MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
OVERVIEW
THE DISCUSSION BELOW CONTAINS FORWARD-LOOKING STATEMENTS THAT INVOLVE RISKS AND
UNCERTAINTIES RELATING TO THE FUTURE FINANCIAL PERFORMANCE OF CHIRON CORPORATION
(THE "COMPANY" OR "CHIRON"), AND ACTUAL EVENTS OR RESULTS MAY DIFFER MATERIALLY.
IN EVALUATING SUCH STATEMENTS, STOCKHOLDERS AND INVESTORS SHOULD SPECIFICALLY
CONSIDER THE VARIOUS FACTORS IDENTIFIED UNDER THE CAPTION "FACTORS THAT MAY
AFFECT FUTURE OPERATING RESULTS" WHICH COULD CAUSE ACTUAL RESULTS TO DIFFER
MATERIALLY FROM THOSE INDICATED BY SUCH FORWARD-LOOKING STATEMENTS. THE COMPANY
UNDERTAKES NO OBLIGATION TO PUBLICLY RELEASE THE RESULTS OF ANY REVISIONS TO
THESE FORWARD-LOOKING STATEMENTS WHICH MAY BE MADE TO REFLECT EVENTS OR
CIRCUMSTANCES AFTER THE DATE HEREOF OR TO REFLECT THE OCCURRENCES OF
UNANTICIPATED EVENTS.
Chiron develops, manufactures and markets human healthcare products for the
prevention, diagnosis and treatment of disease utilizing innovations in
biology and chemistry. Chiron participates in three human healthcare
markets: (i) diagnostics, including blood screening tests, automated
immunodiagnostic systems, critical blood analyte systems and nucleic acid
probe tests; (ii) therapeutics, with an emphasis on oncology, serious
infectious diseases and critical care diseases; and (iii) adult and pediatric
vaccines. Chiron also develops or acquires new technologies, employing these
technologies to discover new products for the Company or for its partners.
On December 29, 1997, Chiron completed the sale of its ophthalmic business
unit, Chiron Vision Corporation ("Chiron Vision"), to Bausch & Lomb
Incorporated ("B&L"). The Company's consolidated financial statements reflect
the after-tax results of Chiron Vision as discontinued operations for all
periods presented. In addition, Chiron is currently examining various
strategic transactions, including a possible joint venture arrangement,
involving significant portions of Chiron's diagnostics business.
RESULTS OF OPERATIONS
REVENUES
The Company's revenues are derived from a variety of sources, including product
sales, joint business arrangements, collaborative agreements and product royalty
agreements. Product sales, Chiron's largest revenue category, consists of the
following product lines for the years ended December 31:
1997 1996 1995
--------- --------- ---------
(IN THOUSANDS)
Diagnostic products $ 606,734 $ 577,307 $ 541,113
Vaccine products 82,031 91,934 74,837
Therapeutic products 150,576 135,668 129,952
--------- --------- ---------
$ 839,341 $ 804,909 $ 745,902
--------- --------- ---------
--------- --------- ---------
DIAGNOSTIC PRODUCTS Diagnostic product sales include sales and sales-type
leases of immunodiagnostic testing systems (ACS:180-Registered Trademark-
automated chemiluminescence systems), reagents and supplies for these systems
and revenues from instruments, reagents and supplies under related operating
leases; sales of critical care systems, clinical chemistry products and
manual immunodiagnostic systems; and sales of branched DNA ("bDNA") probe
systems and kits for human immunodeficiency virus ("HIV"), hepatitis C virus
("HCV") and hepatitis B virus ("HBV"), which are available in the U.S. for
research use only. Sales of diagnostic products increased from $577.3
million in 1996 to $606.7 million in 1997. The increase of $29.4 million, or
5 percent, resulted primarily from a 60 percent increase in sales of bDNA
probe kits, reflecting the continued overall growth in viral load testing for
HIV, and increased sales of ACS:180-Registered Trademark- immunodiagnostic
products. An increase in ACS:180-Registered Trademark- immunodiagnostic
product sales of $21.1 million in 1997 resulted from increased sales volume
of reagents resulting from the compounding effect of increased
ACS:180-Registered Trademark- system placements as compared with 1996. The
overall increase in diagnostic product sales in 1997 was partially offset by
declining average selling prices of ACS:180-Registered Trademark-
immunodiagnostic assays and nucleic acid diagnostic products, and by reduced
sales of manual immunodiagnostic systems, and of critical care and chemistry
products. The overall increase in diagnostic product sales was also
reduced by the impact of unfavorable changes in foreign currency exchange rates
between years. Had exchange rates remained constant, particularly in Japan,
Germany and France, diagnostic product sales would have been higher by $31.9
million in 1997.
Sales of diagnostic products increased from $541.1 million in 1995 to $577.3
million in 1996. The increase of $36.2 million, or 7 percent, was primarily
due to increased sales of bDNA probe kits and increased sales of
ACS:180-Registered Trademark- immunodiagnostic products. The growth in
ACS:180-Registered Trademark- immunodiagnostic product sales was due
primarily to a 23 percent increase in sales of reagents, resulting from
continued penetration of the fully-automated instruments market.
ACS:180-Registered Trademark- placements increased 27 percent during 1996 as
compared with 1995. The overall increase in diagnostic product sales was
partially offset by reduced sales of manual immunodiagnostic systems and
unfavorable changes in foreign currency exchange rates between years. Had
exchange rates remained constant, particularly in Japan and Germany,
diagnostic product sales would have been higher by $17.0 million in 1996.
VACCINE PRODUCTS Vaccine product sales consist primarily of sales by
Chiron's Italian subsidiary of pediatric and flu vaccines in Italy and
certain international markets. Vaccine products include Polioral-TM-, a
pediatric oral polio vaccine; TriAcelluvax-TM- (formerly Acelluvax DTP-TM-),
a recombinant pediatric acellular pertussis vaccine; Agrippal-TM-, a flu
vaccine; and Morupar-TM-, a pediatric measles, mumps and rubella vaccine.
Vaccine product sales decreased from $91.9 million in 1996 to $82.0 million
in 1997. The overall decrease in vaccine product sales of $9.9 million as
compared with 1996 resulted primarily from decreased sales of Polioral-TM-
due to supply constraints during much of 1997. These supply constraints are
expected to be alleviated in the second quarter of 1998. Additionally, had
the United States ("U.S.") dollar and Italian lira exchange rate remained
constant in 1997 and 1996, vaccine product sales would have been higher by
$8.5 million in 1997. The overall increase of $17.1 million in vaccine
product sales from 1995 to 1996 was due to Chiron's expansion into new export
markets of its polio and other vaccines.
THERAPEUTIC PRODUCTS Sales of Proleukin-Registered Trademark- (aldesleukin,
interleukin-2), increased from $60.9 million in 1996 to $70.5 million in 1997,
due primarily to 16 percent and 15 percent increases in Proleukin-Registered
Trademark- units sold in domestic and European markets, respectively, and a
domestic sales price increase in April 1997. Sales of Proleukin-Registered
Trademark- increased from $54.8 million in 1995 to $60.9 million in 1996, due
primarily to 13 percent and 10 percent increases in Proleukin-Registered
Trademark- units sold in domestic and European markets, respectively. Average
worldwide selling prices remained roughly constant between 1996 and 1995.
Under the terms of a development and supply agreement with Schering AG,
Germany ("Schering AG"), and its U.S. affiliate, Berlex Laboratories, Inc.
("Berlex"), Chiron manufactures Betaseron-Registered Trademark- (interferon
beta-1b) for Berlex and Schering AG. Under the terms of the agreement,
Chiron earns an initial partial payment for Betaseron-Registered Trademark-
upon shipment to Berlex and Schering AG and a subsequent secondary payment
for Betaseron-Registered Trademark- upon net sales of the product to
patients. Beginning July 1997, the terms of payment changed, with a larger
portion due when sales are realized rather than at the time of initial
shipment. Betaseron-Registered Trademark- product sales decreased from $67.2
million in 1996 to $54.8 million in 1997 due primarily to the introduction of
a competing product in the second quarter of 1996, the decrease in contracted
initial revenues per vial and Berlex's management of its existing inventory
level. Betaseron-Registered Trademark- product sales in 1996, which decreased
slightly from 1995, reflect an increase in secondary revenues and an
offsetting decrease in initial revenues from 1995 to 1996. Offsetting these
decreases in Betaseron-Registered Trademark- product sales were increased
royalty revenues resulting from Schering AG's European sales of
Betaferon-Registered Trademark-. See additional discussion under OTHER
REVENUES herein. Based upon the level of inventories carried by Berlex, the
timing of future shipments to Berlex and the related revenue may vary.
The Company's first sales of platelet-derived growth factor ("PDGF")
contributed $18.3 million to Chiron's net product sales in 1997. PDGF is the
active ingredient in Johnson & Johnson's Regranex-Registered Trademark-
(becaplermin) Gel (recombinant human platelet-derived growth factor -
rhPDGF-BB). On December 17, 1997, Ortho-McNeil Pharmaceutical, Inc.
("Ortho-McNeil"), a Johnson & Johnson ("J&J") company, was granted Food and
Drug Administration ("FDA") approval to market Regranex-Registered Trademark-
as a treatment for diabetic foot ulcers. Chiron's sales of PDGF in the
second half of 1997 to Ortho-McNeil were made in preparation for J&J's
commercial launch of Regranex-Registered Trademark- in early 1998. Sales of
PDGF will likely fluctuate in future periods depending upon the level of
inventories carried by Ortho-McNeil and the timing of future PDGF shipments.
In December 1997, a binding agreement for supply of PDGF was executed by
Chiron and J&J.
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The Company markets most of its commercial products internationally. As a
result, product revenues in almost all product lines are affected by fluctuating
foreign currency exchange rates. Foreign product sales were approximately
$498.7 million, $486.8 million, and $453.5 million in 1997, 1996 and 1995,
respectively. The overall increase in foreign product sales from 1996 to 1997
was due primarily to increased international sales of diagnostic products,
partially offset by decreased sales of pediatric vaccines by Chiron's Italian
subsidiary. International sales of diagnostic and vaccine products accounted
for the majority of the increase in foreign product sales from 1995 to 1996. In
1997, 1996 and 1995, approximately 59 percent, 60 percent and 61 percent,
respectively, of Chiron's product sales were denominated in foreign currencies.
Product sales would have been $45.2 million higher in 1997 if currency exchange
rates had remained constant with the rates in 1996. The net effect of changing
foreign currency exchange rates did not significantly impact total product sales
in 1996 when compared with total product sales in 1995. Changing currency
exchange rates have had, and will continue to have, an impact on Chiron's
results. The Company's non-product revenues, discussed below, are largely
denominated in U.S. dollars but are affected by the Company's joint partners'
and collaborators' non-U.S. operations.
DIAGNOSTIC JOINT BUSINESS Equity in earnings of unconsolidated joint
businesses consists substantially of Chiron's one-half interest in the pretax
operating earnings of its joint diagnostics business with Ortho Diagnostic
Systems, Inc. ("Ortho"), a J&J company. The joint business sells a full line
of tests required to screen blood for hepatitis viruses and retroviruses, and
provides supplemental tests and microplate-based instrument systems to
automate test performance and data collection. The joint business also holds
the immunodiagnostic rights to Chiron's hepatitis and retrovirus technology
and receives royalties from several companies, including Abbott Laboratories
("Abbott"), Pasteur Sanofi Diagnostics, International Murex Technologies
Corporation and Genelabs Diagnostic, Inc., for their sales of certain tests.
Chiron and Ortho separately are developing new immunodiagnostic instrument
systems expected to contain broad menus of immunodiagnostic tests to serve
their respective clinical diagnostic businesses. Chiron must obtain Ortho's
agreement in order that hepatitis and retrovirus tests may be developed and
marketed for use on Chiron Diagnostics' new systems. There can be no
assurance that Chiron can obtain such agreement on acceptable terms or at
all. Refer to Item 3, "Legal Proceedings--Ortho Diagnostic Systems, Inc." of
Chiron's Form 10-K report for the fiscal year ended December 28, 1997.
Chiron's share of the pretax operating earnings of the joint business are
recorded by Chiron on a one-month lag based upon estimates supplied by Ortho.
These estimates are subject to a final adjustment 90 days after the end of each
calendar year (the "final annual accounting"). Chiron's share of the pretax
operating earnings of the Chiron-Ortho joint business decreased from $95.8
million in 1996 to $92.9 million in 1997. This decrease resulted primarily from
$6.9 million of royalties resulting from a settlement with Abbott in the third
quarter of 1996 related to prior sales of HIV immunodiagnostic tests by Abbott
(the "Abbott settlement"). Under the terms of the Abbott settlement, the joint
business continues to receive a royalty from Abbott based on the sale of
products incorporating technology covered by certain of Chiron's HIV patents.
In addition, the final annual accounting in the first quarter of 1997
contributed $2.9 million to the overall decrease in joint business revenue from
1996. Excluding the impact of the Abbott settlement and revenues derived from
the final annual accounting, Chiron's share of the pretax operating earnings of
the joint business in 1997 increased by $6.9 million as compared with Chiron's
share in 1996, primarily as a result of increased royalties.
Chiron's share of the pretax operating earnings of the Chiron-Ortho joint
business increased from $76.9 million in 1995 to $95.8 million in 1996. This
increase was due principally to an increase in the volume of HCV and HIV tests
sold; the introduction of a new HIV antigen test; increased profits from sales
growth to Ortho's overseas affiliates; the Abbott settlement; and $3.8 million
of revenues derived from the final annual accounting in the first quarter of
1996. Partially offsetting this overall increase from 1995 to 1996 was a decline
in certain product margins. The revenue recognized from the final annual
accounting in the first quarter of 1995 was not material.
Preliminary estimates of the final annual accounting for 1997 and certain
other adjustments to be recorded in Chiron's first quarter of 1998 indicate
that Chiron's share of the pretax operating earnings of the joint business in
the first quarter of 1998 will be significantly less than Chiron's share of
$25.1 million in the first quarter of 1997.
AGREEMENT WITH HOECHST AG Equity in earnings of unconsolidated joint
businesses also includes Chiron's 49 percent share of the after-tax operating
results of a joint venture, acquired in July 1996, with Hoechst AG, successor
to Behringwerke AG ("Behring"). Chiron's share of earnings from the joint
venture, including amortization of intangibles, was $13.8 million in 1997 and
$4.2 million in 1996. Chiron's share of earnings in 1997 included Chiron's
share of a $2.0
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million up-front license fee that was expensed by the joint venture during
the first quarter of 1997. Under the terms of the joint venture agreement,
Chiron has an option to purchase the remaining 51 percent interest in the
joint venture in March 1998, 1999, 2000 or 2001, and Hoechst AG has the
option to require Chiron to acquire the remaining 51 percent interest in
March 2001. In February 1998, Chiron gave notice to Hoechst AG that the
Company intends to exercise its option to purchase the remaining 51 percent
interest in the joint venture in Chiron's second fiscal quarter of 1998 for
approximately 210.7 million Deutsche marks.
BEN VENUE LABORATORIES, INC. Equity in earnings of unconsolidated joint
businesses in 1996 and 1995 includes $1.9 million and $4.1 million,
respectively, of revenues related to Chiron's 50 percent interest in a generic
cancer chemotherapeutics business with Ben Venue Laboratories, Inc. ("Ben
Venue"). In May 1996, Chiron sold its interest to Ben Venue.
COLLABORATIVE AGREEMENT REVENUES Collaborative agreement revenues consist of
fees received for research services as they are performed, proceeds from sales
of product rights, proceeds from sales of biological materials to research
partners for preclinical and clinical testing, and fees received upon attainment
of benchmarks specified in the related research agreements. Collaborative
agreement revenues recognized by the Company were $115.1 million, $122.1 million
and $58.1 million in 1997, 1996 and 1995, respectively.
During 1995, Chiron and Novartis AG ("Novartis"), successor to Ciba-Geigy
Ltd. ("Ciba"), entered into a limited liability company agreement (the
"Research Funding Agreement") to utilize research funding to be provided by
Novartis. Under the terms of the agreement, Novartis will fund from time to
time through December 31, 1999, at Chiron's request, research and development
costs for adult and pediatric vaccines and insulin-like growth factor-1
("IGF-1"). In return, Novartis will receive an interest in a stream of
royalties from future worldwide sales of certain adult and pediatric vaccines
and IGF-1. In addition, Novartis will receive an interest in promotional
rights, in countries other than in North America and Europe, for certain
adult vaccines. In December 1997, Chiron and Novartis amended the Research
Funding Agreement to add herpes simplex virus thymidine kinase ("HSV-tk") and
Factor VIII gene therapy to the funded projects. In return, Novartis will
receive a royalty stream from future worldwide sales of certain HSV-tk and
Factor VIII gene therapy products. Royalties on all specified products will
be paid for a minimum of 10 years from the later of October 1, 2001 or the
date of the first commercial sale of individual products covered by the
Research Funding Agreement, as amended. Further, such royalty payments will
continue until Novartis has received an aggregate amount equal to the sum of
all research and development funding provided by Novartis plus interest
thereon from the date of payment at a rate equal to the London Interbank
Offered Rate ("LIBOR"). In connection with these funding arrangements, Chiron
recognized collaborative agreement revenues of $53.3 million, $72.0 million
and $27.0 million from Novartis during 1997, 1996 and 1995, respectively.
The variability of this funding was principally responsible for the
fluctuation in the Company's collaborative agreement revenues between years.
In November 1995, Chiron and Novartis entered into a collaboration agreement
under which Novartis will pay $26.0 million to Chiron over a five-year period,
subject to certain adjustments, in exchange for a non-exclusive, perpetual
license to utilize Chiron's combinatorial chemistry techniques. In connection
with this agreement, Chiron recognized collaborative agreement revenues of $10.2
million, $9.4 million and $5.5 million in 1997, 1996 and 1995, respectively.
Under a November 1996 agreement with Novartis (the "November 1996 agreement"),
executed primarily in connection with a consent and agreement that resolved the
Federal Trade Commission's review of the Ciba and Sandoz Ltd. merger that
created Novartis, Chiron agreed to grant royalty-bearing licenses to
Rhone-Poulenc Rorer Inc. and Novartis for certain patent rights on the HSV-tk
gene in the field of gene therapy. As partial consideration, Novartis will pay
the Company, beginning in 1997, up to an aggregate of $60.0 million through
2001, $15.0 million of which was recognized as collaborative agreement revenues
in 1997.
In addition to increased revenues recognized under the Research Funding
Agreement, as amended, and the November 1995 collaboration agreement with
Novartis, the increase in collaborative agreement revenues from 1995 to 1996
was also attributable to amounts earned by Chiron's wholly owned subsidiary,
Viagene, Inc. ("Viagene"), which was acquired in September 1995, and Chiron's
new collaboration in 1996 with Japan Tobacco Inc. ("JT"). Chiron recognized
increased revenues of $6.9 million in
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1996 from Viagene's collaborative agreement with Green Cross of Japan for HIV
gene therapy research and clinical development. In 1996, Chiron received
$7.7 million under the collaboration with JT, whereby JT's pharmaceutical
division acquired a non-exclusive, perpetual license to apply certain of
Chiron's combinatorial chemistry technologies in its research and product
development programs. Collaborative agreement revenues recognized under the
collaboration with JT increased by an immaterial amount from 1996 to 1997.
OTHER REVENUES Other revenues consist principally of product royalties,
including royalty revenues resulting from Schering AG's European sales of
Betaferon-Registered Trademark-, and revenues generated from promotion and
co-promotion of Novartis' product Aredia-Registered Trademark- (pamidronate
disodium for injection). Other revenues recognized by the Company in 1997,
1996 and 1995 were $101.3 million, $72.8 million and $39.3 million,
respectively. Royalty revenues resulting from Schering AG's European sales
of Betaferon-Registered Trademark-, which began in the second quarter of
1996, contributed $24.1 million in 1997 and $13.6 million in 1996 to the
Company's other revenues. In 1997, increased royalties related to sales by
Merck & Co., Inc. of HBV vaccines also contributed to the increase in other
revenues from 1996.
