**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**Washington,D.C. 20549**

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**FORM 10-Q**

| **(Mark one)**                                              |
|-------------------------------------------------------------|
| **x**                                                       | **QUARTERLY  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE  ACT OF 1934.** |
| **For the quarterly period ended  September 30, 2005** |
| **OR**                                                      |
| **o**                                                       | **TRANSITION  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE  ACT OF 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 markwhether the 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

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

Yes o    No x

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

| Title of Class                 | ** ** | **Outstanding at October 31, 2005** |
|--------------------------------|------------|---------------------------------------------------------|
| Common Stock,  $0.01 par value |       | 188,575,753                                             |

 

 

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**CHIRON CORPORATIONTABLE OF CONTENTS**

|                                                                                                                                                   | ** ** | **Page No.** |
|---------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------|
| **PART I.   FINANCIAL  INFORMATION**                                                                                               |       |              |   |   |
| **ITEM 1.   Financial Statements (Unaudited)**                                                                                          |       |              |   |   |
| Condensed Consolidated Balance  Sheets at September 30, 2005 and December 31, 2004                                                      |       |              | 3 |   |
| Condensed Consolidated  Statements of Operations for the three and nine months ended  September 30, 2005 and 2004                       |       |              | 5 |   |
| Condensed Consolidated Statements of  Comprehensive Income (loss) for the three and nine months ended  September 30, 2005 and 2004 |       |              | 6 |   |
| Condensed Consolidated Statements of  Cash Flows for the nine months ended September 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**                          |       |              | 23 |   |
| **ITEM 3.   Quantitative  and Qualitative Disclosures About Market Risk**                                                               |       |              | 60 |   |
| **ITEM 4.   Controls  and Procedures**                                                                                                  |       |              | 61 |   |
| **PART II.   OTHER  INFORMATION**                                                                                                  |       |              |   |   |
| **ITEM 1.   Legal  Proceedings**                                                                                                        |       |              | 63 |   |
| **ITEM 2.   Unregistered  Sales of Equity Securities and Use of Proceeds**                                                              |       |              | 65 |   |
| **ITEM 3.   Defaults  Upon Senior Securities**                                                                                          |       |              | 65 |   |
| **ITEM 4.   Submission  of Matters to a Vote of Security Holders**                                                                      |       |              | 65 |   |
| **ITEM 5.   Other  Information**                                                                                                        |       |              | 65 |   |
| **ITEM 6.   Exhibits**                                                                                                                  |       |              | 66 |   |
| **SIGNATURES**                                                                                                                                    |       |              | 68 |   |

 

2

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**Item 1**.                        FinancialStatements

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

| ** **                                                       | ** ** | **September 30,  2005** | ** ** | **December 31,  2004** | ** ** |
|------------------------------------------------------------------|------------|------------------------------|------------|-----------------------------|------------|
| **ASSETS**                                                       |       |                         |       |                        |       |   |   |   |   |
| Current assets:                                                  |       |                         |       |                        |       |   |   |   |   |
| Cash and cash equivalents                                        |       |                         | $          | 204,368                     |       |   |   | $ | 209,509 |   |   |
| Short-term investments in marketable debt securities             |       |                         | 375,738    |                        |       |   | 394,112 |   |   |
| Total cash, cash equivalents and short-term  investments         |       |                         | 580,106    |                        |       |   | 603,621 |   |   |
| Accounts receivable, net of allowances                           |       |                         | 383,925    |                        |       |   | 402,094 |   |   |
| Inventories, net of reserves                                     |       |                         | 268,566    |                        |       |   | 221,154 |   |   |
| Assets held for sale                                             |       |                         | 1,221      |                        |       |   | — |   |   |
| Current net deferred income tax asset                            |       |                         | 61,398     |                        |       |   | 71,287 |   |   |
| Derivative financial instruments                                 |       |                         | 5,418      |                        |       |   | 4,969 |   |   |
| Other current assets                                             |       |                         | 141,488    |                        |       |   | 90,898 |   |   |
| Total current assets                                             |       |                         | 1,442,122  |                        |       |   | 1,394,023 |   |   |
| Non-current  investments in marketable debt securities           |       |                         | 437,650    |                        |       |   | 409,421 |   |   |
| Property, plant,  equipment and leasehold improvements, at cost: |       |                         |       |                        |       |   |   |   |   |
| Land and buildings                                               |       |                         | 379,799    |                        |       |   | 379,861 |   |   |
| Laboratory, production and office equipment                      |       |                         | 674,094    |                        |       |   | 637,394 |   |   |
| Leasehold improvements                                           |       |                         | 137,099    |                        |       |   | 125,858 |   |   |
| Construction-in-progress                                         |       |                         | 247,349    |                        |       |   | 225,482 |   |   |
|                                                             |       |                         | 1,438,341  |                        |       |   | 1,368,595 |   |   |
| Less accumulated depreciation and amortization                   |       |                         | (614,244   | )                           |       |   | (569,180 | ) |   |
| Property, plant, equipment and leasehold  improvements, net      |       |                         | 824,097    |                        |       |   | 799,415 |   |   |
| Purchased  technologies, net                                     |       |                         | 200,830    |                        |       |   | 216,037 |   |   |
| Goodwill                                                         |       |                         | 805,948    |                        |       |   | 861,394 |   |   |
| Other intangible  assets, net                                    |       |                         | 375,994    |                        |       |   | 457,707 |   |   |
| Investments in  equity securities and affiliated companies       |       |                         | 64,812     |                        |       |   | 100,951 |   |   |
| Non-current notes  receivable                                    |       |                         | 12,467     |                        |       |   | 7,500 |   |   |
| Other non-current  assets                                        |       |                         | 52,886     |                        |       |   | 59,055 |   |   |
|                                                             |       |                         | $          | 4,216,806                   |       |   |   | $ | 4,305,503 |   |   |

 

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

3

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

| ** **                                                                                                                 | ** ** | **September 30,  2005** | ** ** | **December 31,  2004** | ** ** |
|----------------------------------------------------------------------------------------------------------------------------|------------|------------------------------|------------|-----------------------------|------------|
| **LIABILITIES AND STOCKHOLDERS’ EQUITY**                                                                              |       |                         |       |                        |       |   |   |   |   |
| Current liabilities:                                                                                                       |       |                         |       |                        |       |   |   |   |   |
| Accounts payable                                                                                                           |       |                         | $          | 124,612                     |       |   |   | $ | 129,942 |   |   |
| Accrued compensation and related expenses                                                                                  |       |                         | 80,634     |                        |       |   | 79,113 |   |   |
| Derivative financial instruments                                                                                           |       |                         | —     |                        |       |   | 10,395 |   |   |
| Current portion of long-term debt and capital lease                                                                        |       |                         | 1,569      |                        |       |   | 2,687 |   |   |
| Current portion of unearned revenue                                                                                        |       |                         | 54,454     |                        |       |   | 35,651 |   |   |
| Income taxes payable                                                                                                       |       |                         | 18,051     |                        |       |   | 16,363 |   |   |
| Other current liabilities                                                                                                  |       |                         | 180,202    |                        |       |   | 160,293 |   |   |
| Total current liabilities                                                                                                  |       |                         | 459,522    |                        |       |   | 434,444 |   |   |
| Long-term debt                                                                                                             |       |                         | 938,449    |                        |       |   | 936,652 |   |   |
| Long-term portion  of capital lease                                                                                        |       |                         | 156,723    |                        |       |   | 156,952 |   |   |
| Non-current  derivative financial instruments                                                                              |       |                         | —     |                        |       |   | 156 |   |   |
| Non-current net  deferred income tax liability                                                                             |       |                         | 37,063     |                        |       |   | 60,427 |   |   |
| Non-current  unearned revenue                                                                                              |       |                         | 25,146     |                        |       |   | 26,175 |   |   |
| Other non-current  liabilities                                                                                             |       |                         | 68,549     |                        |       |   | 79,643 |   |   |
| Minority interest                                                                                                          |       |                         | 10,679     |                        |       |   | 9,350 |   |   |
| Total liabilities                                                                                                          |       |                         | 1,696,131  |                        |       |   | 1,703,799 |   |   |
| Commitments and  contingencies                                                                                             |       |                         |       |                        |       |   |   |   |   |
| Stockholders’ equity:                                                                                                 |       |                         |       |                        |       |   |   |   |   |
| Common stock                                                                                                               |       |                         | 1,917      |                        |       |   | 1,917 |   |   |
| Additional paid-in capital                                                                                                 |       |                         | 2,539,628  |                        |       |   | 2,527,709 |   |   |
| Deferred stock compensation                                                                                                |       |                         | (15,988    | )                           |       |   | (13,825 | ) |   |
| Accumulated deficit                                                                                                        |       |                         | (14,920    | )                           |       |   | (11,843 | ) |   |
| Accumulated other comprehensive income                                                                                     |       |                         | 158,809    |                        |       |   | 330,491 |   |   |
| Treasury stock, at cost (3,156,000 shares at  September 30, 2005 and 4,804,000 shares at December 31, 2004) |       |                         | (148,771   | )                           |       |   | (232,745 | ) |   |
| Total stockholders’ equity                                                                                            |       |                         | 2,520,675  |                        |       |   | 2,601,704 |   |   |
|                                                                                                                       |       |                         | $          | 4,216,806                   |       |   |   | $ | 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  September 30,** | ** ** | **Nine Months Ended  September 30,** | ** ** |
|--------------------------------------------------------------------------------------------------|------------|------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                                                                       | ** ** | **2005**                                             | ** ** | **2004**                                            | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **                                                                                       | ** ** | ** **                                           | ** ** | **Restated**                                        | ** ** | ** ** | ** ** | **Restated** | ** ** |
| Revenues:                                                                                        |       |                                                 |       |                                                |       |   |   |   |   |
| Product sales, net                                                                               |       | $                                                    | 367,175    |                                                | $          | 375,549 |   | $ | 947,913 |   | $ | 937,836 |   |
| Revenues from joint business arrangement                                                         |       | 36,093                                               |       | 34,017                                              |       | 103,154 |   | 92,910 |   |
| Collaborative agreement revenues                                                                 |       | 3,149                                                |       | 4,124                                               |       | 11,129 |   | 14,467 |   |
| Royalty and license fee revenues                                                                 |       | 70,726                                               |       | 111,396                                             |       | 227,309 |   | 221,384 |   |
| Other revenues                                                                                   |       | 2,470                                                |       | 4,450                                               |       | 16,221 |   | 22,363 |   |
| Total revenues                                                                                   |       | 479,613                                              |       | 529,536                                             |       | 1,305,726 |   | 1,288,960 |   |
| Operating  expenses:                                                                             |       |                                                 |       |                                                |       |   |   |   |   |
| Cost of sales (excludes amortization expense related  to acquired developed products)            |       | 168,726                                              |       | 241,044                                             |       | 511,005 |   | 498,808 |   |
| Research and development                                                                         |       | 107,309                                              |       | 103,000                                             |       | 324,620 |   | 301,736 |   |
| Selling, general and administrative                                                              |       | 117,152                                              |       | 112,013                                             |       | 375,802 |   | 321,775 |   |
| Amortization expense of intangible assets acquired  in business combinations and asset purchases |       | 12,361                                               |       | 20,566                                              |       | 54,237 |   | 63,077 |   |
| Purchased in-process research and development                                                    |       | —                                               |       | 9,629                                               |       | — |   | 9,629 |   |
| Impairment loss on acquired intangible assets                                                    |       | 14,522                                               |       | —                                              |       | 14,522 |   | — |   |
| Other operating expenses                                                                         |       | 3,621                                                |       | 1,280                                               |       | 12,823 |   | 8,040 |   |
| Total operating expenses                                                                         |       | 423,691                                              |       | 487,532                                             |       | 1,293,009 |   | 1,203,065 |   |
| Income from  operations                                                                          |       | 55,922                                               |       | 42,004                                              |       | 12,717 |   | 85,895 |   |
| Interest expense                                                                                 |       | (7,759                                               | )          | (7,063                                              | )          | (22,932 | ) | (19,440 | ) |
| Interest and  other income, net                                                                  |       | 18,514                                               |       | 5,369                                               |       | 66,259 |   | 41,252 |   |
| Minority interest                                                                                |       | (531                                                 | )          | (504                                                | )          | (1,723 | ) | (1,583 | ) |
| Income from  continuing operations before income taxes                                           |       | 66,146                                               |       | 39,806                                              |       | 54,321 |   | 106,124 |   |
| Provision for  income taxes                                                                      |       | 14,835                                               |       | 12,359                                              |       | 11,903 |   | 28,938 |   |
| Income from  continuing operations                                                               |       | 51,311                                               |       | 27,447                                              |       | 42,418 |   | 77,186 |   |
| Gain (loss) from  discontinued operations, net of taxes                                          |       | —                                               |       | (450                                                | )          | — |   | 24,854 |   |
| Net income                                                                                       |       | $                                                    | 51,311     |                                                | $          | 26,997 |   | $ | 42,418 |   | $ | 102,040 |   |
| Basic earnings  per share:                                                                       |       |                                                 |       |                                                |       |   |   |   |   |
| Income from continuing operations                                                                |       | $                                                    | 0.27       |                                                | $          | 0.15 |   | $ | 0.23 |   | $ | 0.41 |   |
| Net income                                                                                       |       | $                                                    | 0.27       |                                                | $          | 0.14 |   | $ | 0.23 |   | $ | 0.54 |   |
| Diluted earnings  per share:                                                                     |       |                                                 |       |                                                |       |   |   |   |   |
| Income from continuing operations                                                                |       | $                                                    | 0.27       |                                                | $          | 0.14 |   | $ | 0.22 |   | $ | 0.40 |   |
| Net income                                                                                       |       | $                                                    | 0.27       |                                                | $          | 0.14 |   | $ | 0.22 |   | $ | 0.53 |   |

 

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

5

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**CHIRON CORPORATIONCONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME(LOSS)(Unaudited)(In thousands)**

| ** **                                                                                                                                                                                                                                                                                                             | ** ** | **Three Months Ended  September 30,** | ** ** | **Nine Months Ended  September 30,** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                                                                                                                                                                                                                                                                                             | ** ** | **2005**                                             | ** ** | **2004**                                            | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **                                                                                                                                                                                                                                                                                                             | ** ** | ** **                                           | ** ** | **Restated**                                        | ** ** | ** ** | ** ** | **Restated** | ** ** |
| Net income                                                                                                                                                                                                                                                                                                             |       | $                                                    | 51,311     |                                                | $          | 26,997 |   | $ | 42,418 |   | $ | 102,040 |   |
| Other comprehensive  loss:                                                                                                                                                                                                                                                                                             |       |                                                 |       |                                                |       |   |   |   |   |
| Change in foreign currency translation adjustment  during the period                                                                                                                                                                                                                                                   |       | (27,980                                              | )          | 2,960                                               |       | (152,119 | ) | (34,452 | ) |
| Unrealized gains  (losses) from investments:                                                                                                                                                                                                                                                                           |       |                                                 |       |                                                |       |   |   |   |   |
| Net unrealized holding gains (losses) arising during  the period, net of tax (provision) benefit of ($3,098) and ($5,977) for  the three months ended September 30, 2005 and 2004, respectively, and  ($1,419) and ($3,865) for the nine months ended September 30, 2005 and  2004, respectively   |       | 5,013                                                |       | (2,680                                              | )          | 2,564 |   | 4,864 |   |
| Reclassification adjustment for net gains included  in net income, net of tax (provision) of ($2,773) and ($400) for the  three months ended September 30, 2005 and 2004, respectively, and  ($13,682) and ($9,753) for the nine months ended September 30,  2005 and 2004, respectively |       | (4,472                                               | )          | (625                                                | )          | (22,127 | ) | (15,254 | ) |
| Net unrealized gains (losses) from investments                                                                                                                                                                                                                                                                         |       | 541                                                  |       | (3,305                                              | )          | (19,563 | ) | (10,390 | ) |
| Other comprehensive loss                                                                                                                                                                                                                                                                                               |       | (27,439                                              | )          | (345                                                | )          | (171,682 | ) | (44,842 | ) |
| Comprehensive income  (loss)                                                                                                                                                                                                                                                                                           |       | $                                                    | 23,872     |                                                | $          | 26,652 |   | $ | (129,264 | ) | $ | 57,198 |   |

 

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)**

| ** **                                                                     | ** ** | **Nine Months Ended  September 30,** | ** ** |
|--------------------------------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                                                     | ** ** | **2005**                                            | ** ** | **2004** | ** ** |
| ** **                                                                     | ** ** | ** **                                          | ** ** | **Restated** | ** ** |
| Net cash provided  by operating activities                                     |       | $                                                   | 117,561    |   | $ | 132,633 |   |
| Cash flows from  investing activities:                                         |       |                                                |       |   |   |
| Purchases of investments in marketable debt  securities                        |       | (714,151                                            | )          | (724,616 | ) |
| Proceeds from sales of investments in marketable  debt securities              |       | 194,500                                             |       | 415,100 |   |
| Proceeds from maturities of investments in  marketable debt securities         |       | 499,119                                             |       | 225,959 |   |
| Capital expenditures                                                           |       | (140,952                                            | )          | (134,079 | ) |
| Purchases of equity securities and interests in  affiliated companies          |       | (4,291                                              | )          | (6,216 | ) |
| Proceeds from sale of equity securities and  interests in affiliated companies |       | 30,036                                              |       | 31,421 |   |
| Cash paid for acquisitions, net of cash acquired                               |       | (3,294                                              | )          | (32,289 | ) |
| Proceeds from (issuance of) notes receivable                                   |       | (4,967                                              | )          | 1,479 |   |
| Other, net                                                                     |       | (10,420                                             | )          | (5,167 | ) |
| Net cash used in investing activities                                          |       | (154,420                                            | )          | (228,408 | ) |
| Cash flows from  financing activities:                                         |       |                                                |       |   |   |
| Repayment of debt and capital leases                                           |       | (599                                                | )          | (380,159 | ) |
| Payments to acquire treasury stock                                             |       | —                                              |       | (129,665 | ) |
| Proceeds from re-issuance of treasury stock                                    |       | 38,619                                              |       | 64,178 |   |
| Proceeds from issuance of debt                                                 |       | 1,002                                               |       | 4,996 |   |
| Payment of bond issuance costs                                                 |       | —                                              |       | (8,285 | ) |
| Proceeds from issuance of convertible debentures                               |       | —                                              |       | 385,000 |   |
| Net cash provided by (used in) financing activities                            |       | 39,022                                              |       | (63,935 | ) |
| Effect of exchange rate changes on cash and cash  equivalents                  |       | (7,304                                              | )          | (3,577 | ) |
| Net decrease in cash and cash equivalents                                      |       | (5,141                                              | )          | (163,287 | ) |
| Cash and cash  equivalents at beginning of the period                          |       | 209,509                                             |       | 364,270 |   |
| Cash and cash  equivalents at end of the period                                |       | $                                                   | 204,368    |   | $ | 200,983 |   |

 

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 September 30, 2005 (Unaudited)**

**Note 1**—Basisof Presentation

The information presented in the CondensedConsolidated Financial Statements at September 30, 2005, and for the threeand nine months ended September 30, 2005 and 2004, is unaudited butincludes all adjustments, consisting only of normal recurring adjustments,which Chiron Corporation believes to be necessary for fair presentation of theperiods 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 in conjunctionwith Chiron’s audited Consolidated Financial Statements as of and for the yearended December 31, 2004, which are included in the Annual Report on Form 10-Kfiled by Chiron with the Securities and Exchange Commission, or SEC.

