition in the influenza market in the future andchallenges in distribution arrangements as a result of recent BEGRIVACTM andFLUVIRIN® vaccine developments. There can be no assurance that ourout-licensing activity will generate significant revenue, or that ourin-licensing activities will fully protect us from claims of infringement bythird parties. In addition, we may engage in business opportunities, thesuccessful completion of which is subject to certain risks, including approvalby Novartis, stockholder and regulatory approvals and the integration ofoperations. We have discussed the important factors, which we believe couldcause actual results to differ from what is expressed in the forward-lookingstatements, under the caption “Factors That May Affect Future Results” inthis Form 10-Q. We do not undertake an obligation to update theforward-looking information contained in this Form 10-Q.

***Introduction***

We are a global biopharmaceutical company thatparticipates in three healthcare markets: blood-testing, vaccines, andbiopharmaceuticals. Our research and development efforts are focused ondeveloping products for cancer and infectious and pulmonary disease.

Our blood-testing segment is dedicated to preventingthe spread of infectious diseases through the development and sale of novelblood-screening assays and equipment that protect the world’s blood supply. Weare the world leader in nucleic acid testing, or NAT, blood screening withleading market share in the U.S, a strong presence in Europe, and sales in Asia.Our blood-testing segment consists of two separate collaborations: an alliancewith Gen-Probe Incorporated for NAT products, and a joint business contractualarrangement with Ortho-Clinical Diagnostics, Inc, a Johnson & Johnsoncompany for immunodiagnostic products. Our collaboration with Gen-Probe isfocused on developing and commercializing NAT products to screen donated blood,plasma, organs and tissue for viral infection. We sell the collaboration’sassays and instruments to blood banks under the PROCLEIX® brand name.Under a joint business contractual arrangement, Ortho-Clinical Diagnosticsmanufactures and sells immunodiagnostic tests to detect retroviruses andhepatitis viruses in blood. Our blood-testing segment also earns royalties andlicense fees from third parties based on their sales of immunodiagnostic and 

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nucleic acid testing probediagnostic products utilizing our hepatitis C virus and HIV-related patents,for use in blood screening and plasma fractionation markets.

Our vaccines segment is the fifth largest vaccinesbusiness in the world. We offer more than 20 pediatric and adult vaccinesincluding influenza, meningococcal, travel and pediatric vaccines. Thesevaccines have protected millions of people globally from potentially fataldiseases such as polio, measles and meningococcal disease. We market ourvaccines primarily in the United States, Germany, Italy and the United Kingdom.We acquired a number of vaccines including FLUVIRIN® vaccine as partof our July 8, 2003 acquisition of PowderJect. Our vaccines segmentresearch and development is focused on developing next generation influenzamanufacturing capability, developing new vaccines for pandemic preparedness,and broadening our meningococcal franchise.

Our biopharmaceuticals segment discovers, develops,manufactures and markets a range of therapeutic products for cancer andinfectious and pulmonary disease. Our marketed products include TOBI®tobramycin solution for inhalation for pseudomonal lung infections in cysticfibrosis patients; PROLEUKIN®(aldesleukin) for injection for metastaticmelanoma and renal cell carcinoma; and BETASERON® (interferon beta-1b)for SC injection for multiple sclerosis. In 2005, we received an action letterfrom the U.S. Food and Drug Administration (FDA) stating that the company’s NewDrug Application (NDA) for PULMINIQTM (cyclosporine, USP) inhalationsolution is “approvable” but that an additional pre-approval study is requiredto confirm the efficacy of the drug. Chiron is evaluating possible next stepsfor PULMINIQ. In 2004, we filed for marketing approval for CUBICIN®(daptomycin for injection) for complicated skin and soft tissue infections.

Research and development efforts include advancingclinical programs and product improvements in oncology and pulmonary andinfectious disease, including the use of PROLEUKIN® to enhance thebenefit of monoclonal antibodies in cancer treatment, the development of newformulations of TOBI® and the clinical advancement of tifacogin fortreatment of severe community-acquired pneumonia, CHIR-258, a growthfactor kinase inhibitor, and CHIR-12.12, a monoclonal antibody.

We earn royalty and license fee revenue in all threesegments by licensing some of our key intellectual property in areas such ashepatitis C and HIV. In addition, we generate royalties through agreements withdevelopment and marketing partners, including royalties from Schering AG’ssales of BETAFERON® (interferon beta-1b) for SC injection inEurope. Some royalties and license fees are not considered to be associatedwith any particular business segment and are recorded separately in the segmentdata as Other Royalty and License Fee Revenues.

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

***Influenza Virus 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. Subsequently,we received a warning letter from the Food and Drug Administration, or FDA,citing violations of good manufacturing practices. The FDA later informed usthat implementation and effectiveness of our corrective actions and overallcompliance would be evaluated in a subsequent inspection. As a result of thesuspension of our license, we did not release any FLUVIRIN® vaccineduring the 2004-2005 influenza season.

On March 2, 2005, the MHRA notified us that ithad lifted the license suspension, giving Chiron clearance to initiate fullproduction of FLUVIRIN® vaccine, conditioned on the understandingthat Chiron’s commitment to its remediation plan will continue and will besubject to further inspections by the MHRA. In July 2005, the FDAcompleted an on-site inspection of our Liverpool facility. Consistentwith 

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FDA process, at the conclusionof the on-site inspection, Chiron received a list of observations on aForm 483. Chiron expects to complete its response to these observations inearly August 2005. If the FDA finds that we have failed to adequately addressthe matters discussed in its prior warning letter or any other seriousviolations, the FDA may modify our U.S. license in an adverse manner, takeaction that could result in imposition of fines, require temporary or permanentcessation of future selling of FLUVIRIN® vaccine or take otheraction that could reduce our ability to market FLUVIRIN® vaccine. Inaddition to the facility inspection, we will need to receive supplemental approvalsfor changes in our FLUVIRIN® vaccine from the MHRA and the FDAbecause of variations to our manufacturing process.

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 MHRA of our license. In February 2005,after having previously commenced an informal inquiry, the Securities andExchange Commission, or SEC, notified us that it would commence a formalinvestigation into whether we or our employees violated any federal securitieslaws in connection with these developments regarding FLUVIRIN®vaccine, and Chiron subsequently received subpoenas from the SEC requestingproduction of certain documents relating to our Liverpool facility and FLUVIRIN®vaccine. We also received a voluntary request for information from the UnitedStates House of Representatives, Energy and Commerce Committee, Subcommittee onOversight and Investigations requesting production of certain documents. Numerous documents have been collectedand produced in response to these requests, and several witnesses have beeninterviewed by the U.S. Attorney’s Office, the SEC staff and Congressionalstaff and additional interviews are anticipated. Additional investigationsregarding these matters may arise.

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 aredescribed below in Part II, Item 1, “Legal Proceedings.” Certaindistributors and other parties with whom we had contracted to supply FLUVIRIN®vaccine are considering or have communicated claims against us as a result ofour inability to supply FLUVIRIN®vaccine, and additional parties maydo so in the future. On January 27, 2005, the U.S. Centers for Disease Controland Prevention, or CDC, terminated its contracts with us for the supply ofFLUVIRIN®vaccine for default on the basis of our failure to supplysuch vaccine to the U.S. government for the 2004-2005 influenza season. The CDChas reserved the right to hold us liable for any excess costs it may haveincurred in replacing any FLUVIRIN® vaccine that we failed todeliver and further has reserved all other remedies provided under thecontract. It is not possible to predict whether any of these claims will bepursued and, if so, whether those claims will be upheld. Investigations,litigation and disputes have caused us to incur substantial expense and haverequired significant time and attention from our management and will continueto do so in the future and could result in civil action and/or criminalproceedings against us. The results of any such investigations, proceedings ordisputes could have a material adverse effect on our consolidated financialposition and results of operations and/or cash flow.

Although the MHRA has lifted itssuspension of our license to manufacture FLUVIRIN® vaccine, we expect to incur additional expenses inconnection with ongoing FLUVIRIN® vaccine matters, which could be material, including in connection with (1) ourcontinuing remediation efforts at our Liverpool facility; and (2) respondingto the U.S. Attorney for the Southern District of New York, the SEC, the UnitedStates House of Representatives, Energy and Commerce Committee, Subcommitteeon Oversight and Investigations and the privatelawsuits and other claims and investigations that exist or may arise.

In July 2005, we reported that we would be unableto supply any BEGRIVACTM vaccine doses for the 2005-2006 influenza season due toa product sterility issue and wrote off our existing product inventoryresulting in a $15.0 million charge to cost of sales for the three and sixmonths ended June 30, 2005. BEGRIVACTM vaccine is manufactured at ourfacility in Marburg, Germany. Our inability to supply BEGRIVACTM vaccine as planned to non-U.S. marketsfor the 2005-2006 influenza season or future 

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seasons could have a material adverse affect on ourbusiness and results of operations. Inaddition, it is possible that distributors and other parties with whom we hadcontracted to supply influenza vaccine maymake claims against us as a result of Chiron not supplying influenzavaccine. Any such claims may cause us to incursubstantial expense and require significant time and attention from ourmanagement. The results of any such claims could have a material adverse effecton our consolidated financial position and results of operations and/or cashflow.

Our inability to supply influenza vaccine may alsolead to loss of market share in the 2005-2006 influenza season and futureseasons. Following the announcement of our FLUVIRIN® licensesuspension, competitors announced plans to introduce influenza vaccine productsin the United States and sought expedited regulatory approval to do so. Eventhough the license suspension has been lifted, some of our customers may chooseto purchase influenza vaccine from other providers as their products becomeavailable in the United States. Loss of market share in the United States orforeign markets could have a material adverse effect on our business andresults of operations.

Delays in start-up procedures for ramping up to fullproduction and normal manufacturing issues inherent in the complexity ofinfluenza vaccine production, have adversely affected the amount of FLUVIRIN®vaccine that Chiron is able to produce for the 2005-2006 influenza season andmay result in further loss of market share.

For additional informationconcerning the risks we face as a result of these influenza vaccinedevelopments, see “Factors That May Affect Future Results—Developmentswith respect to influenza vaccines over the past nine months will harm ourbusiness and results of operations. “ For additional information on the U.S.Attorney’s investigation, SEC investigation and private lawsuits and otherclaims, see Part II, Item 1. “Legal Proceedings” of this report on Form 10-Q.

***Restated Second-Quarter and Third-Quarter 2004Financial Statements***

During our 2004 year-end financial statement review,we determined that certain sales of the travel vaccine recorded as revenues inthe second quarter of 2004 should not have been recorded as revenue at thattime, and that portions of those sales should have been recorded as revenues inthe third and fourth quarters of 2004 and possibly in later quarters. As aresult, we restated the financial statements included in our Quarterly Reportson Form 10-Q for such quarters and filed amended Form10-Q’s for suchquarters on April 6, 2005.

In light of the fact thatwe were already in contact with the SEC in relation to their investigationdescribed above under *“Influenza Virus VaccinesRecent Events,”* we informed the SEC of these matters, andadjustments we made after January 26, 2005 to the fourth quarter andfull-year 2004 financial information we released on January 26, 2005, andhave been providing the SEC information.

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***Summary Consolidated Financial Data***

Followingis an analysis and discussion of our operating results on a consolidated basis,which is followed by a description of our most critical accounting policies anduse of estimates and more detailed analysis and discussion of our operatingresults by segment and our liquidity and capital resources.
| ** **                                         | ** ** | **Three Months Ended**                                           | ** ** | **Six Months Ended** | ** ** | ** **        | ** ** | ** **        | ** ** | ** **        | ** ** | ** **      | ** ** |
|----------------------------------------------------|------------|----------------------------------------------------------------------------|------------|--------------------------------|------------|-------------------|------------|-------------------|------------|-------------------|------------|-----------------|------------|
| ** **                                         | ** ** | **June 30,**                                                          | ** ** | **June 30,**              | ** ** | **$ Change** | ** ** | **% Change** | ** ** |
| ** **                                         | ** ** | **2005**                                                                   | ** ** | **2004**                       | ** ** | **2005**          | ** ** | **2004**          | ** ** | **Three  Months** | ** ** | **Six  Months** | ** ** | **Three  Months** | ** ** | **Six  Months** | ** ** |
| ** **                                         | ** ** | ** **                                                                 | ** ** | **(Restated)**                 | ** ** | ** **        | ** ** | **(Restated)**    | ** ** | ** **        | ** ** | ** **      | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                                         | ** ** | **($ in 000’s, except per share data)** | ** ** |
| Product sales, net                                 |       | $                                                                          | 303,575    |                           | $          | 281,221           |       | $                 | 580,738    |              | $          | 562,287         |       | $ | 22,354 |   | $ | 18,451 |   | 7.9 | % | 3.3 | % |
| Royalty and  license fee revenues                  |       | 76,522                                                                     |       | 55,196                         |       | 156,583           |       | 109,988           |       | 21,326            |       | 46,595          |       | 38.6 | % | 42.4 | % |
| Total revenues                                     |       | 418,757                                                                    |       | 379,752                        |       | 826,113           |       | 759,424           |       | 39,005            |       | 66,689          |       | 10.3 | % | 8.8 | % |
| Gross profit  margin                               |       | 42                                                                         | %          | 54                             | %          | 41                | %          | 54                | %          |              |       |            |       |   |   |   |   |
| Research and development  expenses                 |       | 107,472                                                                    |       | 100,326                        |       | 217,311           |       | 198,736           |       | 7,146             |       | 18,575          |       | 7.1 | % | 9.3 | % |
| Selling, general and  administrative expenses |       | 128,492                                                                    |       | 106,857                        |       | 260,400           |       | 211,597           |       | 21,635            |       | 48,803          |       | 20.2 | % | 23.1 | % |
| Income (loss) from continuing operations           |       | 49                                                                         |       | 22,812                         |       | (8,893            | )          | 49,739            |       | (22,763           | )          | (58,632         | )          | (99.8 | )% | (117.9 | )% |
| Diluted earnings (loss) per share:                 |       |                                                                       |       |                           |       |              |       |              |       |              |       |            |       |   |   |   |   |
| Income (loss) from continuing operations           |       | $                                                                          | —     | *                              | $          | 0.12              |       | $                 | (0.05      | )                 | $          | 0.26            |       | $ | (0.12 | ) | $ | (0.31 | ) | (100.0 | )% | (119.2 | )% |

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*       Diluted earnings per share is less than $0.01per share.

