- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
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 JUNE 30, 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__
(Exact name of registrant as specified in its charter)
DELAWARE 94-2754624
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
4560 HORTON STREET, EMERYVILLE, CALIFORNIA 94608
(Address of principal executive offices) (Zip code)
(510) 655-8730
(Registrant's telephone number, including area code)
NOT APPLICABLE
(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 JULY 31, 1999
Common Stock, $0.01 par value 180,978,200
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
CHIRON CORPORATION
TABLE OF CONTENTS
PART I. FINANCIAL INFORMATION PAGE NO.
-------------
ITEM 1. FINANCIAL STATEMENTS
Condensed Consolidated Balance Sheets as of June 30, 1999 and December 31,
1998......................................................................... 3
Condensed Consolidated Statements of Operations for the three and six months
ended June 30, 1999 and 1998................................................. 4
Condensed Consolidated Statements of Comprehensive Income for the three and
six months ended June 30, 1999 and 1998...................................... 5
Condensed Consolidated Statements of Cash Flows for the six months ended June
30, 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................................................................. 15
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.............. 27
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS....................................................... 27
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS..................... 28
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K........................................ 28
SIGNATURES........................................................................ 31
2
ITEM 1. FINANCIAL STATEMENTS
CHIRON CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE DATA)
JUNE 30, DECEMBER 31,
1999 1998
------------- --------------
(UNAUDITED)
ASSETS
Current assets:
Cash and cash equivalents......................................... $ 47,534 $ 513,315
Short-term investments in marketable debt securities.............. 725,290 716,619
------------- --------------
Total cash and short-term investments........................... 772,824 1,229,934
Accounts receivable............................................... 179,286 167,588
Inventories....................................................... 93,233 79,862
Other current assets.............................................. 91,960 153,558
------------- --------------
Total current assets............................................ 1,137,303 1,630,942
Noncurrent investments in marketable debt securities................ 706,702 360,069
Property, plant, equipment, and leasehold improvements, at cost:
Land and buildings................................................ 140,713 141,452
Laboratory, production, and office equipment...................... 296,082 236,803
Leasehold improvements............................................ 67,293 84,607
Construction-in-progress.......................................... 34,041 38,321
------------- --------------
538,129 501,183
Less accumulated depreciation and amortization.................... (218,438) (198,102)
------------- --------------
Net property, plant, equipment, and leasehold improvements...... 319,691 303,081
Purchased technology, net........................................... 13,090 14,753
Other intangible assets, net........................................ 146,017 167,534
Investments in equity securities and affiliated companies........... 35,086 27,456
Other assets........................................................ 42,711 20,429
------------- --------------
$ 2,400,600 $ 2,524,264
------------- --------------
------------- --------------
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable.................................................. $ 46,451 $ 44,833
Accrued compensation and related expenses......................... 41,672 40,727
Short-term borrowings............................................. 25,445 17,554
Note payable to Novartis.......................................... 65,945 63,945
Current portion of unearned revenue............................... 42,321 41,893
Taxes payable..................................................... 24,525 180,536
Other current liabilities......................................... 134,588 167,947
------------- --------------
Total current liabilities....................................... 380,947 557,435
Long-term debt...................................................... 349,145 338,158
Other noncurrent liabilities........................................ 61,880 82,869
------------- --------------
Total liabilities............................................... 791,972 978,462
------------- --------------
Commitments and contingencies
Stockholders' equity:
Common stock...................................................... 1,815 1,799
Additional paid-in capital........................................ 2,010,737 1,979,615
Accumulated deficit............................................... (382,625) (437,873)
Accumulated other comprehensive (loss) income..................... (14,553) 2,261
Treasury stock, at cost (329,500 shares).......................... (6,746) --
------------- --------------
Total stockholders' equity...................................... 1,608,628 1,545,802
------------- --------------
$ 2,400,600 $ 2,524,264
------------- --------------