*Principles of Consolidation*

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 filedamended Form 10-Qs 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 reasonableunder the circumstances, the results of 

8

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

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

The following tableillustrates the effect on net income and related net income per share, hadcompensation cost for stock-based employee compensation been determined basedupon the fair value method:

| ** **                            | ** **                                                                                                                            | **Three Months Ended  September 30,**               | ** ** | **Nine Months Ended  September 30,** | ** ** |
|---------------------------------------|---------------------------------------------------------------------------------------------------------------------------------------|--------------------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                            | ** **                                                                                                                            | **2005**                                                           | ** ** | **2004**                                            | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **                            | ** **                                                                                                                            | ** **                                                         | ** ** | **Restated**                                        | ** ** | ** ** | ** ** | **Restated** | ** ** |
| ** **                            | ** **                                                                                                                            | **(in thousands, except per share data)** | ** ** |
| Net income (loss):                    |                                                                                                                                  |                                                               |       |                                                |       |   |   |   |   |
| As reported                           |                                                                                                                                  | $                                                                  | 51,311     |                                                | $          | 26,997 |   | $ | 42,418 |   | $ | 102,040 |   |
| Add:                                  | Stock-based  employee compensation expense included in reported net income, net  of related tax effects                          |                                                               | 1,189      |                                                | 1,118      |   | 3,264 |   | 3,807 |   |
| Less:                                 | Total stock-based  employee compensation expense determined under fair value based method for  all awards, net of related tax effects |                                                               | 17,450     |                                                | 23,778     |   | 53,186 |   | 68,055 |   |
| Pro forma                             |                                                                                                                                  | $                                                                  | 35,050     |                                                | $          | 4,337 |   | $ | (7,504 | ) | $ | 37,792 |   |
| Basic net income (loss)  per share:   |                                                                                                                                  |                                                               |       |                                                |       |   |   |   |   |
| As reported                           |                                                                                                                                  | $                                                                  | 0.27       |                                                | $          | 0.14 |   | $ | 0.23 |   | $ | 0.54 |   |
| Pro forma                             |                                                                                                                                  | $                                                                  | 0.19       |                                                | $          | 0.02 |   | $ | (0.04 | ) | $ | 0.20 |   |
| Diluted net income  (loss) per share: |                                                                                                                                  |                                                               |       |                                                |       |   |   |   |   |
| As reported                           |                                                                                                                                  | $                                                                  | 0.27       |                                                | $          | 0.14 |   | $ | 0.22 |   | $ | 0.53 |   |
| Pro forma                             |                                                                                                                                  | $                                                                  | 0.19       |                                                | $          | 0.02 |   | $ | (0.04 | ) | $ | 0.20 |   |

 

**Note 2—New AccountingStandards**

In December 2004, the Financial AccountingStandards Board (FASB) issued Statement of Financial Accounting Standards No. 123(revised 2004),*Share-Based Payment*(SFAS 123(R)), which requires the cost resulting from all share-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. Chiron is currently evaluatingtransition methods, option valuation methodologies and assumptions in light ofSFAS 123(R) and, therefore, cannot estimate the impact of its adoptionat this time, although Chiron expects that its adoption will have a materialimpact on Chiron’s consolidated financial statements. Current option valuesdetermined 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 Securities and Exchange Commission (SEC) announced the adoption of anew rule that delays the effective date of SFAS 123(R) forregistrants, such as Chiron, that are not small business issuers. The 

10

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

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

SEC’s new rule allowscalendar year non-small business issuers to implement SFAS 123(R) atthe beginning of 2006, which makes SFAS 123(R) effective for Chironin 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 September 30, 2005, Chiron has not provided deferred taxes onforeign earnings because such earnings were intended to be indefinitelyreinvested outside the U.S. Presently Chiron does not have any plan torepatriate earnings under the Act. Accordingly, Chiron has made no change inits current intention to indefinitely reinvest accumulated earnings of itsforeign subsidiaries. If Chiron repatriates these earnings, a tax charge to itsconsolidated results of operations could occur. Chiron will continue toevaluate the impact of this provision.

**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:

| ** **          | ** ** | **September 30,  2005** | ** ** | **December 31,  2004** | ** ** |
|---------------------|------------|------------------------------|------------|-----------------------------|------------|
| ** **          | ** ** | **(in thousands)**      | ** ** |
| Finished goods |       |                         | $          | 84,675                      |       |   |   | $ | 59,206 |   |   |
| Work-in-process     |       |                         | 138,211    |                        |       |   | 116,660 |   |   |
| Raw materials       |       |                         | 45,680     |                        |       |   | 45,288 |   |   |
|                |       |                         | $          | 268,566                     |       |   |   | $ | 221,154 |   |   |

 

**Note 4—Income Taxes**

The effective tax rate was21.9% and 27.3% of pretax income from continuing operations for the nine monthsended September 30, 2005 and 2004, respectively. The tax rate decreased primarily dueto lower expected taxable incomes, year to year, in certain high taxjurisdictions, as well as increased benefits of U.S. research credits. Suchitems are not expected to recur in future years. The effective tax rate may be affected in future periods bychanges in management’s estimates with respect to our deferred tax assets andother items affecting the overall tax rate.

11

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

**Note 5—ComprehensiveIncome (Loss)**

For the three and ninemonths ended September 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 $21.4 million and $45.6 million for the three and nine monthsended September 30, 2005, respectively, and $9.0 million and $39.1 millionfor the three and nine months ended September 30, 2004, respectively, to “Accumulateddeficit” in the Condensed Consolidated Balance Sheets.

**Note 7—Earnings PerShare**

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

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

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

12

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

**Note 7—EarningsPer Share (Continued)**

The following table setsforth the computations for basic and diluted earnings per share on income fromcontinuing operations (in thousands, except per share data):

| ** **                                                                             | ** ** | **Three Months Ended  September 30,** | ** ** | **Nine Months Ended  September 30,** | ** ** |
|----------------------------------------------------------------------------------------|------------|------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                                                             | ** ** | **2005**                                             | ** ** | **2004**                                            | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **                                                                             | ** ** | ** **                                           | ** ** | **Restated**                                        | ** ** | ** ** | ** ** | **Restated** | ** ** |
| Income (Numerator):                                                                    |       |                                                 |       |                                                |       |   |   |   |   |
| Income from continuing operations                                                      |       | $                                                    | 51,311     |                                                | $          | 27,447 |   | $ | 42,418 |   | $ | 77,186 |   |
| Plus: Interest on the 2033 Debentures, net of  taxes                                   |       | 1,589                                                |       | —                                              |       | — |   | — |   |
| Plus: Interest on Liquid Yield Option Notes, net  of taxes                             |       | 147                                                  |       | —                                              |       | — |   | — |   |
| Income from continuing operations, plus impact from  assumed conversions               |       | $                                                    | 53,047     |                                                | $          | 27,447 |   | $ | 42,418 |   | $ | 77,186 |   |
| Shares (Denominator):                                                                  |       |                                                 |       |                                                |       |   |   |   |   |
| Weighted-average common shares outstanding                                             |       | 188,039                                              |       | 187,368                                             |       | 187,564 |   | 187,751 |   |
| Effect of dilutive  securities:                                                        |       |                                                 |       |                                                |       |   |   |   |   |
| Stock options and equivalents                                                          |       | 1,883                                                |       | 2,646                                               |       | 1,500 |   | 3,150 |   |
| 2033 Debentures                                                                        |       | 7,306                                                |       | —                                              |       | — |   | — |   |
| Liquid Yield Option Notes                                                              |       | 574                                                  |       | —                                              |       | — |   | — |   |
| Weighted-average common shares outstanding,  plus impact from assumed conversions |       | 197,802                                              |       | 190,014                                             |       | 189,064 |   | 190,901 |   |
| Basic earnings per share from continuing operations                                    |       | $                                                    | 0.27       |                                                | $          | 0.15 |   | $ | 0.23 |   | $ | 0.41 |   |
| Diluted earnings  per share from continuing operations                                 |       | $                                                    | 0.27       |                                                | $          | 0.14 |   | $ | 0.22 |   | $ | 0.40 |   |

 

13

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

**Note 7—EarningsPer Share (Continued)**

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

| ** **                                                                        | ** ** | **Three Months Ended  September 30,** | ** ** | **Nine Months Ended  September 30,** | ** ** |
|-----------------------------------------------------------------------------------|------------|------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                                                        | ** ** | **2005**                                             | ** ** | **2004**                                            | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **                                                                        | ** ** | ** **                                           | ** ** | **Restated**                                        | ** ** | ** ** | ** ** | **Restated** | ** ** |
| Income  (Numerator):                                                              |       |                                                 |       |                                                |       |   |   |   |   |
| Net income                                                                        |       | $                                                    | 51,311     |                                                | $          | 26,997 |   | $ | 42,418 |   | $ | 102,040 |   |
| Plus: Interest on the 2033 Debentures, net of  taxes                              |       | 1,589                                                |       | —                                              |       | — |   | — |   |
| Plus: Interest on Liquid Yield Option Notes, net  of taxes                        |       | 147                                                  |       | —                                              |       | — |   | — |   |
| Net income, plus impact from assumed  conversions                                 |       | $                                                    | 53,047     |                                                | $          | 26,997 |   | $ | 42,418 |   | $ | 102,040 |   |
| Shares  (Denominator):                                                            |       |                                                 |       |                                                |       |   |   |   |   |
| Weighted-average common shares outstanding                                        |       | 188,039                                              |       | 187,368                                             |       | 187,564 |   | 187,751 |   |
| Effect of dilutive securities:                                                    |       |                                                 |       |                                                |       |   |   |   |   |
| Stock options and equivalents                                                     |       | 1,883                                                |       | 2,646                                               |       | 1,500 |   | 3,150 |   |
| 2033 Debentures                                                                   |       | 7,306                                                |       | —                                              |       | — |   | — |   |
| Liquid Yield Option Notes                                                         |       | 574                                                  |       | —                                              |       | — |   | — |   |
| Weighted-average common shares outstanding, plus  impact from assumed conversions |       | 197,802                                              |       | 190,014                                             |       | 189,064 |   | 190,901 |   |
| Basic earnings  per share from net income                                         |       | $                                                    | 0.27       |                                                | $          | 0.14 |   | $ | 0.23 |   | $ | 0.54 |   |
| Diluted earnings per  share from net income                                       |       | $                                                    | 0.27       |                                                | $          | 0.14 |   | $ | 0.22 |   | $ | 0.53 |   |

 

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

The dilutive effect of CoCos must be included indiluted earnings per share regardless of whether the triggering contingency hasbeen satisfied, if dilutive. For the nine months ended September 30, 2005and the three and nine months ended September 30, 2004, 7.3 million sharesof common stock issuable upon conversion of the 2033 Debentures were excludedfrom the computations of diluted earnings per share as their inclusion would beantidilutive.

If the 2034 Debentures aretendered for conversion, the value (“Conversion Value”) of cash and shares ofChiron’s common stock, if any, to be received by a holder converting $1,000principal amount of the debentures will be determined by multiplying theapplicable conversion rate by a weighted average price. Chiron will deliver theConversion Value to debenture holders as follows: (1) an amount in cash (“PrincipalReturn”) equal to the lesser of (a) the aggregate Conversion Value of thedebentures to be 

14

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

**Note 7—EarningsPer Share (Continued)**

convertedand (b) the aggregate principal amount of the debentures to be convertedand (2) if the aggregate Conversion Value of the debentures to beconverted 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 nine monthsended September 30, 2005 and 2004, the assumed conversion of the 2034Debentures was not dilutive.

**Note 8—DiscontinuedOperations**

In a strategic effort to focus on Chiron’s corebusinesses of blood-testing, vaccines and biopharmaceuticals, Chiron completedthe sale of Chiron 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.Pursuant to this settlement, Chiron recognized a tax benefit of approximately$12.5 million for the nine months ended September 30, 2004.

Chiron and Bayer 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 nine months ended September 30,2004. This net gain primarily relates to a tax benefit as a result of thesettlement payment to Bayer.

15

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

**Note 9—IntangibleAssets**

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

| ** **                                       | ** ** | **September 30, 2005** | ** ** | **December 31, 2004** | ** ** |
|--------------------------------------------------|------------|----------------------------------|------------|---------------------------------|------------|
| ** **                                       | ** ** | **Gross  Carrying  Value**       | ** ** | **Accumulated  Amortization**   | ** ** | **Net Carrying  Value** | ** ** | **Gross  Carrying  Value** | ** ** | **Accumulated  Amortization** | ** ** | **Net Carrying  Value** | ** ** |
| Purchased technologies                           |       | $                                | 332,283    |                            |       | $ | 131,453 |   |   |   | $ | 200,830 |   |   | $ | 333,085 |   |   | $ | 117,048 |   |   |   | $ | 216,037 |   |   |
| Patents                                          |       | $                                | 141,114    |                            |       | $ | 78,061 |   |   |   | $ | 63,053 |   |   | $ | 132,385 |   |   | $ | 71,616 |   |   |   | $ | 60,769 |   |   |
| Trademarks                                       |       | 60,330                           |       |                            | 25,840     |   |   |   | 34,490 |   |   | 65,609 |   |   | 25,450 |   |   |   | 40,159 |   |   |
| Licenses and technology  rights                  |       | 48,760                           |       |                            | 37,692     |   |   |   | 11,068 |   |   | 47,745 |   |   | 34,079 |   |   |   | 13,666 |   |   |
| Developed product  technologies             |       | 327,381                          |       |                            | 98,595     |   |   |   | 228,786 |   |   | 374,025 |   |   | 77,253 |   |   |   | 296,772 |   |   |
| Customer relationships                           |       | 27,674                           |       |                            | 12,092     |   |   |   | 15,582 |   |   | 31,234 |   |   | 12,421 |   |   |   | 18,813 |   |   |
| Know how(1)                                      |       | 12,568                           |       |                            | 7,366      |   |   |   | 5,202 |   |   | 14,185 |   |   | 7,548 |   |   |   | 6,637 |   |   |
| Databases                                        |       | 7,100                            |       |                            | 2,367      |   |   |   | 4,733 |   |   | 7,100 |   |   | 2,012 |   |   |   | 5,088 |   |   |
| Other                                            |       | 24,689                           |       |                            | 11,609     |   |   |   | 13,080 |   |   | 34,893 |   |   | 19,090 |   |   |   | 15,803 |   |   |
| Total other intangible  assets                   |       | $                                | 649,616    |                            |       | $ | 273,622 |   |   |   | $ | 375,994 |   |   | $ | 707,176 |   |   | $ | 249,469 |   |   |   | $ | 457,707 |   |   |
| Total intangible assets  subject to amortization |       | $                                | 981,899    |                            |       | $ | 405,075 |   |   |   | $ | 576,824 |   |   | $ | 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.

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

| For the nine  months ended September 30, 2005                       |   | $ | 64,009 |   |
|--------------------------------------------------------------------------|--------|---|--------|--------|
| For the remaining  three months in the year ended December 31, 2005 |   | $ | 15,557 |   |
| For the year  ended December 31, 2005                               |   | $ | 79,566 |   |
| For the year  ended December 31, 2006                               |   | $ | 68,618 |   |
| For the year  ended December 31, 2007                               |   | $ | 74,830 |   |
| For the year  ended December 31, 2008                               |   | $ | 75,239 |   |
| For the year  ended December 31, 2009                               |   | $ | 73,668 |   |
| For the year ended  December 31, 2010                               |   | $ | 72,766 |   |

 

16

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

**Note 9—IntangibleAssets (Continued)**

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

| ** **                             | ** ** | **Biopharmaceuticals** | ** ** | **Vaccines** | ** ** | **Total** | ** ** |
|----------------------------------------|------------|------------------------|------------|--------------|------------|-----------|------------|
| Balance as of  December 31, 2004  |       |                   | $          | 192,186      |       |      | $          | 669,208 |   | $ | 861,394 |   |
| Effect of exchange rate changes        |       |                   | —     |         |       | (55,446   | )          | (55,446 | ) |
| Balance as of  September 30, 2005 |       |                   | $          | 192,186      |       |      | $          | 613,762 |   | $ | 805,948 |   |

 

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

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

In the third quarter of2005, Chiron recognized an impairment loss of $14.5 million on acquiredintangible assets from Chiron’s acquisition of PowderJect related to ARILVAXTM,a yellow fever vaccine. This impairment loss was due to a focus of resourcestowards the influenza market, resulting in a reduction of the expected activityfor ARILVAXTM. ARILVAXTM remains in Chiron’s portfolio of trademarks and Chironmay re-enter the yellow fever vaccine market in the future with this product. ARILVAXTMis included in the caption “Developed product technologies” in the table above.

**Note 10—SegmentInformation**

Chiron is organized based on the products and servicesthat it offers. Under this organizational structure, there are three reportablesegments: (i) blood-testing, (ii) vaccines and (iii) biopharmaceuticals.The blood-testing segment consists of an alliance with Gen-Probe and Chiron’sone-half share in the pretax operating earnings generated by the joint businesscontractual arrangement with Ortho-Clinical Diagnostics. Chiron’s alliance withGen-Probe is focused on developing and commercializing nucleic acid testingproducts using Transcription-Mediated Amplification technology to screendonated blood, plasma products, organs and tissues for viral infection. Chiron’sjoint business arrangement with Ortho-Clinical Diagnostics is operated under acontractual arrangement and is not a separate and distinct legal entity.Through Chiron’s joint business contractual arrangement with Ortho-ClinicalDiagnostics, Chiron sells a line of immunodiagnostic tests to detect hepatitisviruses and retroviruses 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 

17

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

**Note 10—SegmentInformation (Continued)**

international markets. Thevaccines segment is also involved in the development of novel vaccines and vaccinationtechnology. The biopharmaceuticals segment consists of therapeutic products andservices, with an emphasis on the treatment of cancer and infectious andpulmonary diseases, using the development and acquisition of technologiesrelated to therapeutic proteins, antibodies and small molecules. Thebiopharmaceuticals segment earns royalties on third party sales of severalproducts, including BETAFERON® interferon beta-1b, andearns license fees for technologies, such as hepatitis C virus-related patents,used by third parties to develop therapeutic products.

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

18

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

**Note 10—SegmentInformation (Continued)**

Thefollowing segment information excludes all significant intersegmenttransactions as these transactions are eliminated for management reportingpurposes (in thousands):