Income from continuing operations was $49 thousand orless than $0.01 per diluted share and $22.8 million or $0.12 per dilutedshare for the three months ended June 30, 2005 and 2004, respectively. Lossfrom continuing operations was $8.9 million or $0.05 per diluted share for thesix months ended June 30, 2005. Income from continuing operations was$49.7 million or $0.26 per diluted share for the six months ended June 30,2004. For the three months ended June 30 2005, we incurred $8.0 million ofFLUVIRIN® vaccine remediation costs and $5.0 million of legal costsassociated with the FLUVIRIN® vaccine-related developments. For thesix months ended June 30 2005, we incurred $24.0 million of FLUVIRIN®vaccine remediation costs and $15.0 million of legal costs associated with theFLUVIRIN® vaccine-related developments. In addition, our Liverpoolfacility had limited influenza vaccine production during the first six monthsof 2005. For the three months ended June 30, 2005 as compared with thethree months ended June 30, 2004, idle facility costs from our Liverpoolfacility increased by $14.0 million. For the six months ended June 30,2005 as compared with the six months ended June 30, 2004, idle facilitycosts from our Liverpool facility increased by $27.0 million. In addition,BEGRIVACTM product inventory has been written off as a result of the mattersdescribed above under *“Influenza VirusVaccines Recent Events”*, resulting in a $15.0 million charge tocost-of-sales for the three and six months ended June 30, 2005.

Total revenues were $418.8 million and $826.1 millionfor the three and six months ended June 30, 2005, and $379.8 million and$759.4 million for the three and six months ended June 30, 2004,respectively.

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Revenues increased for the three months ended June 30,2005 as compared with the three months ended June 30, 2004 primarily dueto increased product sales and royalty and license fee revenues. The increasein total revenues was attributable in part to the movement in exchange rates,in particular the movements in the Euro and British Pound against the U.S.dollar. The movement in exchange rates added approximately 1% to our totalrevenues for the three months ended June 30, 2005. However, since our Euroand British Pound denominated expenses have also increased due to the movementin exchange rates, our income per share from continuing operations decreasedapproximately $0.01 per diluted share for the three months ended June 30,2005, due to higher expenses compared to revenues denominated in Euros and BritishPounds.

Revenues increased for the six months ended June 30,2005 as compared with the six months ended June 30, 2004 primarily due toincreased royalty and license fee revenues and increased product sales. Theincrease in total revenues was attributable in part to the movement in exchangerates, in particular the movements in the Euro and British Pound against theU.S. dollar. The movement in exchange rates added approximately 1% to our totalrevenues for the six months ended June 30, 2005. However, since our Euroand British Pound denominated expenses have also increased due to the movementin exchange rates, our loss per share from continuing operations increased$0.02 per diluted share for the six months ended June 30, 2005, due tohigher expenses compared to revenues denominated in Euros and British Pounds.

For the three months ended June 30, 2005 ,product sales increased compared with the three months ended June 30, 2004primarily due to increases in sales of our travel vaccines, Meningococcal vaccines,BETASERON® interferon beta-1b, Procleix® product salesand TOBI® tobramycin, offset primarily by decreases in sales of our influenzavaccines, pediatric and other vaccines, and PROLEUKIN®(aldesleukin), as discussed below.

For the six months ended June 30, 2005 , productsales increased compared with the six months ended June 30, 2004 primarilydue to increases in sales of our travel vaccines, Meningococcal vaccines,PROCLEIX® product sales and TOBI® tobramycin, offsetprimarily by decreases in sales of our influenza vaccines and pediatric andother vaccines as discussed below.

For the three and six months ended June 30, 2005as compared with the three and six months ended June 30, 2004, royalty andlicense fee revenues increased, primarily due to our September 2004settlement agreement with Roche regarding our HIV patent in the United States,increased BETAFERON® product royalties, our settlement with theScottish National Blood Transfusion Service in the current quarter androyalties from our licensing agreement in 2004 with Laboratory Corporation ofAmerica Holdings for our HCV intellectual property for nucleic acid testing.

The decline in gross profit margins for the three andsix months ended June 30, 2005 as compared with the three and six monthsended June 30, 2004 was primarily due to increased idle facility costs asa result of the delay in commercial production of FLUVIRIN® vaccinefor the 2005-2006 influenza season, FLUVIRIN® vaccine remediationcosts and the write-off of the BEGRIVACTM product inventory, as discussed above.Also, contributing to the decrease was planned idle facility time and ongoingprocess improvement efforts related to Biopharmaceuticals manufacturing. Grossprofit margins do not include amortization expense of intangible assets fromacquired developed products related to business combinations.

The main components of the increase in research anddevelopment expenses for the three months ended June 30, 2005 as compared withthe three months ended June 30, 2004 relate to development efforts in theoncology franchise, meningococcal franchise and for CUBICIN®(daptomycin for injection). This increase was partially offset by eliminatedcosts from research and development programs that were discontinued prior tothe second quarter of 2005. In addition, the second quarter of 2004 includedhigher costs for the Phase III CAPTIVATE trial for tifacogin which commenced inthe second quarter of 2004, due to production of clinical materials.

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The main components of the increase in research anddevelopment expenses for the six months ended June 30, 2005 as comparedwith the six months ended June 30, 2004 relate to development efforts inour oncology franchise, development efforts for CUBICIN® (daptomycinfor injection), blood-testing programs, meningococcal vaccines franchise, flucell culture and development of new processes and procedures in existingmanufacturing facilities for BETAFERON interferon beta-1b. This increase waspartially offset by research and development programs that have beendiscontinued or disposed of prior to the first six months of 2005.

The increase in selling, general and administrativeexpenses for the three and six months ended June 30, 2005 as compared withthe three and six months ended June 30, 2004 was due partially to legalexpenses associated with the FLUVIRIN® developments discussed aboveunder *“Influenza Virus Vaccines Recent Events.”*Such legal expenses were $5.0 million and $15.0 million for the three and sixmonths ended June 30, 2005, respectively. The increase also reflects $2.0million and $5.0 million for the three and six months ended June 30, 2005,respectively due to the movement in the Euro and British Pound exchange rates.The remaining increase in selling, general and administrative expenses reflectsa broad range of activities, significant among them being on-going marketingand pre-launch programs to support the continued growth of our business, investmentin geographic penetration and corporate governance costs.

The effective tax rate was24.8% and 25.0% of pretax income (loss) from continuing operations for the sixmonths ended June 30, 2005 and 2004, respectively. The effective tax ratemay be affected in future periods by changes in management’s estimates withrespect to our deferred tax assets and other items affecting the overall taxrate.

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

Our critical accounting policies, which incorporateour more significant judgments and estimates used in the preparation of ourCondensed Consolidated Financial Statements, are the same as those described inPart II, Item 7, “Management’s Discussion and Analysis of FinancialCondition and Results of Operations” in our Annual Report on Form 10-K forthe year ended December 31, 2004.

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

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**Results of Operations**

***Blood-testing***
| ** **                                    | ** ** | **Three Months Ended**                              | ** ** | **Six Months Ended** | ** ** | ** **        | ** ** | ** **        | ** ** | ** **        | ** ** | ** **      | ** ** |
|-----------------------------------------------|------------|---------------------------------------------------------------|------------|--------------------------------|------------|-------------------|------------|-------------------|------------|-------------------|------------|-----------------|------------|
| ** **                                    | ** ** | **June 30,**                                             | ** ** | **June 30,**              | ** ** | **$ Change** | ** ** | **% Change** | ** ** |
| ** **                                    | ** ** | **2005**                                                      | ** ** | **2004**                       | ** ** | **2005**          | ** ** | **2004**          | ** ** | **Three  Months** | ** ** | **Six  Months** | ** ** | **Three  Months** | ** ** | **Six  Months** | ** ** |
| ** **                                    | ** ** | **($ in 000’s, except percentages)** | ** ** |
| Product sales, net:                           |       |                                                          |       |                           |       |              |       |              |       |              |       |            |       |   |   |   |   |   |   |   |   |
| PROCLEIX® products                       |       | $                                                             | 66,104     |                           | $          | 60,589            |       | $                 | 130,535    |              | $          | 122,475         |       | $ | 5,515 |   | $ | 8,060 |   |   | 9.1 | % |   |   | 6.6 | % |   |
| Ortho-Clinical   Diagnostics                  |       | 7,988                                                         |       | 6,608                          |       | 14,450            |       | 12,842            |       | 1,380             |       | 1,608           |       |   | 20.9 | % |   |   | 12.5 | % |   |
|                                          |       | 74,092                                                        |       | 67,197                         |       | 144,985           |       | 135,317           |       | 6,895             |       | 9,668           |       |   | 10.3 | % |   |   | 7.1 | % |   |
| Revenue from joint business arrangement       |       | 31,003                                                        |       | 28,532                         |       | 67,061            |       | 58,893            |       | 2,471             |       | 8,168           |       |   | 8.7 | % |   |   | 13.9 | % |   |
| Collaborative agreement revenues              |       | 2,128                                                         |       | 2,325                          |       | 4,010             |       | 4,389             |       | (197              | )          | (379            | )          |   | (8.5 | )% |   |   | (8.6 | )% |   |
| Royalty and license fee revenues              |       | 25,990                                                        |       | 16,267                         |       | 51,194            |       | 32,701            |       | 9,723             |       | 18,493          |       |   | 59.8 | % |   |   | 56.6 | % |   |
| Other revenues                                |       | 200                                                           |       | 235                            |       | 275               |       | 430               |       | (35               | )          | (155            | )          |   | (14.9 | )% |   |   | (36.0 | )% |   |
| Total blood-testing    revenues               |       | $                                                             | 133,413    |                           | $          | 114,556           |       | $                 | 267,525    |              | $          | 231,730         |       | $ | 18,857 |   | $ | 35,795 |   |   | 16.5 | % |   |   | 15.4 | % |   |
| Gross profit margin                           |       | 40                                                            | %          | 42                             | %          | 42                | %          | 42                | %          |              |       |            |       |   |   |   |   |   |   |   |   |
| Research and development expenses             |       | $                                                             | 6,922      |                           | $          | 6,258             |       | $                 | 14,726     |              | $          | 11,367          |       | $ | 664 |   | $ | 3,359 |   |   | 10.6 | % |   |   | 29.6 | % |   |
| Selling, general  and administrative expenses |       | $                                                             | 10,928     |                           | $          | 10,323            |       | $                 | 22,703     |              | $          | 19,580          |       | $ | 605 |   | $ | 3,123 |   |   | 5.9 | % |   |   | 15.9 | % |   |

 

**Product sales**

*PROCLEIX*®*Products*   On February 27, 2002,the U.S. Food and Drug Administration approved the PROCLEIX® HIV-1/HCV Assay. We have marketed the PROCLEIX® HIV-1/HCV Assay in Europesince 1999. On January 15, 2004, the PROCLEIX® ULTRIOTMHIV-1/HCV/HBV Assay received European CE marking for use on the semi-automatedPROCLEIX® System, and on December 14, 2004 the PROCLEIX ULTRIOAssay received European CE marking for use on the fully automated, highthroughput PROCLEIX®TIGRIS® System. Under a collaborationagreement with Gen-Probe, we market and sell the PROCLEIX® HIV-1/HCV Assay, the PROCLEIX ULTRIOTM Assay and related instrument systems. Inaddition to selling directly in the U.S., we also sell in various internationalmarkets, directly and through distributors. We record revenue based upon thereported results obtained from the customer from the use of assays to screendonations or upon sale and delivery of the assays, depending on the underlyingcontract. In the case of equipment sales or leases, we record revenue upon thesale and transfer of the title of the instrument or ratably over the life ofthe lease term, respectively. For provision of service on the instruments, werecognize revenue ratably over the life of the service agreement.

The increase in product sales for the three monthsended June 30, 2005 as compared with the three months ended June 30,2004 was primarily due to $4.3 million from the conversion to the PROCLEIX®ULTRIOTM Assay from the PROCLEIX® HIV-1/HCV Assay outside of the U.S.and continued penetration into several markets abroad. The increase in productsales for the six months ended June 30, 2005 as compared with the sixmonths ended June 30, 2004 was primarily due to $8.1 million from theconversion to the PROCLEIX® ULTRIOTM Assay from the PROCLEIX®HIV-1/HCV Assay outside the U.S. and from continued penetration into severalmarkets abroad.

**Revenuefrom joint business arrangement  **The increase in revenuefrom the joint business arrangement for the three months ended June 30,2005 as compared with the three months ended June 30, 

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2004 was primarilydue to $2.5 million from an increase in profitability realized by thejoint business arrangement. The increase in revenue from the joint businessarrangement for the six months ended June 30, 2005 as compared with thesix months ended June 30, 2004 was primarily due to higher profitabilityrealized by the joint business arrangement.

