FORM 10-Q
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
(MARK ONE)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934.
FOR THE QUARTERLY PERIOD ENDED MARCH 31, 1999
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM ____________ TO ____________
Commission File Number: 0-12798
CHIRON CORPORATION
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(Exact name of registrant as specified in its charter)
DELAWARE 94-2754624
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(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
4560 HORTON STREET, EMERYVILLE, CALIFORNIA 94608
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(Address of principal executive offices) (Zip code)
(510) 655-8730
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(Registrant's telephone number, including area code)
NOT APPLICABLE
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(Former name, former address and former fiscal year,
if changed since last report)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or
15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or
for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
Yes [X] No [ ]
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date.
TITLE OF CLASS OUTSTANDING AT APRIL 30, 1999
Common Stock, $0.01 par value 181,602,491
CHIRON CORPORATION
TABLE OF CONTENTS
PAGE NO.
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PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
Condensed Consolidated Balance Sheets as of
March 31, 1999 and December 31, 1998.................................................3
Condensed Consolidated Statements of Operations for
the three months ended March 31, 1999 and 1998.......................................4
Condensed Consolidated Statements of Comprehensive
Income for the three months ended March 31, 1999 and 1998............................5
Condensed Consolidated Statements of Cash Flows for
the three months ended March 31, 1999 and 1998.......................................6
Notes to Condensed Consolidated Financial Statements.................................7
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS....................................13
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT
MARKET RISK......................................................................22
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS................................................................22
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.................................................23
SIGNATURES.............................................................................................25
2
ITEM 1. FINANCIAL STATEMENTS
CHIRON CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE DATA)
MARCH 31, DECEMBER 31,
1999 1998
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(UNAUDITED)
ASSETS
Current assets:
Cash and cash equivalents $ 69,146 $ 513,315
Short-term investments in marketable debt securities 648,355 716,630
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Total cash and short-term investments 717,501 1,229,945
Accounts receivable 184,032 169,098
Inventories 80,842 79,869
Other current assets 133,368 152,727
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Total current assets 1,115,743 1,631,639
Noncurrent investments in marketable debt securities 719,924 360,069
Property, plant, equipment, and leasehold improvements, at cost:
Land and buildings 162,487 141,452
Laboratory, production, and office equipment 236,758 236,803
Leasehold improvements 70,844 84,607
Construction-in-progress 56,000 38,328
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526,089 501,190
Less accumulated depreciation and amortization (208,588) (197,812)
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Net property, plant, equipment, and leasehold improvements 317,501 303,378
Purchased technology, net 13,848 14,753
Other intangible assets, net 152,864 166,699
Investments in equity securities and affiliated companies 25,554 27,456
Other assets 27,906 20,261
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$ 2,373,340 $ 2,524,255
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LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 28,229 $ 44,999
Accrued compensation and related expenses 39,668 40,034
Short-term borrowings 22,027 17,554
Note payable to Novartis 65,101 63,945
Current portion of unearned revenue 38,175 41,893
Taxes payable 28,783 180,088
Other current liabilities 163,487 168,905
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Total current liabilities 385,470 557,418
Long-term debt 339,259 338,158
Other noncurrent liabilities 76,343 82,877
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Total liabilities 801,072 978,453
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Commitments and contingencies
Stockholders' equity:
Common stock 1,815 1,799
Additional paid-in capital 2,005,620 1,979,615
Accumulated deficit (419,368) (437,873)
Accumulated other comprehensive (loss) income (15,244) 2,261
Treasury stock, at cost (25,000 shares) (555) --
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Total stockholders' equity 1,572,268 1,545,802
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$ 2,373,340 $ 2,524,255
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THE ACCOMPANYING NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS ARE AN
INTEGRAL PART OF THIS STATEMENT.
3
CHIRON CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
(IN THOUSANDS, EXCEPT PER SHARE DATA)
THREE MONTHS ENDED
MARCH 31,
-------------------------------
1999 1998
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Revenues:
Product sales, net $ 92,967 $ 69,220
Equity in earnings of unconsolidated joint businesses 18,086 12,874
Collaborative agreement revenues 22,425 24,400
Royalty and license fee revenues 32,433 16,074
Other revenues 9,649 10,719
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Total revenues 175,560 133,287
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Expenses:
Cost of sales 44,073 28,077
Research and development 69,115 63,907
Selling, general, and administrative 40,544 23,707
Restructuring and reorganization charges (Note 3) 3,352 7,548
Other operating expenses 3,216 656
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Total expenses 160,300 123,895
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Income from operations 15,260 9,392
Interest expense (6,071) (6,580)
Other income, net 22,559 8,595
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Income from continuing operations before income taxes 31,748 11,407
Provision for income taxes 8,010 3,865
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Income from continuing operations 23,738 7,542
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Discontinued operations (Note 2):
Loss from discontinued operations -- (18,393)
Gain on disposal of discontinued operations -- 65,332
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Net income $ 23,738 $ 54,481
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Basic earnings per common share:
Income from continuing operations $ 0.13 $ 0.04
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Net income $ 0.13 $ 0.31
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Diluted earnings per common share:
Income from continuing operations $ 0.13 $ 0.04
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Net income $ 0.13 $ 0.30
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THE ACCOMPANYING NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS ARE AN
INTEGRAL PART OF THIS STATEMENT.
4
CHIRON CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(UNAUDITED)
(IN THOUSANDS)
THREE MONTHS ENDED
MARCH 31,
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1999 1998
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Net income $ 23,738 $ 54,481
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Other comprehensive (loss) income:
Foreign currency translation adjustment:
Change in foreign currency translation adjustment during the
period (14,365) (326)
Plus: reclassification adjustment for loss included in discontinued
operations -- 2,087
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Net foreign currency translation adjustment (14,365) 1,761
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Unrealized (loss) gain from investments:
Unrealized holding (loss) gain arising during the period (1,726) 2,246
Less: reclassification adjustment for net gains included in net income,
net of income tax benefits of $795 and $1,014 for the three months
ended March 31, 1999 and 1998, respectively (1,414) (1,800)
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Net unrealized (loss) gain from investments (3,140) 446
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Other comprehensive (loss) income (17,505) 2,207
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Comprehensive income $ 6,233 $ 56,688
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THE ACCOMPANYING NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS ARE AN
INTEGRAL PART OF THIS STATEMENT.
5
CHIRON CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
(IN THOUSANDS)
THREE MONTHS ENDED
MARCH 31,
-------------------------------
1999 1998
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Net cash used in operating activities $ (130,274) $ (638)
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Cash flows from investing activities:
Purchases of investments in marketable debt securities (701,195) (165,197)
Proceeds from sale and maturity of investments in marketable debt securities 412,142 54,249
Capital expenditures (33,889) (10,896)
Proceeds from disposal of discontinued operations -- 298,939
Other, net (18,604) 101
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Net cash (used in) provided by investing activities (341,546) 177,196
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Cash flows from financing activities:
Net proceeds (repayment) of short-term debt 1,024 (114,483)
Repayment of notes payable and capital leases (887) (308)
Proceeds from issuance of common stock 28,069 17,340
Payments to acquire treasury stock (555) --
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Net cash provided by (used in) financing activities 27,651 (97,451)
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Net (decrease) increase in cash and cash equivalents (444,169) 79,107
Cash and cash equivalents at beginning of the period 513,315 98,483
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Cash and cash equivalents at end of the period $ 69,146 $ 177,590
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THE ACCOMPANYING NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS ARE AN
INTEGRAL PART OF THIS STATEMENT.
6
CHIRON CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 1999
(UNAUDITED)
NOTE 1--THE COMPANY AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
BASIS OF PRESENTATION
The information presented in the accompanying Condensed Consolidated
Financial Statements at March 31, 1999, and for the three months ended March
31, 1999 and 1998, is unaudited, but includes all normal recurring
adjustments which the management of Chiron Corporation ("Chiron" or the
"Company") believes to be necessary for fair presentation of the periods
presented. In addition, certain previously reported amounts have been
reclassified to conform to the current period presentation. The condensed
consolidated balance sheet amounts at December 31, 1998 have been derived
from audited financial statements. Interim results are not necessarily
indicative of results for a full year. This information should be read in
conjunction with Chiron's audited consolidated financial statements for the
year ended January 3, 1999, which are included in the Annual Report on Form
10-K filed by the Company with the Securities and Exchange Commission.