| ** **                                             | ** ** | **Three Months Ended  September 30,** | ** ** | **Nine Months Ended  September 30,** | ** ** |
|--------------------------------------------------------|------------|------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                             | ** ** | **2005**                                             | ** ** | **2004**                                            | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **                                             | ** ** | ** **                                           | ** ** | **Restated**                                        | ** ** | ** ** | ** ** | **Restated** | ** ** |
| *Revenues*                                             |       |                                                 |       |                                                |       |   |   |   |   |   |   |
| Blood-testing:                                         |       |                                                 |       |                                                |       |   |   |   |   |   |   |
| Product sales, net:                                    |       |                                                 |       |                                                |       |   |   |   |   |   |   |
| PROCLEIX®  products                     |       | $                                                    | 70,677     |                                                |       | $ | 63,629 |   |   | $ | 201,212 |   | $ | 186,104 |   |
| Ortho-Clinical  Diagnostics                            |       | 7,023                                                |       |                                                | 7,098      |   |   | 21,473 |   | 19,940 |   |
| Total product  sales, net                              |       | 77,700                                               |       |                                                | 70,727     |   |   | 222,685 |   | 206,044 |   |
| Revenues from  joint business arrangement              |       | 36,093                                               |       |                                                | 34,017     |   |   | 103,154 |   | 92,910 |   |
| Collaborative  agreement revenues                      |       | 1,579                                                |       |                                                | 1,616      |   |   | 5,589 |   | 6,005 |   |
| Royalty and license  fee revenues                      |       | 22,501                                               |       |                                                | 34,115     |   |   | 73,695 |   | 66,817 |   |
| Other revenues                                         |       | 137                                                  |       |                                                | 243        |   |   | 412 |   | 673 |   |
| Total  blood-testing revenues                          |       | 138,010                                              |       |                                                | 140,718    |   |   | 405,535 |   | 372,449 |   |
| Vaccines:                                              |       |                                                 |       |                                                |       |   |   |   |   |   |   |
| Product sales, net:                                    |       |                                                 |       |                                                |       |   |   |   |   |   |   |
| Influenza vaccines                                     |       | 60,321                                               |       |                                                | 93,486     |   |   | 63,400 |   | 109,398 |   |
| Meningococcal  vaccines                                |       | 11,635                                               |       |                                                | 8,865      |   |   | 34,393 |   | 18,430 |   |
| Travel vaccines                                        |       | 35,012                                               |       |                                                | 26,434     |   |   | 123,785 |   | 75,705 |   |
| Pediatric and  other vaccines                          |       | 45,800                                               |       |                                                | 44,491     |   |   | 115,420 |   | 143,292 |   |
| Total product  sales, net                              |       | 152,768                                              |       |                                                | 173,276    |   |   | 336,998 |   | 346,825 |   |
| Collaborative  agreement revenues                      |       | 999                                                  |       |                                                | 2,230      |   |   | 4,240 |   | 7,410 |   |
| Royalty and  license fee revenues                      |       | 1,263                                                |       |                                                | 1,213      |   |   | 3,448 |   | 3,888 |   |
| Other revenues                                         |       | 1,802                                                |       |                                                | 3,006      |   |   | 7,558 |   | 12,563 |   |
| Total vaccines  revenues                               |       | 156,832                                              |       |                                                | 179,725    |   |   | 352,244 |   | 370,686 |   |
| Biopharmaceuticals:                                    |       |                                                 |       |                                                |       |   |   |   |   |   |   |
| Product sales, net                                     |       |                                                 |       |                                                |       |   |   |   |   |   |   |
| BETASERON®  interferon  beta-1b         |       | 36,927                                               |       |                                                | 35,171     |   |   | 101,693 |   | 96,933 |   |
| TOBI® tobramycin                             |       | 57,890                                               |       |                                                | 55,734     |   |   | 167,425 |   | 159,600 |   |
| PROLEUKIN® aldesleukin                       |       | 31,028                                               |       |                                                | 31,739     |   |   | 92,290 |   | 98,664 |   |
| Other                                                  |       | 10,862                                               |       |                                                | 8,902      |   |   | 26,822 |   | 29,770 |   |
| Total product  sales, net                              |       | 136,707                                              |       |                                                | 131,546    |   |   | 388,230 |   | 384,967 |   |
| Collaborative  agreement revenues                      |       | 571                                                  |       |                                                | 278        |   |   | 1,300 |   | 1,052 |   |
| Royalty and  license fee revenues                      |       | 17,321                                               |       |                                                | 15,412     |   |   | 55,739 |   | 47,892 |   |
| Other revenues                                         |       | 531                                                  |       |                                                | 1,201      |   |   | 8,251 |   | 9,127 |   |
| Total  biopharmaceuticals revenues                     |       | 155,130                                              |       |                                                | 148,437    |   |   | 453,520 |   | 443,038 |   |
| Other:                                                 |       |                                                 |       |                                                |       |   |   |   |   |   |   |
| Royalty and  license fee revenues                      |       | 29,641                                               |       |                                                | 60,656     |   |   | 94,427 |   | 102,787 |   |
| Total revenues                                         |       | $                                                    | 479,613    |                                                |       | $ | 529,536 |   |   | $ | 1,305,726 |   | $ | 1,288,960 |   |
| *Income (loss) from continuing  operations:*           |       |                                                 |       |                                                |       |   |   |   |   |   |   |
| Blood-testing                                          |       | $                                                    | 75,036     |                                                |       | $ | 80,690 |   |   | $ | 220,171 |   | $ | 203,538 |   |
| Vaccines                                               |       | (28,295                                              | )          |                                                | (65,528    | ) |   | (195,428 | ) | (161,880 | ) |
| Biopharmaceuticals                                     |       | 8,660                                                |       |                                                | 1,683      |   |   | 5,149 |   | 29,709 |   |
| Other                                                  |       | 521                                                  |       |                                                | 34,788     |   |   | (17,175 | ) | 24,157 |   |
| Segment income from  operations                        |       | 55,922                                               |       |                                                | 51,633     |   |   | 12,717 |   | 95,524 |   |
| Operating expense  reconciling item:                   |       |                                                 |       |                                                |       |   |   |   |   |   |   |
| Purchased  in-process research and development         |       | —                                               |       |                                                | (9,629     | ) |   | — |   | (9,629 | ) |
| Income from  operations                                |       | 55,922                                               |       |                                                | 42,004     |   |   | 12,717 |   | 85,895 |   |
| Interest expense                                       |       | (7,759                                               | )          |                                                | (7,063     | ) |   | (22,932 | ) | (19,440 | ) |
| Interest and other  income, net                        |       | 18,514                                               |       |                                                | 5,369      |   |   | 66,259 |   | 41,252 |   |
| Minority interest                                      |       | (531                                                 | )          |                                                | (504       | ) |   | (1,723 | ) | (1,583 | ) |
| Income from  continuing operations before income taxes |       | $                                                    | 66,146     |                                                |       | $ | 39,806 |   |   | $ | 54,321 |   | $ | 106,124 |   |

** **

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

**Note 11—Commitmentsand Contingencies**

In October 2004, the U.K. regulatory body, theMedicines and Healthcare products Regulatory Agency, or MHRA, suspended Chiron’slicense to manufacture FLUVIRIN® atour Liverpool, U.K. facility.

On March 2, 2005, the MHRA notified Chiron thatit had 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.

On October 17, 2005 Chiron initiated delivery andrelease of FLUVIRIN® vaccine to customers in the United States forthe 2005-2006 influenza season. As of such time, Chiron had received allnecessary approvals from the U.S. Food and Drug Administration (FDA) and MHRAto start supplying FLUVIRIN® vaccine to the U.S. market. Continuedshipments of FLUVIRIN® vaccine will need to undergo correspondinginternal release procedures and standard FDA influenza vaccine lot releaseprocedures.

Chiron received a grand jury subpoena issued by theU.S. Attorney’s Office for the Southern District of New York in October 2004requesting production of certain documents relating to FLUVIRIN® vaccine and the suspension by the MHRA ofChiron’s license. In February 2005, after having previously commenced aninformal inquiry, the Securities and Exchange Commission, or SEC, notifiedChiron that it would commence a formal investigation into whether Chiron orChiron employees violated any federal securities laws in connection with thesedevelopments regarding FLUVIRIN® vaccine, and Chiron subsequently receivedsubpoenas from the SEC requesting production of certain documents relating toour Liverpool facility and FLUVIRIN® vaccine. Chiron also received a voluntaryrequest for information from the United States House of Representatives, Energyand Commerce Committee, Subcommittee on Oversight and Investigations requestingproduction of certain documents. Numerous documents have been collected andproduced in response to these requests, and several witnesses have beeninterviewed by the U.S. Attorney’s Office, the SEC staff and Congressionalstaff. Additional investigations regarding these matters may arise.

In addition, Chiron and certain of its officers anddirectors have also been named as defendants in several putative shareholderclass action and derivative lawsuits alleging various claims arising out of orrelating to these developments regarding FLUVIRIN® vaccine. Certain distributors and otherparties with whom Chiron had contracted to supply FLUVIRIN® vaccine are considering or have communicatedclaims against Chiron as a result of our inability to supply FLUVIRIN® vaccine, and additional parties may do so inthe future. On January 27, 2005, the U.S. Centers for Disease Control andPrevention, or CDC, terminated its contracts with Chiron for the supply ofFLUVIRIN® vaccine for default on the basis of Chiron’sfailure to supply such vaccine to the U.S. government for the 2004-2005influenza season. The CDC has reserved the right to hold Chiron liable for anyexcess costs it may have incurred in replacing any FLUVIRIN® vaccine that Chiron failed to deliver andfurther has reserved all other remedies provided under the contract. It is notpossible to predict whether any of these claims will be pursued and, if so,whether those claims will be upheld. Investigations, litigation and disputeshave caused us to incur substantial expense and have required significant timeand attention from Chiron management and will 

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

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

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

Although the MHRA has lifted its suspension of Chiron’slicense to manufacture FLUVIRIN® vaccine, Chiron expects to incur additionalexpenses in connection with ongoing FLUVIRIN® vaccine matters, which could be material,including in connection with (1) our continuing remediation efforts at ourLiverpool facility; and (2) responding to the U.S. Attorney for theSouthern District of New York, the SEC, the United States House ofRepresentatives, Energy and Commerce Committee, Subcommittee on Oversight andInvestigations and the private lawsuits and other claims and investigationsthat exist or may arise.

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

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

Chiron’s tax filings are presently under examinationin several domestic and international tax jurisdictions. While there is noassurance that Chiron will prevail in all tax examinations in the event thetaxing authorities disagree with Chiron’s interpretation of the tax law, Chiron’smanagement does not believe, based upon information known to it, that the finalresolution of any of these audits will have a material adverse effect uponChiron’s consolidated financial position and results of operations or cashflows. Adequate provisions have been made for these tax examinations.

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

**Note 12—Subsequentevents**

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

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

 

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**Item 2**.                        Management’sDiscussion and Analysis of Financial Condition and Results of Operations

***Forward-Looking Statements***

This Form 10-Qcontains forward-looking statements regarding our pending merger with Novartis,our expectations, hopes or intentions regarding the future, includingstatements relating to sales growth, product development initiatives, newproduct marketing, acquisitions, competition, and licensing activities thatinvolve risks and uncertainties and are subject to change. The forward-lookingstatements contained in this Form 10-Q reflect our currentexpectations on the date of this Form 10-Q. Actual results,performance or outcomes may differ materially from current expectations. Ouractual performance may differ from current expectations due to many factors,including additional adverse developments resulting from the suspension from October 5,2004 through March 2, 2005 of our UK license to manufacture FLUVIRIN® influenza virus vaccine, the announcement ofsuch suspension and the litigation and investigations relating to thosematters, the outcome of clinical trials, regulatory review and approvals,manufacturing capabilities, intellectual property protections and defenses,litigation, stock price and interest rate volatility, marketing effectivenessand the severity of the 2005-2006 influenza season. In particular, therecan be no assurance that we will increase sales of existing products,successfully develop and receive approval to market new products, or achievemarket acceptance for such new products. No assurances can be given thatadditional issues with respect to BEGRIVACTM or FLUVIRIN® vaccines or our manufacturing generally willnot arise in the future, that we will be able to cover vaccine shortfalls, orthat we will resume sale of BEGRIVACTM vaccine for the 2006-2007 influenzaseason. In addition, we may face additional competition in the influenza marketin the future and challenges in distribution arrangements as a result of recentBEGRIVACTM and FLUVIRIN® vaccine developments. There can be noassurance that the merger with Novartis will be completed on a timely basis orcompleted at all. There can be no assurance that our out-licensing activitywill generate significant revenue, or that our in-licensing activities willfully protect us from claims of infringement by third parties. In addition, wemay engage in business opportunities, the successful completion of which issubject to certain risks, including approval by Novartis, stockholder andregulatory approvals and the integration of operations. We have discussed theimportant factors, which we believe could cause actual results to differ fromwhat is expressed in the forward-looking statements, under the caption “FactorsThat May Affect Future Results” in this Form 10-Q. We do notundertake an obligation to update the forward-looking information contained inthis Form 10-Q.

***Recent Developments***

On October 30, 2005, weentered into a merger agreement with Novartis Corporation (“Novartis”),Novartis Biotech Partnership, Inc., a subsidiary of Novartis (“Merger Sub”),and Novartis AG.  Pursuant to the termsof the merger agreement, Merger Sub will merge with and into our company, withour company as the surviving corporation. In the merger, each share of our common stock, other than those held byNovartis and its affiliates, will be converted into the right to receive $45.00per share in cash.  Completion of themerger is subject to approval of (1) the holders of a majority of theoutstanding shares of our common stock and (2) the holders of a majority of theoutstanding shares of our common stock, excluding shares owned by Novartis andits affiliates.  The merger is alsosubject to the satisfaction of other customary conditions, includinggovernmental and regulatory approvals. We expect that the transaction will be completed in the first half of2006.

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

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***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 with a leadingpresence in the U.S, a strong presence in Europe, and sales in Asia. Ourblood-testing segment consists of two separate collaborations: an alliance withGen-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 contractualarrangement, Ortho-Clinical Diagnostics manufactures and sells immunodiagnostictests to detect retroviruses and hepatitis viruses in blood. Our blood-testingsegment also earns royalties and license fees from third parties based on theirsales of immunodiagnostic and nucleic acid testing probe diagnostic productsutilizing our hepatitis C virus and HIV-related patents, for use in bloodscreening 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 part of our July 8, 2003acquisition of PowderJect. Our vaccines segment research and development isfocused on developing next generation influenza manufacturing capability,developing new vaccines for pandemic preparedness, and broadening ourmeningococcal franchise.

Our biopharmaceuticals segment researches, 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 metastatic melanoma and renal cell carcinoma; and BETASERON® (interferon beta-1b) for subcutaneousinjection for multiple sclerosis. In 2004, we filed for marketing approval inEurope for CUBICIN® (daptomycin for injection) for complicatedskin and soft tissue infections. Research and development efforts includeadvancing clinical programs and product improvements in oncology and pulmonaryand infectious disease, including the development of new formulations 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, and CHIR-265,a Raf kinase inhibitor.

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.

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***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® atour Liverpool, U.K. facility. As a result of the suspension of our license, wedid not release any FLUVIRIN® vaccine during the 2004-2005 influenzaseason. On March 2, 2005, the MHRA notified us that it had lifted thelicense suspension, giving Chiron clearance to initiate full production ofFLUVIRIN® vaccine, conditioned on the understanding thatChiron’s commitment to its remediation plan will continue and will be subjectto further inspections by the MHRA.

On October 17, 2005 we initiated delivery andrelease of FLUVIRIN® vaccine to customers in the United States forthe 2005-2006 influenza season. As of such time, we had received allnecessary approvals from the U.S. Food and Drug Administration (FDA) and MHRAto start supplying FLUVIRIN® vaccine to the U.S. market. Continuedshipments of FLUVIRIN® vaccine will need to undergo correspondinginternal release procedures and standard FDA influenza vaccine lot releaseprocedures.

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 ourlicense. In February 2005, after having previously commenced an informalinquiry, the Securities and Exchange Commission, or SEC, notified us that itwould commence a formal investigation into whether we or our employees violatedany federal securities laws in connection with these developments regardingFLUVIRIN® vaccine, and Chiron subsequently receivedsubpoenas from the SEC requesting production of certain documents relating toour Liverpool facility and FLUVIRIN® vaccine. We also received a voluntary requestfor information from the United States House of Representatives, Energy andCommerce Committee, Subcommittee on Oversight and Investigations requestingproduction of certain documents. Numerous documents have been collected andproduced in response to these requests, and several witnesses have beeninterviewed by the U.S. Attorney’s Office, the SEC staff and Congressionalstaff. Additional investigations 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 are described below in Part II,Item 1, “Legal Proceedings.” Certain distributors and other parties withwhom 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, theU.S. Centers for Disease Control and Prevention, or CDC, terminated itscontracts with us for the supply of FLUVIRIN® vaccine for default on the basis of ourfailure to supply such vaccine to the U.S. government for the 2004-2005influenza season. The CDC has reserved the right to hold us liable for anyexcess costs it may have incurred in replacing any FLUVIRIN® vaccine that we failed to deliver and furtherhas reserved all other remedies provided under the contract. It is not possibleto predict whether any of these claims will be pursued and, if so, whetherthose claims will be upheld. Investigations, litigation and disputes havecaused us to incur substantial expense and have required significant time andattention from our management and will continue to do so in the future andcould result in civil action and/or criminal proceedings against us. Theresults of any such investigations, proceedings or disputes could have amaterial adverse effect on our consolidated financial position and results ofoperations and/or cash flow.

Although the MHRA has lifted its suspension of ourlicense to manufacture FLUVIRIN® vaccine, we expect to incur additionalexpenses in connection with ongoing FLUVIRIN® vaccine matters, which could be material,including in connection with (1) our continuing remediation efforts at ourLiverpool facility; and (2) responding to the U.S. Attorney for theSouthern District of New York, the SEC, the United 

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StatesHouse of Representatives, Energy and Commerce Committee, Subcommittee onOversight and Investigations and the private lawsuits and other claims andinvestigations that exist or may arise.

BEGRIVACTM vaccine is manufactured at our facility in Marburg,Germany. In July 2005, we reported that we would be unable to supply anyBEGRIVACTM vaccine doses for the 2005-2006 influenza season due to aproduct sterility issue and wrote off our existing product inventory resultingin charges of $3.0 million and $18.0 million to cost of sales for the three andnine months ended September 30, 2005, respectively. Investigation of theproduct sterility issue has been completed and implementation of remedialmeasures and facility modifications is underway. Our inability to supplyBEGRIVACTM vaccine as planned to non-U.S. markets for the 2005-2006influenza season or, if remedial efforts are delayed or not sucessful, futureseasons could have a material adverse affect on our business and results ofoperations. In addition,it is possible that distributors and other parties with whom we had contractedto supply influenza vaccine may make claims against us as a result of Chironnot supplying influenza vaccine. Any such claims may cause us to incur substantialexpense and require significant time and attention from our management. Theresults of any such claims could have a material adverse effect on ourconsolidated financial position and results of operations and/or cash flow.

Our inability to supply influenza vaccine may alsolead to loss of market share in future seasons. Following the announcement ofour 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.Loss of market share in the United States or foreign markets could have amaterial adverse effect on our business and results of operations. Delays instart-up procedures for ramping up to full production and normal manufacturingissues inherent in the complexity of influenza vaccine production, haveadversely affected the amount of FLUVIRIN® vaccine thatChiron is able to produce for the 2005-2006 influenza season and mayresult 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—*Developments with respect to influenza vaccines over the past year willharm our business and results of operations.”* For additionalinformation on the U.S. Attorney’s investigation, SEC investigation and privatelawsuits and other claims, 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 Form 10-Qsfor such quarters 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 VirusVaccines Recent Events,”* we informed the SEC of these matters, andthe adjustments 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 pursuant to its requests.

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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  September 30,**                       | ** ** | **Nine Months Ended  September 30,** | ** ** | **$ Change** | ** ** | **% Change** | ** ** |
|--------------------------------------------------------------------------------------------------|------------|----------------------------------------------------------------------------|------------|-----------------------------------------------------|------------|-------------------|------------|-------------------|------------|
| ** **                                                                                       | ** ** | **2005**                                                                   | ** ** | **2004**                                            | ** ** | **2005**          | ** ** | **2004**          | ** ** | **Three  Months** | ** ** | **Nine  Months** | ** ** | **Three  Months** | ** ** | **Nine  Months** | ** ** |
| ** **                                                                                       | ** ** | ** **                                                                 | ** ** | **(Restated)**                                      | ** ** | ** **        | ** ** | **(Restated)**    | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                                                                                       | ** ** | **($ in 000’s, except per share data)** | ** ** |
| Product sales, net                                                                               |       | $                                                                          | 367,175    |                                                |       | $                 | 375,549    |              |       | $ | 947,913 |   |   | $ | 937,836 |   |   | $ | (8,374 | ) | $ | 10,077 |   |   | (2.2 | )% |   |   | 1.1 | % |   |
| Revenue from joint business arrangement                                                          |       | 36,093                                                                     |       |                                                | 34,017     |              |       | 103,154           |       |   | 92,910 |   |   | 2,076 |   | 10,244 |   |   | 6.1 | % |   |   | 11.0 | % |   |
| Royalty and license fee revenues                                                                 |       | 70,726                                                                     |       |                                                | 111,396    |              |       | 227,309           |       |   | 221,384 |   |   | (40,670 | ) | 5,925 |   |   | (36.5 | )% |   |   | 2.7 | % |   |
| Total revenues                                                                                   |       | 479,613                                                                    |       |                                                | 529,536    |              |       | 1,305,726         |       |   | 1,288,960 |   |   | (49,923 | ) | 16,766 |   |   | (9.4 | )% |   |   | 1.3 | % |   |
| Gross profit Margin                                                                              |       | 54                                                                         | %          |                                                | 36         | %                 |       | 46                | %          |   | 47 | % |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Research and development expenses                                                                |       | 107,309                                                                    |       |                                                | 103,000    |              |       | 324,620           |       |   | 301,736 |   |   | 4,309 |   | 22,884 |   |   | 4.2 | % |   |   | 7.6 | % |   |
| Selling, general and administrative expenses                                                |       | 117,152                                                                    |       |                                                | 112,013    |              |       | 375,802           |       |   | 321,775 |   |   | 5,139 |   | 54,027 |   |   | 4.6 | % |   |   | 16.8 | % |   |
| Purchased in-process research and development                                                    |       | —                                                                     |       |                                                | 9,629      |              |       | —            |       |   | 9,629 |   |   | (9,629 | ) | (9,629 | ) |   | (100 | )% |   |   | (100 | )% |   |
| Impairment loss on acquired intangible assets                                                    |       | 14,522                                                                     |       |                                                | —     |              |       | 14,522            |       |   | — |   |   | 14,522 |   | 14,522 |   |   | 100 | % |   |   | 100 | % |   |
| Amortization expense of intangible assets acquired in  business combinations and asset purchases |       | 12,361                                                                     |       |                                                | 20,566     |              |       | 54,237            |       |   | 63,077 |   |   | (8,205 | ) | (8,840 | ) |   | (39.9 | )% |   |   | (14.0 | )% |   |
| Income from continuing operations                                                                |       | 51,311                                                                     |       |                                                | 27,447     |              |       | 42,418            |       |   | 77,186 |   |   | 23,864 |   | (34,768 | ) |   | 86.9 | % |   |   | (45.0 | )% |   |
| Diluted earnings per  share:                                                                     |       |                                                                       |       |                                                |       |              |       |              |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Income from  continuing operations                                                               |       | $                                                                          | 0.27       |                                                |       | $                 | 0.14       |              |       | $ | 0.22 |   |   | $ | 0.40 |   |   | $ | 0.13 |   | $ | (0.18 | ) |   | 92.9 | % |   |   | (45.0 | )% |   |