**Collaborativeagreement revenues  **Collaborative agreement revenuestend to fluctuate based on the amount and timing of research servicesperformed, the status of projects under collaboration and the achievement of milestones.Due to the nature of our collaborative agreement revenues, results in any oneperiod are not necessarily indicative of results to be achieved in the future.Our ability to generate additionalcollaborative agreement revenues may depend, in part, on our ability toinitiate and maintain relationships with potential and current collaborativepartners.

**Royaltyand license fee revenues  **Our blood-testing segmentearns royalties from third parties based on their sales of immunodiagnostic andnucleic acid testing probe diagnostic products utilizing our hepatitis C virus(HCV) and HIV-related (HIV) patents, for use in the blood screening and plasmafractionation markets. Our blood-testing segment also earns license feesrelated to our HCV and HIV patents for technologies used by third parties todevelop products for use in the blood screening and plasma fractionationmarkets.

The increase in royaltyand license fee revenues for the three months ended June 30, 2005 ascompared with the three months ended June 30, 2004 was primarily due to (i) $2.7million from a settlement with the Scottish National Blood Transfusion Service(SNBTS) regarding our HCV and HIV patents, (ii) $2.7 million from theRoche settlement reached in September 2004 as discussed below under “Other—Royaltyand license fee revenues—*Roche Settlement*,”(iii) $2.5 million from increased royalties from Roche due to rateincreases resulting from certain countries entering the European Union (EU) andan increase in reported donations and (iv) $1.2 million in royalties fromour licensing agreement reached in 2004 with Laboratory Corporation of AmericaHoldings (LabCorp) for our HCV intellectual property for nucleic acid testing.

The increase in royaltyand license fee revenues for the six months ended June 30, 2005 ascompared with the six months ended June 30, 2004 was primarily due to (i) $8.0 millionfrom the Roche settlement, (ii) $3.3 million in royalties from Roche dueto rate increases resulting from certain countries entering the EU and anincrease in reported donations, (iii) $3.2 million in fees and royaltiesfrom our licensing agreement with LabCorp, (iv) $2.7 million from asettlement with the SNBTS regarding our HCV and HIV patents and (v) $1.3 millionin royalty fees from the blood transfusion centers of the German Red Cross.

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 licenseecommercializes 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.

**Grossprofit margin  **The decrease in gross profit margin forthe three months ended June 30, 2005 as compared with the three monthsended June 30, 2004 was primarily due to additional support and servicecosts associated with our fully automated, high throughput PROCLEIX®TIGRIS®System. Gross profit margin was consistent for the six months ended June 30,2005 as compared with the six months ended June 30, 2004.

Blood-testing gross profitmargin may fluctuate in future periods as the blood-testing product andcustomer mix changes.

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**Researchand development expenses  **The increase in research anddevelopment expenses for the three months ended June 30, 2005 as comparedwith the three months ended June 30, 2004 was primarily due to $1.8million for research activities focused primarily on variant Creutzfeldt-Jakobdisease (vCJD), primarily offset by a $0.9 million decrease in costs relatingto our nucleic acid testing products. The increase in research and developmentexpenses for the six months ended June 30, 2005 as compared with the sixmonths ended June 30, 2004 was primarily due to $4.4 million forresearch activities focused primarily on vCJD primarily offset by a $0.9million decrease in costs relating to our nucleic acid testing products.

Research and developmentexpenses may fluctuate from period to period depending upon the stage ofcertain projects and the level of pre-clinical and clinical trial-relatedactivities.

**Selling,general, and administrative expenses  **Selling, general,and administrative expenses were consistent for the three months ended June 30,2005 as compared with the three months ended June 30, 2004. The increasein selling, general and administrative expenses for the six months ended June 30,2005 as compared with the six months ended June 30, 2004 was primarily dueto $2.5 million from the geographic expansion of our customer base for thePROCLEIX® HIV-1/HCV Assay in international markets.

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***
| ** **                                    | ** ** | **Three Months Ended**                              | ** ** | **Six Months Ended** | ** ** | ** **        | ** ** | ** **        | ** ** | ** **        | ** ** | ** **      | ** ** |
|-----------------------------------------------|------------|---------------------------------------------------------------|------------|--------------------------------|------------|-------------------|------------|-------------------|------------|-------------------|------------|-----------------|------------|
| ** **                                    | ** ** | **June 30,**                                             | ** ** | **June 30,**              | ** ** | **$ Change** | ** ** | **% Change** | ** ** |
| ** **                                    | ** ** | **2005**                                                      | ** ** | **2004**                       | ** ** | **2005**          | ** ** | **2004**          | ** ** | **Three  Months** | ** ** | **Six  Months** | ** ** | **Three  Months** | ** ** | **Six  Months** | ** ** |
| ** **                                    | ** ** | ** **                                                    | ** ** | **Restated**                   | ** ** | ** **        | ** ** | **Restated**      | ** ** | ** **        | ** ** | ** **      | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                                    | ** ** | **($ in 000’s, except percentages)** | ** ** |
| Product sales, net:                           |       |                                                          |       |                           |       |              |       |              |       |              |       |            |       |   |   |   |   |
| Influenza vaccines:                           |       |                                                          |       |                           |       |              |       |              |       |              |       |            |       |   |   |   |   |
| Other Influenza vaccines                 |       | $                                                             | (492       | )                              | $          | 8,207             |       | $                 | 3,079      |              | $          | 13,467          |       | $ | (8,699 | ) | $ | (10,388 | ) | (106.0 | )% | (77.1 | )% |
| FLUVIRIN® vaccine                        |       | —                                                        |       | —                         |       | —            |       | 2,445             |       | —            |       | (2,445          | )          | — |   | (100.0 | )% |
| Influenza vaccines                            |       | (492                                                          | )          | 8,207                          |       | 3,079             |       | 15,912            |       | (8,699            | )          | (12,833         | )          | (106.0 | )% | (80.6 | )% |
| Meningococcal vaccines                        |       | 13,605                                                        |       | 5,016                          |       | 22,758            |       | 9,565             |       | 8,589             |       | 13,193          |       | 171.2 | % | 137.9 | % |
| Travel vaccines                               |       | 45,014                                                        |       | 26,261                         |       | 88,773            |       | 49,271            |       | 18,753            |       | 39,502          |       | 71.4 | % | 80.2 | % |
| Pediatric and other vaccines                  |       | 39,127                                                        |       | 47,619                         |       | 69,620            |       | 98,802            |       | (8,492            | )          | (29,182         | )          | (17.8 | )% | (29.5 | )% |
|                                          |       | 97,254                                                        |       | 87,103                         |       | 184,230           |       | 173,550           |       | 10,151            |       | 10,680          |       | 11.7 | % | 6.2 | % |
| Collaborative agreement  revenues             |       | 999                                                           |       | 1,214                          |       | 3,241             |       | 5,180             |       | (215              | )          | (1,939          | )          | (17.7 | )% | (37.4 | )% |
| Royalty and license fee  revenues             |       | 769                                                           |       | 25                             |       | 2,185             |       | 2,675             |       | 744               |       | (490            | )          | 2,976.0 | % | (18.3 | )% |
| Other revenues                                |       | 2,480                                                         |       | 5,914                          |       | 5,756             |       | 9,556             |       | (3,434            | )          | (3,800          | )          | (58.1 | )% | (39.8 | )% |
| Total Vaccines revenues                       |       | $                                                             | 101,502    |                           | $          | 94,256            |       | $                 | 195,412    |              | $          | 190,961         |       | $ | 7,246 |   | $ | 4,451 |   | 7.7 | % | 2.3 | % |
| Gross profit margin                           |       | 7                                                             | %          | 34                             | %          | 2                 | %          | 34                | %          |              |       |            |       |   |   |   |   |
| Research and development expenses        |       | $                                                             | 34,387     |                           | $          | 31,918            |       | $                 | 67,943     |              | $          | 66,328          |       | $ | 2,469 |   | $ | 1,615 |   | 7.7 | % | 2.4 | % |
| Selling, general and  administrative expenses |       | $                                                             | 42,625     |                           | $          | 35,887            |       | $                 | 82,087     |              | $          | 74,890          |       | $ | 6,738 |   | $ | 7,197 |   | 18.8 | % | 9.6 | % |
| Amortization expense                          |       | $                                                             | 14,362     |                           | $          | 14,942            |       | $                 | 29,361     |              | $          | 30,026          |       | $ | (580 | ) | $ | (665 | ) | (3.9 | )% | (2.2 | )% |

 

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

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*Influenza vaccines  *Asdescribed above under *“Influenza Virus VaccineRecent Events,”* as a result of recent developments with respect toFLUVIRIN® and BEGRIVACTM vaccines, we had no FLUVIRIN® orBEGRIVACTM vaccine sales in the three and six months ended June 30, 2005.Sales of FLUVIRIN® influenza vaccine were $2.4 million for thesix months ended June 30, 2004 from the 2003-2004 influenza season. Therewere no sales of BEGRIVACTM influenza vaccine for the three and six months endedJune 30, 2004. The decrease in sales of our other influenza vaccines forthe three and six months ended June 30, 2005 as compared with the three andsix months ended June 30, 2004 was due to a manufacturing upgrade. For thethree and six months ended June 30, 2004, sales of our other influenzavaccines to the southern hemisphere were $8.2 million and $9.9 million,respectively. The three months ended June 30, 2005 reflects $0.5 millionof returns for other influenza vaccines for the 2004-2005 influenzaseason in excess of our returns estimate.

*Meningococcal vaccines  *Theincrease in meningococcal vaccines sales for the three months ended June 30,2005 as compared with the three months ended June 30, 2004 was primarilydue to (i) $7.7 million of MENZBTM meningococcal B vaccine sales to theMinistry of Health in New Zealand and (ii) $1.9 million increase intender sales of MENJUGATE® meningococcus C conjugate vaccine toCanada. These increases are partially offset by a $1.5 million decline inMENJUGATE® vaccine tender sales in Australia. The increase inmeningococcal vaccines sales for the six months ended June 30, 2005 ascompared with the six months ended June 30, 2004 was primarily due to (i) $12.5million of MENZBTM meningococcal B vaccine sales to the Ministry of Health inNew Zealand and (ii) $3.7 million increase in tender sales ofMENJUGATE® meningococcus C conjugate vaccine to Canada. Theseincreases are partially offset by a $2.7 million decline in MENJUGATE®vaccine tender sales in Australia.

*Travel vaccines  *Theincrease in travel vaccines sales for the three months ended June 30, 2005as compared with the three months ended June 30, 2004 was primarily due to(i) $16.7 million increase in tick-borne encephalitis (TBE) vaccine salesdue to growth in the overall market and a number of marketing initiatives, (ii) $1.7million due to increased sales of our rabies vaccine in India, and (iii) $1.4 millionfrom increased demand for our rabies vaccines in the U.K., primarily due to aproduct recall from a competitor. These increases were partially offset by adecline of $1.5 million in rabies vaccine sales in the U.S. The increase intravel vaccines sales for the six months ended June 30, 2005 as comparedwith the six months ended June 30, 2004 was primarily due to: (i) $28.8million increase in TBE vaccine sales. Sales in the first quarter of 2004 werelower than in the first quarter of 2005 by $12.0 million due to $15.1 millionof sales in the fourth quarter of 2003; TBE vaccines are typically sold in thefirst half of the year; and in addition, the second quarter of 2005 comparedwith the second quarter of 2004 reflected a $16.7 million increase in the TBEvaccine sales due to growth in the overall market and a number of marketinginitiatives, (ii) $6.7 million from increased demand for our rabiesvaccines in the U.S., primarily due to a product recall from a competitor, andincreased sales to Canada, (iii) $5.9 million from increased demand forour rabies vaccines in Asia and (iv) $2.1 million from increased demandfor our rabies vaccines in the U.K., primarily due to a product recall from acompetitor. These increases were partially offset by a decline of $2.4 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.

*Pediatric and other vaccines  *Salesof our pediatric and other vaccines decreased for the three months ended June 30,2005 as compared with the three months ended June 30, 2004. This decreasewas primarily due to (i) $6.0 million decline due to a tender for a large-scalemeasles, mumps, rubella vaccination campaign in the second quarter of 2004, (ii) $1.8million decline due to the timing of tender sales for our polio vaccines (iii) $1.4million decline due to the planned divestiture of certain vaccines operationsin Sweden in the second quarter of 2004 acquired through our acquisition ofPowderJect and (iv) $4.2 million from the temporary interruption ofproduction of certain vaccines in our Liverpool plant to focus on ourremediation efforts at that plant. These decreases were partially offset by a$4.4 million increase related to the timing of tender sales for diphtheria,tetanus and pertussis vaccines. Sales of our pediatric and other 

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vaccines decreased for thesix months ended June 30, 2005 as compared with the six months ended June 30,2004 primarily due to (i) $11.0 million decline in polio vaccines andmeasles, mumps and rubella vaccines sales due to a lack of product availabilityas a result of manufacturing upgrades that have delayed production, (ii) $7.8million decline due to the timing of tender sales for our polio vaccines andmeasles, mumps and rubella vaccines, (iii) $6.7 million decline due to theplanned divestiture of certain vaccines operations in Sweden in the secondquarter of 2004 acquired from our acquisition of PowderJect and (iv) $8.1million from the temporary interruption of production of certain vaccines inour Liverpool plant to focus on our remediation efforts at that plant. Thesedecreases were partially offset by a $5.3 million increase related to thetiming of tender sales for diphtheria, tetanus and pertussis vaccines.

Certain of our vaccine products are seasonal,particularly our influenza vaccines, which have higher sales primarily in thesecond half of the year. Our tick-borne encephalitis vaccine is also seasonalwith higher sales typically in the first half of the year. Certain of ourvaccines require regulatory approval for production or sale of the product and salesmay fluctuate 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® meningococcus C conjugate vaccine sales tocontinue to fluctuate as public health authorities consider adoption of broadvaccination programs and competitive pressures continue to increase.