In the first quarter of 1998, Chiron completed the sale of its
ophthalmics business ("Chiron Vision") to Bausch & Lomb Incorporated ("B&L")
and in the fourth quarter of 1998, Chiron completed the sale of its IN VITRO
diagnostics business ("Chiron Diagnostics") to Bayer Corporation ("Bayer")
(see Note 2). The accompanying Condensed Consolidated Statements of
Operations for the three months ended March 31, 1998 reflect the after-tax
results of Chiron Diagnostics and the gain on disposal of Chiron Vision as
discontinued operations.
On March 31, 1998, in an acquisition accounted for under the purchase
method of accounting, Chiron acquired the remaining 51% interest in Chiron
Behring GmbH & Co ("Chiron Behring") from Hoechst AG. Beginning in the second
quarter of 1998, the results of Chiron Behring were consolidated with those of
the Company.
Prior to January 1999, the results of Chiron's Italian subsidiary ("Chiron
S.p.A.") were reported on a one-month lag. In the first quarter of 1999, Chiron
S.p.A. was brought current. As a result, during the first quarter of 1999, the
Company recorded a loss of approximately $5.2 million for the month of December
1998 as a component of "Accumulated deficit" in the accompanying Condensed
Consolidated Balance Sheets.
FISCAL YEAR
Effective with the beginning of fiscal year 1999, the Company changed
its fiscal year from a 52 or 53-week year ending on the Sunday nearest the
last day in December to coincide with a calendar year ending on December 31.
In 1998, the Company's fiscal year was a 53-week year ending on January 3,
1999 and the first fiscal quarter of 1998 was a 13-week period ending on
March 29, 1998. For presentation purposes, the 1998 dates used in the
condensed consolidated financial statements and notes refer to the fiscal
month end.
INVENTORIES
Pharmaceutical inventories are stated at the lower of cost or market using
the average cost method or, in the case of certain vaccine products, using the
last-in, first-out ("LIFO") method. Inventories consist of the following:
MARCH 31, DECEMBER 31,
1999 1998
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(IN THOUSANDS)
Finished goods $ 25,792 $ 12,301
Work-in-process 39,189 54,333
Raw materials 15,861 13,235
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$ 80,842 $ 79,869
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7
CHIRON CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
MARCH 31, 1999
(UNAUDITED)
NOTE 1--THE COMPANY AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
INCOME TAXES
The 1999 estimated annual tax provision is expected to be approximately 25%
of pretax income from continuing operations. The provision may be affected in
future periods by changes in management's estimates with respect to the
Company's deferred tax assets and other items affecting the overall tax rate.
Income tax expense for the three months ended March 31, 1998 was based on an
estimated annual effective tax rate on pretax income from continuing operations
of approximately 34%. The actual 1998 annual effective tax rate of 20% reflects
the deferred tax assets that were recognized during the second half of 1998
through a reduction in the valuation allowance associated with such assets.
PER SHARE DATA
Basic earnings per share is based upon the weighted-average number of
common shares outstanding. Diluted earnings per share is based upon the
weighted-average number of common shares and dilutive potential common shares
outstanding. Dilutive potential common shares result from (i) the assumed
exercise of outstanding stock options, warrants, and equivalents, which are
included under the treasury-stock method; and (ii) performance units to the
extent that dilutive shares are assumed issuable.
The following table sets forth the computation for basic and diluted
earnings per share for the three months ended March 31:
1999 1998
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(IN THOUSANDS)
Weighted-average common shares outstanding 180,639 176,199
Effect of dilutive securities:
Options and equivalents 4,160 2,820
Warrants 255 189
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Weighted-average common shares outstanding plus
assumed conversions 185,054 179,208
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Options to purchase 1,380,000 shares and 13,189,000 shares with exercise
prices greater than the average market prices of common stock were outstanding
during the three months ended March 31, 1999 and 1998, respectively. These
options were excluded from the respective computations of diluted earnings per
share as their inclusion would be antidilutive.
Also excluded from the computations of dilutive earnings per share were
12,026,000 shares of common stock issuable upon conversion of the Company's
convertible subordinated debentures as the average conversion price was greater
than the average market price for the three months ended March 31, 1999 and
1998.
NOTE 2--DISCONTINUED OPERATIONS
On November 30, 1998, Chiron completed the sale of its IN VITRO
diagnostics business to Bayer for $1,013.8 million in cash, subject to
certain post-closing adjustments. The sale was completed under the terms of a
Stock Purchase Agreement (the "Bayer Agreement"), dated as of September 17,
1998, between Chiron and Bayer. In accordance with Accounting Principles
Board 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" ("APB 30"), Chiron
Diagnostics is reported as a discontinued operation for
8
CHIRON CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
MARCH 31, 1999
(UNAUDITED)
NOTE 2--DISCONTINUED OPERATIONS (CONTINUED)
the three months ended March 31, 1998 in the accompanying Condensed Consolidated
Statements of Operations. Chiron has agreed to provide customary indemnities
under the terms of the Bayer Agreement.
On December 29, 1997, Chiron completed the sale of all of the outstanding
capital stock of Chiron Vision to B&L for approximately $300.0 million in cash,
subject to certain post-closing adjustments. The sale was completed under the
terms of a Stock Purchase Agreement (the "B&L Agreement"), dated as of October
21, 1997, between Chiron and B&L. 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 million and Chiron Vision's
future noncancelable operating lease costs totaling $1.1 million were retained
by the Company upon the completion of the sale. The Company has
agreed to provide customary indemnities under the terms of the B&L Agreement.
For a period of three years following the completion of the sale, Chiron
Vision has the right to use a portion of the real estate assets, which were
occupied at closing, on a rent-free basis. As of March 31, 1999 and December 31,
1998, the real estate assets, which represent all of the remaining net assets of
Chiron's discontinued operations, are recorded in the accompanying Condensed
Consolidated Balance Sheets as "Other current assets." In the first quarter of
1998, the Company recorded an adjustment to record the real estate
assets at their estimated fair value, determined on the basis of independent
appraisals, less costs to sell. This adjustment was recorded as a reduction to
the "Gain on disposal of discontinued operations" in the accompanying Condensed
Consolidated Statements of Operations for the period ended March 31, 1998.
In the first quarter of 1998, Chiron Diagnostics recognized total revenues
of $135.6 million. For the three months ended March 31, 1998, "Loss from
discontinued operations" and "Gain on disposal of discontinued operations" are
reported net of income tax (benefit) provision of ($1.1) million and $31.2
million, respectively.
For the three months ended March 31, 1998, basic and diluted income per
common share from discontinued operations were $0.27 and $0.26, respectively.
NOTE 3--RESTRUCTURING AND REORGANIZATION CHARGES
In the first quarter of 1999, the Company recorded restructuring and
reorganization charges of $3.4 million primarily related to the continued
integration of its worldwide vaccine operations. These charges primarily
consisted of termination and other employee-related costs recognized in
connection with the elimination of 28 positions in the Company's Italian
manufacturing facility. Six of these positions had been eliminated as of March
31, 1999.
In fiscal year 1998, the Company recorded restructuring and
reorganization charges of $26.8 million, of which $7.5 million was recognized
in the first quarter. These charges consisted primarily of termination and
other employee-related expenses recognized in connection with the elimination
of 400 positions in manufacturing, research and development, sales,
marketing, and other administrative functions, and facility-related costs. As
of March 31, 1999, 249 of these 400 employees had been terminated.
At March 31, 1999 and December 31, 1998, the liabilities associated with
the Company's restructuring and reorganization charges were $18.0 million and
$23.8 million, respectively. These liabilities are expected to be substantially
settled within 12 months of accruing the related charges.
9
CHIRON CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
MARCH 31, 1999
(UNAUDITED)
NOTE 4--AGREEMENT WITH HOECHST AG
Effective July 1, 1996, Chiron purchased a 49% interest in the human
vaccine business of Behringwerke AG, which subsequently merged into its
parent company, Hoechst AG. The total acquisition price, which was paid in
cash, was approximately $120.0 million, including costs directly related to
the acquisition. 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 five to 20 years.
From July 1, 1996 through March 31, 1998 (period of joint ownership),
Chiron and Hoechst AG operated the vaccine business as a joint venture under the
name Chiron Behring GmbH & Co. Chiron accounted for its 49% interest under the
equity method and recognized revenues of $2.4 million as a component of "Equity
in earnings of unconsolidated joint businesses" in the accompanying Condensed
Consolidated Statements of Operations for the three months ended March 31, 1998.