 

Income from continuing operations was $51.3 million or$0.27 per diluted share and $27.4 million or $0.14 per diluted share for thethree months ended September 30, 2005 and 2004, respectively. Income fromcontinuing operations was $42.4 million or $0.22 per diluted share and $77.2million or $0.40 per diluted share for the nine months ended September 30,2005 and 2004, respectively. Income from continuing operations increased forthe three months ended September 30, 2005 as compared with the threemonths ended September 30, 2004 primarily due to a $91.3 million charge tocost of sales resulting from the write-off of our entire FLUVIRIN® vaccine inventory in the third quarter of 2004and $8.2 million lower amortization expense in the third quarter of 2005,resulting from a revision of estimated future sales. The amortization expense relatedto certain developed product technologies from our acquisition of PowderJect,which are amortized under the estimated sales method over ten years. Theseincreases were partially offset by $46.0 million of royalties and license feesrecognized from the F. Hoffman-LaRoche settlement (the Roche settlement) in thethird quarter of 2004 compared with $8.0 million recognized in the thirdquarter of 2005 and the impairment loss of $14.5 million on acquired intangibleassets from our acquisition of PowderJect related to a yellow fever vaccine inthe third quarter of 2005. In addition, there was a lost contribution fromsales of BEGRIVACTM influenza virus vaccine as there were no sales of BEGRIVACTMvaccine in the third quarter of 2005, compared to $41.0 million of sales forthe three months ended September 30, 2004. Income from continuing operationsdecreased for the nine months ended September 30, 2005 as compared withthe nine months ended September 30, 2004 primarily due to $46.0 million ofroyalties and license fees recognized from the Roche settlement for the ninemonths ended September 30, 2004 compared with $32.0 million of royalties andlicense fee revenues 

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recognized for the ninemonths ended September 30, 2005 and the impairment loss of $14.5 millionon acquired intangible assets from our acquisition of PowderJect related to ayellow fever vaccine in the third quarter of 2005. Lastly, there was a lostcontribution from sales of BEGRIVACTM influenza virus vaccine as there were nosales of BEGRIVACTM vaccine for the nine months ended September 30, 2005,compared to $41.0 million of sales for the nine months ended September 30,2004. These decreases were partially offset by a $91.3 million charge to costof sales resulting from the write-off of our entire FLUVIRIN® vaccine inventory in the third quarter of 2004and $4.8 million lower amortization expense for the nine months ended September 30,2005 related to certain developed product technologies from our acquisition ofPowderJect, which are amortized under the estimated sales method over ten years,resulting from a revision of estimated future sales. For the three months endedSeptember 30 2005, we incurred $3.0 million of FLUVIRIN® vaccine remediation costs and $0.5 million oflegal costs associated with the FLUVIRIN® vaccine-relateddevelopments. For the nine months ended September 30, 2005, we incurred$27.0 million of FLUVIRIN® vaccine remediation costs and $15.5 million oflegal costs associated with the FLUVIRIN® vaccine-relateddevelopments. In addition, our Liverpool facility had limited influenza vaccineproduction during the first nine months of 2005. For the three months ended September 30,2005 as compared with the three months ended September 30, 2004, idlefacility costs from our Liverpool facility increased by $9.0 million. For thenine months ended September 30, 2005 as compared with the nine monthsended September 30, 2004, idle facility costs from our Liverpool facilityincreased by $36.0 million. In addition, BEGRIVACTM product inventory has beenwritten off as a result of the matters described above under*“Influenza Virus Vaccines Recent Events”*,resulting in charges of $3.0 million and $18.0 million to cost-of-sales for thethree and nine months ended September 30, 2005 respectively.

Revenues decreased for the three months ended September 30,2005 as compared with the three months ended September 30, 2004 primarilydue to decreased royalty and license fee revenues and product sales. Revenuesincreased for the nine months ended September 30, 2005 as compared withthe nine months ended September 30, 2004 primarily due to increasedrevenues from the joint business arrangement, increased royalty and license feerevenues and increased product sales. The change in total revenues wasattributable in part to the movement in exchange rates, in particular themovements in the Euro and British Pound against the U.S. dollar. The movementin exchange rates reduced by approximately 1% our total revenues for the ninemonths ended September 30, 2005. However, since our Euro and British Pounddenominated expenses have also changed due to the movement in exchange rates,our income per share from continuing operations increased $0.02 per dilutedshare for the nine months ended September 30, 2005, due to higher expensescompared with revenues denominated in Euros and British Pounds.

For the three months ended September 30, 2005,product sales decreased as compared with the three months ended September 30,2004 primarily due to lower influenza vaccine sales because we were unable tosupply any BEGRIVACTM vaccine doses for the 2005-2006 influenza season dueto a product sterility issue. There was $41.0 million of sales of BEGRIVACTMvaccine in the third quarter of 2004. This decrease was offset by increases inour travel vaccines, PROCLEIX® product sales,Meningococcal vaccines, TOBI® tobramycin and BETASERON® interferon beta-1b.

For the nine months ended September 30, 2005,product sales increased compared with the nine months ended September 30,2004 primarily due to increases in sales of our travel vaccines, Meningococcalvaccines, PROCLEIX® product sales and TOBI® tobramycin, offset primarily by decreases insales of our influenza vaccines and pediatric and other vaccines as discussedbelow. Sales of our influenza vaccine decreased primarily due to lowerinfluenza vaccine sales because we were unable to supply any BEGRIVACTM vaccinedoses for the 2005-2006 influenza season due to a product sterilityissue.

For the three months ended September 30, 2005,royalty and license fee revenues decreased compared with the three months endedSeptember 30, 2004 primarily due to recognition of $46.0 million in 

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the third quarter of 2004relating to the Roche settlement, as compared with recognition of $8.0 millionin the third quarter of 2005 relating to the settlement. For the nine monthsended September 30, 2005, royalties and license fee revenues increased as comparedwith the nine months ended September 30, 2004 primarily due to increasedBETAFERON® product royalties and our settlement with theScottish National Blood Transfusion Service. These increases were partiallyoffset by royalties and license fees recognized from the Roche settlement inthe third quarter of 2004. The increase in revenue from the joint businessarrangement for the nine months ended September 30, 2005 as compared withthe nine months ended September 30, 2004 was primarily due to higherprofitability realized by the joint business arrangement.

Gross profit margin increased for the three monthsended September 30, 2005 as compared with the three months ended September 30,2004 primarily due to a $91.3 million charge to cost of sales resulting fromthe write-off of our entire FLUVIRIN® inventory in the third quarter of 2004,partially offset by there being no BEGRIVACTM vaccine sales for the three monthsended September 30, 2005.

Gross profit margin decreased for the nine monthsended September 30, 2005 as compared with the nine months ended September 30,2004 primarily due to increased idle facility costs as a result of the delay incommercial production of FLUVIRIN® vaccine for the 2005-2006 influenzaseason, FLUVIRIN® vaccine remediation costs and the write-off ofthe BEGRIVACTM product inventory and the resulting loss of BEGRIVACTM vaccinesales for the three months ended September 30, 2005. These decreases wereprimarily offset by a $91.3 million charge to cost of sales resulting from thewrite-off of our entire Fluvirin inventory in the third quarter of 2004.

Gross profit margins do not include amortizationexpense of intangible assets from acquired developed products related tobusiness combinations.

The main components of the increase in research anddevelopment expenses for the nine months ended September 30, 2005 ascompared with the nine months ended September 30, 2004 relate todevelopment efforts in our oncology franchise, development efforts for CUBICIN® (daptomycin for injection), meningococcalvaccines franchise, flu cell culture, development of new processes andprocedures in existing manufacturing facilities for BETAFERON interferon beta-1band blood-testing programs. These increases were partially offset by researchand development programs that have been discontinued or disposed of prior tothe first nine months of 2005.

The increase in selling, general and administrativeexpenses for the three months ended September 30, 2005 as compared withthe three months ended September 30, 2004 was due primarily to pre-launchcosts for CUBICIN® (daptomycin for injection), higher employeerelated expenses and higher corporate governance costs.

The increase in selling, general and administrativeexpenses for the nine months ended September 30, 2005 as compared with thenine months ended September 30, 2004 was due partially to legal expensesassociated with the FLUVIRIN® developmentsdiscussed above under*“Influenza VirusVaccines Recent Events.”* Such legal expenses were $15.5 million forthe nine months ended September 30, 2005. The increase also reflects $4.3million due to the movement in the Euro and British Pound exchange rates. Theremaining increase in selling, general and administrative expenses reflects abroad range of activities, significant among them being on-going marketing andpre-launch programs to support the continued growth of our business, investmentin geographic penetration, higher employee related costs and corporategovernance costs.

The effective tax rate was21.9% and 27.3% of pretax income from continuing operations for the nine monthsended September 30, 2005 and 2004, respectively. The tax rate decreased primarily dueto lower expected taxable incomes, year to year, in certain high taxjurisdictions, as well as increased benefits of U.S. research credits. Suchitems are not expected to recur in future years. The effective tax rate may be 

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affectedin future periods by changes in management’s estimates with respect to ourdeferred tax assets and other items affecting the overall tax rate.

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

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-Kfor the 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.

**Results ofOperations**

***Blood-testing***

| ** **                                    | ** ** | **Three Months Ended  September 30,**          | ** ** | **Nine Months Ended  September 30,** | ** ** | **$ Change** | ** ** | **% Change** | ** ** |
|-----------------------------------------------|------------|---------------------------------------------------------------|------------|-----------------------------------------------------|------------|-------------------|------------|-------------------|------------|
| ** **                                    | ** ** | **2005**                                                      | ** ** | **2004**                                            | ** ** | **2005**          | ** ** | **2004**          | ** ** | **Three  Months** | ** ** | **Nine  Months** | ** ** | **Three  Months** | ** ** | **Nine  Months** | ** ** |
| ** **                                    | ** ** | **($ in 000’s, except percentages)** | ** ** |
| Product sales,  net:                          |       |                                                          |       |                                                |       |              |       |              |       |   |   |   |   |   |   |   |   |   |   |   |   |
| PROCLEIX® products                  |       | $                                                             | 70,677     |                                                | $          | 63,629            |       | $                 | 201,212    |   | $ | 186,104 |   | $ | 7,048 |   | $ | 15,108 |   |   | 11.1 | % |   |   | 8.1 | % |   |
| Ortho-Clinical Diagnostics                    |       | 7,023                                                         |       | 7,098                                               |       | 21,473            |       | 19,940            |       | (75 | ) | 1,533 |   |   | (1.1 | )% |   |   | 7.7 | % |   |
|                                          |       | 77,700                                                        |       | 70,727                                              |       | 222,685           |       | 206,044           |       | 6,973 |   | 16,641 |   |   | 9.9 | % |   |   | 8.1 | % |   |
| Revenue from joint business arrangement       |       | 36,093                                                        |       | 34,017                                              |       | 103,154           |       | 92,910            |       | 2,076 |   | 10,244 |   |   | 6.1 | % |   |   | 11.0 | % |   |
| Collaborative agreement revenues              |       | 1,579                                                         |       | 1,616                                               |       | 5,589             |       | 6,005             |       | (37 | ) | (416 | ) |   | (2.3 | )% |   |   | (6.9 | )% |   |
| Royalty and license fee  revenues             |       | 22,501                                                        |       | 34,115                                              |       | 73,695            |       | 66,817            |       | (11,614 | ) | 6,878 |   |   | (34.0 | )% |   |   | 10.3 | % |   |
| Other revenues                                |       | 137                                                           |       | 243                                                 |       | 412               |       | 673               |       | (106 | ) | (261 | ) |   | (43.6 | )% |   |   | (38.8 | )% |   |
| Total blood-testing Revenues             |       | $                                                             | 138,010    |                                                | $          | 140,718           |       | $                 | 405,535    |   | $ | 372,449 |   | $ | (2,708 | ) | $ | 33,086 |   |   | (1.9 | )% |   |   | 8.9 | % |   |
| Gross profit margin                           |       | 42                                                            | %          | 43                                                  | %          | 42                | %          | 42                | %          |   |   |   |   |   |   |   |   |   |   |   |   |
| Research and development expenses             |       | $                                                             | 6,211      |                                                | $          | 8,387             |       | $                 | 20,937     |   | $ | 19,754 |   | $ | (2,176 | ) | $ | 1,183 |   |   | (25.9 | )% |   |   | 6.0 | % |   |
| Selling, general  and administrative expenses |       | $                                                             | 11,341     |                                                | $          | 11,077            |       | $                 | 34,044     |   | $ | 30,657 |   | $ | 264 |   | $ | 3,387 |   |   | 2.4 | % |   |   | 11.0 | % |   |

 

**Product sales**

*PROCLEIX*®* Products*   OnFebruary 27, 2002, the U.S. Food and Drug Administration approved thePROCLEIX® HIV-1/ HCV Assay. We have marketed thePROCLEIX® HIV-1/HCV Assay in Europe since 1999. OnJanuary 15, 2004, the PROCLEIX® ULTRIOTM HIV-1/HCV/HBV Assay receivedEuropean CE marking for use on the semi-automated PROCLEIX® System, and on December 14, 2004 

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the PROCLEIX ULTRIO Assayreceived European CE marking for use on the fully automated, high throughputPROCLEIX®TIGRIS® System. Under a collaboration agreement withGen-Probe, we market and sell the PROCLEIX® HIV-1/ HCVAssay, the PROCLEIX ULTRIOTM Assay and related instrument systems. In additionto selling directly in the U.S., we also sell in various international markets,directly and through distributors. We record revenue based upon the reportedresults obtained from the customer from the use of assays to screen donationsor upon sale and delivery of the assays, depending on the underlying contract.In the case of equipment sales or leases, we record revenue upon the sale andtransfer of the title of the instrument or ratably over the life of the leaseterm, respectively. For provision of service on the instruments, we recognize revenueratably over the life of the service agreement.

The increase in product sales for the three monthsended September 30, 2005 as compared with the three months ended September 30,2004 was primarily due to $5.5 million from the conversion to the PROCLEIX® ULTRIOTM Assay from the PROCLEIX® HIV-1/HCVAssay outside of the U.S. and continued penetration into several markets abroadand $1.4 million due to an increase in donations in the United States. Theincrease in product sales for the nine months ended September 30, 2005 ascompared with the nine months ended September 30, 2004 was primarily dueto $13.6 million from the conversion to the PROCLEIX® ULTRIOTM Assay from the PROCLEIX® HIV-1/HCVAssay outside the U.S. and from continued penetration into several marketsabroad.

Under a collaboration agreement with Gen-Probe, wemarket and sell the PROCLEIX® HIV-1/ HCVAssay, the PROCLEIX ULTRIOTM Assay and related instrument systems. The Food andDrug Administration, or FDA, notified Gen-Probe on October 3, 2005 that itconsiders the PROCLEIX® TIGRIS® system “not substantiallyequivalent” to the PROCLEIX enhanced semi-automated system (eSAS) for screeningdonated human blood with the PROCLEIX ULTRIOTM assay. The FDA made thisdetermination in response to Gen-Probe’s 510(k) application for the TIGRISsystem. We understand that Gen-Probe is in discussions with the FDA to resolvethe outstanding issues, and we are not in direct communication with the FDAregarding this matter.

**Revenue from joint businessarrangement****  **Theincrease in revenue from the joint business arrangement for the three monthsended September 30, 2005 as compared with the three months ended September 30,2004 was primarily due to $5.6 million from an increase in profitabilityrealized by the joint business arrangement offset by a decline of $4.2 millionin royalties. The increase in revenue from the joint business arrangement forthe nine months ended September 30, 2005 as compared with the nine monthsended September 30, 2004 was primarily due to $14.5 million from higherprofitability realized by the joint business arrangement offset by a decline of$5.9 million in royalties.

**Collaborative agreement revenues****  **Collaborative agreement revenues tend tofluctuate based on the amount and timing of research services performed, thestatus of projects under collaboration and the achievement of milestones. Dueto 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 additional collaborative agreement revenues may depend,in part, on our ability to initiate and maintain relationships with potentialand current collaborative partners.

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

The decrease in royalty and license fee revenues forthe three months ended September 30, 2005 as compared with the threemonths ended September 30, 2004 was primarily due to (i) $10.1million 

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recognized in the thirdquarter of 2004 for deferred revenues and a non-refundable portion of the Rochesettlement reached in September 2004 as discussed below under “Other—Royaltyand license fee revenues—*Roche Settlement,*”and (ii) $7.9 million in the third quarter of 2004 due to recognition of aportion of the license fee under our license agreements with the German RedCross for the use of our HIV-1 and hepatitis C virus (HCV) technology foruse in molecular probe “home brew” blood screening. These decreases werepartially offset by (i)$2.7 million of royalties recognized in the thirdquarter of 2005 from the Roche settlement reached in September 2004 asdiscussed below under “Other—Royalty and license fee revenues—*Roche Settlement,*” (ii)$1.9 million in thethird quarter of 2005 from increased royalties from Roche due to rate increasesresulting from certain countries entering the European Union (EU) and anincrease in reported donations and (iii) $1.5 million in the third quarterof 2005 in royalties from our licensing agreement reached in 2004 withLaboratory Corporation of America Holdings (LabCorp) for our HCV intellectualproperty for nucleic acid testing.

The increase in royalty and license fee revenues forthe nine months ended September 30, 2005 as compared with the nine monthsended September 30, 2004 was primarily due to (i) $10.7 millionof royalties from the Roche settlement, (ii) $5.2 million in royaltiesfrom Roche due to rate increases resulting from certain countries entering theEU and an increase in reported donations, (iii) $4.7 million in fees androyalties from our licensing agreement with LabCorp, (iv) $2.7 millionfrom a settlement with the SNBTS regarding our HCV and HIV patents and (v) $2.1million in royalty fees from the blood transfusion centers of the German RedCross. These increases were partially offset by (i) $10.1 millionrecognized in the third quarter of 2004 for deferred revenues and anon-refundable portion of the Roche settlement reached in September 2004as discussed below under “Other—Royalty and license fee revenues—*Roche Settlement,*” and (ii) $7.9million in the third quarter of 2004 due to recognition of a portion of thelicense fee under our license agreements with the German Red Cross for the useof our HIV-1 and hepatitis C virus (HCV) technology for use in molecularprobe “home brew” blood screening.

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

**Gross profit margin****  **The decrease in gross profit margin for thethree months ended September 30, 2005 as compared with the three monthsended September 30, 2004 was primarily due to additional support andservice costs associated with our fully automated, high throughput PROCLEIX®TIGRIS® System. Gross profit margin was consistent forthe nine months ended September 30, 2005 as compared with the nine monthsended September 30, 2004. Blood-testing gross profit margin mayfluctuate in future periods as the blood-testing product and customer mixchanges.

**Research and development expenses****  **The decrease in research and developmentexpenses for the three months ended September 30, 2005 as compared withthe three months ended September 30, 2004 was primarily due to $2.4million decrease in costs relating to our nucleic acid testing products. Theincrease in research and development expenses for the nine months ended September 30,2005 as compared with the nine months ended September 30, 2004 wasprimarily due to $4.6 million for research activities focused primarily onvCJD partially offset by a $3.5 million decrease in costs relating to ournucleic acid testing products. Research and development expenses may fluctuatefrom period to period depending upon the stage of certain projects and thelevel of pre-clinical and clinical trial-related activities.

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**Selling, general, and administrativeexpenses****  **Selling,general, and administrative expenses were consistent for the three months endedSeptember 30, 2005 as compared with the three months ended September 30,2004. The increase in selling, general and administrative expenses for the ninemonths ended September 30, 2005 as compared with the nine months ended September 30,2004 was primarily due to $2.5 million from the geographic expansion ofour customer base for the PROCLEIX® HIV-1/HCV Assay in internationalmarkets.