Prior to April 1997, Chiron recognized other revenues from sales fees earned
under an agreement with Novartis which provided Chiron with sole promotional
rights in the U.S. to Novartis' product Aredia-Registered Trademark-. Under
this exclusive agreement which expired in March 1997, Chiron recognized
Aredia-Registered Trademark- sales fees of $12.5 million, $30.2 million and
$6.7 million in 1997, 1996 and 1995, respectively, as other revenues. The
November 1996 agreement provided that Chiron, through a co-promotion
arrangement with Novartis, would promote Aredia-Registered Trademark- for two
years after a six-month transitional period beginning April 1997. Chiron
recognized $31.1 million of other revenues in 1997 related to
Aredia-Registered Trademark- co-promotion services provided to Novartis. In
December 1997, the co-promotion arrangement with Novartis was modified such
that Chiron will no longer promote Aredia-Registered Trademark- after April
3, 1998. Other revenues to be recognized by Chiron in the first quarter of
1998 will approximate $9.2 million plus a percentage of Aredia-Registered
Trademark- sales in the first quarter of 1998 in excess of a specified
amount. Other revenues to be recognized by Chiron in the second quarter of
1998 will approximate $0.6 million.
COSTS AND EXPENSES
GROSS PROFIT Gross profit as a percentage of net product sales was 58 percent
in 1997 and 1996 and 56 percent in 1995. Relative to 1996, improvements in 1997
gross profit margin percentage resulted from sales of PDGF, increased sales of
bDNA probe kits and increased sales of Proleukin-Registered Trademark- in
domestic and European markets. In addition, during the second quarter of 1997,
a $6.6 million reduction in cost of sales was recognized due to a revised
estimate of royalties to be paid on sales of certain products. These
improvements in gross margin percentage were substantially offset in 1997 by the
impact, relative to 1996, of declining average selling prices of
ACS:180-Registered Trademark- immunodiagnostic assays, an adverse sales mix of
lower margin critical blood analyte systems to foreign distributors and
decreased secondary revenues from sales of Betaseron-Registered Trademark-. The
increase in gross profit margin percentage in 1996, relative to 1995, resulted
from increased secondary revenues from sales of Betaseron-Registered Trademark-,
increased sales of ACS:180-Registered Trademark- immunodiagnostic assays and
increased sales of bDNA probe kits. This increase in gross profit margin
percentage was partially offset, however, by charges recorded in 1996 related to
inventory reserves and temporarily idled manufacturing facilities in Italy.
Gross profit margin percentages may fluctuate significantly in future periods as
the Company's product mix continues to evolve.
RESEARCH AND DEVELOPMENT Chiron recognized research and development expense of
$376.0 million, $352.5 million and $327.9 million in 1997, 1996 and 1995,
respectively. Generally, Chiron's research and development expenses fluctuate
from period to period depending upon the extent of clinical trial-related
activities, including the manufacturing of clinical material; the number of
products under development and their progress; and the acquisition of companies
and new technology and licensing rights.
In 1997, the overall increase in research and development expense from 1996 was
due to the continued development of bDNA probes, as well as additional
expenditures related to Myotrophin-Registered Trademark- (rhIGF-1 or mecasermin
[recombinant DNA origin]) Injection; a collaboration in the field of genomics;
and research involving gene therapies and pertussis, HCV and other vaccines. In
July 1997, Chiron and Pharmacia & Upjohn AB ("Pharmacia & Upjohn") entered into
certain agreements under which Chiron was granted certain licenses related to
rhIGF-1. In connection with the agreements, Chiron recorded research and
development expense of $4.6 million in 1997. On May 8, 1997, an FDA
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advisory committee found that there was not sufficient evidence of efficacy
in the use of Myotrophin-Registered Trademark- Injection for the treatment of
amyotrophic lateral sclerosis (ALS or Lou Gehrig's disease) to warrant FDA
approval. In November 1997, Chiron and its collaborative partner, Cephalon,
Inc. ("Cephalon"), withdrew and resubmitted their application to the FDA.
The FDA has scheduled further consideration of the application before the
advisory committee on April 9, 1998.
In May 1997, Chiron entered into an agreement with Hyseq, Inc. ("Hyseq") to
collaborate in the identification of genetic targets for the development of
pharmaceutical treatments for cancer. Under the agreement, Chiron is obligated
to fund allowable research costs, in amounts not less than $8.5 million in the
first year and $5.5 million in each of the second and third years of the
collaboration term, incurred by Hyseq in performing research requested by
Chiron. In connection with this agreement, Chiron recognized $5.3 million of
research and development expense in 1997.
The overall increase in research and development expenses from 1996 to 1997 was
partially offset by decreased expense related to agreements with J&J and G.D.
Searle & Co. ("Searle"). During 1996 and 1995, Chiron, together with J&J,
co-funded the development and introduction of a home HIV testing service
business, Direct Access Diagnostics. Chiron elected not to exercise its option,
which expired in May 1997, to participate in this venture with J&J. During 1996
and 1995, Chiron recognized research and development expense of $10.1 million
and $6.1 million, respectively, related to its option to participate in this
venture. In 1997, no amounts related to this option were recognized as research
and development expense. Further, in 1996, Chiron incurred research and
development expenses of $14.6 million in connection with a collaboration
agreement with Searle for the research, development and marketing of Tissue
Factor Pathway Inhibitor. In 1997 and 1995, Chiron recognized $8.0 million and
$8.8 million, respectively, of research and development expense under this
agreement.
In addition to increased expense incurred under the agreements with J&J and
Searle from 1995 to 1996, the overall increase in research and development
expense from 1995 to 1996 was also attributable to the acquisition of Viagene
in September 1995; research and development activities involving vaccines;
and an increase of $16.8 million in diagnostics research and development
expense, primarily related to the continued improvement of existing
immunodiagnostic instrument systems and development of bDNA probes. Chiron's
Viagene subsidiary, involved in the discovery and development of gene
transfer products for the treatment or prevention of severe viral infections,
cancers and other diseases, contributed $13.0 million to research and
development expense in 1996. Additionally, an increase in vaccines research
and development of $19.4 million from 1995 to 1996 resulted from Chiron's
effort to obtain FDA approval of Pertugen-TM-, a diphtheria, tetanus and
genetically engineered acellular pertussis ("DTaP") vaccine for infants and
children; expenditures related to the herpes simplex virus-2 clinical trials;
and research related to HCV and other new vaccines. The overall increase in
1996 research and development expense that resulted from the acquisition of
Viagene and increased vaccine and diagnostics research and development
activities was partially offset by reduced expenses related to
Myotrophin-Registered Trademark-. In 1995, Chiron incurred expenses of
approximately $34.1 million for the funding of certain collaboration expenses
related to Myotrophin-Registered Trademark- and the purchase of additional
program rights from Cephalon. In 1997 and 1996, Chiron recognized research
and development expenses of $17.6 million and $20.4 million, respectively, in
connection with its collaboration with Cephalon. Additionally, in 1995,
Chiron incurred research and development expenses of $6.4 million under an
agreement with Genelabs Technologies, Inc. for the cross-license of certain
rights to viral diagnostic tests and $5.0 million under an agreement with New
York University for certain licenses related to the use of optical mapping.
Expenses incurred in connection with these agreements in 1997 and 1996 were
not material.
OTHER OPERATING EXPENSES Selling, general and administrative ("SG&A") expenses
as a percentage of net product sales were 38 percent in 1997 and 1995 and 39
percent in 1996. In 1997, total SG&A expenses were offset by $8.6 million of
changes to estimated accruals created in prior years. Selling and marketing
expenses continued to represent the largest portion of total SG&A expenses, as
Chiron devoted significant resources to support sales volumes in its existing
product lines as well as new products.
In connection with the January 1995 agreements, Chiron acquired from Novartis
all of the outstanding common stock of Chiron Diagnostics Corporation ("Chiron
Diagnostics"), formerly Ciba Corning Diagnostics Corp., and Novartis' interests
in Chiron Vaccines Company ("Chiron Vaccines"), formerly Chiron Biocine Company,
and Chiron S.p.A., formerly Biocine S.p.A, effective January 1, 1995. The
acquisitions of Chiron Diagnostics and Novartis' interests in Chiron Vaccines
and Chiron S.p.A. were accounted for under the purchase method of
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accounting and resulted in a $222.9 million charge in 1995 for purchased
in-process technology. The acquisition of Viagene in September 1995 resulted in
an additional charge to purchased in-process technology of $130.3 million in
1995. The fair value of the net assets acquired in the acquisitions of Chiron
Diagnostics, Chiron S.p.A. and Chiron Vaccines, including in-process technology,
was estimated based on independent valuations of the acquired net assets. The
fair value of the net assets acquired in the Viagene acquisition was determined
to be equal to book value, as Viagene was an early-stage company with no
intangible assets other than in-process technology.
Expenses of $45.3 million were also incurred in January 1995 in connection with
the Novartis transaction, consisting primarily of employee payments and related
tax liabilities and legal and investment advisor fees. Pursuant to the January
1995 agreements, Novartis reimbursed the Company $24.8 million for a portion of
the employee payments. This reimbursement, of which $4.2 million was
attributable to Chiron Vision, was recorded as a capital contribution from
Novartis.
During 1997, the cumulative impact on the Company's manufacturing needs of
recent product developments prompted management to conclude that Chiron
currently has excess manufacturing capacity relative to its projected needs.
Specifically, management concluded that the Company's need for its idle
pharmaceutical fill and finishing facility in Puerto Rico (the "Puerto Rico
facility"), originally outfitted as a second manufacturing site of
Betaseron-Registered Trademark-, was eliminated due to manufacturing process
improvements and the cumulative impact of the introduction of a competing
product in the second quarter of 1996. In the third quarter of 1997, management
determined that it could not find a suitable use for the Puerto Rico facility
consistent with its previous expectations for the facility's use as a contract
manufacturing plant. As a result, the Company recorded a $31.3 million
impairment loss to record the Puerto Rico facility and related machinery and
equipment assets at their individual estimated fair market values, determined on
the basis of independent appraisals.
In March 1998, the Company committed to plans to sell the Puerto Rico
facility and a manufacturing facility in St. Louis, Missouri. The resulting
adjustments, if any, in the first quarter of 1998 to record the assets held
for sale at the lower of their aggregate carrying amount or estimated fair
value, determined on the basis of independent appraisals, less cost to sell,
are not expected to be material. In the first quarter of 1998, the Company
expects to record certain restructuring and reorganization charges in
connection with the plans to dispose of the Puerto Rico and St. Louis
facilities.
As circumstances dictate, Chiron's management reviews the carrying value of all
facilities to determine whether an impairment of the carrying value has
occurred. To date, management has determined that no material impairment of the
carrying value of any of its facilities, other than the Puerto Rico facility,
has occurred. There can be no assurance, however, that global manufacturing
needs for existing products will continue unchanged and product development
programs will be successful. Accordingly, changes in assumptions and
manufacturing plans, needs and capacity may occur in the future which may
require a reduction of the carrying value of certain facilities to their fair
value.
During 1997, Chiron commenced a restructuring of certain of its operations
and recorded a restructuring and reorganization charge of $3.3 million,
consisting primarily of employee termination and other costs related to the
closure of Chiron Diagnostics' electrophoresis business and to the sale of
its Quality Controls business. In 1995, restructuring and reorganization
charges of $22.1 million resulted primarily from the idling of the Puerto
Rico facility and the Company's change in plans to expand its Emeryville
research and development facilities. The charges recorded in 1995 also
reflected the scale-back of manufacturing operations at the Company's
Amsterdam facility and the write-down of duplicate facilities at Chiron's
Emeryville, California headquarters. Employee termination costs related to
the Company's 1995 restructuring were not material. At December 31, 1997,
the accrued liability for restructuring and reorganization charges totaled
$6.9 million (exclusive of amounts related to Chiron Vision) and consisted
primarily of $3.6 million related to the idling of the Puerto Rico facility
and $2.4 million of employee-related costs recorded in 1997. Liabilities
associated with the Company's restructuring activities in 1997 and the
remaining accrual for the Puerto Rico facility are expected to be
substantially settled in 1998.
7
NON-OPERATING INCOME AND EXPENSE In December 1997, Chiron Diagnostics completed
the sale of certain of the assets of its worldwide Quality Controls business to
Bio-Rad Laboratories, Inc. In connection with this sale, Chiron recognized a
gain on sale of assets of $18.6 million. In May 1996, Chiron sold its 50
percent interest in a joint venture to Ben Venue, its joint venture partner.
Chiron recognized a $12.2 million gain on this sale in 1996.
In 1997, interest expense increased $2.3 million from 1996 due to increased
average borrowings outstanding during the year. Other income, net, consists
primarily of investment income on the Company's cash and investment balances and
other non-operating gains and losses. The annual variability in interest and
dividend income is primarily responsible for the fluctuations in the Company's
other income, net. In addition, Chiron recognized a $5.5 million gain on sale
of equity securities in 1997.
The provision for income taxes in 1997 consisted primarily of federal taxes and
foreign taxes on certain foreign operations of the Company. The 1997 effective
tax rate on pretax income from continuing operations was 34 percent. Excluding
the impact of the impairment loss on the Puerto Rico facility, the 1997
effective tax rate was 24 percent. The charge for the impairment loss on the
Puerto Rico facility in 1997 did not create a corresponding current income tax
benefit and, therefore, increased the effective tax rate for the year. The
effective tax rate, excluding the impact of the impairment loss, decreased from
1996 due principally to the use of federal net operating loss carryforwards, the
recognition of domestic deferred tax assets, and certain foreign sales
corporation tax benefits. The provision for income taxes in 1996 and 1995
consisted primarily of foreign taxes. The amount of foreign taxes provided
significantly increased since the acquisitions of Chiron Diagnostics, Chiron
S.p.A. and the Chiron Behring joint venture, each of which has operations in
foreign countries for which income tax is provided.
In 1997, Chiron recognized U.S. deferred tax assets related to continuing
operations of $13.8 million. Of this amount, $7.8 million reduced current tax
expense and $6.0 million reduced intangible assets on the balance sheet. It has
been Chiron's general policy to recognize deferred tax assets on an entity by
entity basis when an entity has a history of reported taxable income and the
entity anticipates taxable income in subsequent years of an amount sufficient to
realize the benefit of the deferred tax asset.
LIQUIDITY AND CAPITAL RESOURCES
Chiron's capital requirements have been generally funded from cash and
investments on hand, debt borrowings and sales of equity. In addition to these
sources of capital, future capital requirements may be financed through a
combination of research and development funding provided by Novartis, possible
off-balance sheet financing and cash provided by operations. Chiron's cash and
investments in marketable debt securities, which totaled $258.5 million at
December 31, 1997, are invested in a diversified portfolio of investment grade
financial instruments, including money market instruments, corporate notes and
bonds, government or government agency securities, and other debt securities.
By policy, the amount of credit exposure to any one institution is limited.
These investments are generally not collateralized and primarily mature within
three years. Investments with maturities in excess of one year are presented on
the balance sheet as noncurrent investments.
SOURCES AND USES OF CASH Chiron had cash and cash equivalents of $98.5 million
and $68.1 million at December 31, 1997 and 1996, respectively. Cash provided by
operating activities was $149.5 million in 1997 as compared with $62.7 million
in 1996. Primary sources of the increase in cash provided by operating
activities were increased annual profitability and certain charges to net income
not resulting in the use of cash, including the $31.3 million impairment loss on
the Puerto Rico facility, an increase of $16.5 million in tax benefits from
employee stock plans and an increase of $13.2 million in expense recognized in
connection with the establishment of asset reserves. A decrease in accounts
receivable at December 31, 1997, relative to the increase in accounts receivable
from 1995 to 1996, also contributed to the increase in cash provided by
operating activities. These increases were partially offset by components of
net income in 1997 not providing cash from operations, including the Company's
$18.6 million gain on sale of assets, income of $17.6 million attributable to
changes in estimated liabilities, and recognition of domestic deferred tax
assets. In 1995, the Company used $24.4 million in operating activities. This
use of cash in 1995 reflects the Company's net loss for the year, partially
offset by adjustments for the write-off of purchased in-process technologies and
depreciation and amortization expense. An increase in inventories from the
prior year end also contributed to the use of cash in operating activities in
1995.
8
Cash used in investing activities was $169.0 million in 1997 as compared with
$191.3 million in 1996. In 1997, the primary uses of cash in investing
activities were for the net purchase of $99.2 million of investments in
marketable debt securities and acquisitions of property and equipment
totaling $77.5 million. These uses of cash in 1997 were partially offset by
$29.9 million of cash proceeds from Chiron Diagnostics' sale of certain of
the assets of its worldwide Quality Controls business. In 1996, the primary
uses of cash in investing activities were for the purchase of Chiron's 49
percent interest in the Chiron Behring joint venture for approximately $120.0
million in cash and acquisitions of property and equipment totaling $120.2
million. These uses of cash in 1996 were partially offset by the proceeds
from sale and maturity of a net $88.9 million of investments in marketable
debt securities. In 1995, cash used in investing activities was $51.5
million. The primary uses of cash in investing activities in 1995 were for
the acquisitions of (i) Chiron Diagnostics and Novartis' interests in Chiron
Vaccines and Chiron S.p.A; (ii) Viagene; (iii) the ophthalmic surgical
product division of IOLAB, which is classified as a component of discontinued
operations; and (iv) additional property and equipment totaling $101.1
million. These uses of cash in 1995 were partially offset by the proceeds
from sale and maturity of a net $175.6 million of investments in marketable
debt securities.
On December 29, 1997, Chiron completed the sale of all of the outstanding
capital stock of Chiron Vision for approximately $300.0 million in cash. In
January 1998, $100.0 million of borrowings outstanding under the Company's U.S.
credit facilities was repaid from a portion of these proceeds.
Cash provided by financing activities was $49.8 million in 1997 as compared with
$122.3 million in 1996. In 1997, the primary sources of cash from financing
activities were the proceeds of $61.5 million from issuance of common stock
under the Company's stock option and employee stock purchase plans and $20.6
million of short-term borrowings. Partially offsetting these sources of cash
was Chiron's purchase of a previously leased manufacturing facility and related
buildings in Emeryville, California for $29.8 million in cash. In 1996, the
primary sources of cash from financing activities were $100.0 million of
short-term borrowings under the Company's U.S. credit facilities and the
proceeds of $44.6 million from issuance of common stock under the Company's
stock option and employee stock purchase plans. Cash provided by financing
activities in 1995 was $65.3 million, consisting primarily of the proceeds from
issuance of common stock under the Company's stock option and employee stock
purchase plans and a $24.8 million capital contribution from Novartis.
In January 1998, the Company's Board of Directors authorized the purchase of up
to 2.5 million shares of Chiron common stock from time to time on the open
market in order to offset the dilution associated with the operation of the
Company's stock option and employee stock purchase plans and the granting of
share rights. The Board of Directors has authorized such purchases through
January 1999. To date, no shares have been purchased.
Chiron believes that its cash and investments, funds provided by operations and
capital market transactions will be sufficient to meet its cash requirements
during the upcoming twelve months and through the foreseeable future.
AGREEMENTS WITH NOVARTIS In connection with the January 1995 agreements,
Novartis agreed to guarantee $425.0 million of new debt for Chiron and
provided Chiron with the option to issue up to $500.0 million of new equity
to Novartis. In addition, Novartis agreed to provide $250.0 million (which
may be increased to $300.0 million subject to certain reductions in the debt
guarantee) over five years in support of research at Chiron. In December
1997, Chiron and Novartis amended the funding arrangement to add HSV-tk and
Factor VIII gene therapy to the funded projects. Under these funding
arrangements, annual funding amounts will not exceed $62.3 million in 1998
and $50.3 million (plus any unused portion of the funding limit for 1998) in
1999. See additional discussion under COLLABORATIVE AGREEMENT REVENUES
herein. In connection with the November 1996 agreement, Novartis agreed to
extend the term during which Novartis is committed to provide a debt
guarantee from 1999 to January 1, 2008. Further, Novartis granted an option
to Chiron to increase the amount of the debt guarantee from $425.0 million to
$725.0 million with a corresponding equivalent dollar reduction in the equity
put now available to Chiron (from $500.0 million to $200.0 million). Should
Chiron elect to replace certain existing convertible debt, Novartis also
agreed to provide additional guarantees totaling $200.0 million for such
purposes. Refer to Note 2 of Notes to Consolidated Financial Statements.