In the second quarter of 1998, in an acquisition accounted for under the
purchase method of accounting, Chiron acquired the remaining 51% interest in
Chiron Behring from Hoechst AG. The purchase price of approximately $113.1
million, including acquisition costs, was allocated to the acquired assets and
liabilities assumed based upon their estimated fair value on the date of
acquisition. In connection with the acquisition, liabilities assumed were as
follows:
(IN THOUSANDS)
Cash acquired $ 57,119
Fair value of all other assets acquired 206,922
Carrying value of original investment in Chiron Behring (117,157)
Cash paid (111,889)
Acquisition costs (1,180)
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Liabilities assumed $ 33,815
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At the time of acquisition, Chiron expensed $1.6 million of purchased
in-process technologies. Other purchased intangible assets of approximately
$135.0 million, including goodwill, trademarks, patents, and customer list,
are being amortized over their estimated useful lives of four to 17 years on
a straight-line basis. Chiron Behring's operating results were included in
Chiron's consolidated operating results beginning in the second quarter of
1998.
The following unaudited pro forma information presents the results of
continuing operations of Chiron and Chiron Behring for the three months ended
March 31, 1998 with pro forma adjustments as if Chiron's acquisition of the
remaining 51% interest in Chiron Behring had been consummated as of January 1,
1998. The 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 that
may occur in the future. The unaudited pro forma information is as follows:
THREE MONTHS ENDED
MARCH 31, 1998
----------------------
(IN THOUSANDS,
EXCEPT PER SHARE DATA)
Total revenues $ 167,248
Income from continuing operations $ 13,537
Pro forma income per share from continuing operations:
Basic $ 0.08
Diluted $ 0.08
10
CHIRON CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
MARCH 31, 1999
(UNAUDITED)
NOTE 5--SEGMENT INFORMATION
Chiron is organized based on the products and services that it offers.
Under this organizational structure, the Company has the following three
reportable segments: (i) biopharmaceuticals, (ii) vaccines, and (iii) blood
testing. The biopharmaceuticals segment consists of products and services
related to therapeutics, with an emphasis on oncology, serious infectious
diseases, and cardiovascular diseases as well as the development and
acquisition of technologies related to recombinant technology, gene therapy,
small molecule therapeutics, and genomics. The vaccines segment consists
principally of products and services related to adult and pediatric vaccines
sold primarily in Germany, Italy, and certain other international markets.
The blood testing segment consists primarily of Chiron's one-half interest in
the pretax operating earnings of its joint business with Ortho-Clinical
Diagnostics, Inc. 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. Certain revenues and expenses, particularly
Novartis research and development funding, certain royalty revenues, and
unallocated corporate expenses, are not viewed by management as belonging to
any one reportable segment. As a result, these items have been aggregated
into an "Other" segment, as permitted by Statement of Financial Accounting
Standards No. 131, "Disclosures about Segments of an Enterprise and Related
Information" ("SFAS 131").
The accounting policies of the Company's reportable segments are the same
as those described in Note 1--The Company and Summary of Significant Accounting
Policies. Chiron evaluates the performance of its segments based on each
segment's income (loss) from operations, excluding certain special items, such
as restructuring and reorganization charges, which are shown as reconciling
items in the table below. The following segment information excludes all
significant intersegment transactions as these transactions are eliminated for
management reporting purposes:
THREE MONTHS ENDED
MARCH 31,
--------------------------
1999 1998
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(IN THOUSANDS)
REVENUES
Biopharmaceuticals $ 67,741 $ 83,285
Vaccines, includes $243 and $1,436 of equity
in earnings of unconsolidated joint
businesses for the three months ended
March 31, 1999 and 1998, respectively 56,473 16,845
Blood testing, includes $17,843 and $11,438
million of equity in earnings of unconsolidated
joint businesses for the three months ended
March 31, 1999 and 1998, respectively 24,630 17,157
Other 26,716 16,000
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Total revenues $ 175,560 $ 133,287
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11
CHIRON CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
MARCH 31, 1999
(UNAUDITED)
NOTE 5--SEGMENT INFORMATION (CONTINUED)
THREE MONTHS ENDED
MARCH 31,
--------------------------
1999 1998
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(IN THOUSANDS)
INCOME FROM CONTINUING OPERATIONS
Biopharmaceuticals $ (4,692) $ 15,929
Vaccines (6,308) (14,515)
Blood testing 14,515 10,588
Other 15,097 4,938
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Segment income from operations 18,612 16,940
Reconciling items:
Restructuring and reorganization charges (3,352) (7,548)
----------- -----------
Income from operations 15,260 9,392
Interest expense (6,071) (6,580)
Other income, net 22,559 8,595
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Income from continuing operations
before income taxes $ 31,748 $ 11,407
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NOTE 6--CONTINGENCIES
The Company is party to various claims, investigations, and legal
proceedings arising in the ordinary course of business. These claims,
investigations, and legal proceedings relate to intellectual property rights,
contractual rights and obligations, employment matters, claims of product
liability, and other issues. While there is no assurance that an adverse
determination of any of 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 any of these matters will have a
material adverse effect upon the Company's consolidated financial position
and annual results of operations and cash flows.
12
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
OVERVIEW
THIS QUARTERLY REPORT ON FORM 10-Q CONTAINS FORWARD-LOOKING STATEMENTS.
THESE INCLUDE STATEMENTS CONCERNING PLANS, OBJECTIVES, GOALS, STRATEGIES, FUTURE
EVENTS OR PERFORMANCE, AND ALL OTHER STATEMENTS WHICH ARE OTHER THAN STATEMENTS
OF HISTORICAL FACT, INCLUDING, WITHOUT LIMITATION, STATEMENTS CONTAINING WORDS
SUCH AS "BELIEVES", "ANTICIPATES", "EXPECTS", "ESTIMATES", "PROJECTS", "WILL",
"MAY", "MIGHT", AND WORDS OF A SIMILAR NATURE. THE FORWARD-LOOKING STATEMENTS
CONTAINED IN THIS REPORT REFLECT MANAGEMENT'S CURRENT BELIEFS AND EXPECTATIONS
ON THE DATE OF THIS REPORT. ACTUAL RESULTS, PERFORMANCE OR OUTCOMES MAY DIFFER
MATERIALLY FROM THOSE EXPRESSED IN THE FORWARD-LOOKING STATEMENTS. SOME OF THE
IMPORTANT FACTORS WHICH, IN THE VIEW OF CHIRON CORPORATION ("CHIRON" OR THE
"COMPANY"), COULD CAUSE ACTUAL RESULTS TO DIFFER ARE DISCUSSED UNDER THE CAPTION
"FACTORS THAT MAY AFFECT FUTURE RESULTS." THE COMPANY UNDERTAKES NO OBLIGATION
TO PUBLICLY ANNOUNCE ANY REVISIONS TO THESE FORWARD-LOOKING STATEMENTS TO
REFLECT FACTS OR CIRCUMSTANCES OF WHICH MANAGEMENT BECOMES AWARE AFTER THE DATE
THEREOF.
THE DISCUSSION BELOW SHOULD BE READ IN CONJUNCTION WITH PART I, ITEM 1.,
"FINANCIAL STATEMENTS", OF THIS QUARTERLY REPORT ON FORM 10-Q AND PART II,
ITEMS 7, 7A, AND 8, "MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS", "QUANTITATIVE AND QUALITATIVE
DISCLOSURES ABOUT MARKET RISK", AND "FINANCIAL STATEMENTS AND SUPPLEMENTARY
DATA", RESPECTIVELY, OF THE COMPANY'S ANNUAL REPORT ON FORM 10-K FOR THE YEAR
ENDED JANUARY 3, 1999.
Chiron is a biotechnology company that participates in three global
healthcare businesses: biopharmaceuticals, vaccines, and blood testing. The
biopharmaceuticals segment consists of products and services related to
therapeutics, with an emphasis on oncology, serious infectious diseases, and
cardiovascular diseases as well as the development and acquisition of
technologies related to recombinant technology, gene therapy, small molecule
therapeutics, and genomics. The vaccines segment consists principally of
adult and pediatric vaccines sold primarily in Germany, Italy, and certain
other international markets. The blood testing segment primarily
consists of Chiron's one-half interest in the pretax operating earnings of
its joint business with Ortho-Clinical Diagnostics, Inc. ("Ortho"), a
Johnson & Johnson 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.
On December 29, 1997, Chiron completed the sale of its ophthalmics
business ("Chiron Vision") to Bausch & Lomb Incorporated ("B&L") and on
November 30, 1998, Chiron completed the sale of its IN VITRO diagnostics
business ("Chiron Diagnostics") to Bayer Corporation ("Bayer"). The Company's
condensed consolidated statements of operations reflect the after-tax results
of Chiron Diagnostics and the gain on disposal of Chiron Vision as
discontinued operations for the three months ended March 31, 1998.