**Collaborative agreement revenues  **Werecognize collaborative agreement revenues for fees received as we performresearch services and achieve specified milestones. Collaborative agreementrevenues for the three months ended June 30, 2005 as compared with thethree months ended June 30, 2004 were consistent. Collaborative agreementrevenues for the six months ended June 30, 2005 as compared with the sixmonths ended June 30, 2004 decreased primarily due to $1.2 million inlower milestone payments related to an agreement to supply MENZBTM meningococcalB vaccine to the Ministry of Health in New Zealand.

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.

**Other revenues**

Other revenues recognized in our vaccines segmentprimarily consist of grant revenues and contract manufacturing revenues and mayfluctuate due to the nature of the revenues recognized and the timing of eventsgiving rise to these revenues.

**Gross profit margin  **Grossprofit margin decreased for the three months ended June 30, 2005 ascompared with the three months ended June 30, 2004 primarily due to (i)$14.0 million increase in idle facility costs as our Liverpool facility hadlimited FLUVIRIN® vaccine production during the three months ended June 30,2005 due to FLUVIRIN® vaccine remediation activities and $8.0 millionof FLUVIRIN® vaccine remediation costs charged to cost of sales and (ii) $15.0million charge for the write-off of BEGRIVACTM product inventory due to productsterility issues. Gross profit margin decreased for the six months ended June 30,2005 as compared with the six months ended June 30, 2004 primarily due to (i) $24.0million of FLUVIRIN® vaccine remediation costs and $27.0 millionincrease in idle facility costs as our Liverpool facility had limited FLUVIRIN®vaccine production during the six months ended June 30, 

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2005 due to FLUVIRIN®vaccine remediation activities and (ii) $15.0 million charge for thewrite-off of BEGRIVACTM product inventory due to product sterility issues.

Vaccines gross profit margin does not includeamortization expense of intangible assets from acquired developed productsrelated to business combinations. Such amortization expense is included in thecaption “amortization expense of intangible assets acquired in businesscombinations and asset purchases.”

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

**Research and development expenses  **Theincrease in research and development expenses for the three months ended June 30,2005 as compared with the three months ended June 30, 2004 was primarilydue to $2.9 million from advancing our quadrivalent meningococcal vaccinecandidate for serogroups A,C,W and Y. The increase in research and developmentexpenses for the six months ended June 30, 2005 as compared with the sixmonths ended June 30, 2004 was primarily due $4.3 million from advancingour quadrivalent meningococcal vaccine candidate for serogroups A,C,W and Y,and $2.4 million from our flu cell culture development program. These increaseswere partially offset by the second quarter of 2004 divestiture of certainresearch and development operations, acquired in the acquisition of PowderJect.The divested operations included $4.2 million in research and developmentexpenses for the six months ended June 30, 2004.

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

**Selling,general, and administrative expenses  **The increase inselling, general and administrative expenses for the three months ended June 30,2005 as compared with the three months ended June 30, 2004 was due to (i) $2.7million from marketing activities focused on international markets, (ii)$2.2 millionfor corporate governance costs, (iii) $1.2 million for regulatory andlegal costs and (iv) $1.6 million due to the movement in the Euro andBritish pound to U.S. dollar exchange rate. These increases were partiallyoffset by a reduction of $2.1 million as a result of the planneddivestiture of certain PowderJect operations in the second quarter 2004. Theincrease in selling, general and administrative expenses for the six monthsended June 30, 2005 as compared with the six months ended June 30,2004 was due to (i) $2.7 million from marketing activities focused oninternational markets, (ii) $3.6 million due to the movement in the Euroand British pound to U.S. Dollar exchange rate, (iii) an additional$2.5 million from the establishment of sales and marketing operations inthe U.S., (iv) $2.2 million for corporate governance costs and (v) $1.7 millionfor executive severance. These increases were partially offset by a reductionof $4.1 million as a result of the planned divestiture of certainPowderJect operations in the second quarter 2004 and $1.7 million from therecovery of bad debt.

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***Biopharmaceuticals***
| ** **                                     | ** ** | **Three Months Ended  June 30,**               | ** ** | **Six Months Ended  June 30,** | ** ** | **$ Change** | ** ** | **%** Change | ** ** |
|------------------------------------------------|------------|---------------------------------------------------------------|------------|-----------------------------------------------|------------|-------------------|------------|-------------------|------------|
| ** **                                     | ** ** | **2005**                                                      | ** ** | **2004**                                      | ** ** | **2005**          | ** ** | **2004**          | ** ** | **Three Months** | ** ** | **Six Months** | ** ** | **Three Months** | ** ** | **Six Months** | ** ** |
| ** **                                     | ** ** | **($ in 000’s, except percentages)** | ** ** |
| Product sales, net:                            |       |                                                          |       |                                          |       |              |       |              |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| BETASERON®  interferon beta-1b            |       | $                                                             | 38,132     |                                          | $          | 31,626            |       | $                 | 64,766     |   | $ | 61,762 |   |   | $ | 6,506 |   |   |   | $ | 3,004 |   |   |   | 20.6 | % |   |   | 4.9 | % |   |
| TOBI® tobramycin                     |       | 56,600                                                        |       | 51,342                                        |       | 109,535           |       | 103,866           |       |   | 5,258 |   |   |   | 5,669 |   |   |   | 10.2 | % |   |   | 5.5 | % |   |
| PROLEUKIN®  aldesleukin                   |       | 31,727                                                        |       | 35,057                                        |       | 61,262            |       | 66,925            |       |   | (3,330 | ) |   |   | (5,663 | ) |   |   | (9.5 | )% |   |   | (8.5 | )% |   |
| Other                                          |       | 5,770                                                         |       | 8,896                                         |       | 15,960            |       | 20,867            |       |   | (3,126 | ) |   |   | (4,907 | ) |   |   | (35.1 | )% |   |   | (23.5 | )% |   |
|                                           |       | 132,229                                                       |       | 126,921                                       |       | 251,523           |       | 253,420           |       |   | 5,308 |   |   |   | (1,897 | ) |   |   | 4.2 | % |   |   | (0.7 | )% |   |
| Collaborative  agreement revenues              |       | 326                                                           |       | 289                                           |       | 729               |       | 774               |       |   | 37 |   |   |   | (45 | ) |   |   | 12.8 | % |   |   | (5.8 | )% |   |
| Royalty and  license fee revenues              |       | 19,792                                                        |       | 15,183                                        |       | 38,418            |       | 32,480            |       |   | 4,609 |   |   |   | 5,938 |   |   |   | 30.4 | % |   |   | 18.3 | % |   |
| Other revenues                                 |       | 1,524                                                         |       | 4,826                                         |       | 7,720             |       | 7,927             |       |   | (3,302 | ) |   |   | (207 | ) |   |   | (68.4 | )% |   |   | (2.6 | )% |   |
| Total Biopharmaceutical  revenues              |       | $                                                             | 153,871    |                                          | $          | 147,219           |       | $                 | 298,390    |   | $ | 294,601 |   |   | $ | 6,652 |   |   |   | $ | 3,789 |   |   |   | 4.5 | % |   |   | 1.3 | % |   |
| Gross profit  margin.                          |       | 68                                                            | %          | 74                                            | %          | 70                | %          | 75                | %          |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Research and development  expenses             |       | $                                                             | 65,542     |                                          | $          | 61,808            |       | $                 | 133,271    |   | $ | 120,375 |   |   | $ | 3,734 |   |   |   | $ | 12,896 |   |   |   | 6.0 | % |   |   | 10.7 | % |   |
| Selling, general  and  administrative expenses |       | $                                                             | 36,841     |                                          | $          | 33,248            |       | $                 | 74,738     |   | $ | 65,174 |   |   | $ | 3,593 |   |   |   | $ | 9,564 |   |   |   | 10.8 | % |   |   | 14.7 | % |   |
| Amortization  expense                          |       | $                                                             | 6,251      |                                          | $          | 6,237             |       | $                 | 12,515     |   | $ | 12,485 |   |   | $ | 14 |   |   |   | $ | 30 |   |   |   | 0.2 | % |   |   | 0.2 | % |   |

 

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

*BETASERON*®*interferon beta-1b  *We manufactureinterferon beta-1b, which is marketed by Schering AG and its affiliates,including Berlex Laboratories, Inc. (collectively, Schering), under thetrade names BETASERON®(in the U.S and other non-European markets) and BETAFERON® (in Europe). Boehringer Ingelheimalso supplies BETAFERON®interferon beta-1b to Schering for sale in Europe. For product we manufacture,we recognize a portion of revenue for product sales upon shipment to Scheringand the remainder based on a contractual percentage of sales by Schering, bothof which we record as product sales. For product manufactured by BoehringerIngelheim and marketed by Schering in Europe under the trade name BETAFERON®, we receiveroyalties calculated at the same percentage of sales less the amount paid orincurred by Schering for supply costs, which we record in royalty and licensefee revenues.

The increase in BETASERON® product sales forthe three months ended June 30, 2005 as compared with the three monthsended June 30, 2004 primarily related to (i) $1.9 million frominventory ordering patterns, (ii) $1.9 million from shipments toBerlex and (iii) $1.5 million from price increases. The increase inBETASERON®product sales for the six months ended June 30, 2005 as compared with thesix months ended June 30, 2004 primarily related to (i) $2.1 millionfrom price increases, (ii) $0.9 million from inventory orderingpatterns and (iii) $0.8 million due to the benefit of the movement in theEuro to U.S. Dollar exchange rate. These increases were partially offsetby $1.7 million from reduced shipments to Berlex.

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*TOBI*®*tobramycin solution for inhalation  *Wesell TOBI®solution directly in the U.S. and certain international markets. The increasein sales for the three months ended June 30, 2005 as compared with thethree months ended June 30, 2004 was primarily due to (i) $5.0million due to increased patient demand in both the United States and Europe, (ii) $1.4 milliondue to price increases and (iii) $0.8 million due to the benefit ofthe movement in the Euro to U.S. Dollar exchange rate. These increases werepartially offset by $1.2 million reduction due to wholesaler orderingpatterns. The increase in sales for the six months ended June 30, 2005 ascompared with the six months ended June 30, 2004 was primarily due to (i) $6.3million due to increased patient demand in both the United States and Europe, (ii) $4.3 milliondue to price increases and (iii) $1.6 million due to the benefit ofthe movement in the Euro to U.S. Dollar exchange rate. These increases werepartially offset by $5.8 million reduction due to wholesaler orderingpatterns.

*PROLEUKIN*®*(aldesleukin)  *The decrease inPROLEUKIN (aldesleukin) product sales for the three months ended June 30,2005 as compared with the three months ended June 30, 2004 was primarilydue to (i) $1.8 million due to a decrease in patient demand as aresult of increased competition, (ii) $1.6 million for a government rebateadjustment and (iii) $1.2 million for wholesaler inventory orderingpatterns. These decreases were partially offset by (i) $1.0 million forprice increases and (ii) $0.4 million due to the benefit of the movementin the Euro to U.S. Dollar exchange rate. The decrease in PROLEUKIN(aldesleukin) product sales for the six months ended June 30, 2005 ascompared with the six months ended June 30, 2004 was primarily due to (i) $3.7million due to a decrease in patient demand as a result of increasedcompetition, (ii) $2.4 million for wholesaler inventory ordering patternsand (iii) $1.6 million for a government rebate adjustment. These decreases werepartially offset by (i) $1.8 million for price increases and (ii) $0.8million due to the benefit of the movement in the Euro to U.S. Dollar exchangerate.

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

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

**Royalty and license fee revenues  **Ourbiopharmaceuticals segment earns royalties on third party sales of severalproducts, including BETAFERON®interferon beta-1b and recombinant insulin and glucagon products. Ourbiopharmaceuticals segment also earns license fees for technologies, such ashepatitis C virus-related patents, used by third parties to develop therapeuticproducts.

*BETAFERON*®*interferon beta-1b  *BETAFERONproduct royalties were $16.9 million and $11.6 million for the threemonths ended June 30, 2005 and 2004, respectively, and $32.4 million and$25.4 million for the six months ended June 30, 2005 and 2004,respectively.

The increase in BETAFERON® product royaltiesfor the three months ended June 30, 2005 as compared with the three monthsended June 30, 2004 was primarily due to (i) $1.2 million from priceincreases and (ii) $1.0 million from an increase in demand. The increasein BETAFERON®product royalties for the six months ended June 30, 2005 as compared withthe six months ended June 30, 2004 was primarily due to (i) $2.3million from an increase in demand and (ii) $1.7 million from priceincreases.

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 additional 

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royaltyand license fee revenues may depend, in part, on our ability to market andcapitalize on the value of our technologies.

**Other revenues**

*Contract manufacturing revenues  *Ourbiopharmaceuticals segment recognized contract manufacturing revenues of $0.9million and $4.7 million for the three months ended June 30, 2005 and2004, respectively. Contract manufacturing revenues were $7.0 million and$7.5 million for the six months ended June 30, 2005 and 2004,respectively. The fluctuation resulted from the timing of contractmanufacturing activities.

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.

**Gross profit margin  **Thedecrease in gross profit margin for the three and six months ended June 30,2005 as compared with the three and six months ended June 30, 2004 wasprimarily due to a planned increase in idle time for manufacturing facilitiesand ongoing process improvement efforts.

Biopharmaceutical gross profit margin does not includeamortization expense of intangible assets from acquired developed productsrelated to business combinations. Such amortization expense is included in thecaption “amortization expense of intangible assets acquired in businesscombinations and asset purchases”.