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  September 30,**          | ** ** | **Nine Months Ended  September 30,** | ** ** | **$ Change** | ** ** | **% Change** | ** ** |
|------------------------------------------------|------------|---------------------------------------------------------------|------------|-----------------------------------------------------|------------|-------------------|------------|-------------------|------------|
| ** **                                     | ** ** | **2005**                                                      | ** ** | **2004**                                            | ** ** | **2005**          | ** ** | **2004**          | ** ** | **Three  Months** | ** ** | **Nine  Months** | ** ** | **Three  Months** | ** ** | **Nine  Months** | ** ** |
| ** **                                     | ** ** | ** **                                                    | ** ** | **Restated**                                        | ** ** | ** **        | ** ** | **Restated**      | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                                     | ** ** | **($ in 000’s, except percentages)** | ** ** |
| Product sales,  net:                           |       |                                                          |       |                                                |       |              |       |              |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Influenza vaccines:                            |       |                                                          |       |                                                |       |              |       |              |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Other Influenza vaccines                       |       | $                                                             | 60,321     |                                                |       | $                 | 93,486     |              |       | $ | 63,400 |   |   | $ | 106,953 |   |   | $ | (33,165 | ) | $ | (43,553 | ) |   | (35.5 | )% |   |   | (40.7 | )% |   |
| FLUVIRIN® vaccine                    |       | —                                                        |       |                                                | —     |              |       | —            |       |   | 2,445 |   |   | — |   | (2,445 | ) |   | — |   |   |   | (100.0 | )% |   |
| Influenza vaccines                             |       | 60,321                                                        |       |                                                | 93,486     |              |       | 63,400            |       |   | 109,398 |   |   | (33,165 | ) | (45,998 | ) |   | (35.5 | )% |   |   | (42.0 | )% |   |
| Meningococcal vaccines                         |       | 11,635                                                        |       |                                                | 8,865      |              |       | 34,393            |       |   | 18,430 |   |   | 2,770 |   | 15,963 |   |   | 31.2 | % |   |   | 86.6 | % |   |
| Travel vaccines                                |       | 35,012                                                        |       |                                                | 26,434     |              |       | 123,785           |       |   | 75,705 |   |   | 8,578 |   | 48,080 |   |   | 32.5 | % |   |   | 63.5 | % |   |
| Pediatric and other vaccines                   |       | 45,800                                                        |       |                                                | 44,491     |              |       | 115,420           |       |   | 143,292 |   |   | 1,309 |   | (27,872 | ) |   | 2.9 | % |   |   | (19.5 | )% |   |
|                                           |       | 152,768                                                       |       |                                                | 173,276    |              |       | 336,998           |       |   | 346,825 |   |   | (20,508 | ) | (9,827 | ) |   | (11.8 | )% |   |   | (2.8 | )% |   |
| Collaborative agreement revenues          |       | 999                                                           |       |                                                | 2,230      |              |       | 4,240             |       |   | 7,410 |   |   | (1,231 | ) | (3,170 | ) |   | (55.2 | )% |   |   | (42.8 | )% |   |
| Royalty and license fee revenues               |       | 1,263                                                         |       |                                                | 1,213      |              |       | 3,448             |       |   | 3,888 |   |   | 50 |   | (440 | ) |   | 4.1 | % |   |   | (11.3 | )% |   |
| Other revenues                                 |       | 1,802                                                         |       |                                                | 3,006      |              |       | 7,558             |       |   | 12,563 |   |   | (1,204 | ) | (5,005 | ) |   | (40.1 | )% |   |   | (39.8 | )% |   |
| Total Vaccines revenues                        |       | $                                                             | 156,832    |                                                |       | $                 | 179,725    |              |       | $ | 352,244 |   |   | $ | 370,686 |   |   | $ | (22,893 | ) | $ | (18,442 | ) |   | (12.7 | )% |   |   | (5.0 | )% |   |
| Gross profit margin                            |       | 45                                                            | %          |                                                | 9          | %                 |       | 21                | %          |   | 21 | % |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Research and development expenses         |       | $                                                             | 34,942     |                                                |       | $                 | 30,985     |              |       | $ | 102,885 |   |   | $ | 97,313 |   |   | $ | 3,957 |   | $ | 5,572 |   |   | 12.8 | % |   |   | 5.7 | % |   |
| Selling, general and administrative expenses   |       | $                                                             | 42,320     |                                                |       | $                 | 42,288     |              |       | $ | 122,657 |   |   | $ | 115,343 |   |   | $ | 32 |   | $ | 7,314 |   |   | 0.1 | % |   |   | 6.3 | % |   |
| Amortization  expense                          |       | $                                                             | 6,121      |                                                |       | $                 | 14,326     |              |       | $ | 35,482 |   |   | $ | 44,352 |   |   | $ | (8,205 | ) | $ | (8,870 | ) |   | (57.3 | )% |   |   | (20.0 | )% |   |
| Impairment loss on  acquired intangible assets |       | $                                                             | 14,522     |                                                |       | $                 | —     |              |       | $ | 14,522 |   |   | $ | — |   |   | $ | 14,522 |   | $ | 14,522 |   |   | 100 | % |   |   | 100 | % |   |
|                                                |            |                                                               |            |                                                     |            |                   |            |                   |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

**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.

*Influenza vaccines  *Asdescribed above under*“Influenza Virus VaccinesRecent Events,”* as a result of recent developments with respect toFLUVIRIN® and BEGRIVACTM vaccines, we had no FLUVIRIN® or BEGRIVACTM vaccine sales in the three andnine months ended September 30, 2005. Sales of FLUVIRIN® influenza vaccine were $2.4 million forthe nine months ended September 30, 2004 from the 2003-2004influenza season. Sales of BEGRIVACTM influenza vaccine were $41.0 millionfor the three and nine months ended September 30, 2004. The decrease insales of our other influenza vaccines for the three months ended September 30,2005 as compared with the three months ended September 30, 2004 wasprimarily due to there being no BEGRIVACTM vaccine sales for the three monthsended September 30, 2005. This decrease was offset by an increase in salesof our other influenza vaccine products.

The decrease in sales of our other influenza vaccinesfor the nine months ended September 30, 2005 as compared with the ninemonths ended September 30, 2004 was primarily due to (i) there being noBEGRIVACTM vaccine sales for the nine months ended September 30, 2005 and (ii) amanufacturing 

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upgrade of facilities thatproduce influenza vaccine for the southern hemisphere. For the nine monthsended September 30, 2004, sales of our other influenza vaccines to the southernhemisphere were $9.9 million. These decreases were offset by an increase insales of our other influenza vaccine products to the northern hemisphere forthe nine months ended September 30, 2005.

*Meningococcal vaccines  *Theincrease in meningococcal vaccines sales for the three months ended September 30,2005 as compared with the three months ended September 30, 2004 wasprimarily due to $5.4 million increase in tender sales of MENJUGATE® vaccine in Spain. This increase was partiallyoffset by a $2.3 million decrease in tender sales of MENJUGATE® vaccine in the United Kingdom and a $1.2million decrease in tender sales of MENJUGATE® vaccinein Canada. The increase in meningococcal vaccines sales for the nine monthsended September 30, 2005 as compared with the nine months ended September 30,2004 was primarily due to (i) $12.1 million of MENZBTM meningococcal Bvaccine sales to the Ministry of Health in New Zealand, (ii) $5.4 millionincrease in tender sales of MENJUGATE® vaccine in Spain and (iii) a $2.5 millionincrease in tender sales of MENJUGATE® vaccine to Canada. These increases arepartially offset by a $2.7 million decrease tender sales of MENJUGATE® vaccine in Australia and a $2.3 milliondecrease in tender sales of MENJUGATE® vaccine in the United Kingdom.

*Travel vaccines  *Theincrease in travel vaccines sales for the three months ended September 30,2005 as compared with the three months ended September 30, 2004 wasprimarily due to (i) $4.6 million from increased demand for ourrabies vaccines in the U.S., primarily due to a product recall from acompetitor, and a price increase and (ii) $3.3 million from increaseddemand for our rabies vaccines in Europe, primarily due to tender sales toTurkey, Hungary and the United Kingdom. The increase in travel vaccines salesfor the nine months ended September 30, 2005 as compared with the ninemonths ended September 30, 2004 was primarily due to: (i) a $29.9million increase in tick-borne encephalitis (TBE) vaccine sales. Sales in thefirst quarter of 2004 were lower than in the first quarter of 2005 by $12.0million due to $15.1 million of sales in the fourth quarter of 2003; TBEvaccines are typically sold in the first half of the year; and in addition, thesecond and third quarters of 2005 compared with the second and third quartersof 2004 reflected a $17.9 million increase in the TBE vaccine sales due togrowth in the overall market and a number of marketing initiatives, (ii) $11.3million from increased demand for our rabies vaccines in the U.S., primarilydue to a product recall from a competitor and price increases, and increasedsales to Canada, (iii) $6.4 million from increased demand for our rabiesvaccines in Asia and (iv) a $5.4 million from increased demand for ourrabies vaccines in Europe, primarily due to tender sales to Turkey, Hungary andthe U.K. These increases were partially offset by a decline of $1.8 million insales of Dukoral vaccine due to the divestiture in the second quarter of 2004of certain vaccines operations in Sweden acquired in our acquisition ofPowderJect.

*Pediatric and other vaccines  *Salesof our pediatric and other vaccines increased for the three months ended September 30,2005 as compared with the three months ended September 30, 2004. Thisincrease was primarily due to a $15.7 million increase related to the timing ofsales for diphtheria, tetanus and pertussis vaccines. This increase ispartially offset by (i) a $8.8 million decrease of polio vaccine sales dueto product write-offs and product unavailability as a result of manufacturingupgrades, (ii) a $1.0 million decrease due to the timing of tender salesfor our measles, mumps and rubella vaccines and (iii) a $4.6 milliondecrease from the interruption of production of certain vaccines in ourLiverpool plant to focus on our remediation efforts at that plant. Sales of ourpediatric and other vaccines decreased for the nine months ended September 30,2005 as compared with the nine months ended September 30, 2004 primarilydue to (i) a $19.8 million decline in polio vaccines and measles, mumpsand rubella vaccines sales due to product write-offs and a lack of productavailability as a result of manufacturing upgrades (ii) an $8.8 milliondecrease due to the timing of tender sales for our polio vaccines and measles,mumps and rubella vaccines, (iii) a $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) a $12.7million decrease from the interruption of production of certain vaccines in ourLiverpool plant to focus on our 

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remediation efforts atthat plant. These decreases were partially offset by a $21.1 million increaserelated to the timing of 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 TBE vaccine is also seasonal with higher salestypically in the first half of the year. Certain of our vaccines requireregulatory approval for production or sale of the product and sales mayfluctuate depending on these regulatory approvals. We expect increasedcompetition for our influenza vaccines business in the future as a result ofthe recent influenza vaccines developments. For more information on this, see*“Influenza Virus Vaccines Recent Events”*above. In addition, we expect MENJUGATE® vaccinesales to continue to fluctuate as public health authorities consider adoptionof broad vaccination programs and competitive pressures continue to increase.

On October 27, 2005, we announced that we won a $62.5million contract to supply the U.S. government with pre-pandemic influenzavaccine for a stockpile to protect against the H5N1 avian influenza virusstrain. Under the agreement with the Department of Health and Human Services(HHS), we will provide a bulk stockpile of H5N1 influenza vaccine, which wewill produce at our Liverpool manufacturing facility using the U.S.-licensedcommercial-scale manufacturing process. Production of the H5N1 stockpilevaccine under this agreement will not affect production of our annual FLUVIRIN® influenza virus vaccine.

**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 September 30, 2005 as compared withthe three months ended September 30, 2004 decreased due to $1.2 millionfrom a milestone payment in the third quarter of 2004 related to an agreementto supply MeNZBTM meningococcal B vaccine to the Ministry of Health in NewZealand. Collaborative agreement revenues for the nine months ended September 30,2005 as compared with the nine months ended September 30, 2004 decreasedprimarily due to $2.4 million in lower milestone payments related to anagreement to supply MeNZBTM meningococcal B vaccine to the Ministry of Health inNew Zealand.

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

**Other revenues**   Otherrevenues recognized in our vaccines segment primarily consist of grant revenuesand contract manufacturing revenues and may fluctuate due to the nature of therevenues recognized and the timing of events giving rise to these revenues.

**Gross profit margin  **Grossprofit margin increased for the three months ended September 30, 2005 ascompared with the three months ended September 30, 2004 primarily due to a$91.3 million charge to cost of sales resulting from the write-off of ourentire Fluvirin inventory in the third quarter of 2004, partially offset by noBEGRIVACTM vaccine sales for the three months ended September 30, 2005.

Gross profit margin wasnegatively impacted for the nine months ended September 30, 2005 primarilydue to (i) $27.0 million of FLUVIRIN® vaccine remediation costs and$36.0 million increase in idle facility costs as our Liverpool facilityhad limited FLUVIRIN® vaccine production during the nine monthsended September 30, 2005 due to FLUVIRIN® vaccine remediation activities, (ii) an $18.0million charge for the write-off of BEGRIVACTM product inventory due to productsterility issues and (iii) lack of BEGRIVACTM 

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salesfor the nine months ended September 30, 2005. Gross profit margin wasnegatively impacted for the nine months ended September 30, 2004 due to therebeing no FLUVIRIN® sales for the 2004-2005 influenza seasonand a $91.3 million charge to cost of sales resulting from the write-off of ourentire FLUVIRIN® inventory in the third quarter of 2004.

Vaccines gross profitmargin does not include amortization expense of intangible assets from acquireddeveloped products related to business combinations. Such amortization expenseis included in the caption “amortization expense of intangible assets acquiredin business combinations and asset purchases.”

Vaccines gross profitmargin may fluctuate significantly in future periods due to product andcustomer mix, seasonality and ordering patterns, production yields, regulatoryapprovals and competitive pressures.

**Researchand development expenses  **The increase in research anddevelopment expenses for the three months ended September 30, 2005 ascompared with the three months ended September 30, 2004 was primarily dueto $2.3 million from advancing our quadrivalent meningococcal vaccine candidatefor serogroups A,C,W and Y. The increase in research and development expensesfor the nine months ended September 30, 2005 as compared with the ninemonths ended September 30, 2004 was primarily due $6.6 million fromadvancing our quadrivalent meningococcal vaccine candidate for serogroups A,C,Wand Y, and $3.0 million from our flu cell culture development program. Theseincreases were partially offset by the second quarter of 2004 divestiture ofcertain research and development operations, acquired in the acquisition ofPowderJect. The divested operations included $4.2 million in research anddevelopment expenses for the nine months ended September 30, 2004.

Research and developmentexpenses may fluctuate from period to period depending upon the stage of certainprojects and the level of pre-clinical and clinical trial-related activities.

**Selling,general, and administrative expenses  **The increase inselling, general and administrative expenses for the three months ended September 30,2005 as compared with the three months ended September 30, 2004 was due to(i) $1.2 million for corporate governance costs and (ii) $0.7 millionfor executive severance. These increases were partially offset by (i) a $1.4million decrease in marketing activities focused on international markets. Theincrease in selling, general and administrative expenses for the nine monthsended September 30, 2005 as compared with the nine months ended September 30,2004 was due to (i) $3.2 million due to the movement in the Euro andBritish pound to U.S. Dollar exchange rate, (ii) $3.4 million forcorporate governance costs, (iii) an additional $2.5 million from theestablishment of sales and marketing operations in the U.S., (iv) $2.4 millionfor executive severance and (v) $1.3 million from marketing activitiesfocused on international markets. These increases were partially offset by areduction of $4.1 million as a result of the planned divestiture ofcertain PowderJect operations in the second quarter 2004 and $2.2 million fromthe recovery of bad debt.

**Amortizationexpenses  **The decrease in amortization expense for thethree and nine months ended September 30, 2005 as compared with the threeand nine months ended September 30, 2004 was due to lower amortizationexpense related to certain developed product technologies from our acquisitionof PowderJect which are amortized under the estimated sales method. Theestimated sales method considers forecasted FLUVIRIN® sales during each influenza season through theremaining period of the benefit. Related amortization was $4.1 million and$30.1 million as compared to $12.3 million and $34.9 million during the threeand nine months ended September 30, 2005 and 2004, respectively,reflecting updated forecasted FLUVIRIN® sales.

**Impairmentloss on acquired intangible assets  **In the third quarterof 2005, we recognized an impairment loss of $14.5 million on acquiredintangible assets from our acquisition of PowderJect related to a ARILVAXTM, ayellow fever vaccine. This impairment loss was due to a focus of our resourcestowards the influenza market, resulting in a reduction of the expected activityfor ARILVAXTM. ARILVAXTM remains in our portfolio of trademarks and we mayre-enter the yellow fever vaccine market in the future with this product.

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***Biopharmaceuticals***

| ** **                                   | ** ** | **Three Months Ended  September 30,**          | ** ** | **Nine Months Ended  September 30,**      | ** ** | **$ Change** | ** ** | **% Change** | ** ** |
|----------------------------------------------|------------|---------------------------------------------------------------|------------|----------------------------------------------------------|------------|-------------------|------------|-------------------|------------|
| ** **                                   | ** ** | **    2005    **      | ** ** | **    2004    ** | ** ** | **2005**          | ** ** | **2004**          | ** ** | **Three  Months** | ** ** | **Nine  Months** | ** ** | **Three  Months** | ** ** | **Nine  Months** | ** ** |
| ** **                                   | ** ** | **($ in 000’s, except percentages)** | ** ** |
| Product sales,  net:                         |       |                                                          |       |                                                     |       |              |       |              |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| BETASERON® interferon beta-1b      |       |                                                          | $          | 36,927                                                   |       |              |       | $                 | 35,171     |   |   | $ | 101,693 |   | $ | 96,933 |   |   | $ | 1,756 |   |   |   | $ | 4,760 |   |   |   | 5.0 | % |   |   | 4.9 | % |   |
| TOBI®  tobramycin             |       |                                                          | 57,890     |                                                     |       |              | 55,734     |              |       | 167,425 |   | 159,600 |   |   | 2,156 |   |   |   | 7,825 |   |   |   | 3.9 | % |   |   | 4.9 | % |   |
| PROLEUKIN® aldesleukin        |       |                                                          | 31,028     |                                                     |       |              | 31,739     |              |       | 92,290 |   | 98,664 |   |   | (711 | ) |   |   | (6,374 | ) |   |   | (2.2 | )% |   |   | (6.5 | )% |   |
| Other                                        |       |                                                          | 10,862     |                                                     |       |              | 8,902      |              |       | 26,822 |   | 29,770 |   |   | 1,960 |   |   |   | (2,948 | ) |   |   | 22.0 | % |   |   | (9.9 | )% |   |
|                                         |       |                                                          | 136,707    |                                                     |       |              | 131,546    |              |       | 388,230 |   | 384,967 |   |   | 5,161 |   |   |   | 3,263 |   |   |   | 3.9 | % |   |   | 0.8 | % |   |
| Collaborative agreement revenues             |       |                                                          | 571        |                                                     |       |              | 278        |              |       | 1,300 |   | 1,052 |   |   | 293 |   |   |   | 248 |   |   |   | 105.4 | % |   |   | 23.6 | % |   |
| Royalty and license fee revenues             |       |                                                          | 17,321     |                                                     |       |              | 15,412     |              |       | 55,739 |   | 47,892 |   |   | 1,909 |   |   |   | 7,847 |   |   |   | 12.4 | % |   |   | 16.4 | % |   |
| Other revenues                               |       |                                                          | 531        |                                                     |       |              | 1,201      |              |       | 8,251 |   | 9,127 |   |   | (670 | ) |   |   | (876 | ) |   |   | (55.8 | )% |   |   | (9.6 | )% |   |
| Total Biopharmaceutical revenues             |       |                                                          | $          | 155,130                                                  |       |              |       | $                 | 148,437    |   |   | $ | 453,520 |   | $ | 443,038 |   |   | $ | 6,693 |   |   |   | $ | 10,482 |   |   |   | 4.5 | % |   |   | 2.4 | % |   |
| Gross profit margin.                         |       |                                                          | 71         | %                                                        |       |              | 67         | %                 |       | 70 | % | 72 | % |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Research and development expenses            |       |                                                          | $          | 65,721                                                   |       |              |       | $                 | 63,252     |   |   | $ | 198,992 |   | $ | 183,627 |   |   | $ | 2,469 |   |   |   | $ | 15,365 |   |   |   | 3.9 | % |   |   | 8.4 | % |   |
| Selling, general and administrative expenses |       |                                                          | $          | 34,881                                                   |       |              |       | $                 | 33,322     |   |   | $ | 109,619 |   | $ | 98,496 |   |   | $ | 1,559 |   |   |   | $ | 11,123 |   |   |   | 4.7 | % |   |   | 11.3 | % |   |
| Amortization  expense                        |       |                                                          | $          | 6,240                                                    |       |              |       | $                 | 6,240      |   |   | $ | 18,755 |   | $ | 18,725 |   |   | $ | — |   |   |   | $ | 30 |   |   |   | 0.0 | % |   |   | 0.2 | % |   |

 

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

*BETASERON*®* interferon beta-1b  *Wemanufacture interferon beta-1b, which is marketed by Schering AG and itsaffiliates, including Berlex Laboratories, Inc. (collectively, Schering),under the trade names BETASERON® (in the U.S and other non-European markets)and BETAFERON® (in Europe). Boehringer Ingelheim alsosupplies BETAFERON® interferon beta-1b to Schering for salein Europe. For product we manufacture, we recognize a portion of revenue forproduct sales upon shipment to Schering and the remainder based on acontractual percentage of sales by Schering, both of which we record as productsales. For product manufactured by Boehringer Ingelheim and marketed bySchering in Europe under the trade name BETAFERON®, we receive royalties calculated at thesame percentage of sales less the amount paid or incurred by Schering forsupply costs, which we record in royalty and license fee revenues.