------------- --------------
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 SIX MONTHS ENDED
JUNE 30, JUNE 30,
---------------------- ----------------------
1999 1998 1999 1998
---------- ---------- ---------- ----------
Revenues:
Product sales, net............................................. $ 101,322 $ 96,058 $ 194,289 $ 165,278
Equity in earnings of unconsolidated joint businesses.......... 17,048 17,364 35,134 30,238
Collaborative agreement revenues............................... 18,736 24,432 41,161 48,832
Royalty and license fee revenues............................... 27,335 15,495 59,768 31,569
Other revenues................................................. 24,669 9,541 34,318 20,260
---------- ---------- ---------- ----------
Total revenues............................................... 189,110 162,890 364,670 296,177
---------- ---------- ---------- ----------
Expenses:
Cost of sales.................................................. 40,759 45,186 84,635 73,399
Research and development....................................... 73,806 66,088 141,259 128,890
Selling, general, and administrative........................... 45,153 38,664 86,815 62,788
Write-off of purchased in-process technologies................. -- 1,645 -- 1,645
Restructuring and reorganization charges (Note 3).............. -- (2,610) 3,352 4,938
Other operating expenses....................................... 510 3,755 4,693 4,963
---------- ---------- ---------- ----------
Total expenses............................................... 160,228 152,728 320,754 276,623
---------- ---------- ---------- ----------
Income from operations........................................... 28,882 10,162 43,916 19,554
Gain on sale of assets........................................... -- 6,241 -- 6,241
Interest expense................................................. (5,863) (6,049) (11,708) (12,629)
Other income, net................................................ 20,816 7,566 43,376 16,161
---------- ---------- ---------- ----------
Income from continuing operations before income taxes............ 43,835 17,920 75,584 29,327
Provision (benefit) for income taxes............................. 10,101 (2,182) 18,112 1,683
---------- ---------- ---------- ----------
Income from continuing operations................................ 33,734 20,102 57,472 27,644
---------- ---------- ---------- ----------
Discontinued operations (Note 2):
Income (loss) from discontinued operations..................... -- 5,285 -- (13,108)
Gain on disposal of discontinued operations.................... 3,009 -- 3,009 65,332
---------- ---------- ---------- ----------
Net income....................................................... $ 36,743 $ 25,387 $ 60,481 $ 79,868
---------- ---------- ---------- ----------
---------- ---------- ---------- ----------
Basic earnings per share:
Income from continuing operations.............................. $ 0.19 $ 0.11 $ 0.32 $ 0.16
---------- ---------- ---------- ----------
---------- ---------- ---------- ----------
Net income..................................................... $ 0.20 $ 0.14 $ 0.33 $ 0.45
---------- ---------- ---------- ----------
---------- ---------- ---------- ----------
Diluted earnings per share:
Income from continuing operations.............................. $ 0.18 $ 0.11 $ 0.31 $ 0.15
---------- ---------- ---------- ----------
---------- ---------- ---------- ----------
Net income..................................................... $ 0.20 $ 0.14 $ 0.33 $ 0.44
---------- ---------- ---------- ----------
---------- ---------- ---------- ----------
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 SIX MONTHS ENDED
JUNE 30, JUNE 30,
-------------------- --------------------
1999 1998 1999 1998
--------- --------- --------- ---------
Net income............................................................ $ 36,743 $ 25,387 $ 60,481 $ 79,868
--------- --------- --------- ---------
Other comprehensive income (loss):
Foreign currency translation adjustment:
Change in foreign currency translation adjustment during the
period.......................................................... (5,371) 1,430 (22,246) (983)
Plus: reclassification adjustment for loss included in
discontinued operations......................................... -- -- -- 2,087
--------- --------- --------- ---------
Net foreign currency translation adjustment....................... (5,371) 1,430 (22,246) 1,104
--------- --------- --------- ---------
Unrealized gains (losses) from investments:
Unrealized holding gains (losses) arising during the period......... 5,639 (10,244) 6,422 (4,935)
Reclassification adjustment for net gain included in net income net
of tax (provision) benefit of ($238) and $357 for the three months
ended June 30, 1999 and 1998, respectively, and $557 and $1,371
for the six months ended June 30, 1999 and 1998, respectively..... 423 (635) (990) (2,435)
--------- --------- --------- ---------
Net unrealized gains (losses) from investments...................... 6,062 (10,879) 5,432 (7,370)
--------- --------- --------- ---------
Other comprehensive income (loss)..................................... 691 (9,449) (16,814) (6,266)
--------- --------- --------- ---------
Comprehensive income.................................................. $ 37,434 $ 15,938 $ 43,667 $ 73,602
--------- --------- --------- ---------
--------- --------- --------- ---------
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)
SIX MONTHS ENDED
JUNE 30,
--------------------------
1999 1998
------------- -----------