Biopharmaceutical gross profit margin may fluctuatesignificantly in future periods due to production yields and increased cost toproduce the BETASERON® pre-filled diluent syringe and as thebiopharmaceutical product and customer mix changes.

**Research anddevelopment expenses  **The increase in research anddevelopment expenses for the three months ended June 30, 2005 as compared with the threemonths ended June 30, 2004 was primarily due to (i) $1.8 million forthe progression of phase 1 clinical studies of our oncology compound CHIR-258,(ii) $1.2 million for development activities related to CUBICIN® (daptomycin forinjection) for treatment of complicated skin and soft tissue infections and (iii)$4.4 million for other research and development activities, primarily relatedto early-stage oncology compounds. These increases are partially offset by (i) $2.0million decrease in expenses related to the SILCAAT trial and (ii) $1.7million for activities related to the development of tifacogin (Phase IIIclinical material production expenses were incurred in the second quarter of 2004driving higher expenses in that quarter). The increase in research anddevelopment expenses for the six months ended June 30, 2005 as compared withthe six months ended June 30, 2004 was primarily due to (i) $3.8million for development activities related to CUBICIN® (daptomycin for injection) fortreatment of complicated skin and soft tissue infections, (ii) $3.7million for the progression of phase 1 clinical studies of our oncologycompound CHIR-258, (iii) $2.9 million increase in expense related to thedevelopment of new processes and performance of test runs related to installedequipment of our existing manufacturing facilities to support the supply ofBETAFERON®interferon beta-1b to Schering, (iv) $1.0 million for the progression ofphase 1 clinical studies of our oncology compound CHIR-12.12 and (v) $8.2 millionfor other research and development activities, primarily related to early-stageoncology compounds. These increases are partially offset by (i) $3.9million decrease in expenses related to the SILCAAT trial, as discussed belowand (ii) $2.8 million decrease related 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 gastro esophageal cancer.

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In the fourth quarter 2002, we reached an agreement inprinciple to transfer responsibility for the SILCAAT trial, a Phase III studyfor recombinant human interleukin-2 (IL-2, aldesleukin), to the National InstitutesAllergy and Infectious Disease (NIAID) and the University of Minnesota.Responsibility for the SILCAAT study was transferred to NIAID and University ofMinnesota effective February 14, 2003. Under the agreement, we are obligated tofund a maximum of $18.0 million over the lifetime of the trial and to supplyclinical materials and certain other support services of which $18.0 millionhas been paid through Decemeber 31, 2004.

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

**Selling, general, and administrativeexpenses  **The increase in selling, general andadministrative expenses for the three months ended June 30, 2005 ascompared with the three months ended June 30, 2004 was primarily due to$2.3 million for Daptomycin marketing activities in Europe and $0.9 million forother worldwide marketing activities. The increase in selling, general andadministrative expenses for the six months ended June 30, 2005 as comparedwith the six months ended June 30, 2004 was primarily due to (i) $4.2million for pre-launch costs for CUBICIN® (daptomycin forinjection), (ii) $1.4 million for other worldwide marketingactivities, (iii) $1.1 million of pre-launch costs for PULMINIQTM(cyclosporine, USP) inhalation solution, (iv) $1.0 million for increasedTOBI® sales and marketing activities and (v) $0.4 milliondue to movement in the Euro to U.S. Dollar exchange rate.

On July 14, 2005, wereceived an action letter from the FDA stating that the company’s New DrugApplication (NDA) for PULMINIQTM (cyclosporine, USP) inhalation solution is “approvable”but that an additional pre-approval study is required to confirm the efficacyof the drug. In the NDA for PULMINIQTM, Chiron is seeking an indication toincrease survival and prevent chronic rejection in patients receivingallogeneic lung transplants, in combination with standard immunosuppressivetherapy. We are evaluating possible next steps for PULMINIQTM.

**Other**

Weview certain other revenues and expenses, particularly certain royalty andlicense fee revenues primarily related to HIV and HCV-related patents, andunallocated corporate expenses, as not belonging to any one reportable segment.As a result, we have aggregated these items into an “Other” segment.
| ** **                                    | ** ** | **Three Months Ended  June 30,**               | ** ** | **Six Months Ended  June 30,** | ** ** | **$ Change** | ** ** | **% Change** | ** ** |
|-----------------------------------------------|------------|---------------------------------------------------------------|------------|-----------------------------------------------|------------|-------------------|------------|-------------------|------------|
| ** **                                    | ** ** | **2005**                                                      | ** ** | **2004**                                      | ** ** | **2005**          | ** ** | **2004**          | ** ** | **Three Months** | ** ** | **Six Months** | ** ** | **Three Months** | ** ** | **Six Months** | ** ** |
| ** **                                    | ** ** | **($ in 000’s, except percentages)** | ** ** |
| Royalty and  license fee revenues             |       | $                                                             | 29,971     |                                          | $          | 23,721            |       | $                 | 64,786     |   | $ | 42,132 |   |   | $ | 6,250 |   |   |   | $ | 22,654 |   |   |   | 26.3 | % |   |   | 53.8 | % |   |
| Selling, general  and administrative expenses |       | 38,098                                                        |       | 27,399                                        |       | 80,872            |       | 51,953            |       |   | 10,699 |   |   |   | 28,919 |   |   |   | 39.0 | % |   |   | 55.7 | % |   |
| Interest expense                              |       | 8,094                                                         |       | 6,452                                         |       | 15,173            |       | 12,377            |       |   | 1,642 |   |   |   | 2,796 |   |   |   | 25.4 | % |   |   | 22.6 | % |   |
| Interest and other  income, net               |       | 26,298                                                        |       | 19,809                                        |       | 47,745            |       | 35,883            |       |   | 6,489 |   |   |   | 11,862 |   |   |   | 32.8 | % |   |   | 33.1 | % |   |
|                                               |            |                                                               |            |                                               |            |                   |            |                   |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

**Royalty and license fee revenues  **Ourother segment earns royalties on third party sales of, and license fees on,several products. The majority of royalty and license fee revenues relate tothe use of our HCV and HIV-related patents for diagnostic testing purposes byvarious third parties.

*Roche settlement  *InOctober 2000, we entered into three license agreements with Roche andseveral of its affiliated companies related to the settlement of certainlitigation in the U.S. and certain other 

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countries for use of ourHCV and HIV nucleic acid testing intellectual property. Two agreements relateto*in vitro* diagnostics products.The third agreement relates to blood screening.

Under the hepatitis C virus agreement, we received$85.0 million, of which we recognized $40.0 million in the fourth quarter2000. We deferred the remaining $45.0 million, which becomes nonrefundableratably through 2005. In the first quarter 2001, we began recognizing portionsof the $45.0 million based upon the greater of (i) the scheduledquarterly minimum non-refundable amount or (ii) the actual earned creditsas royalties on future sales related to Roche’s use of our HCV-related patentin its*in vitro* diagnosticproducts. The agreement also provides for royalties on future sales related toRoche’s use of our HCV-related patent in its*in vitro* diagnostic products, which commenced in the first quarter2001. Royalty revenues under the hepatitis C virus agreement decreased for thethree months ended June 30, 2005 as compared with the three months ended June 30,2004, by $0.5 million and 3.1%. Royalty revenues under the hepatitis Cvirus agreement increased for the six months ended June 30, 2005 ascompared with the six months ended June 30, 2004, by $1.4 million and5.0%.

The HIV agreement with Roche provides for royalties onfuture sales related to Roche’s use of our HIV-related patent in its*in vitro* diagnostic products, whichcommenced in the first quarter 2001 when the European Patent Office Board ofTechnical Appeals upheld our HIV-related patent. Royalty revenues recognizedunder this agreement increased by $5.3 million for the three months ended June 30,2005 as compared with the three months ended June 30, 2004. Royaltyrevenues recognized under this agreement increased by $16.4 million forthe six months ended June 30, 2005 as compared with the six months ended June 30,2004. These increases are mainly due to a settlement agreement with Roche,described in more detail below, under which we recognized revenues for aportion of a nonrefundable royalty payment.

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 from Roche,which was received in April 2003. As permitted under the terms of itslicensing agreement, Roche decided to institute arbitration proceedings inregard to the application of the U.S. patent. We had deferred recognition ofthe $10.0 million milestone payment, interest, royalties received 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, during thethird quarter 2004, we recognized $10.0 million in license fees and$21.8 million in royalties up until June 30, 2004, which hadpreviously been deferred, of which $16.3 million has been recognized asrevenue in our other segment and $5.5 million has been recognized asrevenue in our blood testing segment. During the third quarter 2004, we alsorecognized $0.8 million in interest on the license fee. Also under thesettlement agreement, in the first six months of 2005, we received a lump-sumpayment of $78.0 million in lieu of royalties beyond January 1, 2005.Roche may elect under the terms of the agreement to obtain a partial refund andrevert to paying royalties on the sales of its products in North America. Theamount of such potential refund ranges between $64.0 million and$0.0 million. The amount of the refund available decreases in incrementsover the quarters of 2005 and 2006. As such, Chiron expects to recognize$64.0 million of the payment as revenue during 2005 and 2006. Theremaining $14.0 million is nonrefundable and was recognized as revenue inthe third quarter 2004, of which, $9.3 million has been recognized asrevenue in our other segment and $4.7 million has been recognized asrevenue in our blood-testing segment. Currently, the applicable issuedHCV-related patents expire in 2015 for the U.S. and in 2010 for Europe.Currently, the applicable issued HIV-related patent in Europe expires in 2005.For the three months ended June 30, 2005, we recognized $5.3 million ofrevenue for this settlement in our other segment and $2.7 million of revenuefor this settlement in our blood-testing segment. For the six months ended June 30,2005, we recognized $16.0 million of revenue for this settlement in our othersegment and $8.0 million of revenue 

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for this settlement in ourblood-testing segment. Revenues earned from diagnostic products are included inour other segment and revenues earned from blood screening are included in ourblood-testing segment.

*Bayer  *Across-license agreement provides for royalties to us on HIV and hepatitis Cvirus products sold by Bayer Corporation. Royalties increased for the three andsix months ended June 30, 2005 as compared with the three and six monthsended June 30, 2004 due to additional royalties of $1.8 million under ourexisting license agreement, as amended.

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 administrativeexpenses  **The increase in selling, general andadministrative expenses for the three months ended June 30, 2005 ascompared with the three months ended June 30, 2004 was primarily due to (i) $5.0million of legal costs associated with the FLUVIRIN® vaccine-related developmentsdiscussed above under *“Influenza Virus VaccineRecent Events,”* (ii) $2.6 million for corporate governancecosts and (iii) $2.0 million in consulting expenses. These increases were partiallyoffset by lower employee related expenses of $1.1 million. The increase inselling, general and administrative expenses for the six months ended June 30,2005 as compared with the six months ended June 30, 2004 was primarily dueto (i) $15.0 million of legal costs associated with the FLUVIRIN® vaccine-relateddevelopments discussed above under *“Influenza Virus VaccineRecent Events,”* (ii) $4.2 million for corporate governancecosts, (iii) $4.2 million in consulting expenses, (iv) $3.2 millionin legal costs related to the defense of our patents and technology and (v) $2.6million in employee related expenses. These increases were partially offset bylower facility costs of $3.2 million.

**Interest expense  **Theincrease in interest expense for the three and six months ended June 30,2005 as compared with the three and six months ended June 30, 2004primarily related to interest expense recognized on the $385.0 millionconvertible debentures that were issued on June 22, 2004 partially offsetby the lower interest expense recognized on the Liquid Yield Option Notes (LYONs),the majority of which were put to us in June 2004. The $385.0 millionconvertible debentures incur interest at a higher rate than the LYONs.

**Interest and other income, net  **Interestand other income, net, primarily consisted of interest income on our cash andinvestment balances and other non-operating gains and losses. We recognizedinterest income of $8.9 million and $5.8 million for the three monthsended June 30, 2005 and 2004, respectively. We recognized interest incomeof $16.1 million and $10.9 million for the six months ended June 30,2005 and 2004, respectively. These increases were due to higher interest ratesin 2005 as compared with 2004.

We recognized gains of $14.0 million and$14.3 million for the three months ended June 30, 2005 and 2004,respectively, related to the sale of certain equity securities. We recognizedgains of $28.6 million and $24.0 million for the six months ended June 30,2005 and 2004, respectively, related to the sale of certain equity securities.

In the second quarter of 2005, we recognized a $6.0million settlement regarding a dispute with one of our competitors regardingcertain Chiron patents.

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 

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additional payments,calculated as a pre-determined percentage of Henry Schein’s gross profit,through 2003. We received $3.5 million for 2003 during the six monthsended June 30, 2004.

**Income taxes  **Theeffective tax rate was 24.8% and 25.0% of pretax income (loss) from continuingoperations for the six months ended June 30, 2005 and 2004, respectively. 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.

**Discontinued operations  **Ina strategic effort to focus on our core businesses of blood-testing, vaccinesand biopharmaceuticals, we completed the sale of Chiron Diagnostics to BayerCorporation, or Bayer, in 1998.

In the second quarter of 2004, Chiron and the IRSentered into a settlement agreement closing the open tax years 1996 to 1998. Pursuantto this settlement, we recognized a tax benefit of approximately $12.5 millionfor the three and six months ended June 30, 2004.

Chiron and Bayer wereinvolved in a dispute with respect to their respective rights to certainroyalty refunds receivable for which a settlement was reached in 2004. Underthis settlement agreement, we made a settlement payment to Bayer in 2004. Thissettlement includes an agreement that all outstanding items with Bayer relatedto the sale of Chiron Diagnostics are resolved and no future indemnityobligations are required. We released previously established reserves deemed tobe in excess following this settlement. This settlement resulted in a net gainof $12.8 million for the six months ended June 30, 2004. This netgain primarily relates to a tax benefit as a result of the settlement paymentto Bayer.