The increase in BETASERON® product sales for the three months ended September 30,2005 as compared with the three months ended September 30, 2004 primarilyrelated to (i) $3.4 million from price increases, (ii) $2.0 millionfrom a shift of revenue from royalties to product sales as Schering began tosell product manufactured by us in additional European markets and (iii) $1.9million from the timing of clinical products. These increases were partiallyoffset by $3.8 million from reduced shipments to Berlex and $2.7 millionfrom inventory ordering patterns. The increase in BETASERON® product sales for the nine months ended September 30,2005 as compared with the nine months ended September 30, 2004 primarilyrelated to (i) $5.4 million from price increases, (ii) $2.0 millionfrom a shift of revenue from royalties to product sales as Schering began tosell product manufactured by us in additional European markets, (iii) $1.3million from the timing of clinical products and (iv) $0.7 million due tothe benefit of the movement in the Euro to U.S. Dollar exchange rate.These increases were partially offset by $5.5 million from reduced shipments toBerlex and $1.8 million from inventory ordering patterns.

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*TOBI*®* tobramycin solution for inhalation  *Wesell TOBI® solution directly in the U.S. and certaininternational markets. The increase in sales for the three months ended September 30,2005 as compared with the three months ended September 30, 2004 was primarilydue to (i) $4.7 million due to price increases and (ii) $2.1 milliondue to increased patient demand in both the United States and Europe. Theseincreases were partially offset by $4.6 million reduction due towholesaler ordering patterns. The increase in sales for the nine months ended September 30,2005 as compared with the nine months ended September 30, 2004 wasprimarily due to (i) $9.1 million due to price increases, (ii) $8.4million due to increased patient demand in both the United States and Europeand (iii) $1.5 million due to the benefit of the movement in the Euro toU.S. dollar exchange rate. These increases were partially offset by$10.4 million reduction due to wholesaler ordering patterns and $0.8million for a government rebate adjustment.

*PROLEUKIN*®* (aldesleukin)  *Thedecrease in PROLEUKIN® (aldesleukin) product sales for the threemonths ended September 30, 2005 as compared with the three months ended September 30,2004 was primarily due to (i) $2.7 million due to a decrease inpatient demand as a result of increased clinical trial activity and (ii) $1.1million for wholesaler inventory ordering patterns. These decreases werepartially offset by (i) $3.0 million for price increases. The decrease inPROLEUKIN® (aldesleukin) product sales for the nine monthsended September 30, 2005 as compared with the nine months ended September 30,2004 was primarily due to (i) $6.5 million due to a decrease in patientdemand as a result of increased clinical trial activity, (ii) $3.5 millionfor wholesaler inventory ordering patterns and (iii) $1.6 million for agovernment rebate adjustment. These decreases were partially offset by $4.8million for price increases.

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

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

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

*BETAFERON*®* interferon beta-1b  *BETAFERON® product royalties were $13.4 million for eachof the three months ended September 30, 2005 and 2004, respectively, and$45.8 million and $38.8 million for the nine months ended September 30,2005 and 2004, respectively.

BETAFERON® product royalties were consistent for thethree months ended September 30, 2005 as compared with the three monthsended September 30, 2004. The increase in demand of $1.7 million and $0.8million from price increases was partially offset by $1.7 million from a shiftof revenue from royalties to product sales as Schering began to sell productmanufactured by us in additional European markets. The increase in BETAFERON® product royalties for the nine months ended September 30,2005 as compared with the nine months ended September 30, 2004 wasprimarily due to (i) $4.0 million from an increase in demand and (ii) $2.5million from price increases. These increases were partially offset by $1.7million from a shift of revenue from royalties to product sales as Scheringbegan to sell product manufactured by us in additional European markets.

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

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

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

**Other revenues**

*Contract manufacturing revenues  *Ourbiopharmaceuticals segment recognized contract manufacturing revenues of $0.4million and $1.1 million for the three months ended September 30,2005 and 2004, respectively. Contract manufacturing revenues were $7.4 millionand $8.6 million for the nine months ended September 30, 2005 and2004, 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  **Theincrease in gross profit margin for the three months ended September 30,2005 as compared with the three months ended September 30, 2004 wasprimarily due to favorable product mix and increased utilization of facilities.The decrease in gross profit margin for the nine months ended September 30,2005 as compared with the nine months ended September 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 September 30, 2005 ascompared with the three months ended September 30, 2004 was primarily dueto (i) $2.4 million for the progression of phase I clinical studies of ouroncology compound CHIR-258, (ii) $0.9 million for activities relatedto the development of tifacogin and (ii) $5.3 million for other researchand development activities, primarily related to early-stage oncology compounds.These increases were partially offset by (i) a $2.4 million decrease inexpenses for the development of PULMINIQTM (cyclosporine, USP) inhalationsolution, (ii) a $1.5 million decrease in expenses related to the SILCAATtrial, as discussed below and (iii) a $1.4 million decrease in expenses fordevelopment activities related to CUBICIN® (daptomycin forinjection) for treatment of complicated skin and soft tissue infections.

The increase in research and development expenses forthe nine months ended September 30, 2005 as compared with the nine monthsended September 30, 2004 was primarily due to (i) $6.1 million forthe progression of phase I clinical studies of our oncology compound CHIR-258,(ii) $2.4 million for development activities related to CUBICIN® (daptomycin for injection) for treatment ofcomplicated skin and soft tissue infections, (iii) a $1.7 million increase inexpense related to the development of new processes and performance of testruns related to installed equipment of our existing manufacturing facilities tosupport the supply of BETAFERON® interferon beta-1b to Schering, (iv) $1.4million for the progression of phase I clinical studies of our oncologycompound CHIR-12.12, (v) $1.3 million for activities 

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related to the developmentof tifacogin and (vi) $13.5 million for other research and developmentactivities, primarily related to early-stage oncology compounds. Theseincreases are partially offset by (i) a $5.4 million decrease inexpenses related to the SILCAAT trial, as discussed below, (ii) a $2.7million decrease in expenses for the development of PULMINIQ®(cyclosporine, USP) inhalationsolution and (ii) a $3.0 million decrease related to the discontinueddevelopment of tezacitabine in the first quarter of 2004 based on an analysisof the data from a Phase II trial in patients with gastro esophageal cancer.

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 theNational Institutes Allergy and Infectious Disease (NIAID) and the Universityof Minnesota. Responsibility for the SILCAAT study was transferred to NIAID andUniversity of Minnesota effective February 14, 2003. Under the agreement,we are obligated to fund a maximum of $18.0 million over the lifetime of thetrial and to supply clinical materials and certain other support services ofwhich $18.0 million has been paid through December 31, 2004.

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

**Selling, general, and administrativeexpenses  **The increase in selling, general andadministrative expenses for the three months ended September 30, 2005 ascompared with the three months ended September 30, 2004 was primarily dueto pre-launch costs for CUBICIN® (daptomycin for injection). The increase inselling, general and administrative expenses for the nine months ended September 30,2005 as compared with the nine months ended September 30, 2004 wasprimarily due to (i) $6.8 million for pre-launch costs for CUBICIN® (daptomycin for injection), (ii) $1.3 millionfor other worldwide marketing activities, (iii) $1.1 million of pre-launchcosts for PULMINIQTM (cyclosporine, USP) inhalation solution, (iv) $1.0million for increased TOBI® 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**

We view certain otherrevenues and expenses, particularly certain royalty and license fee revenuesprimarily related to HIV and HCV-related patents, and unallocated corporateexpenses, as not belonging to any one reportable segment. As a result, we haveaggregated these items into an “Other” segment.

| ** **                                     | ** ** | **Three Months Ended  September 30,**                 | ** ** | **Nine Months Ended  September 30,**      | ** ** | **$ Change**                                        | ** ** | **% Change**                                        | ** ** |
|------------------------------------------------|------------|----------------------------------------------------------------------|------------|----------------------------------------------------------|------------|----------------------------------------------------------|------------|----------------------------------------------------------|------------|
| ** **                                     | ** ** | **     2005     ** | ** ** | **    2004    ** | ** ** | **    2005    ** | ** ** | **    2004    ** | ** ** | **Three Months** | ** ** | **Nine Months** | ** ** | **Three Months** | ** ** | **Nine Months** | ** ** |
| ** **                                     | ** ** | **($ in 000’s, except percentages)**        | ** ** |
| Royalty and license fee revenues               |       |                                                                 | $          | 29,641                                                   |       |                                                     |       | $                                                        | 60,656     |   |   |   | $ | 94,427 |   |   |   | $ | 102,787 |   |   |   | $ | (31,015 | ) |   |   | $ | (8,360 | ) |   |   | (51.1 | )% |   |   | (8.1 | )% |   |
| Selling, general and administrative expenses   |       |                                                                 | 28,610     |                                                     |       |                                                     | 25,326     |                                                     |       |   | 109,482 |   |   |   | 77,279 |   |   |   | 3,284 |   |   |   | 32,203 |   |   |   | 13.0 | % |   |   | 41.7 | % |   |
| Purchased in-process research and  development |       |                                                                 | —     |                                                     |       |                                                     | 9,629      |                                                     |       |   | — |   |   |   | 9,629 |   |   |   | (9,629 | ) |   |   | (9,629 | ) |   |   | (100 | )% |   |   | (100 | )% |   |
| Interest expense                               |       |                                                                 | 7,759      |                                                     |       |                                                     | 7,063      |                                                     |       |   | 22,932 |   |   |   | 19,440 |   |   |   | 696 |   |   |   | 3,492 |   |   |   | 9.9 | % |   |   | 18.0 | % |   |
| Interest and other  income, net                |       |                                                                 | 18,514     |                                                     |       |                                                     | 5,369      |                                                     |       |   | 66,259 |   |   |   | 41,252 |   |   |   | 13,145 |   |   |   | 25,007 |   |   |   | 244.8 | % |   |   | 60.6 | % |   |

 

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**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 countries for use of our HCV and HIVnucleic acid testing intellectual property. Two agreements relate to*in vitro* diagnostics products. The thirdagreement relates to blood screening.

Under the hepatitis C virus agreement, we received$85.0 million, of which we recognized $40.0 million in the fourthquarter 2000. We deferred the remaining $45.0 million, which becomesnonrefundable ratably through 2005. In the first quarter 2001, we beganrecognizing portions of the $45.0 million based upon the greater of (i) thescheduled quarterly minimum non-refundable amount or (ii) the actualearned credits as royalties on future sales related to Roche’s use of ourHCV-related patent in its*in vitro*diagnostic products. The agreement also provides for royalties on future salesrelated to Roche’s use of our HCV-related patent in its*in vitro* diagnostic products, whichcommenced in the first quarter 2001. Royalty revenues under the hepatitis Cvirus agreement increased for the three months ended September 30, 2005 ascompared with the three months ended September 30, 2004, by$2.6 million and 20.9%. Royalty revenues under the hepatitis C virusagreement increased for the nine months ended September 30, 2005 ascompared with the nine months ended September 30, 2004, by$3.9 million and 10.0%.

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, which commencedin the first quarter 2001 when the European Patent Office Board of TechnicalAppeals upheld our HIV-related patent. Royalty revenues recognized under thisagreement decreased by $31.9 million for the three months ended September 30,2005 as compared with the three months ended September 30, 2004. Thisdecrease is mainly due to the recognition of $35.6 million of deferredroyalties and license fees and a nonrefundable portion of a royalty paymentfrom the September 10, 2004 settlement with Roche, as discussed below. Royaltyrevenues recognized under this agreement decreased by $15.5 million forthe nine months ended September 30, 2005 as compared with the nine monthsended September 30, 2004. This decrease is mainly due to $35.6 million ofdeferred royalties and license fees and a nonrefundable portion of a royaltypayment from the September 10, 2004 settlement with Roche, as discussedbelow. This decrease is partially offset by $21.2 million in royaltiesrecognized under the September 10, 2004 settlement with Roche, asdiscussed below, for the nine months ended September 30, 2005.

An HIV-related patent directed to nucleic acid testingmethods for HIV-1 was issued in the U.S. on March 13, 2003. Thispatent will expire seventeen years from the date of issuance. The issuance ofthe patent triggered a milestone payment to us of $10.0 million fromRoche, which was received in April 2003. As permitted under the terms ofits licensing agreement, Roche decided to institute arbitration proceedings inregard to the application of the U.S. patent. We had deferred recognition ofthe $10.0 million milestone payment, interest, royalties received androyalties accrued under the patent until the resolution of this dispute. On September 10,2004, we reached a settlement agreement with Roche. Under the terms of thesettlement agreement, the milestone payment along with any royalties receivedprior to March 31, 2004 became non-refundable. Accordingly, 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 nine 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 

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between $64.0 millionand $0.0 million. The amount of the refund available to Roche decreases inincrements over the quarters of 2005 and 2006. As such, Chiron expects torecognize $64.0 million of the payment as revenue during 2005 and 2006.The remaining $14.0 million is nonrefundable and was recognized as revenuein the 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. Theapplicable issued HIV-related patent in Europe expired in October 2005.For the three months ended September 30, 2005, we recognized $5.3 millionof revenue from this settlement in our other segment and $2.7 million ofrevenue from this settlement in our blood-testing segment. For the nine monthsended September 30, 2005, we recognized $21.2 million of revenue from thissettlement in our other segment and $10.8 million of revenue from thissettlement in our blood-testing segment. Revenues earned from diagnosticproducts are included in our other segment and revenues earned from bloodscreening are included in our blood-testing segment.

Theimpact on revenues for the three and nine months ended September 30, 2004from the September 10, 2004 settlement with Roche is summarized below (inthousands).

| ** **                                   | ** ** | **Other Segment** | ** ** | **Blood-testing Segment** | ** ** | **Total** | ** ** |
|----------------------------------------------|------------|------------------------|------------|--------------------------------|------------|-----------|------------|
| Deferred revenues  recognized                |       |                   | $          | 16,313                         |       |      |       | $ | 5,453 |   |   | $ | 21,766 |   |
| Deferred license  fee recognized.            |       |                   | 10,000     |                           |       |      | —     |   |   | 10,000 |   |
| Non-refundable  portion of Roche settlement. |       |                   | 9,333      |                           |       |      | 4,667      |   |   | 14,000 |   |
| Total royalty and  license fee revenue       |       |                   | $          | 35,646                         |       |      |       | $ | 10,120 |   |   | $ | 45,766 |   |

 

*Bayer  *Across-license agreement provides for royalties to us on HIV and hepatitis Cvirus products sold by Bayer Corporation. Royalties increased for the ninemonths ended September 30, 2005 as compared with the nine months ended September 30,2004 due to additional royalties of $2.4 million under our existing licenseagreement, 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 September 30, 2005 ascompared with the three months ended September 30, 2004 was primarily dueto (i) $3.9 million in higher employee related expenses and (ii) $1.7million in corporate governance costs. These increases were partially offset bylower facility costs of $1.9 million. The increase in selling, general andadministrative expenses for the nine months ended September 30, 2005 ascompared with the nine months ended September 30, 2004 was primarily dueto (i) $15.5 million of legal costs associated with the FLUVIRIN® vaccine-related developments discussed aboveunder*“Influenza Virus Vaccines RecentEvents,”* (ii) $6.5 million for higher employee relatedexpenses, (iii) $4.2 million for consulting expenses, (iv) $5.9million for corporate governance costs and (v) $1.8 million in legal costsrelated to the defense of our patents and technology. These increases werepartially offset by lower facility costs of $5.1 million.

**Purchasedin-process research and development****  **On July 2, 2004, we acquired Sagres Discoveryand accounted for the acquisition as an asset purchase. We allocated thepurchase price based on fair value of the assets acquired and liabilitiesassumed. We allocated $9.6 million of the purchase price to purchasedin-process research and development, which we charged to operations in thethird quarter 2004. We do not 

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anticipate that there willbe any alternative future use for the purchased in-process research anddevelopment.

**Interest expense  **Interestexpense for the three months ended September 30, 2005 was consistent withinterest expense for the three months ended September 30, 2004. Theincrease in interest expense for the nine months ended September 30, 2005as compared with the nine months ended September 30, 2004 primarilyrelated to interest expense recognized on the $385.0 million convertibledebentures that were issued on June 22, 2004 partially offset by the lowerinterest expense recognized on the Liquid Yield Option Notes (LYONs), themajority 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 $9.2 million and $6.6 million for the three monthsended September 30, 2005 and 2004, respectively. We recognized interestincome of $25.4 million and $17.5 million for the nine months ended September 30,2005 and 2004, respectively. These increases were due to higher interest ratesin 2005 as compared with 2004.

We recognized gains of $7.2 million and$1.0 million for the three months ended September 30, 2005 and 2004,respectively, related to the sale of certain equity securities. We recognizedgains of $35.8 million and $25.0 million for the nine months ended September 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.

In the third quarter of 2005, we recognized a $2.6million insurance settlement regarding a building fire at our Emeryville campus.

There were no losses attributable to impairment ofequity securities for the three months ended September 30, 2005. For thenine months ended September 30, 2005, we recognized losses attributable tothe impairment of certain equity securities of $1.3 million. For the three andnine months ended September 30, 2004, we recognized losses attributable tothe impairment of certain equity securities of $1.4 million.

On December 31, 1998, we completed the sale ofour 30% interest in General Injectibles & Vaccines, Inc., adistribution business, to Henry Schein, Inc. and received payment in fullof certain advances we made to General Injectibles & Vaccines. Theagreement also provided for us to receive additional payments, calculated as apre-determined percentage of Henry Schein’s gross profit, through 2003. Wereceived $3.5 million for 2003 during the nine months ended September 30,2004.

**Income taxes  **Theeffective tax rate was 21.9% and 27.3% of pretax income from continuingoperations for the nine months ended September 30, 2005 and 2004,respectively. The tax ratedecreased primarily due to lower expected taxable incomes, year toyear, in certain high tax jurisdictions, as well as increased benefits ofU.S. research credits. Such items are not expected to recur in future years. The effective tax rate may be affectedin future periods by changes in management’s estimates with respect to ourdeferred tax assets and other items affecting the overall 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.Pursuant to this settlement, we recognized a tax benefit of approximately$12.5 million for the nine months ended September 30, 2004.

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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 nine months ended September 30, 2004. Thisnet gain primarily relates to a tax benefit as a result of the settlementpayment to Bayer.

**New AccountingStandards**

In December 2004, the Financial AccountingStandards Board (FASB) issued Statement of Financial Accounting Standards No. 123(revised 2004),*Share-Based Payment*(SFAS 123(R)), which requires the cost resulting from all share-based paymenttransactions to be recognized in the consolidated financial statements. Thatcost will be measured based on the fair value of the equity instruments issuedor on the fair value of liabilities incurred. Under SFAS 123(R), thefair-value-based method for recognition or disclosure of compensation expensewill be applied using the modified prospective application transition method orthe modified retrospective application transition method. We currently measurecompensation expense for our stock-based employee compensation under theintrinsic method. We are currently evaluating transition methods, option valuationmethodologies and assumptions in light of SFAS 123(R), and therefore cannotestimate the impact of our adoption at this time, although we expect that itsadoption will have a material impact on our consolidated financial statements.Current option values determined using the Black-Scholes-Merton formula, usedfor purposes of proforma disclosure, may not be indicative of results from thevaluation methodologies we finally adopt. The effective date of SFAS 123(R) isthe first reporting period beginning after June 15, 2005. However, on April 14,2005, the Securities and Exchange Commission (SEC) announced the adoption of anew rule that delays the effective date of SFAS 123(R) forregistrants, such as Chiron, that are not small business issuers. The SEC’s newrule allows calendar year non-small business issuers to implement SFAS 123(R) atthe beginning of 2006, which makes SFAS 123(R) effective for Chiron in thefirst 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 September 30, 2005, we have not provided deferred taxes on foreignearnings because such earnings were intended to be indefinitely reinvestedoutside the U.S. Presently we do not have any plan to repatriate earnings underthe Act. Accordingly, we have made no change in our current intention toindefinitely reinvest accumulated earnings of our foreign subsidiaries. If werepatriate these earnings, a tax charge to our consolidated results ofoperations could occur. We will continue to evaluate the impact of thisprovision.