On March 31, 1998, in an acquisition accounted for under the purchase
method of accounting, Chiron acquired the remaining 51% interest in Chiron
Behring GmbH & Co ("Chiron Behring") from Hoechst AG. Beginning in the second
quarter of 1998, the results of Chiron Behring were consolidated with those of
the Company.
RESULTS OF OPERATIONS
REVENUES
BIOPHARMACEUTICAL PRODUCT SALES Product sales from the
biopharmaceuticals segment were $43.1 million and $50.3 million for the three
months ended March 31, 1999 and 1998, respectively. Product sales consisted
principally of Proleukin-Registered Trademark- (aldesleukin, interleukin-2),
Betaseron-Registered Trademark- (interferon beta-1b) and PDGF (recombinant
human platelet-derived growth factor -rhPDGF-BB).
PROLEUKIN-Registered Trademark- Chiron sells Proleukin-Registered
Trademark- directly in the U.S. and certain international markets. Sales of
Proleukin-Registered Trademark- were $25.9 million and $20.9 million for the
three months ended March 31, 1999 and 1998, respectively. The overall
increase in sales is primarily due to continued volume growth in existing
indications and higher prices. Also impacting
13
the increase in Proleukin-Registered Trademark- product sales was the Food
and Drug Administration's ("FDA's") approval of Proleukin-Registered
Trademark- for the indication of metastatic melanoma during the first quarter
of 1998. The Company continues to pursue additional indications related to
human immunodeficiency virus ("HIV"), acute myelogenous leukemia, and HIV
related non-Hodgkin's lymphoma. The Company also anticipates further
geographic expansion of Proleukin-Registered Trademark- into additional
countries.
BETASERON-Registered Trademark- Chiron manufactures
Betaseron-Registered Trademark- for Berlex Laboratories, Inc. ("Berlex") and
its parent company, Schering AG of Germany. Chiron earns a partial payment
for Betaseron-Registered Trademark- upon shipment to Berlex and Schering AG
and a subsequent additional payment upon sales by Berlex and Schering AG.
Accordingly, Chiron's revenues from Betaseron-Registered Trademark- tend to
fluctuate based upon the inventory management practices of Berlex and
Schering AG. For the three months ended March 31, 1999 and 1998, revenues
from Betaseron-Registered Trademark- remained fairly constant at $14.6
million and $14.1 million, respectively.
PDGF Chiron manufactures PDGF for Ortho-McNeil Pharmaceutical, Inc., a
Johnson & Johnson ("J&J") company. PDGF is the active ingredient in
Regranex-Registered Trademark-(becaplermin) Gel, a treatment for diabetic
foot ulcers. Regranex-Registered Trademark- Gel was approved by the FDA in
December 1997 and was launched commercially in early 1998. Sales of PDGF were
$0.5 million and $13.3 million for the three months ended March 31, 1999 and
1998, respectively. As PDGF is the first product of its kind, the Company
believes it will take time for the market to fully develop. In addition,
Chiron's sales of PDGF will tend to fluctuate based upon the inventory
management practices of J&J. Regranex-Registered Trademark- Gel was recently
approved for use in the treatment of diabetic foot ulcers in Canada and
Europe. However, even with these approvals, Chiron's sales to date have
largely filled J&J's initial inventory requirements for product launch, and
as a result, no significant sales of PDGF to J&J are expected during 1999.
VACCINE PRODUCT SALES Chiron sells pediatric and adult vaccines in
Germany, Italy, other international markets, and in the U.S. Certain of the
Company's vaccine products, particularly its flu vaccine, are seasonal and
typically have higher sales in the third and fourth quarters of the year. For
the three months ended March 31, 1999 and 1998, vaccine product sales were
$44.5 million and $14.5 million, respectively. The increase in sales in 1999
as compared with 1998 is primarily due to Chiron's acquisition of the
remaining 51% interest in, and consolidation of, Chiron Behring during the
second quarter of 1998. Chiron Behring contributed $25.4 million to product
sales during the first quarter of 1999. Also contributing to the increase in
product sales was a $4.2 million sale of adult influenza vaccine to Argentina.
EQUITY IN EARNINGS OF UNCONSOLIDATED JOINT BUSINESSES For the three
months ended March 31, 1999 and 1998, Chiron recognized equity in earnings of
unconsolidated joint businesses of $18.1 million and $12.9 million,
respectively. In 1999, equity in earnings of unconsolidated joint businesses
consisted substantially of revenues generated by Chiron's joint business with
Ortho. In 1998, equity in earnings of unconsolidated joint businesses also
included Chiron's 49% share of the after-tax operating results of Chiron
Behring.
CHIRON-ORTHO JOINT BUSINESS For the three months ended March 31, 1999
and 1998, Chiron's 50% share of the pretax operating earnings of the
Chiron-Ortho joint business was $17.8 million and $11.4 million,
respectively. At the end of each year, the joint business records an annual
inventory adjustment. As Chiron recognizes revenues from the joint business
on a lag basis, this adjustment is typically made during the first quarter of
each year. In the first quarter of 1999, the annual inventory adjustment
resulted in a charge of $0.7 million as compared with a $4.1 million charge
recognized in the first quarter of 1998. Also contributing to the increase in
earnings in 1999 as compared with 1998, were certain one-time contract
termination fees, which were incurred during the first quarter of 1998.
CHIRON BEHRING On July 1, 1996, Chiron acquired a 49% interest in
Chiron Behring. On March 31, 1998, Chiron acquired the remaining 51% interest
in Chiron Behring (refer to Note 4 of NOTES TO CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS). From July 1, 1996 through the first quarter of 1998,
equity in earnings of unconsolidated joint businesses included Chiron's 49%
share of the after-tax operating results of Chiron Behring. Chiron's share of
earnings of the joint business, including amortization of intangibles, was
$2.4 million for the three months ended March 31, 1998. Beginning in the
second quarter of 1998, Chiron Behring's results were consolidated with those
of the Company.
COLLABORATIVE AGREEMENT REVENUES Chiron recognizes collaborative
agreement revenues for fees received for research services as they are
performed and fees received upon achievement of specified milestones. For the
three
14
months ended March 31, 1999 and 1998, Chiron recognized collaborative
agreement revenues of $22.4 million and $24.4 million, respectively. The
decrease is primarily due to a contractual decrease in payments received by
the Company under a November 1996 consent agreement between Chiron,
Novartis AG ("Novartis"), and the Federal Trade Commission related to the
Herpes Simplex Virus-thymidine kinase (HSV-tk) gene in the field of gene
therapy (for more information, refer to the Company's Annual Report on
Form 10-K for the year ended January 3, 1999).
Chiron and Novartis entered into an agreement, which expires on
December 31, 1999, under which Novartis agreed to provide research funding
for certain projects (for more information, refer to the Company's Annual
Report on Form 10-K for the year ended January 3, 1999). Under this
agreement, Chiron recognized collaborative agreement revenues of $16.0
million during the first quarters of 1999 and 1998.
Collaborative agreement revenues tend to fluctuate based on the amount
of research services performed, the status of projects under collaboration,
and the achievement of milestones. Due to the nature of the Company's
collaborative agreement revenue, results in any one period are not
necessarily indicative of results to be achieved in the future. The Company's
ability to generate additional collaborative agreement revenues may depend,
in part, on its ability to initiate and maintain relationships with potential
and current collaborative partners. There can be no assurance that such
relationships will be established or that current collaborative agreement
revenues will not decline.
ROYALTY AND LICENSE FEE REVENUES The Company receives royalties and
license fees for products or technologies that are marketed, distributed, or
used by third parties. For the three months ended March 31, 1999 and 1998,
Chiron recognized royalty and license fee revenues of $32.4 million and $16.1
million, respectively. The increase is primarily due to the Bayer
Cross-License Agreement whereby Chiron agreed to grant to Chiron Diagnostics
rights under certain Chiron patents, including rights under patents relating
to HIV and hepatitis C virus. In exchange for these rights, Chiron
Diagnostics paid to Chiron a license fee of $100.0 million, which is
refundable in decreasing amounts over a period of three years. During the
first quarter of 1999, Chiron recognized $10.0 million of license fees, which
represents the portion of the $100.0 million payment that became
nonrefundable during the period. Other items contributing to royalty and
license fee revenues in the first quarter of 1999 were $7.1 million of
royalties related to insulin products, $3.4 million of royalties earned by
Chiron Behring, and $2.1 million of royalties related to human vaccine
products. Partially offsetting these items was a decrease of $5.0 million
related to a one-time license fee received from Pharmacia & Upjohn Company in
January 1998 to research, develop, manufacture, and commercialize therapeutic
products for the treatment of hepatitis C in humans.