BORROWING ARRANGEMENTS Under separate revolving, committed, unsecured credit
agreements with major financial
9
institutions, Chiron can borrow up to $200.0 million in the U.S. These credit
facilities are guaranteed by Novartis and provide for various borrowing rate
options, as defined in the agreements. One of these credit facilities, which
allows for borrowings of up to $100.0 million, matures in February 2003. The
other credit facilities, which allow for aggregate additional borrowings of up
to $100.0 million, were consolidated into a single credit facility maturing in
March 1999. Additionally, at December 31, 1997, Chiron had credit facilities
available outside the U.S. that allow for total borrowings of $130.2 million.
The Company's short-term borrowings totaled $154.7 million at December 31, 1997,
and consisted primarily of borrowings of $100.0 million under Chiron's U.S.
credit facilities and of $54.6 million under Chiron's credit facilities outside
the U.S. In January 1998, the $100.0 million of borrowings outstanding under
the Company's U.S. credit facilities was repaid with a portion of the proceeds
from the sale of Chiron Vision.
OTHER COMMITMENTS In June 1996, the Company entered into a seven-year operating
lease agreement with a group of financial institutions to rent a research and
development facility that is currently under construction in Emeryville,
California. No lease payments are required during the construction period which
is expected to last less than three years. Thereafter, rent amounts will be due
quarterly, based upon the total construction costs incurred. Assuming that
construction is completed on schedule and assuming a current interest rate of
6.0 percent, future minimum lease payments would be $11.7 million annually,
beginning in the third quarter of 1998. Under this lease arrangement, which has
been guaranteed by Novartis through December 31, 1999, the Company has the
option to purchase the constructed properties. Alternatively, Chiron can cause
the property to be sold to a third party. The Company is also contingently
liable under residual value guarantees in the event of market value declines.
In June 1996, Chiron S.p.A. entered into an agreement to purchase in 1998 the
Company's manufacturing and administrative facilities in Siena, Italy which are
currently under lease. The purchase price is approximately $29.6 million and is
payable in Italian lira. The purchase price will be reduced by certain amounts
due from the seller through the date of the purchase.
Additionally, the Company has various commitments for capital expenditures
totaling approximately $2.7 million at December 31, 1997. The majority of these
commitments are for computer system upgrades and enhancements. The Company also
has performance bonds outstanding in the amount of $3.5 million at December 31,
1997, primarily in connection with sales to public health authorities.
In future periods, Chiron expects to incur substantial capital spending. In
February 1998, Chiron gave notice to Hoechst AG that the Company intends to
exercise its option to purchase the remaining 51 percent interest in the
Chiron-Behring joint venture in the Company's second fiscal quarter of 1998
for approximately 210.7 million Deutsche marks. See additional discussion
under AGREEMENT WITH HOECHST AG herein. Chiron's liquidity may be
further affected in future periods by its decision to fund its share of
expenses in certain of its joint ventures and collaboration arrangements.
Over the next several years, Chiron anticipates funding collaborations with a
number of its research partners, and may make additional equity investments
in collaborative partners.
MARKET RISK MANAGEMENT The Company's cash flow and earnings are subject to
fluctuations due to changes in foreign currency exchange rates and interest
rates. Through the use of various financial instruments, the Company attempts
to limit its exposure to these market risks.
To manage foreign currency exchange risks, Chiron enters into forward foreign
currency contracts ("forwards"), cross currency interest rate swaps ("swaps")
and purchases foreign currency option contracts ("options"). Chiron does not
use any of these derivative instruments for trading or speculative purposes.
The total notional amount of these derivative financial instruments at
December 31, 1997 and 1996 was $296.5 million and $208.4 million,
respectively.
The Company uses forwards to hedge the impact of currency fluctuations on
certain assets and liabilities denominated in nonfunctional currencies
("transaction exposures"). Typically, these contracts have maturities of three
months or less. Chiron's objective is to minimize the transaction gains and
losses that result from remeasuring foreign denominated assets and liabilities
based on exchange rate changes. The Company's transaction exposures are
primarily denominated in the major European currencies and the Japanese yen. At
December 31, 1997, these
10
exposures amounted to $44.9 million and were offset by forwards with a notional
amount of $46.1 million. In addition to the exposures noted above, the Company
has exposures totaling approximately $20.2 million denominated in currencies
where the cost of hedging is viewed as excessive relative to the underlying
risk. These exposures, primarily related to the Mexican peso, are not hedged.
In the aggregate, a 10 percent adverse movement against the Company's portfolio
of transaction exposures would result in a loss of approximately $1.7 million.
A 10 percent movement in the value of the dollar versus the Company's portfolio
of transaction exposures has occurred in one of the last twelve quarters.
Foreign currency transaction gains and (losses) from continuing operations, net
of the impact of hedging, were a net ($2.3) million in 1997, ($3.0) million in
1996 and were not material in 1995.
In addition, Chiron also hedges certain anticipated exposures. The Company's
primary anticipated exposures are related to intercompany inventory purchases
by subsidiaries with functional currencies denominated in the major European
currencies and the Japanese yen. The Company attempts to hedge approximately
80 percent of anticipated major currency exposures by purchasing quarterly
put options. To limit hedging costs, the Company generally purchases
out-of-the-money options. As a result, Chiron effectively does not purchase
insurance for the first 2 to 5 percent of the exchange rate risk. The risk
on these hedging instruments is limited to the premium amount paid. The
total notional amount of the options at December 31, 1997 was $111.3 million.
No options were outstanding at December 31, 1996. The options outstanding
at December 31, 1997 expire quarterly over a twelve-month period, and provide
protection against increases in the value of one U.S. dollar beyond 1.82
Deutsche marks and 123 Japanese yen. The fair market value of outstanding
option contracts at December 31, 1997 was $2.9 million.
The Company has entered into a series of swaps to modify the interest and/or
currency characteristics of certain assets and liabilities denominated in
nonfunctional currencies. To date, the objective of the swaps entered into by
the Company is to fix the interest rate exposures associated with the Company's
wholly owned German and Japanese subsidiaries. The exposures are denominated in
Deutsche marks and Japanese yen. The total notional amounts of the Company's
swaps at December 31, 1997 and 1996 were $139.1 million and $137.5 million,
respectively.
Chiron manages the risk of counterparty default on its derivative financial
instruments through the use of credit standards, counterparty diversification
and monitoring of counterparty financial condition. All derivative financial
instruments are executed with financial institutions with strong credit ratings,
which minimizes risk of loss due to nonpayment. Chiron has not experienced any
losses due to counterparty default.
The Company has exposure to changes in interest rates in both its investment
portfolio and certain floating rate liabilities and real estate commitments.
The Company maintains investment portfolio holdings of various issuers, types
and maturities. These securities are generally classified as
available-for-sale and, consequently, are recorded on the balance sheet at
fair value with unrealized gains or losses reported as a separate component
of stockholders' equity. The Company also has short-term debt obligations
and certain real estate lease commitments with interest rates or payments
tied to LIBOR. At December 31, 1997, the net effect of a 100 basis point
increase or decrease in LIBOR over a twelve-month period would not result in
a material change in the Company's results of operations.
YEAR 2000 The Company is evaluating its computer systems in the light of the
"Year 2000" programming issues. In the past, many computer programs were written
using two digits rather than four to identify the relevant year. These programs
may not be able to distinguish between 21st and 20th century dates (for example,
"00" may be read as the year 1900 when the year 2000 is intended). This could
result in a significant system failure or miscalculations. Accordingly, many
companies' computer systems may need to be upgraded or replaced. The Company
and third parties with which the Company does business rely on numerous computer
programs. The Company may incur significant costs in identifying and resolving
Year 2000 issues, including internal staff costs as well as consulting and other
expenses. In addition, the appropriate course of action may include replacement
or an upgrade of certain systems or equipment at a substantial cost to the
Company. There can be no assurance that the Year 2000 issues will be resolved
in 1998 or 1999. If not resolved, this issue could have a significant adverse
impact on the Company's operations.
FACTORS THAT MAY AFFECT FUTURE OPERATING RESULTS
Chiron wishes to caution stockholders and investors that the following important
factors, among others, in some cases have affected, and in the future could
affect, Chiron's actual results and could cause Chiron's actual
11
consolidated results for the first quarter of 1998, and beyond, to differ
materially from those expressed in any forward-looking statements made by, or on
behalf of, Chiron. The statements under this caption are intended to serve as
cautionary statements within the meaning of the Private Securities Litigation
Reform Act of 1995. The following information is not intended to limit in any
way the characterization of other statements or information under other captions
as cautionary statements for such purpose:
* Delays, difficulties or failure in obtaining regulatory approval
(including approval of its systems, procedures and facilities for
production) for the Company's products. These may include, for
example, approval of the Company's Italian manufacturing facilities
and processes as satisfying regulatory requirements for production
of the Company's diphtheria, tetanus and genetically engineered
acellular pertussis and adjuvanted flu vaccines, approval for
Myotrophin-Registered Trademark- for which additional clinical
trials may be required by the FDA, approval for DepoCyt-TM-
(injectable sustained-release cytarabine), and approval for
Quantiplex-Registered Trademark- assays for HIV and follow-on bDNA
probe products, for which the FDA may require substantial
additional process and systems validation.
* Charges that may be incurred or accrued as a result of the
implementation of restructuring plans, including possible disposal of
excess manufacturing and other general facilities, or as a result of
the underutilization of manufacturing and other general facilities,
including facility expansions.
* Costs associated with restructuring or other negative short-term
impacts resulting from the possible establishment of a joint venture
or other transaction involving significant portions of Chiron's
diagnostics business.
* Inability to maintain or initiate third party arrangements which
generate revenues, in the form of license fees, research and
development support, royalties, sales fees and other payments, in
return for rights in technology or products under development or
promotional or other services provided by the Company.
* The issuance and use of patents and proprietary technology by Chiron
and its competitors, including the possible negative effect on the
Company's ability to develop, manufacture and sell its products if it
is unable to obtain licenses to patents which may be required for such
products.
* Failure of corporate partners to successfully commercialize the
Company's products or to retain and expand the markets served by the
commercial collaborations; conflicts of interest, priorities and
commercial strategies which may arise between the Company and such
corporate partners, including conflicts as to the strategy for
realizing value arising from evolving opportunities.
* Delay, difficulty or inability on acceptable terms to resolve
conflicts with partners, including resolution of litigation
initiated by Chiron against Ortho seeking to compel arbitration
regarding access to hepatitis and retrovirus immunodiagnostic
tests for use on Chiron's ACS:Centaur-Registered Trademark-
immunoassay system.
* Delays or difficulties in developing and acquiring technology and
technical and managerial personnel to manufacture and/or deliver the
Company's products in commercial quantities at reasonable costs and in
compliance with applicable quality assurance and environmental
regulations and governmental permitting requirements.
* Possible changes in laws, regulations and guidelines of regulatory
agencies, which may affect the development, manufacture and sale of
certain of the Company's products including, for example, off-label
sales of pharmaceuticals and research use only sales of diagnostic
tests and systems.
* The ability and willingness of customers to substitute competitive
products for the Company's products if other products for similar
indications are approved for marketing.
* Difficulties in obtaining key raw materials and supplies of acceptable
quality used in the manufacture of the Company's products.
12
* Increased costs of development, regulatory approval, manufacture,
sales, and marketing associated with the introduction of novel
products and fluctuation of such costs between periods.
* Difficulties in launching or marketing the Company's products, many of
which are novel products based on biotechnology, and unpredictability
of customer acceptance of such products.
* Decline in the Betaseron-Registered Trademark- customer base in the
U.S.; the extent to which patients, once enrolled, remain compliant
with the prescribed treatment regimen and continue to regularly
receive Betaseron-Registered Trademark-; the impact of competing
products, including other beta interferon products; pricing,
promotional and marketing decisions by the Company's partner, Schering
AG.
* Changes in the product mix of the Chiron-Ortho joint business, whereby
the proportion of higher margin HCV tests sold relative to other lower
margin products decreases; continued margin erosion of HCV tests.
* Continued increases in research and development spending in order to
develop new products and increase market share.
* Continued or increased pressure to reduce selling prices of the
Company's products.
* The cost of acquiring in-process technology, either by license,
collaboration or purchase of another entity.
* The impact of unusual or infrequent charges resulting from Chiron's
ongoing evaluation of its business strategies and organizational
structures, including the continued costs of integration of acquired
businesses.
* Revaluation of assets, including, among others, the Company's
investments in the equity securities of other companies with whom it
collaborates, or related expenses.
* Changes to tax rates or possible future changes to conditions of
certain tax rulings obtained by the Company or its subsidiaries.
* The costs and other effects of legal and administrative cases and
proceedings (whether civil, such as product-related or environmental,
or criminal); settlements and investigations; developments or
assertions by or against Chiron relating to intellectual property
rights and licenses.
* Seasonal fluctuations in product sales and resulting gross margin
amounts.
13
CHIRON CORPORATION
CONSOLIDATED BALANCE SHEETS
ASSETS
(IN THOUSANDS, EXCEPT SHARE DATA)
DECEMBER 31,
------------------------------
1997 1996
----------- -----------
Current assets:
Cash and cash equivalents $ 98,483 $ 68,114
Short-term investments in marketable debt securities 84,588 38,694
----------- -----------
Total cash and short-term investments 183,071 106,808
Accounts receivable, net of allowances of $22,918 in 1997
and $20,692 in 1996:
Related parties 56,672 61,187
Unrelated parties 287,372 290,784
----------- -----------
344,044 351,971
Inventories 165,652 180,534
Other current assets:
Related parties 288 5,000
Unrelated parties 76,997 52,455
----------- -----------
77,285 57,455
----------- -----------
Total current assets 770,052 696,768
Noncurrent investments in marketable debt securities 75,401 22,027
Property, plant, equipment and leasehold improvements, at cost:
Land and buildings 218,509 231,998
Laboratory, production and office equipment 422,278 381,421
Leasehold improvements 123,379 114,282
Construction in progress 67,355 69,120
----------- -----------
831,521 796,821
Less accumulated depreciation and amortization (277,623) (213,217)
----------- -----------
Net property, plant, equipment and leasehold improvements 553,898 583,604
Purchased technology, net of accumulated amortization of
$34,111 in 1997 and $28,089 in 1996 45,903 65,592
Other intangible assets, net of accumulated amortization of
$44,617 in 1997 and $38,382 in 1996 79,955 76,669
Investments in equity securities and affiliated companies:
Related parties 139,305 133,123
Unrelated parties 37,546 51,205
----------- -----------
176,851 184,328
Other assets:
Related parties 15,777 12,724
Unrelated parties 50,641 46,958
----------- -----------
66,418 59,682
----------- -----------
$ 1,768,478 $ 1,688,670
----------- -----------
----------- -----------
(Continued)
The accompanying Notes to Consolidated Financial Statements
are an integral part of this statement.
14
CHIRON CORPORATION
CONSOLIDATED BALANCE SHEETS
LIABILITIES AND STOCKHOLDERS' EQUITY
(IN THOUSANDS, EXCEPT SHARE DATA)
DECEMBER 31,
------------------------------
1997 1996
----------- -----------
Current liabilities:
Accounts payable $ 79,339 $ 96,157
Accrued compensation and related expenses 59,405 56,695
Short-term borrowings 154,700 137,467
Current portion of unearned revenue 13,361 19,638
Taxes payable 37,191 33,407
Other current liabilities 127,190 129,805
----------- -----------
Total current liabilities 471,186 473,169
Long-term debt:
Payable to Novartis 69,934 66,305
Unrelated parties 327,283 353,284
----------- -----------
397,217 419,589
Other noncurrent liabilities 26,130 31,057
----------- -----------
Total liabilities 894,533 923,815
----------- -----------
Commitments and contingencies
Stockholders' equity:
Preferred stock, $0.01 par value; 5,000,000 shares authorized;
none outstanding - -
Common stock, $0.01 par value; 499,500,000 shares authorized;
175,659,000 outstanding (170,675,000 outstanding at
December 31, 1996) 1,757 1,707
Restricted common stock, $0.01 par value; 500,000 shares
authorized; none outstanding - -
Additional paid-in capital 1,853,591 1,774,406
Accumulated deficit (961,986) (1,032,554)
Cumulative foreign currency translation adjustment (27,804) (6,318)
Unrealized gain from investments 8,996 28,574
Notes receivable from stock sales (609) (960)
----------- -----------
Total stockholders' equity 873,945 764,855
----------- -----------
$ 1,768,478 $ 1,688,670
----------- -----------
----------- -----------
The accompanying Notes to Consolidated Financial Statements
are an integral part of this statement.
15
CHIRON CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
YEAR ENDED DECEMBER 31,
----------------------------------------
1997 1996 1995
---------- ---------- ----------
Revenues:
Product sales, net:
Related parties $ 40,426 $ 20,013 $ 21,483
Unrelated parties 798,915 784,896 724,419
---------- ---------- ----------
839,341 804,909 745,902
Equity in earnings of unconsolidated joint businesses 106,356 102,061 81,005
Collaborative agreement revenues:
Related parties 88,130 93,686 45,920
Unrelated parties 26,928 28,419 12,161
---------- ---------- ----------
115,058 122,105 58,081
Other revenues:
Related parties 43,624 32,387 11,156
Unrelated parties 57,679 40,378 28,127
---------- ---------- ----------
101,303 72,765 39,283
---------- ---------- ----------
Total revenues 1,162,058 1,101,840 924,271
---------- ---------- ----------
Expenses:
Cost of sales:
Related parties 25,758 18,658 20,132
Unrelated parties 328,885 323,373 308,312
---------- ---------- ----------
354,643 342,031 328,444
Research and development 375,955 352,472 327,887
Selling, general and administrative 316,822 310,664 279,892
Write-off of purchased in-process technologies - - 353,262
Costs related to Novartis transaction - - 45,254
Impairment loss on long-lived assets 31,300 - -
Restructuring and reorganization charges 3,336 - 22,108
Other operating expenses 4,795 6,410 4,742
---------- ---------- ----------
Total expenses 1,086,851 1,011,577 1,361,589
---------- ---------- ----------
Income (loss) from operations 75,207 90,263 (437,318)
Gain on sale of assets 18,597 - -
Gain on sale of interest in affiliated company - 12,226 -
Interest expense (33,257) (30,934) (30,212)
Other income, net 16,348 7,190 22,143
---------- ---------- ----------
Income (loss) from continuing operations before income taxes 76,895 78,745 (445,387)
Provision for income taxes 26,057 22,142 19,887
---------- ---------- ----------
Income (loss) from continuing operations 50,838 56,603 (465,274)
---------- ---------- ----------
Discontinued operations (Note 3):
Income (loss) from discontinued operations 5,224 (1,458) (47,189)
Gain on disposal of discontinued operations 15,157 - -
---------- ---------- ----------
Net income (loss) $ 71,219 $ 55,145 $ (512,463)
---------- ---------- ----------
---------- ---------- ----------
Earnings per common share:
Income (loss) from continuing operations $ 0.29 $ 0.33 $ (2.86)
---------- ---------- ----------
---------- ---------- ----------
Net income (loss) $ 0.41 $ 0.33 $ (3.15)
---------- ---------- ----------
---------- ---------- ----------
Earnings per common share - assuming dilution:
Income (loss) from continuing operations $ 0.29 $ 0.32 $ (2.86)
---------- ---------- ----------
---------- ---------- ----------
Net income (loss) $ 0.40 $ 0.31 $ (3.15)
---------- ---------- ----------
---------- ---------- ----------
The accompanying Notes to Consolidated Financial Statements
are an integral part of this statement.