**New Accounting Standards**

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. We currently measurecompensation expense for our stock-based employee compensation under theintrinsic method. We are currently evaluating transition methods, optionvaluation methodologies and assumptions in light of SFAS 123(R), and thereforecannot estimate the impact of our adoption at this time, although we expectthat its adoption will have a material impact on our consolidated financialstatements. Current option values determined using the Black-Scholes-Mertonformula, used for purposes of proforma disclosure, may not be indicative ofresults from the valuation methodologies we finally adopt. The effective dateof SFAS 123(R) is the first reporting period beginning after June 15,2005. However, on April 14, 2005, the Securities and Exchange Commission(SEC) announced the adoption of a new rule that delays the effective dateof SFAS 123(R) for registrants, such as Chiron, that are not smallbusiness issuers. The SEC’s new rule allows calendar year non-smallbusiness issuers to implement SFAS 123(R) at the beginning of 2006, whichmakes SFAS 123(R) effective for Chiron in the first quarter of 2006.

On October 22, 2004,the American Jobs Creation Act of 2004 (the Act) was signed into law. The Actincludes a temporary incentive for U.S. multinationals to repatriateaccumulated income earned outside the U.S. at an effective tax rate of 5.25%.On December 21, 2004, the FASB issued Staff Position 109-2,*Accounting and Disclosure Guidance for the ForeignEarnings Repatriation Provisions within the American Jobs Creation Act of 2004(*FSP 109-2*).*FSP 109-2 allows companies additional time to evaluate the effect ofthe law on whether unrepatriated foreign earnings continue to qualify forSFAS No. 109’s exception to recognizing deferred tax liabilities andwould require explanatory disclosures from those who need the additional time.Through June 30, 2005, we have not provided deferred taxes on foreignearnings because 

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suchearnings were intended to be indefinitely reinvested outside the U.S. Presentlywe do not have any plan to repatriate earnings under the Act. Accordingly, wehave made no change in our current intention to indefinitely reinvestaccumulated earnings of our foreign subsidiaries. If we repatriate theseearnings, a one-time tax charge to our consolidated results of operations couldoccur. We will continue to evaluate the impact of this provision for theremainder of 2005.

**Liquidity and Capital Resources**

Our capital requirements have generally been funded bycash flow from operations, borrowings from commercial banks and issuance ofconvertible debt securities and common stock. Our cash, cash equivalents andinvestments in marketable debt securities, which totaled $1,019.3 million at June 30,2005, are invested in a diversified portfolio of fixed income securities,including money market instruments, corporate notes and bonds, and governmentagency securities issued by financial institutions and other issuers withstrong credit ratings. By policy, the amount of credit exposure to any oneinstitution is limited. Investments are generally not collateralized andprimarily mature within three years.

The recent events regarding FLUVIRIN® vaccine, asdiscussed above under “Management’s Discussion and Analysis of FinancialCondition and Results of Operations—*Influenza Virus VaccinesRecent Events*”, will continue to impact our cash flow going forward.As we continue to implement our remediation plan, our efforts will entailadditional cash payments, which will be material. The MHRA’s lifting of ourlicense suspension is conditioned upon the understanding that our commitment toremediation will continue.

In addition, we have incurred and expect to continueto incur substantial expense relating to the investigation by the U.S. Attorney’sOffice for the Southern District of New York, the Securities and ExchangeCommission formal investigation and the shareholder class action and derivativeprivate lawsuits and other claims arising out of or related to thesedevelopments regarding FLUVIRIN® vaccine. The results of any suchinvestigations, proceedings or disputes could have a material adverse effect onour cash flow.

Our inability to supply FLUVIRIN® vaccine may alsolead to loss of market share in the 2005-2006 influenza season and futureseasons. Following the announcement of our FLUVIRIN® license suspension competitors announcedplans to introduce influenza vaccine products in the United States and soughtexpedited regulatory approval to do so. Even though the license suspension hasbeen lifted, some of our customers may choose to purchase influenza vaccinefrom other providers as their products become available in the United States. Delays in start-up procedures for ramping up to full production and normalmanufacturing issues inherent in the complexity of influenza vaccine production,have adversely affected the amount of FLUVIRIN® vaccine that we are able to produce for the 2005-2006 influenzaseason and may result in further loss of market share. Loss of marketshare could have a material adverse effect on cash flow.

The recent events regarding BEGRIVACÔvaccine, as discussed above under “Management’s Discussion and Analysis of FinancialCondition and Results of Operations—*Influenza Virus VaccinesRecent Events*”, will impact our cash flow going forward. We will beunable to supply any BEGRIVACÔ vaccine doses forthe 2005-2006 influenza season, which will eliminate any cash flows wewould receive from the sale of BEGRIVACÔvaccine. Our inability to supply BEGRIVACÔvaccine as planned to non-U.S. markets may also lead to loss of market share infuture seasons. Loss of market share could have a material adverse effect oncash flow. In addition, while we are still in the process of assessing theappropriate steps for our Marburg plant, our remediation efforts could entailcash payments for additional capital and other expenditures, which could bematerial. If we suffer a permanent loss of BEGRIVACÔinfluenza vaccine sales, it would have a material adverse effect on our cashflow. 

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In addition, certain distributorsand other parties with whom we had contracted to supply influenza vaccinemay make claims against us as a result of Chironnot 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 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 to influenza vaccines over the pastnine months will harm our business and results of operations.” For additionalinformation on the U.S. Attorney’s investigation, SEC investigation, privatelawsuits and other claims, see Part II, Item 1. “Legal Proceedings” ofthis Report on Form 10-Q.

Under the terms of theInvestment Agreement between Novartis and Chiron, Novartis agreed to guaranteecertain Chiron obligations up to a maximum of $702.5 million. Under thisagreement, Novartis has guaranteed $100.0 million under a U.S. credit facilityin which there were no borrowings outstanding at June 30, 2005 and $173.3million from a lease commitment for a research and development facility inEmeryville, California.

We believe that our cash, cash equivalents andmarketable debt securities, together with funds provided by operations andborrowing and leasing arrangements, will be sufficient to meet our foreseeableoperating cash requirements including any cash needed for remediation effortsfor our Liverpool plant and Marburg plant, cash utilized for our stockrepurchase program and our current contractual obligations. In addition, webelieve we could access additional funds from the debt and capital marketsshould the need arise. As noted above, if we suffer a permanent loss ofFLUVIRIN®and/or BEGRIVACÔ influenza vaccine sales, whether through loss ofregulatory approvals, market share or otherwise, it would have a materialadverse effect on our cash flow.

**Sources and uses of cash  **Wehad cash and cash equivalents of $184.3 million and $595.0 million at June 30,2005 and 2004, respectively.

*Operating activities  *Forthe six months ended June 30, 2005, net cash provided by operatingactivities was $94.7 million as compared with $74.7 million for the six monthsended June 30, 2004. The increase in cash provided by operating activitieswas primarily due to a $78.0 million lump-sum payment received in lieu ofroyalties beyond January 1, 2005 as part of the Roche settlement reachedon September 10, 2004. This increase was partially offset by costsassociated with our remediation efforts for our Liverpool plant and legal costsrelated to the FLUVIRIN®vaccine developments discussed above.

*Investing activities  *Forthe six months ended June 30, 2005, net cash used in investing activitiesconsisted of purchases of investments in marketable debt securities of $499.3million, capital expenditures of $97.8 million, issuance of notes receivable of$5.0 million, other uses of cash of $4.7 million, purchases of equitysecurities and interests in affiliated companies of $2.5 million and cash paidfor acquisitions net of cash acquired of $2.1 million. Included in net cash paidfor acquisitions was $1.9 million for previously accrued costs in connectionwith acquisition costs related to the acquisition of PowderJect and$0.2 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 $318.1 million, proceeds from sales ofinvestments in marketable debt securities of $141.4 million, and proceeds fromthe sale of equity securities and interests in affiliated companies of $17.9million.

For the six months ended June 30, 2004, net cashprovided by investing activities consisted of proceeds from sales ofinvestments in marketable debt securities of $353.6 million, proceeds frommaturities of investments in marketable debt securities of $154.5 million,proceeds from the sale of equity securities and interests in affiliatedcompanies of $16.3 million and proceeds from notes receivable of $1.0 million. Cashprovided by investing activities was offset by purchases of investments in marketabledebt securities of $218.8 million, capital expenditures of $93.8 million, cashpaid for acquisitions net of cash acquired of 

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$19.5 million whichconsists of $15.5 million of cash delivered on the divestiture of certain researchoperations in Madison, Wisconsin and Oxford, England and certain vaccinesoperations in Sweden and $4.0 million for previously accrued costs inconnection with the acquisition of PowderJect, purchases of equity securitiesand interests in affiliated companies of $4.3 million and other uses of cash of$0.2 million.

*Financing activities  *Forthe six months ended June 30, 2005, net cash provided by financingactivities consisted of $18.4 million of proceeds from the reissuance oftreasury stock and $1.0 million of proceeds from the issuance of debt offset by$0.4 million for the repayment of debt and capital leases.

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 June 30, 2005, no shares wererepurchased.

For the six months ended June 30, 2004, net cashused in financing activities consisted of $380.0 million for the repayment ofdebt and capital leases, $71.7 million for the acquisition of treasury stockand $7.8 million for the payment of debt issuance costs. Cash used in financingactivities was offset by $385.0 million of proceeds from issuance ofconvertible debentures, $45.0 million of proceeds from the reissuance oftreasury stock and $2.3 million of proceeds from the issuance of debt.

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

**Borrowingarrangements  **Under a revolving, committed,uncollateralized credit agreement with a major financial institution, we canborrow up to $100.0 million. This credit facility is guaranteed byNovartis AG under a November 1994 Investment Agreement, provides variousinterest rate options and matures in February 2006. There were noborrowings outstanding under this credit facility at June 30, 2005 and December 31,2004. In July 2003, we entered into a new six-year lease to rent aresearch and development facility in Emeryville, California. Under provisionsof the November 1994 Investment Agreement, Novartis AG guaranteed paymentson this lease commitment to a maximum of $173.3 million. In December 1999,Chiron and Novartis amended the November 1994 Investment Agreement toreduce the maximum amount of our obligations that Novartis would guarantee from$725.0 million to $702.5 million. Out of the maximum guarantee of$702.5 million, the credit agreement and lease discussed above have reduced theamount of our debt Novartis would be required to guarantee by $273.3 million.There remains $429.2 million of the guarantee available at June 30, 2005.The Novartis loan guarantee will expire on January 1, 2008 unless certaindebt ratings are triggered which would extend the guarantee on a decliningbasis ratably over the subsequent three-year period.

**Off-Balance Sheet Arrangements**

As of June 30, 2005,we did not have any off-balance sheet arrangements.

**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-Qand in other periodic reports, press releases and other statements issued by usfrom time to time reflect our current beliefs and expectations concerningobjectives, plans, strategies, future performance and other future events. Thefollowing discussion highlights some of the factors, many of which are beyondour control, which could cause actual results to differ materially.

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*Developments withrespect to influenza vaccines over the past nine months will harm our businessand results of operations.*

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. Subsequently,we received a warning letter from the Food and Drug Administration, or FDA,citing violations of good manufacturing practices. The FDA later informed usthat implementation and effectiveness of our corrective actions and overallcompliance would be evaluated in a subsequent inspection. As a result of thesuspension of our license, we did not release any FLUVIRIN® vaccine during the 2004-2005influenza season.

On March 2, 2005, the MHRA notified us that ithad lifted the license suspension, giving Chiron clearance to initiate fullproduction of FLUVIRIN® vaccine, conditioned on the understanding thatChiron’s commitment to its remediation plan will continue and will be subjectto further inspections by the MHRA. In July 2005,the FDA completed an on-site inspection of our Liverpool facility. Consistentwith FDA process, at the conclusion of the on-site inspection, Chiron receiveda list of observations on a Form 483. Chiron expects to complete itsresponse to these observations in early August 2005. If the FDA finds that wehave failed to adequately address the matters discussed in its prior warningletter or any other serious violations,the FDA may modify our U.S. license in an adverse manner, take action thatcould result in imposition of fines, require temporary or permanent cessationof future selling of FLUVIRIN®vaccine or take other action that could reduce our ability to market FLUVIRIN® vaccine. In addition to the facility inspection, we will needto receive supplemental approvals for changes in our FLUVIRIN® vaccine from the MHRA and the FDA because ofvariations to our manufacturing process.

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. 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 and additional interviews are anticipated. Additionalinvestigations regarding these matters may arise.

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 aredescribed below in Part II, Item 1, “Legal Proceedings”. Certaindistributors and other parties with whom we had contracted to supply FLUVIRIN® vaccine areconsidering or have communicated claims against us as a result of our inabilityto supply FLUVIRIN®vaccine, and additional parties may do so in the future. On January 27,2005, the U.S. Centers for Disease Control and Prevention, or CDC, terminatedits contracts with Chiron for the supply of FLUVIRIN® vaccine for default on the basisof Chiron’s failure 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 todeliver and further has reserved all other remedies provided under thecontract. It is not possible to predict whether any of these claims will bepursued and, if so, whether those claims will be upheld. Investigations,litigation and disputes have caused us to incur substantial expense and haverequired significant time and attention from our management and will continueto do so in the future and could result in civil action 

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and/or criminal proceedingsagainst Chiron. The results of any such investigations, proceedings or disputescould have a material adverse effect on our consolidated financial position andresults of operations and/or cash flow.