Royalty and license fee revenues may fluctuate based on the nature of
the related agreements and the timing of receipt of license fees. Results in
any one period are not necessarily indicative of results to be achieved in
the future. In addition, the Company's ability to generate additional royalty
and license fee revenues may depend, in part, on its ability to market and
capitalize on its technologies. There can be no assurance that the Company
will be able to do so or that future royalty and license fee revenues will
not decline.
OTHER REVENUES For the three months ended March 31, 1999 and 1998,
Chiron recognized other revenues of $9.6 million and $10.7 million,
respectively. Other revenues in the first quarter of 1999 included $5.0
million of commission revenues generated by Chiron Behring, whose operations
were consolidated with those of the Company beginning in the second quarter
of 1998. These revenues consist of commissions received on sales of hepatitis
B products and of immunoglobuline products. For the three months ended March
31, 1999 and 1998, other revenues also included $2.6 million and $0.4
million, respectively, of contract manufacturing revenues. These increases in
other revenues were offset by a decrease of $9.2 million related to an
arrangement which terminated in April 1998 where Chiron promoted
Aredia-Registered Trademark- (pamidronate disodium for injection) on behalf
of Novartis.
The Company's other revenues may fluctuate due to the nature of the
revenues recognized and the timing of events giving rise to these revenues.
There can be no guarantee that the Company will be successful in obtaining
additional revenues or that these revenues will not decline.
COSTS AND EXPENSES
GROSS PROFIT Gross profit as a percentage of net product sales was
52.6% and 59.4%, in the first quarter of 1999 and 1998, respectively. The
decrease is primarily related to (i) an unfavorable mix of vaccine product
sales, which beginning in the second quarter of 1998, includes low margin
products that are in-licensed and sold by Chiron Behring; (ii) certain
inventory-related charges incurred by the Company's Italian vaccine
operations related to inventory obsolescence reserves and inventory
write-offs; and (iii) an unfavorable mix of biopharmaceutical product sales,
which includes fewer sales of the higher margin product, PDGF. These
decreases were partially offset by (i) improvements in the gross margins
15
related to Betaseron-Registered Trademark- due to a reduction in idle
facility costs and certain manufacturing efficiencies resulting from
increased production; and (ii) recent price increases on sales of
Proleukin-Registered Trademark-.
Also impacting the Company's gross profit margin during the first
quarter of 1999 was the write-off of a portion of the Company's tick-borne
encephalitis inventory that failed to satisfy manufacturing specifications
for purity. The Company subsequently retested all remaining tick-borne
encephalitis inventory and found it to meet specifications. The Company has
since received approval from the relevant regulatory authority and is
selling the product. The total charge that related to this issue was $3.1
million.
The Company's gross profit percentages may fluctuate significantly in
future periods as the Company's product mix continues to evolve.
RESEARCH AND DEVELOPMENT For the three months ended March 31, 1999 and
1998, Chiron recognized research and development expenses of $69.1 million
and $63.9 million, respectively. The Company's research and development
expenses may fluctuate from period to period depending upon the stage of
certain projects and the level of clinical trial-related activities. In 1999,
the increase in research and development spending as compared with 1998 was
due, in part, to the acquisition and consolidation of Chiron Behring, which
contributed $2.8 million to research and development expenses during the
first quarter of 1999. Also contributing to the increase in research and
development expenses was the furtherance of the Company's clinical trials
related to Tissue Factor Pathway Inhibitor (TFPI) and Fibroblast Growth
Factor (FGF).
SELLING, GENERAL AND ADMINISTRATIVE In the first quarters of 1999 and
1998, Chiron recognized selling, general and administrative ("SG&A") expenses
of $40.5 million and $23.7 million, respectively. The increase in SG&A
expenses in 1999 as compared with 1998 is primarily due to the acquisition
and consolidation of Chiron Behring, which contributed $10.2 million to SG&A
expenses in the first quarter of 1999. SG&A expenses also increased as a
result of the Company's focus on developing and launching the nucleic acid
testing segment of its blood testing business and to the worldwide
implementation of its integrated information system in April 1999.
OTHER OPERATING EXPENSES During the first quarters of 1999 and 1998,
Chiron incurred net restructuring and reorganization charges of $3.4 million
and $7.5 million, respectively, related to the integration of the Company's
worldwide vaccine operations and the Company's ongoing rationalization of its
U.S. business operations. The 1999 first-quarter charge primarily consisted
of termination and other employee-related costs recognized in connection with
the elimination of 28 positions in the Company's Italian manufacturing
facility. Six of these positions had been eliminated as of March 31, 1999. In
fiscal year 1998, the Company had recorded restructuring and reorganization
charges of $26.8 million of which $7.5 million were recognized in the first
quarter. Major components of these charges consisted primarily of
facility-related exit costs and termination and other employee-related
expenses in connection with the elimination of 400 positions. As of March 31,
1999, 249 of these 400 employees had been terminated.
NON-OPERATING INCOME AND EXPENSE
Other income, net, primarily consists of interest and investment income
on the Company's cash and investment balances and other non-operating gains
and losses. For the three months ended March 31, 1999 and 1998, Chiron
recognized interest and investment income of $20.3 million and $6.4 million,
respectively. The increase in interest and investment income in 1999 as
compared with 1998 is primarily due to higher average cash and investment
balances attributable to the net cash proceeds received from the sale of
Chiron Diagnostics in November 1998. Interest expense remained fairly
constant at $6.1 million and $6.6 million for the three months ended March
31, 1999 and 1998, respectively.
NEW ACCOUNTING STANDARD
In June 1998, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards No. 133, "Accounting for Derivative
Instruments and Hedging Activities" ("SFAS 133"), which is effective for all
quarters of fiscal years beginning after June 15, 1999. SFAS 133 establishes
accounting and reporting standards for
16
derivative instruments, including certain derivative instruments embedded in
other contracts, and for hedging activities. In accordance with SFAS 133, an
entity is required to recognize all derivatives as either assets or
liabilities in the statement of financial position and measure those
instruments at fair value. SFAS 133 requires that changes in the derivative's
fair value be recognized currently in earnings unless specific hedge
accounting criteria are met. Special accounting for qualifying hedges allows
a derivative's gains and losses to offset related results on the hedged item
in the income statement, and requires that a company formally document,
designate, and assess the effectiveness of transactions that receive hedge
accounting. The Company is currently evaluating the effect that
implementation of SFAS 133 will have on its results of operations and
financial position and anticipates that it will implement SFAS 133 during the
first fiscal quarter of 2000.
LIQUIDITY AND CAPITAL RESOURCES
Chiron's capital requirements have generally been funded from
operations, cash and investments on hand, debt borrowings, issuance of common
stock, and off-balance sheet financing. Chiron's cash and investments in
marketable debt securities, which totaled $1.4 billion at March 31, 1999, 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;
however, these investments are generally not collateralized and primarily
mature within three years.
SOURCES AND USES OF CASH Chiron had cash and cash equivalents of $69.1
million and $177.6 million at March 31, 1999 and 1998, respectively. For the
first quarter of 1999, net cash used in operating activities was $130.3
million as compared with $0.6 million in 1998. In the first quarter of 1999,
the Company paid $165.4 million in estimated taxes primarily related to the
sale of the Company's IN VITRO diagnostics business. This use of cash was
partially offset by net income of $23.7 million for the three months ended
March 31, 1999.
In the first quarter 1999, net cash used in investing activities
consisted of purchases of investments in marketable debt securities of $701.2
million, capital expenditures of $33.9 million, and other uses of cash of
$18.6 million. Partially offsetting these uses of cash were proceeds from the
sale and maturity of investments in marketable debt securities of $412.1
million.
In the first quarter of 1999, net cash provided by financing activities
primarily consisted of $28.1 million from the issuance of common stock
related to stock option exercises and $1.0 million related to short-term
borrowings. This was partially offset by $0.9 million related to the
repayment of certain notes payable and short-term leases, and $0.6 million
related to the acquisition of treasury stock.
The Company is currently evaluating a number of business development
opportunities. To the extent that the Company is successful in reaching
agreements with third parties, these transactions may involve the expenditure
of a significant amount of the Company's current investment portfolio.