16
CHIRON CORPORATION
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(IN THOUSANDS)
CUMULATIVE UNREALIZED NOTES
FOREIGN GAIN RECEIVABLE
COMMON STOCK ADDITIONAL CURRENCY (LOSS) FROM
----------------- PAID-IN ACCUMULATED TRANSLATION FROM STOCK
SHARES AMOUNT CAPITAL DEFICIT ADJUSTMENT INVESTMENTS SALES TOTAL
------- ------ ---------- ----------- ----------- ----------- ---------- ---------
Balances at December 31, 1994 33,379 $ 334 $1,161,942 $ (575,236) $ (1,719) $ (12,690) $ - $ 572,631
Issuance of common stock to
Novartis 6,600 66 407,484 - - - - 407,550
Capital contribution by Novartis - - 24,845 - - - - 24,845
Issuance of common stock and
stock options related to the
Viagene acquisition 916 9 91,393 - - - - 91,402
Exercise of stock options 670 6 32,009 - - - - 32,015
Tax benefits from employee
stock plans - - 912 - - - - 912
Exercise of warrants - - 97 - - - - 97
Employee stock purchase plan 173 2 9,029 - - - - 9,031
Foreign currency translation
adjustment - - - - 2,440 - - 2,440
Unrealized gain from
investments - - - - - 43,952 - 43,952
Loans to employees for
stock sales - - - - - - (351) (351)
Net loss - - - (512,463) - - - (512,463)
------- ------ ---------- ----------- ----------- ----------- ---------- ---------
Balances at December 31, 1995 41,738 417 1,727,711 (1,087,699) 721 31,262 (351) 672,061
Exercise of stock options 2,219 22 25,083 - - - - 25,105
Tax benefits from employee
stock plans - - 1,398 - - - - 1,398
Exercise of warrants 61 - 1,570 - - - - 1,570
Employee stock purchase plan 1,443 15 19,897 - - - - 19,912
Additional shares issued in
four-for-one stock split 125,214 1,253 (1,253) - - - - -
Foreign currency translation
adjustment - - - - (7,039) - - (7,039)
Unrealized loss from
investments - - - - - (2,688) - (2,688)
Loans to employees for
stock sales - - - - - - (609) (609)
Net income - - - 55,145 - - - 55,145
------- ------ ---------- ----------- ----------- ----------- ---------- ---------
Balances at December 31, 1996 170,675 1,707 1,774,406 (1,032,554) (6,318) 28,574 (960) 764,855
Exercise of stock options 3,632 36 41,235 - - - - 41,271
Tax benefits from employee
stock plans - - 17,923 - - - - 17,923
Employee stock purchase plan 1,352 14 20,027 - - - - 20,041
Foreign currency translation
adjustment - - - - (21,486) - - (21,486)
Unrealized loss from
investments - - - - - (19,578) - (19,578)
Collection of a loan to
employee for stock sales - - - - - - 351 351
Elimination of one-month lag in
reporting of Chiron Behring - - - (651) - - - (651)
Net income - - - 71,219 - - - 71,219
------- ------ ---------- ----------- ----------- ----------- ---------- ---------
Balances at December 31, 1997 175,659 $1,757 $1,853,591 $ (961,986) $ (27,804) $ 8,996 $ (609) $ 873,945
------- ------ ---------- ----------- ----------- ----------- ---------- ---------
------- ------ ---------- ----------- ----------- ----------- ---------- ---------
The accompanying Notes to Consolidated Financial Statements
are an integral part of this statement.
17
CHIRON CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
YEAR ENDED DECEMBER 31,
---------------------------------------
1997 1996 1995
--------- --------- ---------
Cash flows from operating activities:
Net income (loss) $ 71,219 $ 55,145 $(512,463)
Adjustments to reconcile net income (loss) to net cash provided
by (used in) operating activities:
Depreciation and amortization 102,589 105,080 92,124
Impairment loss on long-lived assets 31,300 - -
Gain on sale of assets (18,597) - -
Gain on sale of equity securities and interest in affiliated company (5,541) (12,226) -
Write-off of purchased in-process technologies - - 365,286
Write-offs of property, plant, equipment and leasehold improvements 4,291 5,031 18,400
Reserves 30,046 16,895 11,321
Changes in estimated liabilities (17,596) - -
Deferred income taxes (20,556) 6,972 9,041
Tax benefits from employee stock plans 17,923 1,398 912
Undistributed earnings of affiliates (14,473) (6,841) (3,944)
Other, net 11,614 17,393 13,860
Changes, excluding effect of acquisitions, to:
Accounts receivable (12,974) (75,825) 2,000
Inventories (40,635) (48,545) (36,094)
Other current assets 8,355 (20,187) (21,462)
Accounts payable and accrued expenses (2,062) 11,427 7,719
Current portion of unearned revenue (5,907) (1,162) 5,979
Other current liabilities 5,890 1,921 21,808
Other noncurrent liabilities 4,626 6,253 1,115
--------- --------- ---------
Net cash provided by (used in) operating activities 149,512 62,729 (24,398)
--------- --------- ---------
Cash flows from investing activities:
Purchases of investments in marketable debt securities (219,522) (55,008) (158,533)
Proceeds from sale and maturity of investments in
marketable debt securities 120,306 143,922 334,117
Businesses acquired, net of cash acquired - (374) (112,633)
Capital expenditures (77,524) (120,162) (101,052)
Proceeds from sale of assets 29,928 - -
Proceeds from sale of equity securities and interest
in affiliated company 5,596 14,000 -
Purchases of investments in equity securities and affiliated companies (10,942) (130,308) (900)
Increase in other assets (16,804) (43,351) (12,494)
--------- --------- ---------
Net cash used in investing activities (168,962) (191,281) (51,495)
--------- --------- ---------
Cash flows from financing activities:
Net borrowings (payments) under line of credit arrangements - (12,606) 4,686
Proceeds from issuance of short-term debt 20,589 100,000 -
Proceeds from issuance of common stock 61,502 44,597 39,509
Proceeds from capital contribution from Novartis - - 24,845
Repayment of notes payable and capital leases (32,272) (9,643) (3,705)
--------- --------- ---------
Net cash provided by financing activities 49,819 122,348 65,335
--------- --------- ---------
Net increase (decrease) in cash and cash equivalents 30,369 (6,204) (10,558)
Cash and cash equivalents at beginning of the year 68,114 74,318 84,876
--------- --------- ---------
Cash and cash equivalents at end of the year $ 98,483 $ 68,114 $ 74,318
--------- --------- ---------
--------- --------- ---------
The accompanying Notes to Consolidated Financial Statements
are an integral part of this statement.
18
CHIRON CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1997
NOTE 1 - THE COMPANY AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
THE COMPANY
Chiron Corporation (the "Company" or "Chiron") develops, manufactures and
markets human healthcare products for the prevention, diagnosis and treatment
of disease utilizing innovations in biology and chemistry. Chiron
participates in three human healthcare markets: (i) diagnostics, including
blood screening tests, automated immunodiagnostic systems, critical blood
analyte systems and nucleic acid probe tests; (ii) therapeutics, with an
emphasis on oncology, serious infectious diseases and critical care diseases;
and (iii) adult and pediatric vaccines. Chiron also develops or acquires new
technologies, employing these technologies to discover new products for the
Company or for its partners. On December 29, 1997, Chiron completed the sale
of its ophthalmic business unit, Chiron Vision Corporation ("Chiron Vision"),
to Bausch & Lomb Incorporated (see Note 3).
PRINCIPLES OF CONSOLIDATION
The accompanying consolidated financial statements include the accounts of the
Company and its majority-owned subsidiaries. All significant intercompany
accounts and transactions have been eliminated in consolidation. Investments in
joint ventures, partnerships and interests in which Chiron has an equity
interest of 50 percent or less are accounted for using either the equity or cost
method. Certain foreign subsidiaries and investments in affiliated companies
are accounted for either on a one-month or one-quarter lag.
FINANCIAL STATEMENT PRESENTATION
The accompanying Consolidated Statements of Operations for all periods presented
reflect the after-tax results of Chiron Vision as discontinued operations (see
Note 3). In addition, certain previously reported amounts have been
reclassified to conform with the current period presentation.
FOREIGN CURRENCY TRANSLATION
Local foreign currencies are generally considered to be the functional currency
of the Company's foreign subsidiaries and equity investments. Accordingly, the
assets and liabilities of subsidiaries and equity investments denominated in
foreign currencies are translated at the exchange rates in effect at the
appropriate year-end. The revenues and expenses of such subsidiaries and
investments are translated at the average exchange rates for the period of
operation. Adjustments resulting from such translations are reflected in the
accompanying Consolidated Balance Sheets as "Cumulative foreign currency
translation adjustment," a component of stockholders' equity. The effect of
foreign currency exchange rate fluctuations on cash and cash equivalents
denominated in foreign currencies was not material.
FISCAL YEAR
During 1995, the Company changed its fiscal year from a December 31 calendar
year-end to a 52 or 53-week year ending on the Sunday nearest the last day in
December of each year. Therefore, the 1997, 1996 and 1995 fiscal years ended on
December 28, 1997, December 29, 1996 and December 31, 1995, respectively. Each
fiscal year was 52 weeks long. For presentation purposes, dates used in the
consolidated financial statements and notes refer to the fiscal month end.
USE OF ESTIMATES
The preparation of financial statements in accordance with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the amounts reported in the Company's consolidated financial statements
and notes. Actual results could differ materially from those estimates.
19
CHIRON CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997
NOTE 1 - THE COMPANY AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
DERIVATIVE FINANCIAL INSTRUMENTS
Derivative financial instruments, including forward foreign currency contracts,
foreign currency option contracts and cross currency interest rate swaps, are
utilized by the Company to reduce foreign exchange and interest rate risks. The
Company has established a control environment that includes policies and
procedures for risk assessment and the approval, reporting and monitoring of
foreign currency hedging activities. Chiron manages the risk of counterparty
default on its derivative financial instruments through the use of credit
standards, counterparty diversification and monitoring of counterparty financial
condition. Counterparties to these hedging agreements are major financial
institutions. Chiron has not experienced any losses due to counterparty
default. The Company's derivative financial instruments are not used for
trading or speculative purposes.
CASH EQUIVALENTS AND INVESTMENTS IN MARKETABLE DEBT SECURITIES
All highly liquid investments with a maturity of three months or less at the
date of purchase are considered to be cash equivalents. Cash equivalents and
short-term investments in marketable debt securities consist principally of
money market instruments which include corporate notes, corporate bonds,
commercial paper and government or government agency securities. Noncurrent
investments in marketable debt securities consist principally of corporate
notes, corporate bonds and government or government agency securities.
CONCENTRATION OF CREDIT RISK
Financial instruments that potentially subject the Company to concentrations of
credit risk consist principally of cash investments and trade accounts
receivable. The Company invests cash which is not required for immediate
operating needs principally in a diversified portfolio of financial instruments
issued by institutions with investment-grade credit ratings. By policy, the
amount of credit exposure to any one institution is limited. These investments
are generally not collateralized and primarily mature within three years. The
Company has not experienced any significant realized losses on these
investments.
The Company has not experienced any significant credit losses from its accounts
receivable from joint business partners or collaborative research agreements,
and none are currently expected. Other accounts receivable arise from product
sales to customers. The Company performs ongoing credit evaluations of these
customers and generally does not require collateral. Reserves are maintained
for potential trade receivable credit losses, and such losses have been within
management's expectations.
INVENTORIES
Pharmaceutical inventories are stated at the lower of cost or market using the
average cost method or, in the case of vaccine products, using the last-in,
first-out ("LIFO") method. Diagnostic and ophthalmic (see Note 3) products are
valued at cost, using the first-in, first-out ("FIFO") method which is less than
market value. Inventories consist of the following at December 31:
1997 1996
-------- --------
(IN THOUSANDS)
Finished goods $ 82,896 $ 94,875
Work in process 47,417 45,874
Raw materials 35,339 39,785
-------- --------
$165,652 $180,534
-------- --------
-------- --------
20
CHIRON CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997
NOTE 1 - THE COMPANY AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
PROPERTY, PLANT, EQUIPMENT AND LEASEHOLD IMPROVEMENTS
Depreciation on property, plant and equipment, including assets held under
capital leases, is computed using the straight-line method over the estimated
useful lives of the assets (3 to 20 years for equipment and 15 to 40 years for
buildings). Leasehold improvements are amortized on a straight-line basis over
the remaining fixed lease term or asset life, whichever is shorter.
INTANGIBLE AND OTHER LONG-LIVED ASSETS
Intangible assets consist primarily of purchased technologies, goodwill and
patents and are amortized on a straight-line basis over their estimated useful
lives, ranging from 3 to 17 years. Amortization expense from continuing
operations for the years ended December 31, 1997, 1996 and 1995 was $8.6
million, $10.0 million and $10.8 million, respectively. Amortization of
purchased technologies and goodwill is primarily included in "Other operating
expenses" and amortization of patents is primarily included in "Research and
development" in the accompanying Consolidated Statements of Operations.
In accordance with Statement of Financial Accounting Standards ("SFAS") No.
121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived
Assets to be Disposed Of" ("SFAS 121"), the Company reviews, as circumstances
dictate, the carrying amount of its intangible assets and manufacturing
facilities. Recoverability is determined by comparing the projected
undiscounted net cash flows of the long-lived assets against their respective
carrying amounts. The amount of impairment, if any, is measured based on the
excess of the carrying value over the fair value. As they relate to the
Company's manufacturing facilities, management's reviews consider, among
other factors, the Company's global manufacturing needs and plans for
existing commercial products, as well as products in development. The
estimates used in the reviews are dependent upon several key assumptions,
including the projected level of demand for the Company's products, product
pricing, success of clinical trials, timing of regulatory approval and the
introduction of competing products. However, there can be no assurance that
global manufacturing needs for existing products will continue unchanged and
product development programs will be successful. Excess manufacturing
capacity may occur in the future, requiring an adjustment of the carrying
value of certain facilities to their fair value.
REVENUE RECOGNITION
"Product sales, net" consist of revenue from product sales which is generally
recognized upon shipment; revenue from service contracts which is recognized
ratably over the life of the contract; revenue from the sale of equipment under
sales-type leases which is recognized at the inception of the lease; and revenue
from the sale of equipment under operating leases which is recognized upon
transfer of title to the equipment to a third party financing company. For
sales of Betaseron-Registered Trademark- (interferon beta-1b), the Company
recognizes a partial share of revenues upon shipment to its marketing partner
and an additional share upon the marketing partner's subsequent sale of
Betaseron-Registered Trademark-. Beginning July 1997, the contractual terms
under which Chiron recognizes Betaseron-Registered Trademark- revenue changed,
with a larger portion of revenues recognized when sales are realized by the
marketing partner, rather than upon Chiron's initial shipment.
"Equity in earnings of unconsolidated joint businesses" represents the Company's
share of the operating results generated by its commercial joint businesses.
"Collaborative agreement revenues" are earned and recognized based upon work
performed, upon the sale of product rights, upon shipment of product for use in
preclinical and clinical testing or upon the attainment of benchmarks specified
in the related agreements. Under contracts where reimbursement is based upon
work performed, the related research and development expenses were $79.5
million, $103.8 million and $51.8 million in 1997, 1996 and 1995, respectively.
"Other revenues" consist primarily of
21
CHIRON CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997
NOTE 1 - THE COMPANY AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
product royalty payments under license agreements, fees for sales and
marketing services performed and grants from government agencies, and are
recognized when earned. "Other revenues" in 1997 also included $31.1 million
of revenue related to Chiron's co-promotion of Novartis AG's product
Aredia-Registered Trademark- (pamidronate disodium for injection) which was
recognized, in part, based on the percentage of effort expended.
MAJOR CUSTOMERS
As discussed in Notes 2 and 6, Novartis AG and its affiliates (collectively,
"Novartis"), successor to Ciba-Geigy Ltd. ("Ciba"), is a related party and
contributed 11 percent and 10 percent of total revenues in 1997 and 1996,
respectively. Novartis contributed less than 10 percent of total revenues in
1995. As discussed in Note 6, Johnson & Johnson ("J&J") and its affiliates are
related parties and collectively contributed 12 percent, 11 percent and 11
percent of total revenues in 1997, 1996 and 1995, respectively.
ADVERTISING
Advertising costs are expensed as incurred and totaled $9.3 million, $12.8
million and $5.8 million from continuing operations in 1997, 1996 and 1995,
respectively.
INCOME TAXES
Income taxes are accounted for under the asset and liability method.
Deferred tax assets and liabilities are recognized for the future tax
consequences attributable to differences between the financial statement
carrying amounts of existing assets and liabilities and their respective tax
bases, and operating loss and tax credit carryforwards. Deferred tax assets
and liabilities are measured using enacted tax rates expected to apply to
taxable income in the years in which those temporary differences are expected
to be recovered or settled. The effect on deferred tax assets and
liabilities of a change in tax rates is recognized in income in the period
that includes the enactment date. No provision is made for U.S. income taxes
applicable to undistributed earnings of foreign subsidiaries that are
indefinitely reinvested in foreign operations.
PER SHARE DATA
In accordance with SFAS No. 128, "Earnings per Share" ("SFAS 128"), per share
data which excludes dilution is based on the weighted-average number of common
shares outstanding during the period. Per share data which assumes dilution is
based on the weighted-average number of common and dilutive potential common
shares outstanding. Dilutive potential common shares result from (i) the
assumed exercise of outstanding stock options, warrants and equivalents thereof
that have a dilutive effect when applying the treasury stock method; and (ii)
performance units (see Note 10) to the extent that dilutive shares are assumed
to be issuable if the contingency and reporting periods ended on the same date.
All prior-period per share data has been restated to conform with the provisions
of SFAS 128 subsequent to its adoption by the Company in the fourth quarter of
1997.
STOCK-BASED COMPENSATION
As permitted by SFAS No. 123, "Accounting for Stock-Based Compensation"
("SFAS 123"), the Company follows the existing accounting requirements for stock
options and other stock-based awards contained in Accounting Principles Board
("APB") Opinion No. 25, "Accounting for Stock Issued to Employees" ("APB 25").
However, the Company has provided in Note 10 the required pro forma disclosures
pursuant to SFAS 123.
SUPPLEMENTAL CASH FLOW INFORMATION
Cash paid for interest and income taxes (including amounts attributable to
Chiron Vision) is as follows for the years ended December 31:
22
CHIRON CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997
NOTE 1 - THE COMPANY AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
1997 1996 1995
----------- ----------- -----------
(IN THOUSANDS)
Interest, net of amounts
capitalized $ 19,973 $ 19,354 $ 18,603
Income taxes $ 10,792 $ 14,505 $ 8,597
Supplemental disclosure of noncash investing and financing activities, as
described in Note 2, is as follows for the years ended December 31:
1997 1996 1995
----------- ----------- -----------
(IN THOUSANDS)
Acquisitions:
Fair value of assets
acquired $ - $ 2,143 $ 962,124
Liabilities assumed - (1,769) (289,025)
Acquisition costs - - (6,013)
Stock and options issued - - (498,952)
Carrying value of original
investment - - (14,130)
----------- ----------- -----------
Total cash paid $ - $ 374 $ 154,004
----------- ----------- -----------
----------- ----------- -----------
NEW ACCOUNTING STANDARDS
In June 1997, the Financial Accounting Standards Board issued SFAS Nos. 130 and
131, "Reporting Comprehensive Income" ("SFAS 130") and "Disclosures about
Segments of an Enterprise and Related Information" ("SFAS 131"), respectively
(collectively, the "Statements"). The Statements are effective for fiscal years
beginning after December 15, 1997. SFAS 130 establishes standards for reporting
of comprehensive income and its components in annual financial statements. SFAS
131 establishes standards for reporting financial and descriptive information
about an enterprise's operating segments in its annual financial statements and
selected segment information in interim financial reports. Reclassification or
restatement of comparative financial statements or financial information for
earlier periods is required upon adoption of SFAS 130 and SFAS 131,
respectively. Application of the Statements' disclosure requirements will have
no impact on the Company's consolidated financial position, results of
operations or earnings per share data as currently reported.
NOTE 2 - BUSINESS COMBINATIONS
AGREEMENTS WITH NOVARTIS
Effective January 1, 1995, under a series of agreements between Chiron and
Novartis, including an Investment Agreement, a Cooperation and Collaboration
Agreement and a Governance Agreement (collectively, the "Agreements"), Novartis
increased its ownership interest in Chiron common stock to 49.9 percent (now
approximately 45 percent as a result of subsequent stock issuances to parties
other than Novartis), partially through a tender offer for approximately 38
percent of Chiron's outstanding common stock for $29.25 per share. At the same
time, Chiron acquired from Novartis all of the outstanding common stock of
Chiron Diagnostics Corporation ("Chiron Diagnostics"), formerly Ciba Corning
Diagnostics Corp., and Novartis' interests in Chiron Vaccines Company ("Chiron
Vaccines"), formerly Chiron Biocine Company, and Chiron S.p.A., formerly Biocine
S.p.A., in exchange for 26.4 million newly-issued Chiron common shares and a
cash payment of $23.5 million.