Although the MHRA has lifted itssuspension of our license to manufacture FLUVIRIN® vaccine, we expect to incur additional expenses inconnection with ongoing FLUVIRIN®vaccine matters, which could be material, including in connection with (1) ourcontinuing remediation efforts at our Liverpool facility; and (2) respondingto the U.S. Attorney for the Southern District of New York, the SEC, the UnitedStates House of Representatives, Energy and Commerce Committee,Subcommittee on Oversight and Investigations andthe private lawsuits and other claims and investigations that exist or mayarise.

For additional information on theU.S. Attorney’s investigation, SEC investigation, private lawsuits and otherclaims, see Part II, Item 1. “Legal Proceedings” of this report on Form 10-Q.

In July 2005, we reported that we would be unableto supply any BEGRIVACTM vaccine doses for the 2005-2006 influenza seasondue to a product sterility issue and wrote off our existing product inventoryresulting in a $15.0 million charge to cost of sales for the three and sixmonths ended June 30, 2005. BEGRIVACTM vaccine is manufactured at ourfacility in Marburg, Germany. Our inability to supply BEGRIVACTM vaccine as planned to non-U.S. markets for the2005-2006 influenza season or future seasons could have a materialadverse affect on our business and results of operations. In addition, it is possible that distributors andother parties with whom we had contracted to supply influenza vaccine may make claims against us as a result of Chiron notsupplying influenza vaccine. Any suchclaims may cause us to incur substantial expense and require significant timeand attention from our management. The results of any such claims could have amaterial adverse effect on our consolidated financial position and results ofoperations and/or cash flow.

We did not release any FLUVIRIN® vaccine during the2004-2005 influenza season. As a result, our results of operations for2004 were materially adversely affected by these matters. In addition, we willnot release any BEGRIVACTM vaccine during the 2005-2006 influenza season.Additional issues with respect to influenza vaccines could cause us to have torecognize an impairment charge with respect to the goodwill, certain otherintangible assets and property, including without limitation the Liverpoolplant resulting from the PowderJect acquisition and the new influenza vaccinesmanufacturing facility under construction in Liverpool, which could have amaterial adverse effect on our results of operations.

Our inability to supply influenzavaccines may also lead to loss of market share in the 2005-2006 seasonand 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 choose topurchase influenza vaccine from other providers as their products becomeavailable in the United States. Loss of market share in the United States orforeign markets could have a material adverse effect on our business andresults of operations. 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.

*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-countrybasis. In the case of influenza vaccines, the failure to obtain or maintain ourlicenses, or delays imposed by regulatory actions, could lead to the loss ofour entire inventory during any given season since each year’s vaccines aremanufactured to meet specific strains of influenza. In the case of therapeuticproducts, a separate approval is required for 

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eachtherapeutic indication. Product candidates that appear promising based onearly, and even large-scale, clinical trials may not receive regulatoryapproval. Furthermore, the results of clinical trials often are susceptible tovarying interpretations that may delay, limit or prevent approval or result inthe need for additional pre-marketing or post-marketing studies. In addition,regulations may be amended from time to time. Revised regulations may requireus to reformulate products on a country or regional basis, obtain additionalregulatory approvals, or accept additional risks that our products will notmaintain market acceptance or be eligible for third party insurance coverage.Increased regulatory scrutiny and restrictions regarding marketing practicesfor products that are subject to government reimbursement may impact the salesof such products. There is no guarantee that we will be able to meet conditionsto obtain 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 rely on assaying of the finished product alone to ensure that the productwill perform in the intended manner. Accordingly, it is essential to be able toboth validate and control the manufacturing process, that is, to show that theprocess works and that the product is made strictly and consistently incompliance with that process. Slight deviations anywhere in the manufacturingprocess, including quality control, labeling and packaging, may result inunacceptable changes in the products that may result in lot failures or productrecalls, or liability to a third party to the extent we are contractmanufacturing products in our facilities for such third party. Manufacturingprocesses which are used to produce the smaller quantities of material neededfor research and development purposes may not be successfully scaled up toallow production of commercial quantities at reasonable cost or at all. All ofthese difficulties are compounded when dealing with novel biologic productsthat require novel manufacturing processes. Additionally, manufacturing issubject to extensive government regulation. Even minor changes in themanufacturing process require regulatory approval, which, in turn, may requirefurther clinical studies. For some of our products, we rely on others to supplyraw materials and to manufacture those products according to regulatoryrequirements.

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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, interruptionsdue to labor action, damage to a facility due to natural disasters, such as anearthquake, suspension of power supplied to these facilities arising out ofregional power shortages or terrorist activities and armed conflict, includingas a result of the disruption of operations of our subsidiaries and ourcustomers, suppliers, distributors, couriers, collaborative partners, licenseesand 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 aproduct, we may find that a competitive product dominates the market for any numberof reasons, including:

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

·       Thecompetitor may have greater access to certain raw materials;

·       Thecompetitor may have more efficient manufacturing processes;

·       Thecompetitor may adapt more quickly to technological change;

·       Thecompetitor may have greater marketing capabilities;

·       Thecompetitive product may have therapeutic or other advantages; or

·       Newcompetitors may enter into markets where we currently have significant competitiveadvantage.

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

*Conflicts with 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 distributeexisting products. As circumstances change, Chiron and our strategicpartners may develop conflicting priorities or other conflicts of interest or decide not to extend existing collaborations.We may experience significant delays and incur significant expenses inresolving these conflicts and may not be able to resolve these matters onacceptable terms. Even without conflicts of interest, we may disagree with ourstrategic partners as to how best to realize the value associated with acurrent product or a product in development. In some cases, the strategicpartner may have responsibility for formulating and implementing key strategicor operational plans. In addition, merger and acquisition activity within thepharmaceutical and biotechnology industries may affect our strategic partners,causing them to reprioritize their efforts related to the researchcollaborations and other joint efforts with us. Decisions by corporate partnerson key clinical, regulatory, marketing (including pricing), inventorymanagement and other issues may prevent successful commercialization of theproduct or otherwise impact our profitability.

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*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 uponobtaining certain materials from specified sources. Our ability to substitutematerial from an alternate source may be delayed pending regulatory approval ofsuch alternate 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, from two of the principal worldwide suppliersof the drug. We anticipate that either one of these suppliers alone will beable to supply sufficient quantities to meet current needs; however, there canbe no assurance that these suppliers will be able to meet future demand in atimely and cost-effective manner. As a result, our operations could beadversely affected by an interruption or reduction in the supply of bulkpowdered tobramycin.

We have entered into contracts with third parties forthe production and packaging of TOBI® tobramycin. Over time, we can use alternative productionand packaging sources. However, if the contracted third parties become unableto produce or package sufficient quantities of TOBI solution due to work stoppages orother factors, our operations could be disrupted until alternative sources aresecured.

We have entered into contracts with third parties forthe packaging of the pre-filled diluent syringe for BETASERON® interferon beta-1b. Overtime, we can use alternative packaging sources. However, if the contractedthird parties become unable to produce or package sufficient quantities of thepre-filled diluent 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 chicken eggs. ForFLUVIRIN®vaccine, we purchase those eggs and incubation services from a single supplierin the United Kingdom and, pursuant to the contract with that supplier, we haveagreed to make specified purchases from that supplier through 2009, subject toour right to terminate this agreement earlier upon payment of a terminationfee. If our supplier were to fail to supply eggs in sufficient quantities orquality, including as a result of any health or other issues related to thechickens, our business would be materially adversely affected.

We are a key provider forthe blood screening field of nucleic acid testing and immunodiagnostics. Innucleic acid testing, we rely on our collaborative partner, Gen-Probe, tomanufacture the West Nile virus assay, currently in use on aninvestigational-use basis in the U.S. and the PROCLEIX® HIV-1/ HCV and PROCLEIX®ULTRIOTM Assays. We currently source the related instrument system from thirdparty suppliers. Currently, Gen-Probe is the only manufacturer of nucleic acidtesting products using Transcription-Mediated Amplification technology. Inimmunodiagnostics, under the Ortho-Clinical Diagnostics, Inc. contract, wemanufacture bulk reagents and antigens and confirmatory test kits sold in theclinical diagnostics and blood screening fields. While we and our partners workto mitigate 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 West Nile virus assay, PROCLEIX® HIV-1/HCV and PROCLEIX® ULTRIOTM Assays or that we will be able to manufacturesufficient bulk reagents and antigens and confirmatory test kits forimmunodiagnostic products. Our difficulties or delays or those of our partners’

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couldcause a public health concern for the blood supply, as well as increase costsand cause loss of revenue or market share.

*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 licenses. If we do not or cannot obtain these licenses,products may be withdrawn from the market or delays could be encountered inmarket introduction while an attempt is made to design around these patents, orwe could find that the development, manufacture or sale of such products isforeclosed. We could also incur substantial costs in licensing or challengingthe validity and scope of these patents.

*Because most of ourproducts are based on technologies that are unfamiliar to the healthcarecommunity, they may not be accepted by healthcare providers and patients, whichcould harm our business.*

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

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

We are exposed to product liability and other claimsin the event that the use of our products is alleged to have resulted inadverse effects. While we will continue to take precautions, we may not avoidsignificant product liability exposure. Although we maintain product liabilityinsurance, there is no guarantee that this coverage will be sufficient. It isnot feasible to obtain adequate insurance coverage for certain products and weare self-insured in relation to these products. If we are sued for any injurycaused by our products, we could suffer a significant financial loss.

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

*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 and reimbursementstatus of newly approved, novel biotechnology products, and it may be 

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challengingto meet the current pricing and reimbursement policies for existing products,which may be complex, subject to change and limit our revenues. In certainforeign markets, governments have issued more extensive regulations relating tothe pricing and profitability of pharmaceutical companies, which can beexpected to limit our revenues from certain products. There have been proposalsin the U.S. (at both the federal and state level) to implement such controls.If the United States Congress enacts legislative proposals addressing parallelimportation currently being deliberated, revenues from certain products may beaffected further by this change in U.S. policy. The growth of managed care inthe U.S. also has placed pressure on the pricing of healthcare products. Thesepressures can be expected to continue.

*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 andenforcement activity 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.

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In addition, state Attorneys General and private classaction plaintiffs have filed civil suits under the federal RICO statute and avariety of state consumer protection laws claiming that pharmaceuticalcompanies reported inflated average wholesale prices to pricing services usedby the federal programs to set reimbursement rates, and that as a result,Medicare beneficiaries, Medicaid programs and private payers overpaid fordrugs. Still other manufacturers have been subject to enforcement activity foralleged violations of such federal statutes as the Prescription Drug MarketingAct, involving pharmaceutical sampling practices. The majority of states alsohave statutes or regulations similar to the federal anti-kickback law andfalse claims laws, which apply to items and services reimbursed under Medicaidand other state programs, or, in several states, apply regardless of the payor.

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

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monetaryrelief and may be unable to enjoin infringement, which could materiallydiminish the value of the patent. In addition, royalty revenues may decline aspatents 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:

·       Useof cash resources;

·       Potentiallydilutive issuances of equity securities;

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

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

·       Amortizationexpenses related to other intangible assets; and

·       Impairment of the value of tangible and intangibleassets resulting from management’s decision to discontinue a line of businessor product previously acquired by Chiron or from changes in businessconditions.

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

·       Challengesassociated with managing an increasingly diversified business;

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

·       Diversionof management’s attention from other business concerns;

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

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

·       Subsequentloss of key personnel.

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.

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*Fluctuations ininterest rates and foreign currency exchange rates could harm our business.*

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

*Our level of 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 June 30,2005, our total debt including current portion, was $939.6 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:

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

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

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

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

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

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

We and our subsidiaries may still be able to incursubstantially more debt. The terms of our credit facility, the indenture governingthe debentures and the agreements governing our other debt permit additionalborrowings. Our incurrence of additional debt could further exacerbate therisks described above.

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

We have an alliance withNovartis AG, a life sciences company headquartered in Basel, Switzerland. Undera series of agreements between Chiron and Novartis, and as a result ofsubsequent stock issuances by Chiron, Novartis’ ownership interest in Chironwas approximately 42% as of June 30, 2005. The governance agreementbetween Chiron and Novartis contains provisions that require the approval ofNovartis before we enter into certain corporate transactions. Thesetransactions generally include significant debt or equity issuances, debt orequity repurchases, most mergers and acquisitions, the payment of cashdividends, amendments to Chiron’s certificate of incorporation or by-laws, andother 

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transactionsthat would adversely impact the rights of Novartis, or discriminate againstNovartis, as a Chiron stockholder. In addition, a majority of the independentdirectors must approve any material transactions between Chiron and Novartis.These provisions may limit our ability to enter into transactions with thirdparties otherwise viewed as beneficial to Chiron. All of our shares owned byNovartis are eligible for sale in the public market subject to compliance withthe applicable securities laws. We have agreed that, upon Novartis’ request, wewill file one or more registration statements under the Securities Act in orderto permit Novartis to offer and sell shares of our common stock. Sales of asubstantial number of shares of our common stock by Novartis in the publicmarket could adversely affect the market price of our common 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:

·       Fluctuationsin earnings from period to period;

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

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

·       Impactfrom the recent influenza vaccines developments;

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

·       Thelaunch of competing products;

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

·       Corporaterestructuring by us;

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

·       Licensingactivities by us; and

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

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

*We are subject 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 anumber of rulings regarding income and other taxes that are subject to periodicreview and renewal. If such rulings are not renewed or are substantiallymodified, income taxes payable in particular jurisdictions could increase.While we believe that all material tax liabilities are reflected 

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properlyin our balance sheet, we are presently under audit in several jurisdictions andmay be subject to further audits in the future, and we have no assurance thatwe will prevail in all cases in the event the taxing authorities disagree withour interpretations of the tax law. In addition, we have assumed liabilitiesfor all income taxes incurred prior to the sales of our former subsidiaries,including PowderJect Vaccines, Inc., SBL Vaccin AB, and PowderJectResearch Limited. Future levels of research and development spending, capitalinvestment and export sales will impact our entitlement to related tax creditsand benefits which have the effect of lowering our effective tax rate.