BORROWING ARRANGEMENTS Under a revolving, committed, unsecured credit
agreement with a major financial institution, Chiron can borrow up to $100.0
million in the U.S. This credit facility is guaranteed by Novartis, provides
various interest rate options, and matures in February 2003. There were no
borrowings outstanding under this credit facility at March 31, 1999. The
Company had an additional credit agreement, which expired unused in March
1999. Chiron also has credit facilities outside the U.S. which allow for
total borrowings of $63.1 million. Under these credit facilities, $20.6
million of borrowings were outstanding at March 31, 1999.
YEAR 2000 Chiron is dependent on a number of computer systems and
applications to conduct its business. 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 significant system failures or
miscalculations. Accordingly, the Company has developed a comprehensive
risk-based plan designed to make its computer hardware and communication
systems, software applications, and facilities and other non-information
technology-related functions Year 2000 compliant. The plan covers three
phases including (i) planning, (ii) assessment, and (iii) implementation. The
Company has completed the planning and assessment phases and expects to
complete the implementation phase by mid-1999. With regard to the Company's
computer hardware and communication systems, Chiron has completed its
technology refresh program which was developed in conjunction with
International Business Machines, Inc. ("IBM") to update and standardize the
17
Company's computer hardware and communication systems. With regard to the
Company's software applications, the Company has identified critical and
non-critical software applications. Mission critical applications have been
remediated. Non-critical applications are in progress and are targeted for
completion prior to September 1999. The Company has completed testing and
installation of an integrated information system that was implemented across
the Company on April 5, 1999. With regard to the Company's facilities and
other non-information technology-related functions, including research,
manufacturing, and inventory management practices, the Company is on schedule
and expects to have its facilities and other non-information
technology-related functions Year 2000 compliant by mid-1999 for critical
functions and September 1999 for non-critical functions, in all material
respects.
The Company is using both internal and external resources to prepare for
the year 2000. Although the Company believes that it should be able to
substantially complete the implementation of critical internal aspects of its
Year 2000 plan prior to the commencement of the year 2000, even with
substantial completion of internal remediation plans, the Company's
customers, suppliers, and distributors also present risk of their own Year
2000 compliance over which the Company has no control. The Company has
initiated communications with its critical suppliers and other external
relationships to determine the extent to which the Company may be vulnerable
to such parties' failure to resolve their own Year 2000 issues. Where
practicable, the Company is assessing and attempting to mitigate its risks
with respect to the failure of these entities to be Year 2000 compliant. The
effect, if any, on the Company's results of operations from the failure of
such parties to be Year 2000 compliant cannot be reasonably estimated.
The Company is also preparing to address any Year 2000 issues that do
arise. The Company is implementing specific plans for each critical system to
ensure that the necessary precautions are taken to prevent and/or address an
unexpected system failure. Many of these contingency plans are already in
place as they are based on existing plans that are required for the safe and
proper operation of the Company's business, including its research and
manufacturing facilities.
The SEC has requested that companies disclose the most likely worst case
scenario that could occur as a result of the Year 2000. The Company believes
that its most likely worst case scenario would be delays in product shipments
due to a complete or partial manufacturing shutdown. To address the
manufacturing shutdown scenario, the Company plans, among other things, to
increase its inventory and re-prioritize staff assignments, as needed, but
does not believe that such a scenario is likely to occur.
The Company may incur significant costs in identifying and resolving
Year 2000 issues, including internal staffing costs as well as consulting and
other expenses. In addition, in certain instances, the appropriate course of
action includes replacing or upgrading systems or equipment at a substantial
cost to the Company. Expenses associated with preparing for the year 2000 are
not expected to exceed $5.5 million. The costs related to the technology
refresh program and the integrated information system are not included in the
above estimates as Year 2000 compliance is incidental to the operational
benefits expected to be derived from these programs. As of March 31, 1999,
costs incurred to date have been funded through operations and approximate
$1.4 million. The Company anticipates that most of its Year 2000 costs will
be incurred during the first three quarters of 1999. These costs are
anticipated to be funded with cash on hand and cash generated through
operations.
EURO CONVERSION On January 1, 1999, eleven European Union member
countries established fixed conversion rates between their existing
currencies ("legacy currencies") and one common currency, the Euro. The Euro
is currently traded on currency exchanges and can be used in business
transactions. The Company believes that its financial systems are Euro-ready
in all material respects. However, the Company is still in the process of
evaluating the effect, if any, of the Euro on the Company's product pricing
and gross profit percentages.
FACTORS THAT MAY AFFECT FUTURE RESULTS
As a biotechnology company, Chiron is engaged in a rapidly evolving and
often unpredictable business. The forward-looking statements contained in
this Report and in other periodic reports, press releases and other
statements issued by the Company from time to time reflect management's
current beliefs and expectations concerning objectives, plans, strategies,
future performance, and other future events. The following discussion
highlights some of the factors, many of which are beyond the Company's
control, which could cause actual results to differ.
18
PROMISING TECHNOLOGIES ULTIMATELY MAY NOT PROVE SUCCESSFUL
The Company focuses its research and development activities on areas in
which it has particular strengths, and on technologies that appear promising.
These technologies often are on the "cutting edge" of modern science. As a
result, the outcome of any research or development program is highly
uncertain. Only a very small fraction of such programs ultimately result in
commercial products or even product candidates. Product candidates that
initially appear promising often fail to yield successful products. In many
cases, preclinical or clinical studies will show that a product candidate is
not efficacious (that is, it does not have the intended therapeutic or
prophylactic effect), or that it raises safety concerns or has other side
effects which outweigh the intended benefit. Success in preclinical or early
clinical trials (which generally focus on safety issues) may not translate
into success in large-scale clinical trials (which are designed to show
efficacy), often for reasons that are not fully understood. And even after a
product is approved and launched, general usage or post-marketing studies may
identify safety or other previously unknown problems with the product which
may result in regulatory approvals being suspended, limited to narrow
indications, or revoked, or which otherwise prevent successful
commercialization.
REGULATORY APPROVALS
The Company is required to obtain and maintain regulatory approval in
order to market most of its products. Generally, these approvals are on a
product-by-product and country-by-country basis, and, in the case of
therapeutic products, a separate approval is required for each therapeutic
indication. See Item 1., "Business--Government Regulation" in the Company's
Annual Report on Form 10-K for the year ended January 3, 1999. Product
candidates that appear promising based on early, and even large-scale,
clinical trials may not receive regulatory approval. The results of clinical
trials often are susceptible to varying interpretations that may delay, limit
or prevent approval or result in the need for post-marketing studies.
MANUFACTURING
Most of the Company's products are biologics. Manufacturing biologic
products is complex. Unlike chemical pharmaceuticals, a biologic product
generally cannot be sufficiently characterized (in terms of its physical and
chemical properties) to rely on assaying of the finished product alone to
ensure that the product will perform in the intended manner. Accordingly, it
is essential to be able to both validate and control the manufacturing
process: that is, to show that the process works, and that the product is
made strictly and consistently in compliance with that process. Slight
deviations in the manufacturing process may result in unacceptable changes in
the products which may result in lot failures. Manufacturing processes which
are used to produce the (smaller) quantities of material needed for research
and development purposes may not be successfully scaled up to allow
production of commercial quantities at reasonable cost or at all. All of
these difficulties are compounded when dealing with novel biologic products
that require novel manufacturing processes. Accordingly, manufacturing is
subject to extensive government regulation. Even minor changes in the
manufacturing process require regulatory approval, which, in turn, may
require further clinical studies.
PATENTS HELD BY THIRD PARTIES MAY DELAY OR PREVENT COMMERCIALIZATION
Third parties, including competitors, have patents and patent
applications in the U.S. and other significant markets that may be useful or
necessary for the manufacture, use, or sale of certain of the Company's
products and products in development. It is likely that third parties will
obtain other such patents in the future. Certain of these patents may be
sufficiently broad to prevent or delay Chiron from manufacturing or marketing
products important to the Company's current and future business. The scope,
validity, and enforceability of such patents, if granted, the extent to which
Chiron may wish or need to obtain licenses to such patents, and the cost and
availability of such licenses cannot be accurately predicted. If Chiron does
not obtain such licenses, products may be withdrawn from the market or delays
could be encountered in market introduction while an attempt is made to
design around such patents. Alternatively, Chiron could find that the
development, manufacture, or sale of such products is foreclosed. Chiron could
also incur substantial costs in challenging the validity and scope of such
patents.
PRODUCT ACCEPTANCE
The Company may experience difficulties in launching new products, many
of which are novel products based on
19
technologies that are unfamiliar to the healthcare community. There can be no
assurance that healthcare providers and patients will accept such products.