**Liquidity andCapital Resources**

Our capital requirements have generally been funded bycash flow from operations, borrowings from commercial banks and issuance ofconvertible debt securities and common stock. Our cash, cash equivalents andinvestments in marketable debt securities, which totaled $1,017.8 million at September 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.

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The recent events regarding FLUVIRIN® vaccine, as discussed above under “Management’sDiscussion and Analysis of Financial Condition and Results of Operations—*Influenza Virus Vaccines Recent Events*”will continue to impact our cash flow going forward. As we continue toimplement our remediation plan, our efforts will entail additional cashpayments, which will be material. The MHRA’s lifting of our license suspensionis conditioned upon the understanding that our commitment to remediation willcontinue.

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 investigation and the shareholder class action and derivativeprivate lawsuits and other claims arising out of or related to these developmentsregarding FLUVIRIN® vaccine. The results of any suchinvestigations, proceedings or disputes could have a material adverse effect onour cash flow.

Our previous inability to supply FLUVIRIN® vaccine may also lead to loss of market sharein the 2005-2006 influenza season and future seasons. Following theannouncement of our FLUVIRIN® license suspension competitors announced plansto 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 normal manufacturingissues inherent in the complexity of influenza vaccine production, haveadversely affected the amount of FLUVIRIN® vaccine that weare able to produce for the 2005-2006 influenza season and may result infurther loss of market share. Loss of market share could have a materialadverse effect on cash flow.

The recent events regarding BEGRIVACTM vaccine, as discussed aboveunder “Management’s Discussion and Analysis of Financial Condition andResults of Operations—*Influenza VirusVaccines Recent Events*” will impact our cash flow going forward. Wewill be unable to supply any BEGRIVACTMvaccine doses for the 2005-2006 influenza season, which willeliminate any cash flows we would have received from the sale of BEGRIVACTM vaccine. Our inability to supplyBEGRIVACTM vaccine asplanned 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 in the process of implementing remedialmeasures to address the product sterility issue, including facilitymodifications our remediation efforts will entail cash payments for additionalcapital and other expenditures, which could be material. If we suffer apermanent loss of BEGRIVACTMinfluenza vaccine sales, it could have a material adverse effect on our cash flow.

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

For additional information concerning the risks weface as a result of these influenza vaccine developments, see “Factors That May AffectFuture Results—*Developments with respect to influenzavaccines over the past year will harm our business and results of operations*.”For additional information on the U.S. Attorney’s investigation, SECinvestigation, private lawsuits and other claims, see Part II, Item 1. “LegalProceedings” of this Report on Form 10-Q.

Under the terms of the Investment Agreement betweenNovartis and Chiron, Novartis agreed to guarantee certain Chiron obligations upto a maximum of $702.5 million. As a result of the exercise of our subscriptionright as described under “Management’s Discussion and Analysis of FinancialCondition and Results of Operations—*Recent Developments*,”the maximum amount Novartis is required to guarantee pursuant to the terms ofthe Investment Agreement has been reduced by $300.0 million, the amount of ourcommon stock Novartis will be required to subscribe for, to $402.5 million. Underthis agreement, Novartis 

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has guaranteed $100.0million under a U.S. credit facility in which there were no borrowingsoutstanding at September 30, 2005 and $173.3 million from a leasecommitment for a research and development facility in Emeryville, 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 BEGRIVACTM influenza vaccine sales, whether through loss of regulatoryapprovals, market share or otherwise, it could have a material adverseeffect on our cash flow.

**Sources and uses of cash  **Wehad cash and cash equivalents of $204.4 million and $201.0 million at September 30,2005 and 2004, respectively.

*Operating activities  *Forthe nine months ended September 30, 2005, net cash provided by operatingactivities was $117.6 million as compared with $132.6 million for the ninemonths ended September 30, 2004. The decrease in cash provided byoperating activities was primarily due to costs associated with our remediationefforts for our Liverpool plant and legal costs related to the FLUVIRIN® vaccine developments discussed above. Cashprovided by operating activities also decreased due to (i) increasedselling, general and administrative expenses in the nine months ended September 30,2005 primarily due to ongoing marketing and pre-launch programs to support thecontinued growth of our business, investment in geographic penetration, higheremployee related costs and corporate governance costs, and (ii) increasedresearch and development expenses in the nine months ended September 30,2005 primarily due to development efforts in our oncology franchise,development efforts for CUBICIN® (daptomycin for injection), meningococcalvaccines franchise, flu cell culture, development of new processes andprocedures in existing manufacturing facilities for BETAFERON interferon beta-1band blood-testing programs. These decreases were partially offset by a $78.0million lump-sum payment received in lieu of royalties beyond January 1,2005 as part of the Roche settlement reached on September 10, 2004 andincreased sales of our travel vaccines, meningococcal vaccines and PROCLEIX® product sales, partially offset by decreasesin sales of our pediatric and other vaccines.

*Investing activities  *Forthe nine months ended September 30, 2005, net cash used in investingactivities consisted of purchases of investments in marketable debt securitiesof $714.2 million, capital expenditures of $141.0 million, other uses of cashof $10.4 million, issuance of notes receivable of $5.0 million, purchases ofequity securities and interests in affiliated companies of $4.3 million andcash paid for acquisitions net of cash acquired of $3.3 million. Included innet cash paid for acquisitions was $2.6 million for previously accrued costs inconnection with acquisition costs related to the acquisition of PowderJect and$0.7 million of cash paid for the acquisition of Sagres. Cash used ininvesting activities was offset by proceeds from maturities of investments in marketabledebt securities of $499.1 million, proceeds from sales of investments inmarketable debt securities of $194.5 million, and proceeds from the sale ofequity securities and interests in affiliated companies of $30.0 million.

For the nine months ended September 30, 2004, netcash used in investing activities consisted of purchases of investments inmarketable debt securities of $724.6 million, capital expenditures of $134.1million, cash paid for acquisitions net of cash acquired of $32.3 million, purchasesof equity securities and interests in affiliated companies of $6.2 million andother uses of cash of $5.2 million. Included in net cash paid for acquisitionswas $5.6 million for previously accrued costs in connection with theacquisition of PowderJect, $15.5 million of cash delivered on the divestitureof certain operations in Wisconsin, the U.K., and Sweden and $11.2 million ofcash paid for the acquisition of Sagres. Cash used in investing activities wasoffset by proceeds from sales of investments in marketable debt securities of$415.1 million, proceeds 

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from maturities ofinvestments in marketable debt securities of $226.0 million, and proceeds fromthe sale of equity securities and interests in affiliated companies of $31.4million and proceeds from notes receivable of $1.5 million.

*Financing activities  *Forthe nine months ended September 30, 2005, net cash provided by financingactivities consisted of $38.6 million of proceeds from the re-issuance oftreasury stock and $1.0 million of proceeds from the issuance of debt offset by$0.6 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 September 30,2005, no shares were repurchased.

For the nine months ended September 30, 2004, netcash used in financing activities consisted of $380.2 million for the repaymentof debt and capital leases, $129.7 million for the acquisition of treasurystock and $8.3 million for the payment of debt issuance costs. Cash used infinancing activities was offset by $385.0 million of proceeds fromissuance of convertible debentures, $64.2 million of proceeds from there-issuance of treasury stock and $5.0 million of proceeds from the issuance ofdebt.

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 by NovartisAG under a November 1994 Investment Agreement, provides various interestrate options and matures in February 2006. There were no borrowingsoutstanding under this credit facility at September 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. As a result of the exercise of oursubscription right as described under “Management’s Discussion and Analysis ofFinancial Condition and Results of Operations—*RecentDevelopments*,” the maximum amount Novartis is required to guaranteepursuant to the terms of the Investment Agreement has been reduced by $300.0million, the amount of our common stock Novartis will be required to subscribefor, to $402.5 million. Out of the maximum guarantee of $402.5 million, thecredit agreement and lease discussed above have reduced the amount of our debtNovartis would be required to guarantee by $273.3 million. There remains $129.2million of the guarantee available following the exercise of our subscriptionright. The Novartis loan guarantee will expire on January 1, 2008 unlesscertain debt ratings are triggered which would extend the guarantee on adeclining basis ratably over the subsequent three-year period.

**Off-Balance SheetArrangements**

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

**Factors That May AffectFuture 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, presentations and otherstatements issued by us from time to time reflect our current beliefs andexpectations concerning objectives, plans, strategies, future performance andother future events. The 

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followingdiscussion highlights some of the factors, many of which are beyond ourcontrol, which could cause actual results to differ materially.

*Chironwill be subject to business uncertainties and contractual restrictions whilethe merger with Novartis is pending.*

Uncertainty about the effect of the merger withNovartis on employees, customers and other constituencies may have an adverseeffect on Chiron.  These uncertaintiesmay impair our ability to attract, retain and motivate key personnel until themerger is consummated, and could cause customers, suppliers, partners andothers that deal with us to seek to change existing businessrelationships.  Retention of certainemployees may be challenging during the pendency of the merger, as certainemployees may experience uncertainty about their future roles after themerger.  If key employees depart becauseof issues relating to the uncertainty and difficulty of integration or a desirenot to remain with Novartis after the merger, our business could beharmed.  In connection with the pendingmerger, some distributors, customers and strategic partners could delay ordefer decisions, which could negatively impact revenues, earnings and cashflows of Chiron.

In addition, the merger agreement restricts us fromtaking specified actions without the consent of Novartis, including makingcertain capital expenditures, entering into material contracts and othermatters.  These restrictions may preventus from pursuing attractive business opportunities that may arise prior to thecompletion of the merger and may impede our growth and limit the development ofour projects, which could negatively impact revenues, earnings and cash flowsof Chiron.

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

In October 2004, the U.K. regulatory body, theMedicines and Healthcare products Regulatory Agency, or MHRA, suspended ourlicense to manufacture FLUVIRIN® atour Liverpool, U.K. facility. As a result of the suspension of our license, wedid not release any FLUVIRIN® vaccine during the 2004-2005 influenzaseason. On March 2, 2005, the MHRA notified us that it had lifted thelicense suspension, giving Chiron clearance to initiate full production ofFLUVIRIN® vaccine, conditioned on the understanding thatChiron’s commitment to its remediation plan will continue and will be subjectto further inspections by the MHRA.

On October 17, 2005 we initiated delivery andrelease of FLUVIRIN® vaccine to customers in the United States forthe 2005-2006 influenza season. As of such time, we had received allnecessary approvals from the U.S. Food and Drug Administration (FDA) and MHRAto start supplying FLUVIRIN® vaccine to the U.S. market. Continuedshipments of FLUVIRIN® vaccine will need to undergo correspondinginternal release procedures and standard FDA influenza vaccine lot releaseprocedures.

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 ourlicense. In February 2005, after having previously commenced an informalinquiry, the Securities and Exchange Commission, or SEC, notified us that itwould commence a formal investigation into whether we or our employees violatedany federal securities laws in connection with these developments regardingFLUVIRIN® vaccine, and Chiron subsequently receivedsubpoenas from the SEC requesting production of certain documents relating toour Liverpool facility and FLUVIRIN® vaccine. We also received a voluntary requestfor information from the United States House of Representatives, Energy andCommerce Committee, Subcommittee on Oversight and Investigations requestingproduction of certain documents. Numerous documents have been collected andproduced in response to these requests, and several witnesses have beeninterviewed by the U.S. Attorney’s Office, the SEC staff and Congressionalstaff. Additional investigations regarding these matters may arise.

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In addition, we and certain of our officers anddirectors have also been named as defendants in several putative shareholderclass action and derivative lawsuits alleging various claims arising out of orrelating to these developments regarding FLUVIRIN® vaccine, which are described below in Part II,Item 1, “Legal Proceedings”. Certain distributors and other parties withwhom 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 inthe future. On January 27, 2005, the U.S. Centers for Disease Control andPrevention, or CDC, terminated its contracts with Chiron for the supply ofFLUVIRIN® vaccine for default on the basis of Chiron’sfailure to supply such vaccine to the U.S. government for the 2004-2005influenza season. The CDC has reserved the right to hold Chiron liable for anyexcess costs it may have incurred in replacing any FLUVIRIN® vaccine that Chiron failed to deliver andfurther has reserved all other remedies provided under the contract. It is notpossible to predict whether any of these claims will be pursued and, if so,whether those claims will be upheld. Investigations, litigation and disputeshave caused us to incur substantial expense and have required significant timeand attention from our management and will continue to do so in the future andcould result in civil action and/or criminal proceedings against Chiron. Theresults of any such investigations, proceedings or disputes could have amaterial adverse effect on our consolidated financial position and results ofoperations and/or cash flow.

Although the MHRA has lifted its suspension of ourlicense to manufacture FLUVIRIN® vaccine, we expect to incur additionalexpenses in connection with ongoing FLUVIRIN® vaccine matters, which could be material,including in connection with (1) our continuing remediation efforts at ourLiverpool facility; and (2) responding to the U.S. Attorney for theSouthern District of New York, the SEC, the United States House 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 the U.S. Attorney’sinvestigation, SEC investigation, private lawsuits and other claims, see Part II,Item 1. “Legal Proceedings” of this report on Form 10-Q.

BEGRIVACTM vaccine ismanufactured at our facility in Marburg, Germany. In July 2005, wereported that we would be unable to supply any BEGRIVACTM vaccine doses for the2005-2006 influenza season due to a product sterility issue and wrote offour existing product inventory resulting in charges of $3.0 million and $18.0million to cost of sales for the three and nine months ended September 30,2005 respectively. Investigation of the product sterility issue has beencompleted and implementation of remedial measures and facility modifications isunderway. Our inability to supply BEGRIVACTM vaccine as planned to non-U.S.markets for the 2005-2006 influenza season or, if remedial efforts aredelayed or not sucessful, future seasons could have a material adverse affecton our business and results of operations. In addition, it is possible thatdistributors and other parties with whom we had contracted to supply influenzavaccine may make claims against us as a result of Chiron not supplying influenzavaccine. Any such claims may cause us to incur substantial expense and requiresignificant time and attention from our management. The results of any suchclaims could have a material adverse effect on our consolidated financialposition and results of operations and/or cash flow.

We did not release anyFLUVIRIN® vaccine during the 2004-2005 influenzaseason. As a result, our results of operations for 2004 were materiallyadversely affected by these matters. In addition, we will not release any BEGRIVACTMvaccine during the 2005-2006 influenza season. Additional issues withrespect to influenza vaccines could cause us to have to recognize an impairmentcharge with respect to the goodwill, certain other intangible assets andproperty, including without limitation the Liverpool plant resulting from thePowderJect acquisition and the new influenza vaccines manufacturing facilityunder construction in Liverpool, which could have a material adverse effect onour results of operations.

Our inability to supplyinfluenza vaccines may also lead to loss of market share in future seasons.Following the announcement of our FLUVIRIN® license suspension, competitors announcedplans to 

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introduceinfluenza vaccine products in the United States and sought expedited regulatoryapproval to do so. Even though the license suspension has been lifted, some ofour customers may choose to purchase influenza vaccine from other providers astheir products become available in the United States. Loss of market share inthe United States or foreign markets could have a material adverse effect onour business and results of operations. Delays in start-up procedures forramping up to full production and normal manufacturing issues inherent in thecomplexity of influenza vaccine production, have adversely affected the amountof FLUVIRIN® vaccine that we are able to produce for the2005-2006 influenza season and may result in further loss of marketshare.

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

We must obtain 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 each therapeutic indication.Product candidates that appear promising based on early, and even large-scale,clinical trials may not receive regulatory approval. Furthermore, the resultsof clinical trials often are susceptible to varying interpretations that maydelay, limit or prevent approval or result in the need for additionalpre-marketing or post-marketing studies. In addition, regulations may be amendedfrom time to time. Revised regulations may require us to reformulate productson a country or regional basis, obtain additional regulatory approvals, oraccept additional risks that our products will not maintain market acceptanceor be eligible for third party insurance coverage. Increased regulatoryscrutiny and restrictions regarding marketing practices for products that aresubject to government reimbursement may impact the sales of such products.There is no guarantee that we will be able to meet conditions to obtain ormaintain regulatory approval or to satisfy new regulatory requirements and maysuffer a loss of revenue as a result.

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

We focus our research anddevelopment activities on areas in which we have particular strengths and ontechnologies that appear promising. These technologies often are on the cuttingedge of modern science. As a result, the outcome of any research or developmentprogram is highly uncertain. Only a very small fraction of these programsultimately result in commercial products or even product candidates. Productcandidates that initially appear promising often fail to yield successfulproducts. In many cases, preclinical or clinical studies will show that aproduct candidate is not efficacious (that is, it lacks the intendedtherapeutic or prophylactic effect), or that it raises safety concerns or hasother side effects, which outweigh the intended benefit. Success in preclinicalor early clinical trials (which generally focus on safety issues) may 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.

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*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 contract manufacturingproducts in our facilities for such third party. Manufacturing processes whichare used to produce the smaller quantities of material needed for research anddevelopment purposes may not be successfully scaled up to allow production ofcommercial quantities at reasonable cost or at all. All of these difficultiesare compounded when dealing with novel biologic products that require novelmanufacturing processes. Additionally, manufacturing is subject to extensivegovernment regulation. Even minor changes in the manufacturing process requireregulatory approval, which, in turn, may require further clinical studies. Forsome of our products, we rely on others to supply raw materials and tomanufacture those products according to regulatory requirements.

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

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

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

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

·       The competitor may havegreater access to certain raw materials;

·       The competitor may havemore efficient manufacturing processes;

·       The competitor may adaptmore quickly to technological change;

·       The competitor may havegreater marketing capabilities;

·       The competitive product mayhave therapeutic or other advantages; or

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

The technologies appliedby our competitors and us are rapidly evolving, and new developments frequentlyresult in price competition and product obsolescence. In addition, we may beimpacted by 

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

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

We use raw materials and other supplies that generallyare available from multiple commercial sources. Certain manufacturingprocesses, however, use materials that are available from sole sources, or thatare in short supply, or are difficult for the supplier to produce and certifyin accordance with our specifications. From time to time, concerns are raisedwith respect to potential contamination of biological materials that aresupplied to us. These concerns can further tighten market conditions formaterials that may be in short supply or available from limited sources.Moreover, regulatory approvals to market our products may be conditioned 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 bulk tobramycinpowder.

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 for the packaging ofthe pre-filled diluent syringe for BETASERON® interferon beta-1b. Over time, we can usealternative packaging sources. However, if the contracted third parties becomeunable to produce or package sufficient quantities of the pre-filled diluentsyringe for BETASERON®interferon beta-1b due to work stoppages or other factors, ouroperations could be disrupted until alternative sources are secured.

In connection with the production of our influenza vaccineproducts, we must purchase large quantities of chicken eggs. For FLUVIRIN® vaccine, we purchase those eggsand incubation services from 

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a single supplier in theUnited Kingdom and, pursuant to the contract with that supplier, we have agreedto make specified purchases from that supplier through 2009, subject to ourright to terminate this agreement earlier upon payment of a termination fee. Ifour supplier were to fail to supply eggs in sufficient quantities or quality,including as a result of any health or other issues related to the chickens,our business would be materially adversely affected.

We are a key provider 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 currentlysource the related instrument system from third party suppliers. Currently,Gen-Probe is the only manufacturer of nucleic acid testing products usingTranscription-Mediated Amplification technology. In immunodiagnostics, underthe Ortho-Clinical Diagnostics, Inc. contract, we manufacture bulkreagents and antigens and confirmatory test kits sold in the clinicaldiagnostics and blood screening fields. While we and our partners work tomitigate the risks associated with being a key provider, there can be noassurance that our partner, Gen-Probe, will be able to provide sufficientquantities of the 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’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 our products,we may have to withdraw from the market or delay the introduction of theaffected 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).