In connection with the Agreements, Novartis agreed to guarantee $425.0 million
of new debt for Chiron, agreed to provide $250.0 million (which may be increased
to $300.0 million subject to certain reductions in the debt
23
CHIRON CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997
NOTE 2 - BUSINESS COMBINATIONS (CONTINUED)
guarantee) over five years in support of research at Chiron, and provided Chiron
with the option to issue up to $500.0 million of new equity to Novartis.
Additionally, under the terms of the Agreements, Novartis is entitled to name
three members to Chiron's Board of Directors and has limited rights to review
and approve certain Chiron transactions.
During 1995, Chiron and Novartis entered into a limited liability company
agreement (the "Research Funding Agreement") to utilize research funding to
be provided by Novartis. Under the terms of the agreement, Novartis will
fund from time to time through December 31, 1999, at Chiron's request,
research and development costs for adult and pediatric vaccines and
insulin-like growth factor-1 ("IGF-1"). In return, Novartis will receive an
interest in a stream of royalties from future worldwide sales of certain
adult and pediatric vaccines and IGF-1. In addition, Novartis will receive
an interest in promotional rights, in countries other than in North America
and Europe, for certain adult vaccines. In December 1997, Chiron and Novartis
amended the Research Funding Agreement to add herpes simplex virus thymidine
kinase ("HSV-tk") and Factor VIII gene therapy to the funded projects. In
return, Novartis will receive a royalty stream from future worldwide sales of
certain HSV-tk and Factor VIII gene therapy products. Royalties on all
specified products will be paid for a minimum of 10 years from the later of
October 1, 2001 or the date of the first commercial sale of individual
products covered by the Research Funding Agreement, as amended. Further, such
royalty payments will continue until Novartis has received an aggregate
amount equal to the sum of all research and development funding provided by
Novartis plus interest thereon from the date of payment at a rate equal to
the London Interbank Offered Rate ("LIBOR"). Annual funding amounts will not
exceed $62.3 million in 1998 and $50.3 million (plus any unused portion of
the funding limit for 1998) in 1999.
Under the terms of the Research Funding Agreement, as amended, Chiron was
granted an option through December 31, 2001, to repurchase Novartis' interest,
at cost plus an agreed-upon return, as defined in the agreement. In addition,
if Chiron chooses to exercise the option, Novartis will receive an option to
acquire certain exclusive marketing rights, in countries other than those in
North America and Europe, with respect to certain adult vaccines in countries in
which Novartis has exercised its co-promotion rights. Pursuant to the
agreement, Chiron recognized $53.3 million, $72.0 million and $27.0 million of
funding from Novartis during 1997, 1996 and 1995, respectively, as components of
"Collaborative agreement revenues" in the accompanying Consolidated Statements
of Operations. At December 31, 1997 and 1996, $3.0 million and $20.0 million,
respectively, were due from Novartis under the Research Funding Agreement, as
amended. Chiron anticipates receiving substantial additional funding from
Novartis in future periods under this funding arrangement.
Certain guarantees stated within the Agreements were modified on November 27,
1996 in conjunction with a consent and agreement that resolved the Federal Trade
Commission's review of the Ciba and Sandoz Ltd. merger that created Novartis.
Under the November 27, 1996 agreement, Chiron agreed to grant royalty-bearing
licenses to Rhone-Poulenc Rorer Inc. and Novartis for certain patent rights on
the HSV-tk gene in the field of gene therapy. As partial consideration,
Novartis will pay the Company up to an aggregate of $60.0 million through 2001,
$15.0 million of which was recognized in 1997 as a component of "Collaborative
agreement revenues" in the accompanying Consolidated Statements of Operations.
Novartis also agreed to cross-license to the Company certain Novartis-controlled
gene therapy technologies.
Additionally, Novartis and the Company agreed to a modification of Chiron's
contract, which expired in March 1997 and provided for sole promotional rights
in the U.S. with respect to Novartis' product Aredia-Registered Trademark-.
Under the
24
CHIRON CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997
NOTE 2 - BUSINESS COMBINATIONS (CONTINUED)
exclusive agreement which expired in March 1997, Chiron recognized
Aredia-Registered Trademark- sales fees, included as components of "Other
revenues" in the accompanying Consolidated Statements of Operations, of $12.5
million, $30.2 million and $6.7 million in 1997, 1996 and 1995, respectively.
The November 1996 agreement provided that Chiron, through a co-promotion
arrangement with Novartis, would promote Aredia-Registered Trademark- for two
years after a six-month transitional period beginning April 1997. Chiron
recognized $31.1 million of revenue in 1997, also included as a component of
"Other revenues" in the accompanying Consolidated Statements of Operations,
related to Aredia-Registered Trademark- co-promotion services provided to
Novartis. In December 1997, the co-promotion arrangement with Novartis was
modified such that Chiron will no longer promote Aredia-Registered Trademark-
after April 3, 1998. Revenue to be recognized by Chiron in the first quarter
of 1998 will approximate $9.2 million plus a percentage of Aredia-Registered
Trademark- sales in the first quarter of 1998 in excess of a specified
amount. Revenue to be recognized by Chiron in the second quarter of 1998
will approximate $0.6 million. At December 31, 1997 and 1996, $19.4 million
and $13.4 million, respectively, were due from Novartis under the
Aredia-Registered Trademark- arrangements. Amounts due from Novartis are
payable to Chiron through the first quarter of 2000.
Novartis and Chiron also agreed to extend the deadline for payment of the
repurchase amount under the Research Funding Agreement, as amended, from
January 1, 2002 to January 1, 2005, if Chiron chooses to exercise this option.
However, this will not affect the term of the repurchase option which expires on
December 31, 2001.
Novartis also agreed to extend the term during which Novartis is committed to
provide a debt guarantee from 1999 to January 1, 2008. Further, Novartis
granted an option to Chiron to increase the amount of the debt guarantee from
$425.0 million to $725.0 million with a corresponding equivalent dollar
reduction in the equity put now available to Chiron (from $500.0 million to
$200.0 million).
In addition, should Chiron elect to replace certain existing convertible debt,
Novartis agreed to provide additional guarantees totaling $200.0 million for
such purposes.
ACQUISITIONS OF CHIRON DIAGNOSTICS AND INTERESTS IN CHIRON VACCINES AND CHIRON
S.p.A.
The acquisitions of Chiron Diagnostics and Novartis' interests in Chiron
Vaccines and Chiron S.p.A. (the "Acquisitions") were accounted for under the
purchase method of accounting. The purchase price of approximately $433.4
million was allocated to the acquired assets and assumed liabilities based upon
their estimated fair value on the acquisition date. The fair value of the net
assets acquired in the Acquisitions, including purchased in-process technology,
was estimated based on an independent valuation of the acquired net assets. The
aggregate purchase price of approximately $433.4 million was less than the fair
value of the net assets acquired by approximately $57.3 million. This amount
was ratably allocated as a reduction of the noncurrent assets of the acquired
companies. In connection with the Acquisitions, liabilities were assumed as
follows:
(IN THOUSANDS)
Fair value of assets acquired, net of
negative goodwill $ 694,895
Common stock issued (407,550)
Cash paid (23,504)
Acquisition costs (2,304)
------------
Liabilities assumed $ 261,537
------------
------------
As part of the purchase accounting, Chiron recognized as an expense the amount
allocated to purchased in-process technology, resulting in a noncash charge
against earnings of $222.9 million. Other transaction-related charges which
totaled $49.4 million resulted from employee payments and related taxes, and
legal and investment advisor
25
CHIRON CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997
NOTE 2 - BUSINESS COMBINATIONS (CONTINUED)
fees. Novartis agreed to reimburse the Company $24.8 million for a portion of
the employee payments, and such reimbursement was recorded as a capital
contribution. Other purchased intangible assets of approximately $25.6 million,
consisting of base technology, were offset by $2.3 million, $8.8 million and
$8.1 million of charges in lieu of taxes (see Note 13) in 1997, 1996 and 1995,
respectively, with the remaining base technology being amortized over estimated
useful lives of 10 to 15 years using the straight-line method. The operations
of Chiron Diagnostics, Chiron Vaccines and Chiron S.p.A. are included in
Chiron's consolidated operating results from January 1, 1995 forward.
ACQUISITION OF VIAGENE, INC. ("VIAGENE")
On September 29, 1995, Chiron acquired all of the outstanding common stock of
Viagene, not previously owned by the Company, in exchange for approximately
$35.5 million in cash and 3.7 million shares of Chiron common stock.
Additionally, on September 29, 1995, unexercised options to purchase Viagene
common stock were converted into options to purchase approximately 528,000
shares of Chiron common stock. Viagene was a biotechnology company involved in
the discovery, development and commercialization of gene transfer products for
the treatment or prevention of severe viral infections, cancers and other
diseases. Prior to the acquisition, Chiron had an ongoing collaboration with
Viagene in the area of gene therapy and, pursuant to the collaboration
arrangement, held an investment in the outstanding voting stock of Viagene with
a carrying value, net of unrealized gains and a realized loss, of approximately
$14.1 million at September 29, 1995.
The Viagene acquisition was accounted for under the purchase method of
accounting. The purchase price of approximately $143.7 million was allocated to
the acquired assets and assumed liabilities based on their estimated fair
value on the acquisition date. In connection with the acquisition, liabilities
were assumed as follows:
(IN THOUSANDS)
Fair value of assets acquired $ 158,461
Carrying value of original investment in Viagene (14,130)
Common stock and options issued (91,402)
Cash paid (35,500)
Acquisition costs (2,696)
-----------
Liabilities assumed $ 14,733
-----------
-----------
Chiron recognized as an expense the amount of the purchase price allocated to
purchased in-process technology, resulting in a noncash charge against earnings
of $130.3 million. The results of operations of Viagene are included in
Chiron's consolidated operating results from September 29, 1995 forward.
ACQUISITION OF IOLAB
On March 31, 1995, Chiron acquired the ophthalmic surgical product division of
IOLAB from J&J for approximately $95.0 million. The acquisition was accounted
for under the purchase method of accounting by Chiron Vision, a discontinued
operation (see Note 3). Accordingly, IOLAB's results of operations, net of
applicable income taxes, are included as a component of "Income (loss) from
discontinued operations" in the accompanying Consolidated Statements of
Operations from the date of purchase. The purchase price was allocated to the
acquired assets and assumed liabilities based on their estimated fair value on
the acquisition date. The fair value of the net assets acquired, including
in-process technology, was estimated based on independent valuations of the
acquired net assets. In connection with the acquisition, liabilities were
assumed as follows:
26
CHIRON CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997
NOTE 2 - BUSINESS COMBINATIONS (CONTINUED)
(IN THOUSANDS)
Fair value of assets acquired $ 108,768
Cash paid (95,000)
Acquisition costs (1,013)
-----------
Liabilities assumed $ 12,755
-----------
-----------
The amount allocated to purchased in-process technology of $10.3 million, as
well as additional charges totaling $16.9 million for IOLAB restructuring and
integration-related expenses, are included, net of applicable income taxes, as
components of "Income (loss) from discontinued operations" in the accompanying
Consolidated Statements of Operations in 1995. Other purchased intangible
assets of approximately $46.5 million, consisting of base technology, goodwill,
trade name and a customer list, are being amortized by Chiron Vision over their
estimated useful lives of 10 to 15 years using the straight-line method.
PRO FORMA FINANCIAL INFORMATION
The following unaudited pro forma information presents the results of continuing
operations of Chiron and Viagene for the year ended December 31, 1995, with pro
forma adjustments as if the Viagene acquisition had been consummated as of
January 1, 1995. This pro forma information does not purport to be indicative
of what would have occurred had the acquisition been made as of that date or of
results which may occur in the future. In addition, the pro forma information
does not include the write-off of purchased in-process technology related to the
Viagene acquisition of $130.3 million. The unaudited pro forma information is
as follows for the year ended December 31:
1995
-------------
(IN THOUSANDS,
EXCEPT PER SHARE DATA)
(UNAUDITED)
Total revenues $ 931,229
Loss from continuing operations before
non-recurring charge (352,368)
Pro forma earnings per share data:
Loss from continuing operations before
non-recurring charge (2.17)
Loss from continuing operations before
non-recurring charge - assuming dilution (2.17)
AGREEMENT WITH HOECHST AG, SUCCESSOR TO BEHRINGWERKE AG
Effective July 1, 1996, Chiron purchased a 49 percent interest in the human
vaccine business of Behringwerke AG. Chiron accounts for its interest under the
equity method. The total acquisition price, which was payable in cash, was
approximately $120.0 million, including costs directly related to the
acquisition. This amount is reflected as a component of "Investments in equity
securities and affiliated companies" in the accompanying Consolidated Balance
Sheets. Of the total acquisition price, approximately $97.0 million was
allocated to various intangible assets such as goodwill, trademarks and patents,
and is being amortized on a straight-line basis over lives ranging from 5 to 20
years.
Under the terms of the agreement, Chiron has an option to purchase the
remaining 51 percent interest in the joint venture in March 1998, 1999, 2000
or 2001, and Hoechst AG has the option to require Chiron to acquire the
remaining 51 percent interest in March 2001. In February 1998, Chiron gave
notice to Hoechst AG that the
27
CHIRON CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997
NOTE 2 - BUSINESS COMBINATIONS (CONTINUED)
Company intends to exercise its option to purchase the remaining 51 percent
interest in the joint venture in Chiron's second fiscal quarter of 1998 for
approximately 210.7 million Deutsche marks. During the period of mutual
ownership, Chiron and Hoechst AG are operating the vaccine business as a
joint venture, which has been named Chiron Behring GmbH & Co. ("Chiron
Behring"). The joint venture pays to Hoechst AG an annual royalty comprised
of a percentage of the excess of net sales of certain Chiron vaccine products
in Germany over forecasted amounts for the years 1997 through 2001. No
annual royalty was payable to Hoechst AG in 1997.
In 1997 and 1996, Chiron recognized $13.8 million and $4.2 million,
respectively, as its share of the joint venture's results, which includes
amortization of the aforementioned intangible assets, as a component of "Equity
in earnings of unconsolidated joint businesses" in the accompanying Consolidated
Statements of Operations. Chiron Behring, which was previously reported on a
one-month lag, was brought current in December 1997. As a result, Chiron's
equity in earnings of Chiron Behring of approximately ($0.7) million for the
month of December was recorded as a component of "Accumulated deficit" at
December 31, 1997 in the accompanying Consolidated Balance Sheets.
Summarized financial information for Chiron Behring, which excludes Chiron's
amortization of intangibles, as of and for the year ended December 31, 1997 is
as follows:
DECEMBER 31, 1997
-----------------
(IN THOUSANDS)
SUMMARIZED BALANCE SHEET INFORMATION:
Current assets $ 110,799
Noncurrent assets 9,986
Current liabilities 26,522
Noncurrent liabilities 7,308
YEAR ENDED
DECEMBER 31, 1997
-----------------
(IN THOUSANDS)
SUMMARIZED STATEMENT OF OPERATIONS
INFORMATION:
Net sales $ 173,454
Gross profit 105,827
Income from continuing operations
before extraordinary items and
cumulative effect of a change
in accounting principle 35,530
Net income 35,530
NOTE 3 - DISCONTINUED OPERATIONS
On December 29, 1997, Chiron completed the sale of all of the outstanding
capital stock of Chiron Vision, a wholly owned subsidiary, to Bausch & Lomb
Incorporated ("B&L") for $300.0 million in cash, subject to certain post-closing
adjustments. The sale was completed under the terms of a Stock Purchase
Agreement (the "Agreement"), dated as of October 21, 1997, between Chiron and
B&L. In accordance with APB Opinion No. 30, "Reporting the Results of
Operations - Reporting the Effects of Disposal of a Segment of a Business, and
Extraordinary, Unusual and Infrequently Occurring Events and Transactions,"
Chiron Vision is reported as a discontinued operation for all periods presented
in the accompanying Consolidated Statements of Operations. Chiron Vision's cash
and cash equivalents totaling $2.7 million, certain Chiron Vision real estate
assets (the "real estate assets") with a carrying value of $25.1
28
CHIRON CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997
NOTE 3 - DISCONTINUED OPERATIONS (CONTINUED)
million and Chiron Vision's future noncancelable operating lease costs totaling
$1.1 million were retained by the Company upon completion of the sale. For a
period of three years following the completion of the sale, Chiron Vision has
the right to use the currently occupied portion of the real estate assets on a
rent-free basis. The real estate assets, to be recorded by Chiron at their
estimated fair values less cost to sell, will be reflected in the Company's
consolidated balance sheet at March 31, 1998 as assets held for sale.
Additionally, the Company has agreed to provide customary indemnities under the
terms of the Agreement.
Chiron Vision recognized total revenues of $212.7 million, $211.0 million and
$177.0 million in 1997, 1996 and 1995, respectively. "Income (loss) from
discontinued operations" in the accompanying Consolidated Statements of
Operations is reported net of income tax provisions of $6.4 million, $2.7
million and $1.8 million in 1997, 1996 and 1995, respectively, and includes
approximately $3.8 million of net income from operations recognized by Chiron
Vision from October 21, 1997 to December 28, 1997. Direct transaction costs of
$0.3 million were deferred at December 31, 1997 and included as a component of
"Other current assets" in the accompanying Consolidated Balance Sheets.
The accompanying Consolidated Balance Sheets include the net assets of
discontinued operations, including the real estate assets, as follows at
December 31:
1997 1996
----------- -----------
(IN THOUSANDS)
Accounts receivable, net $ 48,073 $ 48,268
Inventories 37,944 43,577
Property, plant, equipment and
leasehold improvements, net 47,634 48,800
Purchased technology, net 25,068 28,588
Other intangible assets, net 41,567 45,175
Accounts payable and other current
liabilities (38,343) (42,789)
Other assets and liabilities, net 5,025 7,471
----------- -----------
$ 166,968 $ 179,090
----------- -----------
----------- -----------
Management's current best estimate indicates that a net gain will be realized
from the sale of Chiron Vision. In accordance with Emerging Issues Task Force
Issue No. 93-17, "Recognition of Deferred Tax Assets for a Parent Company's
Excess Tax Basis in the Stock of a Subsidiary That Is Accounted for as a
Discontinued Operation" ("EITF 93-17"), Chiron recognized a net deferred tax
asset and a corresponding deferred tax benefit of $15.2 million in the fourth
quarter of 1997, which is reflected in the accompanying Consolidated Statements
of Operations as "Gain on disposal of discontinued operations." The recognition
of this net deferred tax asset in the fourth quarter of 1997 will have the
effect of reducing the actual net gain recognized by Chiron in the first quarter
of 1998 by a corresponding amount.
Income (loss) per common share from discontinued operations was $0.12, ($0.00)
and ($0.29) for the years ended December 31, 1997, 1996 and 1995, respectively.
Income (loss) per common share from discontinued operations, assuming dilution,
was $0.11, ($0.01) and ($0.29) for the years ended December 31, 1997, 1996 and
1995, respectively.
29
CHIRON CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997
NOTE 4 - IMPAIRMENT LOSS ON LONG-LIVED ASSETS
During 1997, the cumulative impact on the Company's manufacturing needs of
recent product developments prompted management to conclude that Chiron
currently has excess manufacturing capacity relative to its projected needs.
Specifically, management concluded that the Company's need for its idle
pharmaceutical fill and finishing facility in Puerto Rico (the "Puerto Rico
facility"), originally outfitted as a second manufacturing site of
Betaseron-Registered Trademark-, was eliminated due to manufacturing process
improvements and the cumulative impact of the introduction of a competing
product in the second quarter of 1996. In September 1997, management determined
that it could not find a suitable use for the Puerto Rico facility consistent
with its previous expectations for the facility's use as a contract
manufacturing plant. As a result, the Company reviewed the carrying amount of
the Puerto Rico facility and related machinery and equipment assets for
impairment in accordance with SFAS 121. Consequently, during the third quarter
of 1997, the Company recorded a $31.3 million impairment loss to record the
Puerto Rico facility and related machinery and equipment assets at their
individual estimated fair market values, determined on the basis of independent
appraisals.
NOTE 5 - RESTRUCTURING AND REORGANIZATION CHARGES
During 1995, Chiron recorded $22.1 million in restructuring and
reorganization charges, representing write-downs of certain previously
capitalized costs. Of the total charge of $22.1 million, $8.0 million was
due to a change in plans to expand the Company's Emeryville research and
development facilities and $7.7 million was related to the idling of the
Puerto Rico facility (see Note 4). The majority of these facility-related
charges, as well as $3.7 million of other facility-related costs, were paid
in 1995. Employee termination costs related to the Company's 1995
restructuring were not significant.