In addition, government agencies as well as private organizations involved in
healthcare from time to time publish guidelines or recommendations to
healthcare providers and patients. Such guidelines or recommendations can be
very influential, and may adversely affect the usage of the Company's
products directly (for example, by recommending a decreased dosage of the
Company's product in conjunction with a concomitant therapy) or indirectly
(for example, by recommending a competitive product over the Company's
product).
COMPETITION
Chiron operates in a highly competitive environment, and the competition is
expected to increase. Competitors include large pharmaceutical, chemical and
blood testing companies, as well as biotechnology companies. Some of these
competitors, particularly large pharmaceutical and blood testing companies, have
greater resources than the Company. Accordingly, even if the Company is
successful in launching a product, it may find that a competitive product
dominates the market for any number of reasons, including the possibility that
the competitor may have launched its product first; the competitor may have
greater marketing capabilities; or the competitive product may have therapeutic
or other advantages. The technologies applied by the Company and its competitors
are rapidly evolving, and new developments frequently result in price
competition and product obsolescence.
CHIRON'S PATENTS MAY NOT PREVENT COMPETITION OR GENERATE REVENUES
Chiron seeks to obtain patents on its inventions. Without the protection of
patents, competitors may be able to use the Company's inventions to manufacture
and market competing products without being required to undertake the lengthy
and expensive development efforts made by Chiron and without having to pay
royalties or otherwise compensate Chiron for the use of the invention.
There can be no assurance that patents and patent applications owned or
licensed to Chiron will provide substantial protection. Important legal
questions remain to be resolved as to the extent and scope of available
patent protection for biotechnology products and processes in the U.S. and
other important markets. It is not known how many of the Company's pending
patent applications will be granted, or the effective coverage of those that
are granted. In the U.S. and other important markets, the issuance of a
patent is neither conclusive as to its validity nor the enforceable scope
of its claims. The Company has engaged in significant litigation to determine
the scope and validity of certain of its patents and expects to continue to
do so in the future.
Even if the Company is successful in obtaining and defending patents, there
can be no assurance that these patents will provide substantial protection. The
length of time necessary to successfully resolve patent litigation may allow
infringers to gain significant market advantage. Third parties may be able to
design around the patents and develop competitive products that do not use the
inventions covered by the patents. Many countries, including certain countries
in Europe, have compulsory licensing laws under which a patent owner may be
compelled to grant licenses to third parties (for example, the third party's
product is needed to meet a threat to public health or safety in that country,
or the patent owner has failed to "work" the invention in that country, or the
third party has patented improvements) and most countries limit the
enforceability of patents against government agencies or government contractors.
In these countries, the patent owner may be limited to monetary relief and may
be unable to enjoin infringement, which could materially diminish the value of
the patent.
AVAILABILITY OF REIMBURSEMENT; GOVERNMENT AND OTHER PRESSURES ON PRICING
In the U.S. and other significant markets, sales of the Company's products
may be affected by the availability of reimbursement from the government or
other third parties, such as insurance companies. It is difficult to predict the
reimbursement status of newly approved, novel biotechnology products, and
current reimbursement policies for existing products may change. In certain
foreign markets, governments have issued regulations relating to the pricing and
profitability of pharmaceutical companies. There have been proposals in the U.S.
(at both the federal and state level) to implement such controls. The growth of
managed care in the U.S. also has placed pressure on the pricing of healthcare
products. These pressures can be expected to continue.
20
COSTS ASSOCIATED WITH REFOCUSING AND EXPANDING THE BUSINESS
The Company is refocusing its efforts on its core businesses and on
improving operational efficiencies. In addition, management expects to grow
the business in areas in which the Company can be most competitive, either
through in-licensing, collaborations, or acquisitions of products or
companies. In connection with these efforts, the Company may incur
significant charges, costs, and expenses which could impact the Company's
profitability, including impairment losses, restructuring charges, the
write-off of in-process technology, transaction-related expenses, costs
associated with integrating new businesses, and the cost of amortizing
goodwill and other intangibles.
OTHER NEW PRODUCTS AND SOURCES OF REVENUE
Many products in the Company's current pipeline are in relatively early
stages of research or development. The Company's ability to grow earnings in the
near- to medium-term may depend, in part, on its ability to initiate and
maintain other revenue generating relationships with third parties, such as
licenses to certain of the Company's technologies, and on its ability to
identify and successfully acquire rights to later-stage products from third
parties. There can be no assurance that such other sources of revenue will be
established.
INTEREST RATE AND FOREIGN CURRENCY EXCHANGE RATE FLUCTUATIONS
In 1998, the Company sold certain businesses for cash, including its IN
VITRO diagnostics and ophthalmics businesses, and as a result has significant
cash balances and short-term investments. The Company's financial results
therefore are sensitive to interest rate fluctuations in the U.S. In
addition, the Company sells products in many countries throughout the world,
and its financial results could be significantly affected by fluctuations in
foreign currency exchange rates or by weak economic conditions in foreign
markets.
COLLABORATION PARTNERS
An important part of the Company's business strategy depends upon
collaborations with third parties, including research collaborations and
joint efforts to develop and commercialize new products. As circumstances
change, the Company and its corporate partners may develop conflicting
priorities or other conflicts of interest. The Company may experience
significant delays and incur significant expenses in resolving these
conflicts and may not be able to resolve these matters on acceptable terms.
Even without conflicts of interest, the parties may differ in their views as
to how best to realize the value associated with a current product or a
product in development. In some cases, the corporate partner may have
responsibility for formulating and implementing key strategic or operational
plans. Decisions by corporate partners on key clinical, regulatory, marketing
(including pricing), inventory management, and other issues may prevent
successful commercialization of the product or otherwise impact the Company's
profitability.
STOCK PRICE VOLATILITY
The price of the Company's stock, like that of other biotechnology
companies, is subject to significant volatility. Any number of events, both
internal and external to the Company, may affect the stock price. These include,
without limitation, results of clinical trials conducted by the Company or by
its competitors; announcements by the Company or its competitors regarding
product development efforts, including the status of regulatory approval
applications; the outcome of legal proceedings, including claims filed by the
Company against third parties to enforce its patents and claims filed by third
parties against the Company relating to patents held by the third parties; the
launch of competing products; the resolution of (or failure to resolve) disputes
with collaboration partners; corporate restructuring by the Company; licensing
activities by the Company; and the acquisition or sale by the Company of
products, products in development, or businesses.
In connection with its research and development collaborations, from time
to time the Company invests in equity securities of its corporate partners. The
price of these securities also is subject to significant volatility and may be
affected by, among other things, the types of events that affect the Company's
stock. Changes in the market price of these securities may impact the Company's
profitability.
21
TAX
The Company is taxable principally in the U.S., Germany, Italy, and The
Netherlands. All of these jurisdictions have in the past and may in the
future make changes to their corporate tax rates and other tax laws, which
could increase the Company's tax provision in the future. The Company has
negotiated a number of rulings regarding income and other taxes that are
subject to periodic review and renewal. If such rulings are not renewed or
are substantially modified, taxes payable in particular jurisdictions could
increase. While the Company believes that all material tax liabilities are
properly reflected in its balance sheet, the Company is presently under audit
in several jurisdictions, and there can be no assurance that Chiron will
prevail in all cases in the event the taxing authorities disagree with its
interpretations of the tax law. In addition, the Company has assumed
liabilities for all income taxes incurred prior to the sales of its former
subsidiaries, Chiron Vision Corporation (subject to certain limitations) and
Chiron Diagnostics Corporation. Future levels of research and development
spending, capital investment, and export sales will impact the Company's
entitlement to related tax credits and benefits which have the effect of
lowering its effective tax rate.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
MARKET RISK MANAGEMENT The Company's cash flow and earnings are subject to
fluctuations due to changes in foreign currency exchange rates, interest rates,
and fair value of equity securities held. The Company attempts to limit its
exposure to some or all of these market risks through the use of various
financial instruments. There were no significant changes in the Company's market
risk exposures during the first quarter of 1999. For further discussion of the
Company's market risk exposures, refer to Part II, Item 7A., "Quantitative and
Qualitative Disclosures About Market Risk" in Chiron's Annual Report on Form
10-K for the fiscal year ended January 3, 1999.
PART II
ITEM 1. LEGAL PROCEEDINGS
The Company is party to certain lawsuits and legal proceedings, which
are described in Part I, Item 3., "Legal Proceedings," of the Company's
Annual Report on Form 10-K for the year ended January 3, 1999. The following
is a description of material developments during the period covered by this
Quarterly Report and should be read in conjunction with the Annual Report.