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*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 andreimbursement status of newly approved, novel biotechnology products, and itmay be challenging to meet the current pricing and reimbursement policies forexisting products, which may be complex, subject to change and limit ourrevenues. In certain foreign markets, governments have issued more extensiveregulations relating to the pricing and profitability of pharmaceuticalcompanies, which can be expected to limit our revenues from certain products.There have been proposals in the U.S. (at both the federal and state level) toimplement such controls. If the United States Congress enacts legislativeproposals addressing parallel importation currently being deliberated, revenuesfrom certain products may be affected further by this change in U.S. policy.The growth of managed care in the U.S. also has placed pressure on the pricingof healthcare products. These pressures 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 

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between drug manufacturerson one hand and prescribers, purchasers, pharmacies, Group Purchasing Organizations,and pharmacy benefit and formulary managers on the other, along with suchindirect purchasers as health plans. Although there are a number of statutoryexemptions and regulatory safe harbors protecting certain activities fromprosecution, the exemptions and safe harbors are drawn narrowly. Activitiesthat fall outside of a safe harbor are not necessarily illegal, but practicesthat involve direct or indirect remuneration intended to induce prescribing,purchasing, or recommending of products may be subject to governmental scrutinyif they do not qualify for an exemption or safe harbor. Our practices may notin all cases meet all of the criteria for safe harbor protection fromanti-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. In addition, state Attorneys General andprivate class action plaintiffs have filed civil suits under the federal RICOstatute and a variety of state consumer protection laws claiming thatpharmaceutical companies reported inflated average wholesale prices to pricingservices used by the federal programs to set reimbursement rates, and that as aresult, Medicare beneficiaries, Medicaid programs and private payers overpaidfor drugs. Still other manufacturers have been subject to enforcement activityfor alleged violations of such federal statutes as the Prescription DrugMarketing Act, involving pharmaceutical sampling practices. The majority ofstates also have statutes or regulations similar to the federal anti-kickbacklaw and false claims laws, which apply to items and services reimbursed underMedicaid and other state programs, or, in several states, apply regardless ofthe payor.

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

*Our mishandling ofhazardous materials could result in substantial costs and harm to our business.*

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

*Our patents may notprevent competition or generate revenues.*

We seek to obtain patentson many of our inventions. Without the protection of patents, competitors maybe able to use our inventions to manufacture and market competing 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 

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remainto be resolved as to the extent and scope of available patent protection forbiotechnology products and processes in the U.S. and other important markets.We do not know how many of our pending patent applications will be granted, orthe effective coverage of those that are granted. In the U.S. and otherimportant markets, the issuance of a patent is neither conclusive as to itsvalidity nor the enforceable scope of its claims. We have engaged insignificant litigation to determine the scope and validity of certain of ourpatents and expect to continue to do so. An adverse outcome of litigation couldresult in the reduction or loss of royalty revenues. Engaging in patentlitigation against one party may place significant royalty revenues received orto be received from other parties at risk. Even if we are successful inobtaining and defending patents, there can be no assurance that these patentswill provide substantial protection. The length of time necessary to resolvepatent litigation successfully may allow infringers to gain significant marketadvantage. Third parties may be able to design around the patents and develop competitiveproducts that do not use the inventions covered by our patents. Many countries,including certain countries in Europe, have compulsory licensing laws underwhich a patent owner may be compelled to grant licenses to third parties (forexample, the third party’s product is needed to meet a threat to public healthor safety in that country, or the patent owner has failed to “work” theinvention in that country, or the third party has patented improvements). Inaddition, most countries limit the enforceability of patents against governmentagencies or government contractors. In these countries, the patent owner may belimited to monetary relief and may be unable to enjoin infringement, whichcould materially diminish the value of the patent. In addition, royaltyrevenues may decline as patents expire.

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

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

·       Use of cash resources;

·       Potentially dilutiveissuances of equity securities;

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

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

·       Amortization expensesrelated to other intangible assets; and

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

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

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

·       Difficulties inassimilating the operations, products, technology, information systems orpersonnel of the acquired company;

·       Diversion of management’sattention from other business concerns;

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

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·       The assumption of known andunknown liabilities of the acquired company, including intellectual propertyclaims; and

·       Subsequent loss of keypersonnel.

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

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

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

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

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

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

·       fluctuationsin currency exchange rates and economic instability such as higher interestrates and inflation;

·       difficultiesin hedging foreign currency transaction exposures;

·       difficultiesin staffing, managing, training and operating our international operations;

·       difficultiesin coordinating the activities of our geographically dispersed and culturallydiverse operations;

·       costsand delays associated with coordinating operations in multiple languages;

·       potentialloss of proprietary information due to laws that may be less protective of ourintellectual property rights; and

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

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

As of September 30,2005, our total debt including current portion, was $939.8 million. Our levelof debt could restrict our operations and make it more difficult for us tosatisfy our obligations under the 2033 and the 2034 convertible debentures (the“debentures”). Among other things, our level of debt may:

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

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

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

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

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

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

We and our subsidiaries may still be able to incursubstantially more debt. The terms of our credit facility, the indenturegoverning the debentures and the agreements governing our other debt permitadditional borrowings. Our incurrence of additional debt could furtherexacerbate the risks described above.

Our ability to satisfy ourobligations under the debentures and our other debt agreements will depend onour future operating performance, which will be subject, in part, to factorsbeyond our control, including general economic and business conditions. If weare unable to generate sufficient cash flow to service our debt, we may berequired to refinance all or a portion of our debt, including the debentures,obtain additional financing, sell some of our assets or operations, reduce ordelay capital expenditures, or revise or delay our strategic plans. If we arerequired to take any of these actions, it could have a material adverse effecton our business, financial condition and results of operations. In addition, wecannot assure you that we would be able to take any of these actions, thatthese actions would enable us to continue to satisfy our capital requirementsor that these actions would be permitted under the terms of our various debtinstruments, including the indenture governing the debentures.

*Our relationshipwith Novartis AG could limit our ability to enter into transactions or pursueopportunities in conflict with Novartis and could cause the price of our commonstock to decline.*

On October 30, 2005, weentered into a merger agreement with Novartis AG and Novartis Corporation,pursuant to which Chiron will become a wholly owned subsidiary of NovartisCorporation.  Apart from the transactionscontemplated by the merger agreement, we have an alliance with Novartis AG, alife sciences company headquartered in Basel, Switzerland. Under a series ofagreements between Chiron and Novartis, which will continue in force while ourmerger with Novartis is pending or if the merger is not completed, and as aresult of subsequent stock issuances by Chiron, Novartis’ ownership interest inChiron was approximately 42% as of September 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 transactions that would adversely impact the rights of Novartis, ordiscriminate against Novartis, as a Chiron stockholder. In addition, a majorityof the independent directors must approve any material transactions betweenChiron and Novartis. These provisions may limit our ability to enter intotransactions with third parties otherwise viewed as beneficial to Chiron. Inaddition, as discussed under “*Chiron will be subject tobusiness uncertainties and contractual restrictions while the merger withNovartis is pending*,” our merger agreement with Novartis containsadditional and more restrictive limitations on our operations while the mergeragreement is in effect. All of our shares owned by Novartis are eligible forsale in the public market subject to compliance with the applicable securitieslaws. We have agreed that, upon Novartis’ request, we will file one or moreregistration statements under the Securities Act in order to permit Novartis tooffer and sell shares of our common stock, including shares that Novartis willbe required to purchase from us pursuant to the exercise of our subscriptionrights under the subscription agreement. Sales of a substantial number ofshares of our 

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commonstock by Novartis in the public market could adversely affect the market priceof our common stock.

*Our stock pricecould be volatile.*

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

·       Fluctuations in earnings from period to period;

·       Results of clinical trials conducted by us or byour competitors;

·       Announcements by us or our competitors regardingproduct development efforts, including the status of regulatory approvalapplications;

·       Impact from the recent influenza vaccinesdevelopments;

·       The outcome of legal proceedings, includingclaims filed by us against third parties to enforce our patents and claimsfiled by third parties against us relating to patents held by the thirdparties;

·       The launch of competing products;

·       The resolution of (or failure to resolve) disputeswith strategic partners;

·       Corporate restructuring by us;

·       Adoptionof new U.S or foreign laws;

·       The sale of a substantial number of shares heldby our existing stockholders;

·       Licensing activities by us; and

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

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

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

·       Inventory managementpractices, including wholesale ordering patterns;

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

·       Seasonality of certainvaccine products;

·       The tender driven nature ofcertain vaccine products;

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

·       Foreign currency exchangerate fluctuations; and

·       The level of productreserves due to various issues, including seasonality patterns, excess andobsolete 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, financial reportingand corporate governance requirements and tax laws set by the governing bodiesand lawmakers in the U.S. and other countries where we do business. From timeto time, these governing bodies and lawmakers implement new and revised rules andlaws. These new and revised accounting standards, financial reporting andcorporate governance requirements and tax laws may require changes to ourfinancial statements, the composition of our board of directors, thecomposition, the responsibility and manner of operation of various board-levelcommittees, the information filed by us with the governing bodies andenforcement of tax laws against us. Implementing changes required by such newstandards, requirements or laws likely will require a significant expenditureof time, attention and resources, especially by our senior management. It isimpossible to completely predict the impact, if any, on Chiron of futurechanges to accounting standards, financial reporting and corporate governancerequirements and tax laws.

It is possible that theapplication of certain current accounting standards may change due toenvironmental factors, which may necessitate a change in our standard practicerelated to these accounting standards. In particular, effective 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.

**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 nine 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 hedge against a portion of ourBritish Pound currency exposures. We manage our exposures to market risks asdiscussed in further detail in Part II, Item 7A, “Quantitative andQualitative Disclosures About Market Risk” in our annual Report on Form 10-Kfor the year ended December 31, 2004.

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**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 materialinformation relating to Chiron required to be included in Chiron’s periodic SECfilings.

**(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 thepreviously issued financial statements for the second and third quarters of2004 should be restated to correct certain errors contained therein and shouldnot be relied upon. The identified errors affected product revenue, cost ofgoods sold, accounts receivable, and unearned revenue for the Company’svaccines segment. In addition to the restatement of the financial statementsfor the second and third quarters of 2004, adjustments were recorded in theconsolidated financial statements for year ended December 31, 2004 tocorrect the identified errors.

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

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

During the first,second and third quarters of fiscal year 2005, and in connection with thepreparation of our condensed consolidated financial statements for the quartersended March 31, June 30 and September 30, 2005, as applicable,we designed and implemented additional controls and procedures 

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relatingto revenue recognition at our vaccines subsidiary in Germany to address thefirst material weakness identified above. Such additional controls andprocedures included, among others:

·       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;

·       Duringthe first, second and third quarters, review of a significant sample ofsupporting sales documentation, including customer agreements, to identifysales transactions with special terms and conditions to determine that thesales were recognized in accordance with applicable accounting principles; and

·       Duringthe third quarter, implementation of additional procedures and controls tofurther enhance detection of customer agreements that have special terms andconditions in order to help ensure that such terms and conditions areconsidered in evaluating revenue recognition.

In addition, duringthe first, second and third quarters of 2005, and in connection with thepreparation of our condensed consolidated financial statements for the quartersended March 31, June 30 and September 30, 2005, as applicable,we designed and implemented additional controls and procedures relating to thetimely recording of legal services invoices payable and estimating the accrualfor unbilled 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 of training and awareness workshops relating tothe new processes.

In addition, we have established a remediation plan toaddress the ineffective controls related to the annual tax provision process.The remediation plan includes additional controls and revisions to the taxprovision process, the implementation of new analytical tools in order toenhance the analysis and calculation of the tax provision and additionaltraining of personnel responsible for the tax provision process. During thethird quarter of 2005, we completed the design of revised controls andprocedures and are in the process of implementing a new analytical tool. Inaddition, personnel responsible for the tax provision process have completed aportion of the training.

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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 Reports on Form 10-Q for the quarters ended March 31,2005 and June 30, 2005.

***Average Wholesale Price Litigation***

In February 2005, the State of Illinois throughits Attorney General filed a complaint in the Circuit Court of Cook County,Illinois, County Department, Chancery Division, against numerous biotechnologyand pharmaceutical companies, including Chiron, in connection with settingaverage wholesale prices for various products that are reimbursed by Medicareand Illinois Medicaid. The Attorney General alleges that defendants violated theIllinois Consumer Fraud and Deceptive Business Practices Act, the IllinoisPublic Assistance Fraud Act, and the Illinois Whistleblower Reward andProtection Act, and seeks declaratory relief as well as damages. In August 2005,the matter was transferred to the In Re Pharmaceutical Industry AverageWholesale Price Litigation in the United States District Court for the Districtof Massachusetts.

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

It is not known when or onwhat basis these matters 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 Securities Class Actions

Between October 2004 and December 2004, fivesecurities class action lawsuits were filed against Chiron and certain Chironofficers on behalf of purchasers of Chiron securities for class periods rangingfrom July 23, 2003 through October 13, 2004. Four of the suits werefiled in the United States District Court for the Northern District ofCalifornia. One action, although originally filed in the United States DistrictCourt for the Eastern District of Pennsylvania, was later transferred to theUnited States District Court for the Northern District of California. In March 2005,the Court named lead counsel and plaintiff, and in April 2005, leadplaintiff filed a consolidated complaint. The consolidated complaint alleges,among other things, that the defendants violated certain provisions of thefederal securities laws by making false and misleading statements from July 23,2003 through October 5, 2004 concerning the amount of FLUVIRIN® vaccine Chiron projected to produceand Chiron’s historical and forecasted financial results, and seeks unspecifiedmonetary damages and other relief from all defendants. The trial is scheduledto begin on May 1, 2006.

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B.   FLUVIRIN® vaccine Shareholder DerivativeActions

Between October 2004and November 2004, six shareholder derivative complaints were filed in theSuperior Court of the State of California for the County of Alameda, namingChiron as a nominal party and naming certain current and former Chiron officersand directors and Novartis AG as defendants in connection with the suspensionof Chiron’s license to manufacture FLUVIRIN® vaccine. One complaint alsonamed Chiron as a defendant and sought relief from Chiron, including anequitable accounting. In December 2004, the six derivative actions wereconsolidated for discovery and trial under the caption In reChiron 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 andother relief from all defendants. The complaints did not seek any affirmativerelief from Chiron. In July 2005, the Court granted without prejudiceChiron’s and Novartis’ motions to dismiss the amended consolidated complaintbased on three agreements entered in 1994 between Chiron and Novartis, all ofwhich contain mandatory forum selection clauses requiring that any claimsarising out of or relating to the agreements must be adjudicated in Delaware.Regarding the directors and officers, the Court also dismissed those claimsimplicated by the 1994 agreements, and stayed the remaining claims pendingresolution of the action it is anticipated plaintiffs will file in Delaware. InSeptember 2005, plaintiffs filed an appeal before the Superior Court ofthe State of California for the County of Alameda.

C.   Other FLUVIRIN® vaccine Legal Matters

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

In December 2004,Belisario and Kimberly Bolanos filed suit against Chiron in the Superior Courtof the State of California for the County of Alameda, alleging they sufferedinjuries as a result of a flu shot Mr. Bolanos received and seekingmonetary damages. In August 2005, plaintiffs agreed to dismiss the suitwithout prejudice to pursue potential administrative remedies and Chiron agreedto toll the statute of limitations with regard to other certain claims.

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

Between September 1 and September 13, 2005,twelve class action lawsuits were filed by Chiron shareholders against Chiron,Novartis AG (“Novartis”), and members of Chiron’s Board of Directors(collectively, the “Defendants”) regarding Novartis’ September 1, 2005offer to acquire the approximately 58% of Chiron shares that Novartis does notalready own for $40 per share (the “Novartis Offer”). Eight of the suits werefiled in the Superior Court of the State of California in Alameda County (the “CaliforniaCourt”) by i) Ronald Abramoff, Harold Adelson, Beverly McCalla, Joan Weisberg,and David Jaroslawicz; ii) Edith Auman; iii) Joseph Fisher, MD, P.C. New ProfitSharing Trust, Trustee Joseph Fisher, MD; iv) William Lattarulo; v) StevenRosenberg and The Harold Grill IRA; vi) Tracie Scotto; vii) Albert Stein; andviii) William Steiner (the “California Plaintiffs”). The remaining four suitswere filed in the Court of Chancery of the State of Delaware in and for NewCastle County (the “Delaware Court”) by ix) Judy Longcore; x) Paulena PartnersL.L.C.; xi) Sylvia Piven; and xii) the Thomas Stone Irrevocable Trust (the “DelawarePlaintiffs”). Both the California and Delaware Plaintiffs allege thatDefendants breached their fiduciary duties or aided in the breach of thoseduties in connection with the Novartis Offer. Two of the Delaware Plaintiffsalso allege that certain provisions of the 1994 Governance Agreement betweenChiron 

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and Novartis are invalidand unenforceable under Delaware law. The complaints seek injunctive relief toprevent the Novartis Offer from being consummated, declaratory relief,unspecified monetary damages and other relief from all Defendants. In October 2005,the California Court consolidated the eight California actions and appointedlead plaintiffs and lead counsel. In November 2005, the Delaware Courtconsolidated the four Delaware actions and appointed lead plaintiffs and leadcounsel. The California Plaintiffs have agreed to stay the CaliforniaLitigation until (i) an announcement, if any, that Chiron and Novartishave agreed to consummate a merger or acquisition; or (ii) Novartisexercises certain arbitration processes contained in the Governance Agreement.

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

***Sysmex Corporation***

In March 2001, Chironfiled a complaint and petition for preliminary injunction with the OsakaDistrict Court in Japan against Sysmex Corporation (“Sysmex”) seeking damagesand an injunction against Sysmex’s manufacture and sale of the RanreamHCV II Ex kit for infringing Chiron’s Japanese Patent No. 2733138(the “‘138 patent”) claiming hepatitis C virus immunodiagnostictechnology. Sysmex denied the infringement allegations and filed twoinvalidation appeals with the Japanese Patent Office Board of Appeals againstthe ‘138 patent. In February 2003, the Japanese Patent Office Boardof Appeals, ruling on one of the invalidation appeals, found that the ‘138 patentwas invalid. In May 2003, Chiron filed an appeal of the invalidationjudgment before the Tokyo High Court. Furthermore, the second invalidationappeal was stayed pending Chiron’s appeal to the Tokyo High Court. In January 2005,the Tokyo High Court upheld the judgment of the Japanese Patent Office Board ofAppeals, and in August 2005, the Japanese Supreme Court declined to hearChiron’s appeal. The matter is thus concluded.

**Item 2**.Unregistered Sales of Equity Securities and Use of Proceeds

(c)   Our Board ofDirectors authorized the repurchase of our common stock on the open market tooffset the dilution associated with the issuance of new shares under the stockoption and stock purchase plans and the granting of share rights. On March 10,2005, the Board of Directors authorized Chiron to repurchase 5.0 millionshares of Chiron common stock through December 31, 2005. There were nostock repurchases in the third quarter of 2005.

**Item 3**.Defaults Upon Senior Securities

None.

**Item 4**.Submission of Matters to a Vote of Security Holders

None.

**Item 5**.Other Information

None.

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**Item 6**.Exhibits.

(a)   Exhibits

| Exhibit   Number | ** ** | **Exhibit**                                                                                                                                                                                                                                                                                                                                                                             |
|------------------|------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 2.01             |       | Agreement and  Plan of Merger, dated as of October 30, 2005, among Novartis Corporation,  Novartis Biotech Partnership, Inc., Chiron and Novartis AG, incorporated by  reference to Exhibit 2.01 of Chiron’s report on Form 8-K filed with the  Commission on November 1, 2005.                                                                                                    |
| 3.01             |       | Restated  Certificate of Incorporation of Chiron, as filed with the Office of the  Secretary of State of Delaware on August 17, 1987, incorporated by  reference to Exhibit 3.01 of Chiron’s report on Form 10-K for  fiscal year 1996.                                                                                                                             |
| 3.02             |       | Certificate of  Amendment of Restated Certificate of Incorporation of Chiron, as filed with  the Office of the Secretary of State of Delaware on December 12, 1991,  incorporated by reference to Exhibit 3.02 of 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 filed with the Commission on 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. |
|--------|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.511 |   | Audit Committee Charter, as amended and restated as  of September 14, 2005.                                                                                                                                                                                                                                                                      |
| 10.628 |   | Letter agreement dated October 20, 2005 between  Howard H. Pien and Chiron, incorporated by reference to Exhibit 99.1 of  Chiron’s current report on Form 8-K filed with the Commission on October  26, 2005.*                                                                                                                    |
| 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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*                    Indicatesmanagement contract or compensatory plan, contract or arrangement.

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**CHIRON CORPORATIONSeptember 30, 2005SIGNATURES**

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: November 3,  2005 |               |
|                              | BY:                | /s/  HOWARD H.  PIEN |
|                              |               | Howard H. Pien |
| * *                          | * *           | *Chief Executive Officer* |
| DATE: November 3,  2005 | * *           |
|                              | BY:                | /s/  DAVID V.  SMITH |
|                              |               | David V. Smith |
| * *                          | * *           | *Vice President and Chief Financial Officer* |

 

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