During 1997, Chiron commenced a restructuring of certain of its operations
and recorded a restructuring and reorganization charge of $3.3 million,
consisting primarily of employee termination and other costs related to the
closure of Chiron Diagnostics' electrophoresis business and to the sale of
its Quality Controls business (see Note 14).
At December 31, 1997, the accrual for restructuring and reorganization charges
totaled $6.9 million. Liabilities associated with the 1997 restructuring and the
remaining accrual for the Puerto Rico facility are expected to be substantially
settled during 1998. The current status of the accrued restructuring charges is
summarized as follows:
30
CHIRON CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997
NOTE 5 - RESTRUCTURING AND REORGANIZATION CHARGES (CONTINUED)
AMOUNT OF AMOUNT AMOUNT TO
TOTAL UTILIZED BE UTILIZED
RESTRUCTURING THROUGH IN FUTURE
CHARGE DEC. 31, 1997 PERIODS
------------- ------------- -----------
(IN THOUSANDS)
1995 RESTRUCTURING AND REORGANIZATION CHARGES:
Puerto Rico facility $ 7,650 $ (4,009) $ 3,641
Postponement of Emeryville facility
expansion 7,990 (7,990) -
Amsterdam manufacturing facilities 1,000 (1,000) -
Other facility-related costs 3,718 (3,718) -
Other 1,750 (1,696) 54
---------- ---------- ----------
$ 22,108 $ (18,413) 3,695
---------- ---------- ----------
---------- ----------
1997 RESTRUCTURING AND REORGANIZATION CHARGES:
Employee-related costs $ 2,420 $ - 2,420
Other 916 (174) 742
---------- ---------- ----------
$ 3,336 $ (174) 3,162
---------- ---------- ----------
---------- ----------
$ 6,857
----------
----------
NOTE 6 - COLLABORATIONS, JOINT BUSINESS ARRANGEMENT AND RELATED PARTY
TRANSACTIONS
COLLABORATIONS
The Company has entered into a number of collaborative arrangements with other
pharmaceutical and biotechnology companies for the development and marketing of
certain technologies and products. Chiron and its collaborative partners
generally contribute certain technologies and research efforts to the
collaboration. In addition, Chiron and its collaborative partners commit,
subject to certain limitations and cancellation clauses, to share in the funding
of the collaborations' ongoing research and clinical trial costs. Chiron will
also be required to make payments under certain of these agreements upon
achievement of specified milestones. Aggregate annual funding commitments under
collaborative arrangements, inclusive of commitments to Hyseq, Inc. discussed
below, are $9.6 million in 1998, $6.0 million in 1999, $3.0 million in 2000 and
insignificant amounts thereafter. Chiron, under certain of the arrangements,
has also purchased equity securities of the collaborative partner.
HYSEQ, INC. ("HYSEQ") In May 1997, the Company entered into an agreement with
Hyseq to collaborate in the identification of genetic targets for the
development of pharmaceutical treatments for cancer. Subject to the
collaboration and in return for a license and other rights, Chiron made an
initial payment of $1.0 million, which was recorded as research and development
expense during the second quarter of 1997. In addition, the Company is
obligated to fund allowable research costs, in amounts not less than $8.5
million in the first year and $5.5 million in each of the second and third years
of the collaboration term, incurred by Hyseq in performing research requested by
Chiron. In addition to the initial payment described above, $4.3 million of
funding was recognized as research and development expense by the Company in
1997. Certain additional payments may be required by Chiron upon achievement of
specified milestones. Hyseq will also receive a royalty from any commercial
sales of products resulting from the collaboration. Pursuant to the terms of
the agreement, Chiron made an investment of $7.5 million in the
31
CHIRON CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997
NOTE 6 - COLLABORATIONS, JOINT BUSINESS ARRANGEMENT AND RELATED PARTY
TRANSACTIONS (CONTINUED)
equity securities of Hyseq during 1997, which is accounted for under the cost
method and is reflected as a component of "Investments in equity securities and
affiliated companies" in the accompanying Consolidated Balance Sheets.
JOINT BUSINESS ARRANGEMENT AND RELATED PARTY TRANSACTIONS
DIAGNOSTIC JOINT BUSINESS
In 1989, Chiron entered into an agreement with Ortho Diagnostic Systems, Inc.
("Ortho"), a J&J company, to jointly develop, manufacture and market certain
immunoassay diagnostic products. Under the terms of the agreement, Chiron
receives 50 percent of the pretax operating profits generated by the joint
business and is reimbursed for its continuing research, development and
manufacturing costs. Ortho and Chiron also licensed Abbott Laboratories
("Abbott"), Pasteur Sanofi Diagnostics, International Murex Technologies
Corporation and Genelabs Diagnostic, Inc. to sell their own immunoassay
diagnostic tests for hepatitis C ("HCV"), using certain technology from the
joint business.
Chiron records its share of profits of the Chiron-Ortho diagnostic business on a
one-month lag using estimates provided by Ortho. These estimates are subject to
a final adjustment 90 days after the end of each calendar year (the "final
annual accounting"), and profit sharing distributions are payable to Chiron
within 90 days after the end of each quarter. At December 31, 1997 and 1996,
$22.8 million and $24.4 million, respectively, were due from Ortho for profit
sharing and reimbursement of costs. Chiron's 50 percent share of the profits
from the joint business in 1997 was $92.9 million, which includes $0.8 million
from the final annual accounting for 1996. In 1996, Chiron recognized
$95.8 million, which includes $3.8 million from the final annual accounting for
1995 and $6.9 million from a settlement with Abbott related to prior period
sales by Abbott of human immunodeficiency virus (HIV) immunodiagnostic tests.
In 1995, Chiron recognized $76.9 million, which includes $1.8 million from the
final annual accounting for 1994. Revenues recognized under the cost
reimbursement portion of the agreement with Ortho for collaborative research
were $7.1 million, $8.6 million and $9.6 million in 1997, 1996 and 1995,
respectively. Revenues recognized under the cost reimbursement portion of the
agreement with Ortho for product sales were $20.1 million, $15.0 million and
$16.1 million in 1997, 1996 and 1995, respectively.
GENELABS TECHNOLOGIES, INC. ("GENELABS") In March 1995, the Company reached
an agreement with Genelabs whereby Chiron and Genelabs cross-licensed certain
rights to viral diagnostic tests. Under the agreement, Chiron acquired
certain rights to develop and market diagnostic products for the detection of
related viruses. In return, Genelabs acquired development and marketing
rights in Asia, except Japan, for certain products incorporating Chiron's HCV
technology. Ortho agreed to participate as Chiron's equal partner in the
collaboration with Genelabs and therefore will share equally in all payments
under the agreement, including $5.0 million in up front license fees, up to
$9.0 million in development milestones and a total of $10.0 million in equity
investments. Chiron paid Genelabs a total of $8.5 million during 1995 related
to the collaboration. Of this total, $2.1 million was recorded as an
investment in equity securities and $6.4 million was recorded as research and
development expense. No amounts were incurred in either 1997 or 1996 related
to this collaboration.
NOVARTIS In November 1995, Chiron and Novartis entered into a collaboration
agreement through which Novartis acquired a non-exclusive, perpetual license to
broadly apply Chiron's combinatorial chemistry technologies in Novartis'
research programs. In addition, Chiron and Novartis agreed to collaborate on
the identification of new drug candidates for specific disease targets. In
exchange for these rights, Novartis agreed to pay certain license, milestone and
royalty payments to Chiron. In addition, Novartis agreed to make certain
payments to Chiron in exchange for access to Chiron's technology, chemical
libraries and exclusive rights relating to specific drug discovery targets.
Novartis was also granted the right to develop and market products resulting
from the drug
32
CHIRON CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997
NOTE 6 - COLLABORATIONS, JOINT BUSINESS ARRANGEMENT AND RELATED PARTY
TRANSACTIONS (CONTINUED)
discovery targets in exchange for certain milestone and royalty payments to
Chiron. Chiron was granted commercialization rights to products developed for
non-competing indications, subject to the payment of royalties to Novartis.
Novartis also agreed to fund Chiron's activities relating to the collaboration
for a period of three years, and up to five years at Novartis' option.
Under the terms of the agreement, Novartis will pay $26.0 million to Chiron over
a five-year period, subject to certain adjustments, in exchange for the
non-exclusive, perpetual license to utilize Chiron's combinatorial chemistry
techniques. In connection with the agreement, Chiron recognized $10.2 million,
$9.4 million and $5.5 million of "Collaborative agreement revenues" in the
accompanying Consolidated Statements of Operations in 1997, 1996 and 1995,
respectively. At December 31, 1997, $7.5 million was due from Novartis under
this agreement.
NEW YORK UNIVERSITY ("NYU") In March 1995, the Company reached an agreement
with NYU under which Chiron agreed to support research at NYU, received an
exclusive license to commercialize a potential optical mapping instrument and,
together with its licensee, Novartis, received a non-exclusive royalty free
license to use optical mapping in connection with the development of other
products. Chiron made a $5.0 million initial payment to NYU, which was recorded
as research and development expense in 1995, for the license and for funding of
certain research facilities at NYU. Novartis made further research payments to
NYU. Chiron has elected to terminate the exclusive license with respect to the
optical mapping instrument, as well as support of the research program at NYU,
effective March 31, 1998. Expenses incurred by Chiron in 1997 and 1996 related
to this collaboration were not significant.
GENERAL INJECTABLES & VACCINES, INC. ("GIV") In September 1996, Chiron entered
into an agreement with Biological and Popular Culture, Inc. ("BPC"), a newly
organized holding company for GIV and affiliated companies, pursuant to which
GIV and its affiliates agreed to perform certain distribution and promotional
services for Chiron's vaccine products in the United States. The initial term
of the service agreement is five years, with potential one-year extensions
thereafter.
In connection with the agreement, Chiron invested $30.0 million in BPC, of which
$13.8 million consisted of BPC voting preferred stock, which is convertible at
Chiron's option into 30 percent of the outstanding common stock of BPC.
Alternatively, Chiron, at its option, may require BPC to redeem the preferred
stock at par plus accrued dividends of 8 percent at a future date. Of the
preferred stock investment, a significant amount represents excess purchase
price and is being amortized over 15 years. The remainder of the $30.0 million
investment consisted primarily of two interest-bearing loans, with principal
amounts of $5.0 million and $11.0 million, to BPC and its subsidiaries with
various maturities. Concurrent with BPC's repayment of the $5.0 million
interest-bearing loan in January 1997, Chiron advanced this same amount to BPC
as a prepayment for future distribution and promotional services. Chiron agreed
to make additional capital contributions, to be used by BPC to repay the $11.0
million interest-bearing loan, in the event BPC exceeds certain earnings
requirements. Pursuant to this agreement, a capital contribution of $5.1
million was made by Chiron in 1997, which was used by BPC to repay a portion of
the remaining loan balance.
In 1997 and 1996, Chiron recognized $0.7 million and $0.2 million,
respectively, as its share of BPC's earnings, which include amortization of
the aforementioned excess purchase price, as components of "Equity in
earnings of unconsolidated joint businesses" in the accompanying Consolidated
Statements of Operations. Chiron's share of BPC's results are reported on a
one-quarter lag.
33
CHIRON CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997
NOTE 7 - FAIR VALUE OF FINANCIAL INSTRUMENTS
MARKETABLE SECURITIES
In accordance with SFAS No. 115, "Accounting for Certain Investments in Debt
and Equity Securities" ("SFAS 115"), the Company has classified its investments
in certain debt and equity securities as "available-for-sale." Such investments
are recorded at fair value based upon year-end quoted market prices, with
unrealized gains and losses, deemed by the Company as temporary in nature,
reported as a separate component of stockholders' equity.
Available-for-sale securities consist of the following at December 31:
1997 1996
-------------------------------------------- ------------------------------------------
ADJUSTED UNREALIZED UNREALIZED FAIR ADJUSTED UNREALIZED UNREALIZED FAIR
COST GAINS LOSSES VALUE COST GAINS LOSSES VALUE
-------- ---------- ---------- -------- -------- ---------- ---------- --------
(IN THOUSANDS)
U.S. Government $ 22,606 $ 8 $ (37) $ 22,577 $ 30,179 $ 17 $(151) $ 30,045
Mortgage-backed 1,998 - (1) 1,997 7,913 22 (1) 7,934
Corporate debt 180,132 12 (132) 180,012 32,803 2 (92) 32,713
-------- ------- -------- -------- -------- ------- ----- --------
204,736 20 (170) 204,586 70,895 41 (244) 70,692
Equity 21,804 12,529 (3,383) 30,950 17,665 28,777 - 46,442
-------- ------- -------- -------- -------- ------- ----- --------
$226,540 $12,549 $ (3,553) $235,536 $ 88,560 $28,818 $(244) $117,134
-------- ------- -------- -------- -------- ------- ----- --------
-------- ------- -------- -------- -------- ------- ----- --------
These securities are classified in the accompanying Consolidated Balance Sheets
as follows at December 31:
1997 1996
----------- ----------
(IN THOUSANDS)
Cash equivalents $ 44,597 $ 9,971
Short-term investments in marketable debt securities 84,588 38,694
Noncurrent investments in marketable debt securities 75,401 22,027
Investments in equity securities and affiliated companies 30,950 46,442
----------- ----------
$ 235,536 $ 117,134
----------- ----------
----------- ----------
The cost and estimated fair value of available-for-sale debt securities by
contractual maturity consist of the following at December 31, 1997:
ADJUSTED FAIR
COST VALUE
----------- ----------
(IN THOUSANDS)
Due within one year $ 161,753 $ 161,655
Due in one to three years 40,985 40,934
----------- ----------
202,738 202,589
Mortgage-backed securities 1,998 1,997
----------- ----------
$ 204,736 $ 204,586
----------- ----------
----------- ----------
The proceeds received from the sale and maturity of securities held as
available-for-sale were $120.3 million, $143.9 million and $334.1 million
during 1997, 1996 and 1995, respectively. During 1997, the gross realized
gains on sales of securities held as available-for-sale were $5.5 million.
The gross realized losses during 1997 and 1996, and the gross realized gains
during 1996, on sales of securities held as available-for-sale were not
significant. During 1995, the gross realized gains and gross realized losses
on sales of securities held as available-for-sale were $0.4 million and $3.5
million, respectively. The cost of securities sold is based on the specific
identification method for debt securities and on the average cost method for
equity securities. The change
34
CHIRON CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997
NOTE 7 - FAIR VALUE OF FINANCIAL INSTRUMENTS (CONTINUED)
in the net unrealized holding gain (loss) on available-for-sale securities,
included as a separate component of stockholders' equity, was ($19.6) million,
($2.7) million and $44.0 million for 1997, 1996 and 1995, respectively.
OTHER FINANCIAL INSTRUMENTS
The carrying amounts and fair values of the Company's financial instruments
other than those accounted for in accordance with SFAS 115 are as follows at
December 31:
1997 1996
------------------------- -------------------------
CARRYING CARRYING
AMOUNT FAIR VALUE AMOUNT FAIR VALUE
---------- ---------- ---------- ----------
(IN THOUSANDS)
ON-BALANCE SHEET FINANCIAL INSTRUMENTS:
Nonmarketable equity investments
(accounted for under the cost method) $ 6,596 $ 9,694 $ 4,763 $ 9,003
Notes receivable 14,697 14,497 20,478 20,518
Deposits 4,449 3,936 3,549 3,413
Due from cross currency interest rate swaps 19,236 15,807 4,018 3,543
Due from forward foreign currency contracts 569 569 - -
Long-term debt:
Convertible subordinated debentures 327,243 334,078 319,713 325,293
Notes payable 67,062 67,062 65,964 65,964
OFF-BALANCE SHEET FINANCIAL INSTRUMENTS:
Foreign currency option contracts - 2,929 - -
Cross currency interest rate swaps - 16,002 - (1,090)
The fair value estimates provided above are based on information available at
December 31, 1997 and 1996. Considerable judgment is required in interpreting
market data to develop the estimates of fair value. As such, these estimated
fair values are not necessarily indicative of the amounts that the Company could
realize in a current market exchange.
The fair value of nonmarketable equity investments that are accounted for
under the cost method is primarily based on estimated market prices
determined by a broker. The carrying values of variable rate notes receivable
and notes payable approximate fair value due to the market-based nature of
these instruments. The fair value of the deposits is based on the discounted
value of expected future cash flows using current rates for assets with
similar maturities. The fair value of the receivables from cross currency
interest rate swaps is based on the discounted value of expected future cash
flows using current rates. The carrying value of the receivables from forward
foreign currency contracts approximates fair value based on the short-term
nature of these contracts. The fair value of convertible subordinated
debentures is based on the market price at the close of business on the last
day of the fiscal year. The fair values of the foreign currency option
contracts and the cross currency interest rate swaps are based on estimated
market prices, determined by a broker.
Included in current assets and current liabilities are certain other financial
instruments whose carrying values approximate fair value due to the short-term
nature of such instruments.
35
CHIRON CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997
NOTE 7 - FAIR VALUE OF FINANCIAL INSTRUMENTS (CONTINUED)
FOREIGN CURRENCY CONTRACTS A significant portion of the Company's operations
consists of manufacturing and sales activities in foreign countries. As a
result, the Company's financial results will be affected by changes in foreign
currency exchange rates. The Company is primarily exposed to fluctuations in
currencies in western European countries and Japan.
Forward foreign currency contracts ("forwards"), generally with average
maturities of three months or less, are used to hedge material foreign currency
denominated receivables and payables. Forwards are generally marked to market
at the end of each quarter with gains or losses recorded as a component of
"Other income, net," in the accompanying Consolidated Statements of Operations
to offset gains or losses on foreign currency denominated receivables and
payables. Outstanding notional amounts of the Company's forwards were $46.1
million and $70.9 million at December 31, 1997 and 1996, respectively.
Foreign currency transaction gains and (losses) from continuing operations, net
of the impact of hedging, were a net ($2.3) million in 1997, ($3.0) million in
1996 and were not significant in 1995.
The Company purchases foreign currency option contracts ("options") to reduce
the exchange rate impact of a strengthening U.S. dollar on the underlying
hedged amounts. These contracts are designated and effective as hedges of a
portion of probable foreign currency exposure on anticipated intercompany
inventory purchases over the next twelve months by subsidiaries with
functional currencies other than the U.S. dollar. The cost of the options,
which is recorded as a component of "Other current assets" in the
accompanying Consolidated Balance Sheets, is deferred and amortized over the
relevant term of the period hedged. The Company's financial exposure is
limited to the amount paid for the options. Any resulting gains from these
option contracts are deferred until the designated intercompany transactions
are recorded, and are recognized as a component of "Other income, net" in the
accompanying Consolidated Statements of Operations. In the event that the
Company no longer anticipates a particular underlying exposure, the related
option contract will be terminated and the gain or loss associated with the
option contract will be recognized immediately. Outstanding notional amounts
of the Company's options were $111.3 million at December 31, 1997. No
options were outstanding at December 31, 1996.
CROSS CURRENCY INTEREST RATE SWAPS The Company selectively enters into cross
currency interest rate swaps ("swaps") with major financial institutions to
modify the interest and/or currency characteristics of certain assets and
liabilities. These swap agreements involve the exchange of interest payments
denominated in different currencies, based upon the terms described in the
swap agreements, with an exchange of the underlying notional principal
amounts upon maturity. The net difference between the interest amounts paid
and received is recognized as a component of "Other income, net" in the
accompanying Consolidated Statements of Operations. The related interest
amount payable or receivable from the major financial institutions is
included as a component of other current liabilities or assets. Outstanding
notional amounts of the Company's swaps were $139.1 million and $137.5
million at December 31, 1997 and 1996, respectively, as discussed below.
In June 1997, the Company entered into a swap agreement that matures in June
2002 with a notional amount of $26.5 million. The Company effectively created a
fixed rate yen-denominated liability in order to fix the interest charges of its
wholly owned Japanese subsidiary. The agreement provides for the Company to
make quarterly interest payments based on a fixed Japanese yen rate of
approximately 2.1 percent while receiving interest based on a variable rate tied
to three-month U.S. dollar LIBOR (5.7 percent at December 31, 1997). This
agreement substantially represents the extension of a swap agreement, which
matured in June 1997, with a notional amount of $24.9 million.