CONNAUGHT LABORATORIES, LIMITED
Chiron is involved in litigation in Italy, Germany, and The Netherlands
with Connaught Laboratories, Limited ("Connaught") relating to
TriAcelluvax-TM-, the Company's diphtheria/tetanus/acellular pertussis
vaccine.
The Company does not sell TriAcelluvax-TM- in Germany. However, in July
1997, Connaught filed suit against Chiron Behring and Chiron S.p.A. in the
District Court in Dusseldorf, Germany, asserting imminent infringement of
Connaught's European Patent 0 322 115 (the "'115 patent"). The '115 patent,
which contains claims relating to pertussis toxin mutants was upheld in
November 1998 by the EPO Opposition Division. In the German action, Connaught
sought damages and an order enjoining Chiron S.p.A. and Chiron Behring from
the manufacture and sale of TriAcelluvax-TM- in both Germany and Italy. A
trial on this matter took place in August 1998. In April, 1999, the German
court rejected Connaught's request for an order enjoining Chiron S.p.A. from
activities in Italy but entered an injunction against the Chiron defendants
prohibiting future sales in Germany. That injunction becomes effective upon
Connaught's posting of a bond. Connaught's damages claims were denied.
F. HOFFMANN-LAROCHE AG
Chiron is involved in certain litigation in the United States, The
Netherlands, Japan, Germany, and other countries with F. Hoffmann-LaRoche AG
and several of its affiliated companies concerning infringement and/or
validity of certain patents related to HCV technology.
In January 1998, Chiron initiated an action against F. Hoffmann-LaRoche AG
and several of its affiliated companies (collectively, "Roche") in the United
States District Court for the Northern District of California. The Company
asserts
22
that Roche's manufacture and sale of Amplicor-Registered Trademark- HCV Test
and Amplicor-Registered Trademark- HCV Monitor Test constitutes infringement
of Chiron's U.S. Patent Nos. 5,712,088 (the "'088 patent") and 5,714,596 (the
"'596 patent"). The action seeks damages, injunctive relief, and a
declaratory judgment that Chiron is the sole and exclusive owner of its HCV
technology. Roche filed a counterclaim requesting a declaratory judgment of
non-infringement and invalidity and also alleging infringement of U.S. Patent
No. 5,580,718 (the "'718 patent"), owned by Roche, which allegedly relates to
nucleic acid-based assays for the detection of HCV. Roche's counterclaim of
infringement seeks damages and injunctive relief. Chiron is defending on the
basis of invalidity and non-infringement of the '718 patent and also seeks a
declaration of invalidity of U.S. Patent No. 5,527,669 (the "'669 patent"), a
related patent also owned by Roche. Roche asserts that Chiron is barred from
interfering with Roche's use of polymerase chain reaction ("PCR") to detect
HCV by virtue of Chiron's status as successor-in-interest to Cetus
Corporation, which sold its PCR business to Roche in 1991. A hearing on the
parties' cross-motions for summary judgment on this issue is scheduled for
May 28, 1999.
In January 1997, Chiron, together with Ortho-Clinical Diagnostics, Inc.
filed suit against F. Hoffmann-LaRoche AG ("Roche Germany") in the Regional
Court, 4th Civil Division, Dusseldorf, Germany, for infringement of HCV
immunoassay technology under Chiron's European Patent 0 318 216 (the "'216
patent"). The suit sought an injunction preventing further manufacture or
sale of infringing HCV immunoassay kits by Roche Germany. On April 29, 1999,
the Court issued a decision granting Chiron's application for injunctive
relief. That order becomes effective only upon posting of a bond and is
subject to appeal.
Chiron also filed a suit against Roche in Dusseldorf, Germany, for
infringement of Chiron's European Patent 0 181 150 relating to HIV
probes technology. The suit seeks injunctive relief and damages. That matter
has been set for trial on February 1, 2000.
It is not known when nor on what bases these matters will be concluded.
ORTHO-CLINICAL DIAGNOSTICS, INC.
On February 17, 1998, Chiron filed a lawsuit against Ortho-Clinical
Diagnostics, Inc. ("Ortho") in the United States District Court for the
Northern District of California. The suit sought to compel arbitration of
certain issues relating to the conduct of the parties' joint business.
Chiron's motion to compel arbitration was granted by the Court in December
1998. Ortho appealed that order to the Ninth Circuit Court of Appeals and
then refused Chiron's demand for arbitration in accordance with the order.
Therefore, on March 31, 1999, Chiron filed a second petition in the United
States District Court for the Northern District of California to compel
arbitration. It is not known when nor on what bases these matters will be
concluded.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
(a) EXHIBITS.
EXHIBIT
NUMBER EXHIBIT
------ -------
3.01 Restated Certificate of Incorporation of the Registrant, as filed with the Office of
the Secretary of State of Delaware on August 17, 1987, incorporated by reference to
Exhibit 3.01 of the Registrant's Form 10-K report for fiscal year 1996.
3.02 Certificate of Amendment of Restated Certificate of Incorporation of the Registrant,
as filed with the Office of the Secretary of State of Delaware on December 12, 1991,
incorporated by reference to Exhibit 3.02 of the Registrant's Form 10-K report for
fiscal year 1996.
3.03 Certificate of Amendment of Restated Certificate of Incorporation of the Registrant,
as filed with the Office of the Secretary of State of Delaware on May 22, 1996,
incorporated by reference to Exhibit 3.04 of the Registrant's Form 10-Q report for the
period ended June 30, 1996.
23
3.04 Bylaws of the Registrant, as amended.
4.01 Indenture, dated as of May 21, 1987, between Cetus Corporation and Bankers Trust
Company, Trustee, incorporated by reference to Exhibit 4.01 of the Registrant's Form
10-Q report for the period ended September 30, 1994.
4.02 First Supplemental Indenture, dated as of December 12, 1991, by and among Registrant,
Cetus Corporation, and Bankers Trust Company, incorporated by reference to Exhibit
4.02 of the Registrant's Form 10-K report for fiscal year 1997.
4.03 Second Supplemental Indenture, dated as of March 25, 1996, by and among the
Registrant, Cetus Oncology Corporation (formerly Cetus Corporation), and Bankers
Trust Company, incorporated by reference to Exhibit 4.03 of the Registrant's Form
10-Q report for the period ended June 30, 1996.
4.04 Indenture, dated as of November 15, 1993, between Registrant and The First National
Bank of Boston, as Trustee, incorporated by reference to Exhibit 4.04 of the
Registrant's Form 10-K report for fiscal year 1998.
10.201 Agreement between the Registrant and Ortho Diagnostic Systems, Inc., a New Jersey
corporation, dated August 17, 1989, and Amendment to Collaboration Agreement between
Ortho Diagnostic Systems, Inc. and Registrant, dated December 22, 1989. (Certain
information has been omitted from the Agreements and filed separately with the
Securities and Exchange Commission (the "Commission") pursuant to a request by
Registrant for confidential treatment pursuant to Rule 24b-2 and a consequent order by
the Commission dated November 30, 1994. The omitted confidential information has been
identified by the following statement: "Confidential Treatment Requested".)
10.202 License and Supply Agreement between Ortho Diagnostic Systems, Inc., a New Jersey
corporation, the Registrant and Abbott Laboratories, an Illinois corporation, dated
August 17, 1989. (Certain information has been omitted from the Agreement and filed
separately with the Securities and Exchange Commission pursuant to a request by
Registrant for confidential treatment pursuant to Rule 24b-2 and a consequent order by
the Commission dated November 30, 1994. The omitted confidential information has been
identified by the following statement: "Confidential Treatment Requested".)
10.206 Agreement between the Registrant and Cephalon, Inc. dated as of January 7, 1994, and
Letter Agreements between the Registrant and Cephalon dated January 13, 1995 and May
23, 1995. (Certain information has been omitted from the Agreements and filed
separately with the Securities and Exchange Commission pursuant to a request by
Registrant for confidential treatment pursuant to Rule 24b-2. The omitted confidential
information has been identified by the following statement: "Confidential Treatment
Requested".)
27 Financial Data Schedule for Three Months ended March 31, 1999.
27.1 Financial Data Schedule for Three Months ended March 29, 1998 and the Six Months
ended June 28, 1998.
(b) REPORTS ON FORM 8-K.
None.
24
CHIRON CORPORATION
March 31, 1999
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
CHIRON CORPORATION
DATE: MAY 12, 1999 BY: /s/ SEAN P. LANCE
------------------------- ------------------------------------
Sean P. Lance
President and Chief Executive
Officer
DATE: MAY 12, 1999 BY: /s/ JAMES R. SULAT
------------------------- ------------------------------------
James R. Sulat
Chief Financial Officer
25