*Our earnings resultsmay 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:

·       Inventorymanagement practices, including wholesale ordering patterns;

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

·       Seasonalityof certain vaccine products;

·       Thetender driven nature of certain vaccine products;

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

·       Foreigncurrency exchange rate fluctuations; and

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

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

*Revisions toaccounting standards, financial reporting and corporate governance requirementsand tax laws could result in changes to our standard practices and couldrequire a significant expenditure of time, attention and resources, especiallyby senior management.*

We must follow accounting standards, financialreporting and corporate governance requirements and tax laws set by the governingbodies and lawmakers in the U.S. and other countries where we do business. Fromtime to time, these governing bodies and lawmakers implement new and revised rules andlaws. These new and revised accounting standards, financial reporting and corporategovernance requirements and tax laws may require changes to our financialstatements, the composition of our board of directors, the composition, theresponsibility and manner of operation of various board-level committees, theinformation filed by us with the governing bodies and enforcement of tax lawsagainst us. Implementing changes required by such new standards, requirementsor laws likely will require a significant expenditure of time, attention andresources, especially by our senior management. It is impossible to completelypredict the impact, if any, on Chiron of future changes to accountingstandards, financial reporting and corporate governance requirements and taxlaws.

It is possible that theapplication of certain current accounting standards may change due toenvironmental factors, which may necessitate a change in our standard practicerelated to these accounting standards. In particular, effective January 1,2006 we will be required to adopt SFAS No. 123(R) requiring us toapply a fair-value based method to account for costs related to share-basedpayments including stock options and employee stock purchase plans. We expectthe adoption of SFAS 123(R) to materially impact our results ofoperations.

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**Item 3.**                        Quantitativeand Qualitative Disclosures about Market Risk

**Marketrisk management  **Our cash flow and earnings are subjectto fluctuations due to changes in foreign currency exchange rates, changes ininterest rates and changes in the fair value of equity securities held forsale. We attempt to limit our exposure to some or all of these market risksthrough the use of various financial and derivative instruments. During thefirst six months of 2005, we added a new hedging instrument to our foreigncurrency hedging strategy. We purchased $54.4 million of British Pounddenominated fixed-income securities to create a natural hedge against a portionof our British Pound currency exposures. We manage our exposures to marketrisks as discussed in further detail in Part II, Item 7A, “Quantitativeand Qualitative Disclosures About Market Risk” in our annual Report on Form 10-Kfor the year ended December 31, 2004.

**Item 4.**                        Controlsand Procedures

**(a) Evaluation of disclosurecontrols and procedures  **As of the end of the periodcovered by this report, Chiron carried out an evaluation under the supervisionand with the participation of Chiron’s management, including Chiron’s CEO andCFO, of the effectiveness of Chiron’s disclosure controls and procedurespursuant to Exchange Act Rule 13a-15(e) or 15d-15(e).Based on that evaluation, which included consideration of the design andimplementation of additional controls and procedures described below, Chiron’smanagement, including the CEO and CFO, concluded that Chiron’s disclosurecontrols and procedures were effective in timely alerting them to material informationrelating to Chiron required to be included in Chiron’s periodic SEC filings.

**(b) Changes in internal controls  **Exceptas set forth below, there have been no significant changes in Chiron’s internalcontrols over financial reporting that have materially affected, or arereasonably likely to materially affect internal controls over financialreporting during the most recent fiscal quarter.

The management of Chiron assessed the effectiveness ofthe Company’s internal control over financial reporting as of December 31,2004. In performing the assessment management identified three materialweaknesses in internal control over financial reporting as of December 31,2004. As a result of the material weaknesses described below, managementdetermined that, as of December 31, 2004, the Company’s system of internalcontrol over financial reporting was not effective based on the criteria in*Internal Control—Integrated Framework*.

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

The second materialweakness pertains to both the design and operating effectiveness of controlsrelating to the annual income tax provision. Specifically, there were errors inthe annual tax provision for the year ended December 31, 2004 as a resultof ineffective controls relating to the design and use of analytical tools toanalyze and calculate the tax provision, the reconciliation of certain taxaccounts, and the review of those reconciliations. These errors affected incometax expense and income tax asset and liability accounts. Adjustments wererecorded in the consolidated financial statements for year ended December 31,2004 to correct the identified errors.

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The third materialweakness pertains to both the design and operating effectiveness of controlsrelating to the timely determination of the appropriate accrual for legalservices. Specifically, procedures to estimate the accrual for unbilledservices and controls over the timely recording of invoices payable were noteffective. Errors resulting from these deficiencies affected operatingexpenses, intangible assets and accrued liabilities. Adjustments were recordedin the consolidated financial statements for year ended December 31, 2004to correct the identified errors.

Duringthe first and second quarters of fiscal year 2005, and in connection with thepreparation of our condensed consolidated financial statements for the quartersended March 31 and June 30, 2005, as applicable, we designed andimplemented additional controls and procedures relating to revenue recognitionat our vaccines subsidiary in Germany to address the first material weaknessidentified above. Such additional controls and procedures included, amongothers:

·       Duringthe first quarter, providing our sales force with training regarding theapplicable accounting principles and procedures for the communication ofspecial terms and conditions and the impact of their activities on our revenuerecognition; and

·       Duringthe first and second quarters, review of a significant sample of supportingsales documentation, including customer agreements, to identify salestransactions with special terms and conditions to determine that the sales wererecognized in accordance with applicable accounting principles

Inaddition, during the first and second quarters of 2005, and in connection withthe preparation of our condensed consolidated financial statements for thequarters ended March 31 and June 30, 2005, as applicable, we designedand implemented additional controls and procedures relating to the timelyrecording of legal services invoices payable and estimating the accrual forunbilled legal services to address the third material weakness identifiedabove. Such additional controls and procedures included, among others:

·       Designingof new procedures for invoice processing and procedures for the accrual ofunbilled services and communication of the new procedures to individualsintegral to the process; and

·       Duringthe first quarter, completion oftraining and awareness workshops relating to the new processes

In addition, we haveestablished a remediation plan to address the ineffective controls related tothe annual tax provision process. The remediation plan includes additionalcontrols and revisions to the tax provision process, the implementation of newanalytical tools in order to enhance the analysis and calculation of the taxprovision and additional training of personnel responsible for the taxprovision process.

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**PART II**

**Item 1. Legal Proceedings**

We are party to certainlawsuits and legal proceedings, which are described in Part I, Item 3. “LegalProceedings” of our Annual Report on Form 10-K for the year ended December 31,2004. The following is a description of material developments during the periodcovered by this Quarterly Report and certain other events and should be read inconjunction with the Annual Report on Form 10-K for the year ended December 31,2004 and the Quarterly Report on Form 10-Q for the quarter ended March 31,2005.

***AverageWholesale Price Litigation***

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 certain generic oncology drugs sold by the Cetus-BenVenue Therapeutics partnership. Plaintiffs allege that defendants violatedfederal and state laws regarding Medicaid fraud, and state laws regardingsocial services fraud, health regulations, breach of contract, unfair tradepractices, and unjust enrichment, and seek declaratory relief, as well ascompensatory and punitive damages.

It is not known when or onwhat basis this matter will be resolved.

***FLUVIRIN®influenza virus vaccine***

For a discussion ofdevelopments related to FLUVIRIN® influenza virus vaccine, see “Item 2—Management’sDiscussion and Analysis of Financial Condition and Results of Operations,Factors That May Affect Future Results.”

A.   FLUVIRIN® vaccine SecuritiesClass 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 toproduce and Chiron’s historical and forecasted financial results, and seeksunspecified monetary damages and other relief from all defendants. The trial isscheduled to begin on May 1, 2006.

B.   FLUVIRIN® vaccineShareholder Derivative Actions

Between October 2004 and November 2004, sixshareholder derivative complaints were filed in the Superior Court of the Stateof California for the County of Alameda, naming Chiron as a nominal party andnaming certain current and former Chiron officers and directors and Novartis AGas defendants in connection with the suspension of Chiron’s license tomanufacture 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 

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Chiron CorporationDerivative Litigation (the “Derivative Action”). In February 2005, leadplaintiff filed a consolidated complaint, and in May 2005 filed an amendedconsolidated complaint alleging that defendants are liable for breach of theirfiduciary duties of loyalty and care and other duties allegedly owed to Chironin connection with Chiron’s acquisition of its Liverpool, England facility andthe British regulatory agency’s decision to suspend temporarily Chiron’slicense to manufacture FLUVIRIN® vaccine at the Liverpool facility,and seeking unspecified monetary damages and other relief from all defendants.The complaints 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.

It is not known when or onwhat basis these matters will be resolved.

***Investigationof Employees of Italian Subsidiary***

Two sales employees of an indirect wholly ownedItalian subsidiary of Chiron are 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 are also conductingan investigation in Milan, Italy concerning alleged corruption and undueinfluence by one sales employee also implicated in the Genoa investigation. Inconnection with the Genoa investigation, authorities placed one employee underhouse arrest, but the employee has since been released. At this time, we arenot aware of any investigation of Chiron with respect to these matters.However, no assurance can be given that Chiron will not become the subject ofcriminal or civil charges, fines or penalties, or incur other damages or costs,in connection with these matters.

It is not known when or onwhat basis these matters will be resolved.

***Senate Finance Committee Information Request***

On June 9, 2005, we received a voluntary request forinformation 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 us as to our practices regarding educational grants.We understand that the Committee has directed similar requests to otherpharmaceutical companies. We are cooperating with the Committee’s informationrequest.

It is not known when or onwhat basis these matters will be resolved.

***SorinBiomedica/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 or onwhat basis these matters will be resolved.

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**Item2. Unregistered Sales of Equity Securities and Use of Proceeds**

(c)   Our Board of Directors authorized the repurchase of our commonstock on the open market to offset the dilution associated with the issuance ofnew shares under the stock option and stock purchase plans and the granting ofshare rights. On March 10,2005, the Board of Directors authorized Chiron to repurchase5.0 million shares of Chiron common stock through December 31, 2005. Therewere no stock repurchases in the second quarter of 2005.

**Item3. Defaults Upon Senior Securities**

None.

**Item4. Submission of Matters to a Vote of Security Holders**

(a)          Chiron held its AnnualMeeting of Stockholders on May 25, 2005.

(b)         Omitted pursuant toInstruction 3 to Item 4 of Form 10-Q.

(c)          The two matters votedupon at the meeting were: (i) election of four directors to hold officefor the term indicated below; and (ii) ratification of the appointment ofErnst & Young LLP as Chiron’s registered public accounting firm forthe year ending December 31, 2005. The four directors, Mr. Lewis W.Coleman, Mr. J. Richard Fredericks, Dr. Paul L. Herrling and Mr. HowardH. Pien, were serving as directors and were nominated for election to the Boardfor a three-year term until Chiron’s Annual Meeting of Stockholders in the year2008.

(i)             Thefollowing votes were cast for or were withheld with respect to each of thenominees for director:
| **DIRECTORS**          | ** ** | ** **  | ** ** | **FOR**   | ** ** | **WITHHELD** | ** ** |
|------------------------|------------|-------------|------------|-----------|------------|--------------|------------|
| *Class of  2008*  |       |        |       |      |       |
| Lewis W. Coleman       |       | 171,949,869 |       | 4,642,568 |       |
| J. Richard  Fredericks |       | 169,138,588 |       | 7,453,849 |       |
| Paul L. Herrling       |       | 171,996,686 |       | 4,595,751 |       |
| Howard H. Pien         |       | 173,130,658 |       | 3,461,779 |       |

 

All nominees were declared to have been elected asdirectors to hold their respective offices until the Annual Meeting ofStockholders in the year 2008 as noted above. No abstentions or brokernon-votes were cast for the election of directors.

The followingdirectors continue in office after Chiron’s Annual Meeting of Stockholders heldon May 25, 2005: Raymund Breu, Denise M. O’Leary and Pieter J. Strijkertuntil the Annual Meeting of Stockholders in the year 2006; and Vaughn D.Bryson, Pierre E. Douaze and Edward E. Penhoet until the Annual Meeting ofStockholders in the year 2007.

(ii)         Withrespect to the proposal to ratify the appointment of Ernst & Young LLPas Chiron’s independent registered public accounting firm, 175,617,959 voteswere cast for the proposal, 190,915 votes were cast against the proposal, and783,563 votes abstained. No broker non-votes were cast in connection withthe proposal. The selection of Ernst & Young LLP as Chiron’sindependent registered public accounting firm for the year ending December 31,2005 was declared to have been ratified.

**Item 5. Other Information**

None.

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**Item 6. Exhibits.**

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

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| 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. |
|------|--------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 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.                                                                                                                                                                                     |

 

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**CHIRONCORPORATION**

**June 30, 2005**

**SIGNATURES**

Pursuantto the requirements of the Securities Exchange Act of 1934, Chiron has dulycaused this report to be signed on its behalf by the undersigned thereunto dulyauthorized.
|                            | CHIRON CORPORATION |
|----------------------------|--------------------|
| DATE: August 4,  2005 |               |   |
|                       | BY:                | /s/  HOWARD H. PIEN |
|                       |               | Howard H. Pien |
|                       |               | *Chief Executive Officer* |
| DATE: August 4,  2005 | * *           | * * |
|                       | BY:                | /s/  DAVID V. SMITH |
|                       |               | David V. Smith |
|                       |               | *Vice President and Chief Financial Officer* |

 

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