36
CHIRON CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997
NOTE 7 - FAIR VALUE OF FINANCIAL INSTRUMENTS (CONTINUED)
In July 1996, the Company also entered into swap agreements that mature in July
2001 with an aggregate notional amount of $112.6 million. The Company
effectively created a fixed rate Deutsche mark liability to fund certain
Deutsche mark assets. The agreements provide for the Company to make quarterly
interest payments based on a fixed Deutsche mark rate of 6.2 percent while
receiving interest based on a variable rate tied to three-month U.S. dollar
LIBOR plus 0.5 percent (6.2 percent at December 31, 1997).
NOTE 8 - DEBT OBLIGATIONS AND CAPITAL LEASES
Long-term debt consists of the following at December 31:
1997 1996
-------- --------
(IN THOUSANDS)
1.9 percent convertible subordinated debentures $236,202 $230,587
5.25 percent convertible subordinated debentures 91,041 89,126
Capital lease obligations 4,316 34,999
Note payable to Novartis 60,566 57,159
Other notes payable 9,347 10,734
-------- --------
401,472 422,605
Less current portion (4,255) (3,016)
-------- --------
$397,217 $419,589
-------- --------
-------- --------
CONVERTIBLE SUBORDINATED DEBENTURES
In 1993, Chiron issued 1.9 percent convertible subordinated debentures with a
face value of $253.9 million and a yield to maturity of 4.5 percent. The notes
are convertible, at the holders' option, into common stock at 34.6 shares per
$1,000 principal amount and are due in November 2000. Interest is paid
semi-annually. The debentures may be redeemed by the Company at any time, at a
redemption price starting at $905.78 per $1,000 principal amount increasing to a
redemption price equal to 100 percent of the principal amount at maturity. The
debentures are carried net of an initial issue discount of $39.3 million which
is being accreted over the life of the debentures using the interest method.
Debentures with a carrying value of $9.4 million and $9.1 million were held by
Novartis at December 31, 1997 and 1996, respectively.
As a result of the 1991 merger with Cetus Corporation ("Cetus"), the Company has
outstanding 5.25 percent convertible subordinated debentures, which are due in
2002, have a face value of $100.0 million and are convertible at the holders'
option at any time into common stock at 32.4 shares per $1,000 principal amount.
Interest is paid annually. At the option of the Company, the debentures may be
redeemed at any time at face value. These debentures are carried at a discount
and the difference between the face value of the debentures and their present
value is being accreted over the remaining term of the debentures using the
interest method.
CAPITAL LEASE OBLIGATIONS At December 31, 1997 and 1996, the gross amount of
land, buildings and equipment leased under noncancelable capital leases,
exclusive of amounts related to discontinued operations, totaled $7.1 million
and $20.0 million, respectively, and accumulated depreciation totaled $3.4
million and $7.0 million, respectively. Future payments under capital lease
obligations of continuing operations (including interest of approximately
$1.1 million) are as follows: 1998-$1.5 million, 1999-$0.7 million,
2000-$0.5 million, 2001-$0.5 million, 2002-$0.5 million and $1.2 million
thereafter.
37
CHIRON CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997
NOTE 8 - DEBT OBLIGATIONS AND CAPITAL LEASES (CONTINUED)
In January 1997, the Company purchased, for $29.8 million, a manufacturing
facility and other related buildings located in Emeryville, California that it
had previously leased under a capital lease agreement.
NOTES PAYABLE
The note payable to Novartis for approximately $60.6 million at December 31,
1997 was assumed by the Company in its acquisition of Chiron Diagnostics. The
note bears interest at a variable rate (approximately 6.0 percent at
December 31, 1997) based on LIBOR and is due in 2000 together with accrued
interest.
At December 31, 1997, exclusive of amounts related to discontinued
operations, the Company had various other notes payable with an average
interest rate of 5.2 percent and maturities ranging from 1998 through 2014.
Future maturities of notes payable of continuing operations are as follows:
1998-$1.5 million, 1999-$1.5 million, 2000-$1.7 million, 2001-$1.7 million,
2002-$0.2 million and $1.4 million thereafter.
SHORT-TERM BORROWINGS
Short-term borrowings totaled $154.7 million at December 31, 1997, consisting of
borrowings of $100.0 million under the Company's U.S. credit facilities,
$54.6 million under the Company's credit facilities outside the U.S. and a
$0.1 million obligation to Novartis. In January 1998, the $100.0 million of
borrowings outstanding under the Company's U.S. credit facilities was repaid by
Chiron from a portion of the cash proceeds from the sale of Chiron Vision (see
Note 3).
Under separate revolving, committed, unsecured credit agreements with major
financial institutions, the Company can borrow up to $200.0 million in the U.S.
These credit facilities are guaranteed by Novartis and provide for various
borrowing rate options, as defined in the agreements. At December 31, 1997, the
interest rate on the outstanding borrowings (approximately 5.8 percent at
December 31, 1997) was tied to U.S. dollar LIBOR. One of these credit
facilities, which allows for borrowings of up to $100.0 million, matures in
February 2003. The other credit facilities, which allow for aggregate
additional borrowings of up to $100.0 million, were consolidated into a single
credit facility maturing in March 1999.
Additionally, the Company has credit facilities available outside the U.S. that
allow for total borrowings of $130.2 million at December 31, 1997. These
revolving facilities are unsecured and are primarily maintained for Chiron
Diagnostics and Chiron S.p.A. At December 31, 1997, the average interest rate
on the outstanding borrowings was 6.2 percent.
NOTE 9 - COMMITMENTS AND CONTINGENCIES
LEASES
Chiron leases laboratory, office and manufacturing facilities, land and
equipment under noncancelable operating leases which expire at various times
through 2037. Rent expense from continuing operations was $26.2 million,
$26.5 million and $23.1 million in 1997, 1996 and 1995, respectively, under
these leases.
Future minimum lease payments under these leases, exclusive of amounts
related to discontinued operations, are as follows: 1998-$23.3 million,
1999-$18.9 million, 2000-$13.8 million, 2001-$10.7 million, 2002-$9.5 million
and $29.3 million thereafter.
Additionally, in June 1996, the Company entered into a seven-year operating
lease agreement with a group of
38
CHIRON CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997
NOTE 9 - COMMITMENTS AND CONTINGENCIES (CONTINUED)
financial institutions to rent a research and development facility that is
currently under construction in Emeryville, California. Under the terms of the
lease agreement, the financial institutions have committed $195.0 million toward
the total construction cost of the project. No lease payments are required
during the construction period which is expected to last less than three years.
Thereafter, rent amounts will be due quarterly, based on the total construction
costs incurred. Assuming a current interest rate of 6.0 percent and that
construction is completed on schedule, future minimum lease payments would be
$11.7 million annually, beginning in the third quarter of 1998.
Under this lease arrangement, which has been guaranteed by Novartis through
December 31, 1999, the Company has the option to purchase the constructed
properties. Alternatively, Chiron can cause the property to be sold to a third
party. The Company is also contingently liable under residual value guarantees
in the event of market value declines.
EQUIPMENT LEASING
Chiron Diagnostics is the lessor of certain equipment to customers under
sales-type leases as defined in SFAS No. 13, "Accounting for Leases." The
current portion of the net investment in sales-type leases is included as a
component of "Accounts receivable" and the long-term portion is included as a
component of "Other assets" in the accompanying Consolidated Balance Sheets.
The components of the net investment in sales-type leases were as follows at
December 31:
1997 1996
-------- --------
(IN THOUSANDS)
Minimum rentals receivable $ 27,911 $ 36,314
Less allowance for uncollectible amounts (54) -
-------- --------
Net minimum rentals receivable 27,857 36,314
Less unearned interest income (2,496) (3,127)
-------- --------
Net investment in sales-type leases $ 25,361 $ 33,187
-------- --------
-------- --------
Included in the net investment in sales-type leases are deferred service
revenues of $4.9 million and $6.3 million at December 31, 1997 and 1996,
respectively. Such amounts are recognized as product sales revenue ratably
over the life of the service contracts.
Future minimum rentals receivable under these leases at December 31, 1997 are
as follows: 1998-$12.1 million, 1999-$8.3 million, 2000-$5.1 million,
2001-$1.9 million and 2002-$0.5 million.
CETUS HEALTHCARE LIMITED PARTNERSHIPS
In 1987 and 1990, Cetus and its affiliate, EuroCetus International N.V.,
exercised their options to repurchase all of the limited partnership
interests in Cetus Healthcare Limited Partnership ("CHLP") and Cetus
Healthcare Limited Partnership II ("CHLP II"). Under the CHLP purchase
agreements, which expire December 31, 2001, the Company is obligated to pay
royalties on sales of certain therapeutic products in the U.S. and certain
diagnostic products worldwide, as well as a portion of license, distribution
or other fees with respect to such products, to the former limited partners
of CHLP. Under the CHLP II purchase agreements, which expire December 31,
2005, the Company is obligated to pay royalties and a portion of other income
with respect to sales of certain products in Europe to the former limited
partners of CHLP II. Because of the inherent uncertainties as to the
likelihood of any product specified in the agreements continuing to be
commercially viable, the Company is unable to estimate future costs subject
to this obligation.
39
CHIRON CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997
NOTE 9 - COMMITMENTS AND CONTINGENCIES (CONTINUED)
OTHER COMMITMENTS
The Company has various commitments for capital expenditures totaling
approximately $2.7 million at December 31, 1997. The majority of these
commitments are for computer system upgrades and enhancements. The Company also
has performance bonds outstanding in the amount of $3.5 million at December 31,
1997, primarily in connection with sales to public health authorities.
In June 1996, Chiron S.p.A. entered into an agreement to purchase in 1998 the
manufacturing and administrative facilities in Siena, Italy which are currently
leased. The purchase price is approximately $29.6 million and is payable in
Italian lira. The purchase price will be reduced by certain amounts due from
the seller through the date of the purchase.
NOTE 10 - STOCKHOLDERS' EQUITY
STOCK SPLIT
In 1996, Chiron's Board of Directors declared a 4-for-1 stock split,
distributed on August 2, 1996, effected in the form of a dividend on the
Company's common stock to stockholders of record on July 19, 1996. As a
result, the Company increased its common stock balance by $1.3 million for
the par value of the common stock issued to effect the stock split and
correspondingly reduced additional paid-in capital. The exercise prices for
all warrants and stock options and the convertible bond conversion rates were
adjusted for the effect of the split.
STOCK COMPENSATION PLANS
At December 31, 1997, the Company has four stock-based compensation plans, which
are described below. The Company applies APB 25 and related Interpretations in
accounting for its plans. Accordingly, no compensation expense has been
recognized for its stock-based compensation plans other than for
performance-based awards and share rights.
Had compensation cost for the Company's other stock-based plans been
determined based on the fair value method prescribed under SFAS 123, the
Company's net income (loss) and related net income (loss) per share would
have been reduced to the following pro forma amounts:
1997 1996 1995
----------- ----------- -------------
Net income (loss) - in thousands
As reported $ 71,219 $ 55,145 $ (512,463)
Pro forma $ 46,318 $ 27,579 $ (529,759)
Net income (loss) per share
As reported $ 0.41 $ 0.33 $ (3.15)
Pro forma $ 0.27 $ 0.16 $ (3.26)
Net income (loss) per share -
assuming dilution
As reported $ 0.40 $ 0.31 $ (3.15)
Pro forma $ 0.26 $ 0.16 $ (3.26)
40
CHIRON CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997
NOTE 10 - STOCKHOLDERS' EQUITY (CONTINUED)
FIXED STOCK OPTION PLAN
The Company's fixed stock option plan provides for the grant to employees of
either nonqualified or incentive options and provides for the grant to
directors, consultants and contractors of nonqualified options. Incentive
options are to be granted at not less than the fair market value of common stock
at the date of grant and nonqualified options at not less than 85 percent of
such fair market value. Options are exercisable based on vesting terms
determined by Chiron's Board of Directors (generally 4 years) and option terms
cannot exceed ten years.
At the annual meeting of stockholders in May 1997, the stockholders approved an
amendment to the Company's stock option plan, increasing the maximum number of
shares that may be issued by 13.0 million shares to 50.3 million shares. Of the
13.0 million share increase, 5.0 million shares were registered with the
Securities and Exchange Commission in 1997. At December 31, 1997, 8.2 million
shares were available for grant.
A summary of the stock option activity is as follows:
1997 1996 1995
----------- ----------- -----------
Outstanding options at January 1, 26,298,373 23,337,652 19,787,536
Granted 6,011,061 6,582,769 10,507,616
Forfeited (3,792,954) (1,159,973) (1,207,336)
Surrendered against payment by Novartis (790,430) (363,525) (3,070,960)
Exercised (3,631,884) (2,098,550) (2,679,204)
----------- ----------- -----------
Outstanding options at December 31, 24,094,166 26,298,373 23,337,652
----------- ----------- -----------
----------- ----------- -----------
Options exercisable at December 31, 12,351,700 11,411,534 8,859,788
----------- ----------- -----------
----------- ----------- -----------
Average exercise price of:
Outstanding options at December 31, $ 18.08 $ 16.80 $ 14.76
Options granted $ 20.96 $ 22.25 $ 16.33
Options forfeited $ 19.72 $ 19.11 $ 16.89
Options exercised $ 11.76 $ 11.02 $ 10.61
Weighted-average fair value of options
granted during the year calculated
pursuant to SFAS 123 $ 9.34 $ 8.90 $ 7.33
The weighted-average fair value of each option grant is estimated on the date of
grant using the Black-Scholes option-pricing model and the following
weighted-average assumptions: expected volatility of 37 percent for 1997 and 35
percent for 1996 and 1995; a risk-free interest rate of 6.2 percent for 1997 and
6.3 percent for 1996 and 1995; and an average expected life of 5 years for 1997,
1996 and 1995.
41
CHIRON CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997
NOTE 10 - STOCKHOLDERS' EQUITY (CONTINUED)
The following table summarizes information concerning outstanding and
exercisable options at December 31, 1997:
Options Outstanding Options Exercisable
---------------------------------------------------------------- ---------------------------
Weighted
Average Weighted Weighted
Remaining Average Average
Range of Exercise Number Contractual Exercise Number Exercise
Prices Outstanding Life Price Outstanding Price
----------------- ----------- ----------- -------- ----------- --------
Less than $14 5,911,457 5.82 $11.80 4,309,794 $11.78
14 to 19 7,970,622 7.28 17.67 4,793,634 16.97
19 to 23 8,150,056 8.63 21.47 2,235,784 21.55
Greater than 23 2,062,031 8.20 27.06 1,012,488 27.26
----------- ----------- -------- ----------- --------
24,094,166 7.48 $18.08 12,351,700 $16.83
----------- -----------
----------- -----------
EMPLOYEE STOCK PURCHASE PLAN
Chiron has a stock purchase plan for U.S. employees in which eligible
employees may participate through payroll deductions. At the end of each
quarter, funds deducted from participating employees' salaries are used to
purchase common stock at 85 percent of the lower of market value at the
quarterly purchase date or the employees' eligibility date for participation.
Purchases of shares made under the plan were 1.4 million, 1.4 million and 0.7
million in 1997, 1996 and 1995, respectively. In 1997, the stockholders
approved a new employee stock purchase plan which will effectively replace
the existing plan when it expires in March 1998. The terms and provisions of
the new plan are substantially similar to those of Chiron's existing plan.
Under the new plan, approximately 8.6 million shares have been reserved for
issuance, of which approximately 0.6 million shares represent the remaining
shares reserved for issuance under Chiron's existing plan.
Under SFAS 123, pro forma compensation cost is recognized for the fair value of
the employees' purchase rights, which was estimated using the Black-Scholes
model and the following assumptions: expected volatility of 28 percent for 1997
and 35 percent for 1996 and 1995; a risk-free interest rate of 5.6 percent for
1997 and 5.7 percent for 1996 and 1995; and an average expected life of one year
for 1997, 1996 and 1995. The weighted-average fair value of the purchase rights
granted was $5.28 per share in 1997 and $4.78 per share in 1996 and 1995.
PERFORMANCE-BASED STOCK PLAN
In 1996, the stockholders approved an amendment to the Company's stock option
plan, allowing certain executives to receive performance units. Performance
units are stock awards for which vesting is contingent upon the attainment of
certain pre-established performance goals over a specified period, as
established by the Compensation Committee of the Board of Directors. Currently,
the performance units are based on total shareholder return over a three-year
period as measured against certain published benchmark indices that are
representative of the Company's peer group.
In order for there to be a payout, Chiron's shareholder return must be within 15
percent of the three-year rolling weighted-average of the benchmark indices. In
accordance with APB 25, compensation expense related to these awards is based on
the extent to which the performance criteria are met. In 1997, the Company
recognized $0.6 million of expense associated with the performance units awarded
in 1997 and 1996. Through December 31, 1996, no expense was recognized.
42
CHIRON CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997
NOTE 10 - STOCKHOLDERS' EQUITY (CONTINUED)
In 1997 and 1996, the Company awarded performance units on 158,738 and 64,400
shares of common stock, respectively. None of these awards were exercisable at
December 31, 1997. Pursuant to SFAS 123, the weighted-average fair value of the
awards in 1997 and 1996 was $6.71 and $7.57 per unit, respectively. The
weighted-average fair values were based on the following assumptions: expected
volatility of 37 percent for 1997 and 35 percent for 1996; a risk-free interest
rate of 6.0 percent for 1997 and 1996; and an average expected life of 3 years
for 1997 and 1996.
SHARE RIGHTS
In 1996, the stockholders also approved an amendment to the Company's stock
option plan, permitting the award of share rights to certain key individuals and
non-employee directors, allowing them the right to receive shares of the
Company's common stock.
In 1997, the Compensation Committee of the Board of Directors awarded
non-employee directors an aggregate of 12,043 share rights that vest over
five years, and also awarded certain key individuals an aggregate of 319,700
share rights that vest over four years. In 1996, the Compensation Committee
awarded non-employee directors an aggregate of 10,320 share rights that vest
over five years and a key executive 40,000 share rights that vest at the end
of five years. The value of the share rights are recognized ratably over the
related vesting periods and, in 1997 and 1996, the Company recognized $0.8
million and $0.1 million of compensation expense, respectively.
COMMON STOCK WARRANTS
As a result of the merger with Cetus, warrants to purchase 600,000 shares of
Chiron common stock were outstanding at December 31, 1997. The exercise price
of the warrants is $13.13 and the warrants expire in July 2001. The warrants
are currently exercisable.
NOTES RECEIVABLE FROM STOCK SALES
The notes receivable are due from certain key employees, resulting from the
exercise of stock options. The notes are full recourse promissory notes,
bearing interest at a rate of approximately 6.0 percent and are primarily
collateralized by the stock issued upon the exercise of the stock options. At
December 31, 1997, the note balance was due from one individual and matures in
June 1998.
STOCK REPURCHASE PROGRAM
In January 1998, the Company's Board of Directors authorized the purchase of up
to 2.5 million shares of Chiron common stock from time to time on the open
market in order to offset the dilution associated with the operation of the
Company's stock option and employee stock purchase plans and the granting of
share rights. The Board of Directors has authorized such purchases through
January 1999.
43
CHIRON CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997
NOTE 11 - EARNINGS PER COMMON SHARE
Income (loss) from continuing operations as reported and available to common
stockholders was $50.8 million, $56.6 million and ($465.3) million in 1997,
1996 and 1995, respectively. A reconciliation of the denominators of Chiron's
earnings per common share computations is as follows for the years ended
December 31:
1997 1996 1995
------- ------- -------
(IN THOUSANDS)
Weighted-average common
shares outstanding 173,524 169,347 162,442
Effect of dilutive securities:
Options and equivalents 4,219 7,450 -
Warrants 204 297 -
Performance units 41 10 -
------- ------- -------
Weighted-average common
shares outstanding plus
assumed conversions 177,988 177,104 162,442
------- ------- -------
------- ------- -------
A total of 12,026,000 shares of common stock issuable upon conversion of the
Company's convertible subordinated debentures (see Note 8), having a weighted
average conversion price of $29.43 per share, have been excluded from the
computations of diluted earnings per common share for all periods presented
since their inclusion would be antidilutive.
For 1997 and 1996, options to purchase 7,832,000 shares and 2,104,000 shares,
respectively, of common stock were outstanding on a weighted-average basis
but were excluded from the computation of diluted earnings per common share
because the options' exercise prices were greater than the respective average
market price of the underlying stock of $19.93 in 1997 and $23.05 in 1996.
At December 31, 1997, 9,959,000 options which were excluded from the diluted
earnings per common share computation for 1997 remained outstanding and
expire on various dates through September 2007. In addition, an
insignificant number of performance units (see Note 10) contingently payable
in shares of common stock was excluded from the computation of diluted
earnings per common share for 1997 and 1996 based on the performance goals
which were then unmet at the respective period ends.
For 1995, approximately 5,971,000 common equivalent shares, primarily resulting
from the application of the treasury stock method to weighted-average options
outstanding, were excluded from the computation of diluted earnings per common
share as their inclusion would be antidilutive to the loss from continuing
operations. In addition, weighted-average options outstanding to purchase
2,782,000 shares of common stock had exercise prices greater than the average
market price of the underlying stock of $18.42 in 1995. Consequently, these
options were excluded from the calculation of common equivalent shares.
44
CHIRON CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997
NOTE 12 - OTHER EMPLOYEE BENEFIT PLANS
RETIREMENT SAVINGS PLAN
The Company maintains a defined-contribution savings plan under Section 401(k)
of the Internal Revenue Code. The plan covers substantially all full-time U.S.
employees. Participating employees may defer a portion of their pretax
earnings, up to the Internal Revenue Service annual contribution limit. The
Company matches employee contributions according to a specified formula. The
Company's matching contributions (exclusive of Chiron Vision) totaled $7.3
million, $5.3 million and $4.6 million in 1997, 1996 and 1995, respectively.
SEVERANCE PLAN
Effective October 1, 1997, the Company adopted the Chiron Corporation Severance
Plan (the "Plan") which supersedes all other plans or arrangements in effect for
the Company, other than Chiron Vision, that deal with the payment of severance
to employees who are involuntarily terminated as a result of a workforce
reduction or job elimination. The Plan is governed by the Employee Retirement
Income Security Act of 1974, as amended and, to the extent applicable, the laws
of the State of California.
Pursuant to the Plan, eligible employees receive eight weeks of paid advance
notice (the "advance notice period"), at least six weeks of which must be
non-working. At the end of the advance notice period, termination of
employment will occur. Payment of severance, calculated as three weeks base
pay per year of service, will generally commence at the end of the advance
notice period (the "salary continuation period"). The total of the advance
notice and salary continuation periods will be no less than three months and
no longer than two years, subject to limitations under the Plan. During the
salary continuation period, certain employee benefits will continue as
provided for under the Plan. Benefits payable under the Plan are accrued when
it is probable that employees will be entitled to benefits and the amount can
be reasonably estimated in accordance with SFAS No. 112, "Employers'
Accounting for Postemployment Benefits" (see Note 5).
NOTE 13 - INCOME TAXES
For financial reporting purposes, "Income (loss) from continuing operations
before income taxes" included the following components for the years ended
December 31:
1997 1996 1995
----------- ----------- -------------
(IN THOUSANDS)
United States $ 58,261 $ 86,678 $ (462,502)
Foreign 18,634 (7,933) 17,115
----------- ----------- -------------
$ 76,895 $ 78,745 $ (445,387)
----------- ----------- -------------
----------- ----------- -------------
45
CHIRON CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997
NOTE 13 - INCOME TAXES (CONTINUED)
COMPONENTS OF PROVISION FOR INCOME TAXES FROM CONTINUING OPERATIONS
Significant components of the provision for income taxes from continuing
operations are as follows for the years ended December 31:
1997 1996 1995
----------- ----------- ----------
(IN THOUSANDS)
Current:
Federal $ 15,862 $ 1,408 $ -
State (280) 1,405 1,757
Foreign 11,580 8,792 8,149
----------- ----------- ----------
27,162 11,605 9,906
----------- ----------- ----------
Deferred:
Federal (7,613) - -
State (235) - -
Foreign 2,606 759 1,260
----------- ----------- ----------
(5,242) 759 1,260
----------- ----------- ----------
Charge in lieu of taxes resulting from
recognition of acquired tax benefits that
are allocated to reduce noncurrent
intangible assets related to the acquired entity 4,137 9,778 8,721
----------- ----------- ----------
Provision for income taxes from
continuing operations $ 26,057 $ 22,142 $ 19,887
----------- ----------- ----------
----------- ----------- ----------
The benefit related to tax deductions for the Company's stock option plans is
recorded as an increase to additional paid-in capital when realized. Tax
benefits of approximately $17.9 million, $1.4 million and $0.9 million were
realized in 1997, 1996 and 1995, respectively.
Included in the 1997 charge in lieu of taxes was a state tax refund of $2.8
million related to an acquired tax benefit. This refund amount has been netted
against the current state tax provision reported above.
RATE RECONCILIATION
The reconciliation of the provision for income taxes from continuing operations,
computed at the statutory U.S. income tax rate, to the reported amounts is as
follows for the years ended December 31:
46
CHIRON CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997
NOTE 13 - INCOME TAXES (CONTINUED)
1997 1996 1995
----------- ----------- -----------
(IN THOUSANDS)
Federal tax provision (benefit) at statutory rates $ 26,913 $ 27,812 $ (157,339)
Tax effect of write-off of purchased in-process technology - - 123,642
State taxes, net of federal benefit 3,008 1,543 4,845
Impact of foreign tax rates and credits 5,309 13,340 15,042
Losses of foreign subsidiaries not providing benefit in current year - 2,777 (5,990)
Write-down of Puerto Rico facility 10,955 - -
Amortization of intangible assets 757 792 601
Effect of net operating loss carryforward - - 27,295
Change in the valuation allowance for deferred tax assets
allocated to income tax expense (7,848) - -
Nondeductible expenses related to Novartis transaction - - 9,308
Utilization of deferred tax assets not previously benefited (10,518) (25,081) -
Utilization of tax credits (2,466) - -
Foreign sales corporation, net of tax (1,135) - -
Other 1,082 959 2,483
----------- ----------- -----------
Provision for income taxes from continuing operations $ 26,057 $ 22,142 $ 19,887
----------- ----------- -----------
----------- ----------- -----------
SUMMARY OF DEFERRED INCOME TAXES
Deferred income taxes reflect the net tax effects of temporary differences
between the carrying amounts of assets and liabilities for financial
reporting purposes and the amounts used for income tax purposes, and the tax
effects of net operating loss and credit carryforwards.
As they more likely than not will be realized, net deferred tax assets have been
recognized for U.S. federal and state purposes based on management's estimates
of future taxable income, including the gain on sale of Chiron Vision (see Note
3), and for certain foreign jurisdictions in which the Company's operations have
historically been profitable. Such estimates are subject to change based upon
future events and, accordingly, the amount of deferred tax assets recognized may
increase or decrease from period to period.
Significant components of the Company's deferred income tax liabilities and
assets from continuing operations are as follows at December 31:
47
CHIRON CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997
NOTE 13 - INCOME TAXES (CONTINUED)
1997 1996
----------- -----------
(IN THOUSANDS)
Deferred income tax liabilities:
Basis differences--purchase accounting $ 21,826 $ 23,813
Patent costs expensed for tax purposes 11,030 8,401
Other 4,525 4,944
----------- -----------
37,381 37,158
----------- -----------
Deferred income tax assets:
Basis differences--purchase accounting and intangibles 75,990 93,493
Depreciation and purchased technologies 5,177 7,146
Reserves and expense accruals 82,101 59,565
Net operating loss carryforwards 111,138 121,926
Business credit carryforwards 48,705 36,179
Other 10,686 11,162
----------- -----------
333,797 329,471
Less valuation allowance (280,302) (287,617)
----------- -----------
53,495 41,854
----------- -----------
Net deferred income tax asset $ 16,114 $ 4,696
----------- -----------
----------- -----------
The net change in the valuation allowance for the years ended December 31, 1997,
1996 and 1995 was a decrease of $7.3 million, and an increase of $18.2 million
and $125.6 million, respectively.
Subsequently recognized tax benefits relating to the valuation allowance for
deferred tax assets at December 31, 1997 will be allocated as follows:
(IN THOUSANDS)
Income tax benefit $ 221,016
Goodwill and other noncurrent intangible assets 13,020
Additional paid-in capital 46,266
------------
$ 280,302
------------
------------
TAX OPERATING LOSS AND CREDIT CARRYFORWARDS
The following presents the carryforwards from continuing operations which are
available to offset future income tax liabilities at December 31, 1997:
(IN THOUSANDS)
Federal net operating loss carryforwards expiring from 2003 through 2010 $ 141,470
State net operating loss carryforwards expiring from 1998 through 2009 49,006
Foreign net operating loss carryforwards principally carried forward
indefinitely 139,171
Federal tax credit carryforwards expiring from 1998 through 2011 26,421
State tax credit carryforwards expiring from 1998 through 2011 22,284
48
CHIRON CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997
NOTE 14 - NON-OPERATING INCOME AND EXPENSE
In December 1997, Chiron Diagnostics completed the sale of certain of the assets
of its worldwide Quality Controls business to Bio-Rad Laboratories, Inc.
Proceeds from the sale consisted of $29.9 million of cash, resulting in an $18.6
million gain reflected as "Gain on sale of assets" in the accompanying
Consolidated Statements of Operations.
Effective May 1, 1996, Chiron sold its 50 percent interest in a generic cancer
chemotherapeutics business to Ben Venue, Chiron's joint venture partner, for
$14.0 million in cash. This sale resulted in a $12.2 million gain reflected as
"Gain on sale of interest in affiliated company" in the accompanying
Consolidated Statements of Operations.
"Interest expense" in the accompanying Consolidated Statements of Operations
consists of the following for the years ended December 31:
1997 1996 1995
------------ ------------ ------------
(IN THOUSANDS)
Interest expense and related costs on
convertible debentures $ (18,384) $ (18,103) $ (17,827)
Interest expense on the debt obligation to
Novartis (3,413) (3,407) (3,543)
Other interest expense (11,460) (9,424) (8,842)
------------ ------------ ------------
$ (33,257) $ (30,934) $ (30,212)
------------ ------------ ------------
------------ ------------ ------------
"Other income, net" in the accompanying Consolidated Statements of Operations
consists of the following for the years ended December 31:
1997 1996 1995
------------ ------------ ------------
(IN THOUSANDS)
Interest and dividend income $ 15,247 $ 11,801 $ 21,386
Capitalized interest - - 420
Write-downs of investments (1,206) (1,529) (200)
Gain on sale of equity securities 5,541 - -
Net realized gain (loss) on sale of
debt securities (23) 41 (3,037)
Net realized loss on foreign
exchange transactions (733) (2,254) (201)
Other (2,478) (869) 3,775
------------ ------------ ------------
$ 16,348 $ 7,190 $ 22,143
------------ ------------ ------------
------------ ------------ ------------
NOTE 15 - GEOGRAPHIC AREA INFORMATION
Chiron operates in the global healthcare industry in three major markets:
diagnostics, therapeutics and vaccines. The Company is a multinational
corporation with operations in many countries including the U.S., Canada, Japan,
Germany, the United Kingdom, Italy, The Netherlands and Australia. Transfers
between geographic areas represent intercompany sales and are accounted for
based on established sales prices between related companies. In computing
earnings from operations for foreign subsidiaries, no allocations of general
corporate expenses or interest have been made. Identifiable assets of foreign
geographic areas relate to the operating assets of the Company's
49
CHIRON CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997
NOTE 15 - GEOGRAPHIC AREA INFORMATION (CONTINUED)
subsidiaries in those countries. Domestic assets consist of all operating
assets of the Company located within the U.S.
Information about the Company's operations in different geographic areas is as
follows for the years ended December 31:
DOMESTIC EUROPE ASIA/PACIFIC OTHER ELIMINATIONS CONSOLIDATED
------------ ---------- ------------ ---------- ------------ -------------
(IN THOUSANDS)
1997:
Revenues from unaffiliated customers $ 666,570 $ 342,832 $ 130,793 $ 21,863 $ - $ 1,162,058
Transfers between geographic areas 213,823 43,814 250 - (257,887) -
------------ ---------- ------------ ---------- ------------ -------------
Total revenues 880,393 386,646 131,043 21,863 (257,887) 1,162,058
Income (loss) from continuing operations 53,423 7,323 (733) (3,106) (6,069) 50,838
Identifiable assets 2,406,561 375,759 56,571 23,273 (1,093,686) 1,768,478
1996:
Revenues from unaffiliated customers $ 609,294 $ 336,152 $ 135,965 $ 20,429 $ - $ 1,101,840
Transfers between geographic areas 207,812 53,205 133 - (261,150) -
------------ ---------- ------------ ---------- ------------ -------------
Total revenues 817,106 389,357 136,098 20,429 (261,150) 1,101,840
Income (loss) from continuing operations 104,947 (11,861) 1,533 97 (38,113) 56,603
Identifiable assets 2,164,792 374,552 66,230 19,311 (936,215) 1,688,670
1995:
Revenues from unaffiliated customers $ 482,098 $ 289,379 $ 132,204 $ 20,590 $ - $ 924,271
Transfers between geographic areas 160,994 34,583 480 - (196,057) -
------------ ---------- ------------ ---------- ------------ -------------
Total revenues 643,092 323,962 132,684 20,590 (196,057) 924,271
Income (loss) from continuing operations (409,641) (25,091) (1,174) (502) (28,866) (465,274)
Identifiable assets 1,900,794 292,628 87,684 12,272 (803,531) 1,489,847
Revenues by customer location, including both local revenues and exports from
other locations, were as follows for the years ended December 31:
1997 1996 1995
------------ ------------ ------------
(IN THOUSANDS)
North America $ 438,426 $ 450,068 $ 407,464
Europe 485,947 443,238 312,943
Asia and Pacific Basin 168,631 178,399 153,982
South America, Africa and Other 69,054 30,135 49,882
------------ ------------ ------------
$ 1,162,058 $ 1,101,840 $ 924,271
------------ ------------ ------------
------------ ------------ ------------
NOTE 16 - LEGAL PROCEEDINGS
The Company is party to various claims, investigations and legal proceedings
arising out of the normal course of its business. These claims, investigations
and legal proceedings relate to intellectual property rights, contractual rights
and obligations, employment matters, shareholder derivative claims, claims of
product liability, and other issues. While there can be no assurance that an
adverse determination of any such matters could not have a material adverse
impact in any future period, management does not believe, based upon information
known to it, that the final resolution of these matters will have a material
adverse effect upon the Company's consolidated financial position and annual
results of operations and cash flows.
50
CHIRON CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997
NOTE 17 - QUARTERLY FINANCIAL DATA (UNAUDITED)
1997
-------------------------------------------------
DEC. 31 SEPT. 30 JUNE 30 MAR. 31
---------- ---------- ---------- ----------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
Total revenues $ 311,171 $ 289,904 $ 281,038 $ 279,945
Gross margin from product sales 132,280 114,034 122,364 116,020
Income (loss) from continuing operations:
Income (loss) 33,837 (14,187) 14,813 16,375
Income (loss) per share 0.19 (0.08) 0.09 0.10
Income (loss) per share - assuming dilution 0.19 (0.08) 0.08 0.09
Net income (loss):
Income (loss) 52,822 (12,681) 15,742 15,336
Income (loss) per share 0.30 (0.07) 0.09 0.09
Income (loss) per share - assuming dilution 0.29 (0.07) 0.09 0.09
1996
-------------------------------------------------
DEC. 31 SEPT. 30 JUNE 30 MAR. 31
---------- ---------- ---------- ----------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
Total revenues $ 313,170 $ 271,638 $ 256,222 $ 260,810
Gross margin from product sales 125,053 109,108 114,516 114,201
Income from continuing operations:
Income 14,145 12,828 14,053 15,577
Income per share 0.08 0.08 0.08 0.09
Income per share - assuming dilution 0.08 0.07 0.08 0.09
Net income:
Income 15,269 11,778 15,355 12,744
Income per share 0.09 0.07 0.09 0.08
Income per share - assuming dilution 0.09 0.07 0.09 0.07
As Chiron expands its presence in international markets, particularly
European markets, seasonal fluctuations in product sales and the related
gross margin amounts have become more significant. As a result of this and
other factors, Chiron's results in any one quarter are not necessarily
indicative of results expected for a full year. Accordingly, the Company
should be evaluated on the basis of annual financial information.
Quarterly total revenues and gross margin amounts exclude total revenues and
gross margin of Chiron Vision, which was classified as a discontinued
operation during the third quarter of 1997 (see Note 3). Total revenues of
Chiron Vision for the 1997 quarters ended December 31, September 30, June 30
and March 31 were $62.0 million, $47.6 million, $52.7 million and $50.4
million, respectively. Gross margin from product sales of Chiron Vision for
the 1997 quarters ended December 31, September 30, June 30 and March 31 was
$32.7 million, $24.3 million, $26.9 million and $26.8 million, respectively.
Total revenues of Chiron Vision for the 1996 quarters ended December 31,
September 30, June 30 and March 31 were $56.6 million, $49.9 million, $59.5
million and $45.0 million, respectively. Gross margin from product sales of
Chiron Vision for the 1996 quarters ended December 31, September 30, June 30
and March 31 was $31.1 million, $25.6 million, $31.7 million and $23.6
million, respectively. In addition, net income in the fourth quarter of 1997
included a deferred tax benefit from discontinued operations of $15.2
million, recognized in accordance with EITF 93-17.
51
CHIRON CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997
NOTE 17 - QUARTERLY FINANCIAL DATA (UNAUDITED) (CONTINUED)
The results of continuing operations for the fourth quarter of 1997 included
an $18.6 million gain on the sale of assets (see Note 14). The results of
continuing operations for the third quarter of 1997 included a $31.3 million
impairment loss on long-lived assets (see Note 4). The results of continuing
operations for the second quarter of 1997 included the recognition of a $6.6
million reduction in cost of sales due to a revised estimate of royalties to
be paid on sales of certain products and a $4.7 million reduction in
operating expenses due to changes in estimated accruals created in prior
periods.
The results of continuing operations for the second and third quarters of
1996 included a gain of $12.1 million and $0.1 million, respectively, on the
sale of Chiron's interest in Ben Venue (see Note 14).
NOTE 18 - SUBSEQUENT EVENT (UNAUDITED)
In March 1998, the Company committed to plans to sell the Puerto Rico
facility and a manufacturing facility in St. Louis, Missouri. The resulting
adjustments, if any, in the first quarter of 1998 to record the assets held
for sale at the lower of their aggregate carrying amount or estimated fair
value, determined on the basis of independent appraisals, less cost to sell,
are not expected to be material. In the first quarter of 1998, the Company
expects to record certain restructuring and reorganization charges in
connection with the plans to dispose of the Puerto Rico and St. Louis
facilities.
52
INDEPENDENT AUDITORS' REPORT
The Board of Directors and Stockholders
Chiron Corporation:
We have audited the accompanying consolidated balance sheets of Chiron
Corporation and subsidiaries as of December 31, 1997 and 1996, and the related
consolidated statements of operations, stockholders' equity and cash flows for
each of the years in the three-year period ended December 31, 1997. These
consolidated financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these consolidated
financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of Chiron Corporation
and subsidiaries as of December 31, 1997 and 1996, and the results of their
operations and their cash flows for each of the years in the three-year period
ended December 31, 1997, in conformity with generally accepted accounting
principles.
/s/ KPMG PEAT MARWICK LLP
San Francisco, California
January 30, 1998
53
CHIRON CORPORATION
MARKET PRICE OF COMMON STOCK
The common stock of Chiron Corporation is traded in the NASDAQ National Market
System under the symbol CHIR. As of December 31, 1997, there were 7,609 holders
of record of Chiron common stock, 422 remaining holders of record of Cetus
common stock and 11 remaining holders of Viagene common stock. The Company has
declared no cash dividends since its inception and does not expect to pay any
dividends in the foreseeable future. The quarterly high and low closing sales
price of Chiron common stock for 1997 and 1996 are shown below.
1997 1996
------------------------- -------------------------
HIGH LOW HIGH LOW
---------- ---------- ---------- ----------
First Quarter $ 21 1/4 $ 17 7/8 $ 29 1/2 $ 23 1/4
Second Quarter 21 17 1/2 26 5/8 23
Third Quarter 24 5/16 19 7/8 25 1/8 17 1/2
Fourth Quarter 23 16 5/8 23 18 1/8
54