Net cash (used in) provided by operating activities................................... $ (125,246) $ 46,698
------------- -----------
Cash flows from investing activities:
Purchases of investments in marketable debt securities.............................. (1,034,474) (222,316)
Proceeds from sale and maturity of investments in marketable debt securities........ 684,708 127,620
Capital expenditures................................................................ (42,350) (35,548)
Proceeds from disposal of discontinued operations................................... 35,425 298,939
Proceeds from sale of assets........................................................ -- 18,482
Business acquired, net of cash acquired............................................. -- (54,770)
Other, net.......................................................................... (15,538) (7,084)
------------- -----------
Net cash (used in) provided by investing activities............................... (372,229) 125,323
------------- -----------
Cash flows from financing activities:
Net proceeds from (repayment of) short-term debt.................................... 8,115 (137,025)
Repayment of notes payable and capital leases....................................... (1,193) (1,319)
Proceeds from issuance of common stock.............................................. 31,518 25,960
Payments to acquire treasury stock.................................................. (6,746) --
------------- -----------
Net cash provided by (used in) financing activities............................... 31,694 (112,384)
------------- -----------
Net (decrease) increase in cash and cash equivalents.............................. (465,781) 59,637
Cash and cash equivalents at beginning of the period.................................. 513,315 98,483
------------- -----------
Cash and cash equivalents at end of the period........................................ $ 47,534 $ 158,120
------------- -----------
------------- -----------
THE ACCOMPANYING NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS ARE AN
INTEGRAL PART OF THIS STATEMENT.
6
CHIRON CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 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 June 30, 1999, and for the three and six months ended
June 30, 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. For the three and six months ended June 30, 1999, the Company's
results include a $6.4 million reduction in other operating expenses resulting
from a change in estimated tax accruals related to certain employee payments
recorded in 1995 in connection with the Novartis transaction and a $3.0 million
adjustment to the gain on disposal of discontinued operations resulting from a
change in estimated accruals created at the time of disposal. For the three and
six months ended June 30, 1998, included in the Company's results were a $6.0
million reduction in cost of sales due to a change in estimated property tax
accruals created in prior periods, a $3.6 million reduction in restructuring and
reorganization charges due to a revised estimate of property and other
tax-related accruals recorded in 1995 in connection with the idling of the
Puerto Rico facility, and a $2.0 million reduction in selling, general, and
administrative expenses due to changes in estimated accruals created in prior
periods.
During the second quarter of 1999, the Company completed the implementation
of an integrated information system. As a result, certain previously reported
amounts have been reclassified to conform with 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 and
six months ended June 30, 1998 reflect the after-tax results of Chiron
Diagnostics 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, the
results of Chiron S.p.A. were 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
7
CHIRON CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
JUNE 30, 1999
(UNAUDITED)
NOTE 1--THE COMPANY AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
ending on December 31. In 1998, the Company's fiscal year was a 53-week year
ending on January 3, 1999 and the second fiscal quarter was a 13-week period
ending on June 28, 1998. For presentation purposes, the 1998 dates used in the
condensed consolidated financial statements and notes refer to the fiscal
month-end.
INVENTORIES
Inventories are stated at the lower of cost or market using the moving
weighted-average cost method as of June 30, 1999. For the period ending December
31, 1998, vaccine inventories were valued using the last-in, first-out ("LIFO")
method. In the second quarter of 1999, the Company changed its inventory
valuation methodology for vaccine inventories from LIFO to the moving
weighted-average cost method. The effect of this change in methodology was not
material to the financial statements. Inventories consist of the following (in
thousands):
JUNE 30, DECEMBER 31,
1999 1998
--------- ------------
Finished goods....................................................... $ 11,708 $ 12,301
Work-in-process...................................................... 62,126 54,333
Raw materials........................................................ 19,399 13,228
--------- ------------
$ 93,233 $ 79,862
--------- ------------
--------- ------------
INCOME TAXES
The 1999 estimated annual tax provision is expected to be approximately 24%
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 and six months ended June 30, 1998 was based on
an actual year-to-date effective tax rate on pretax income from continuing
operations of approximately 6%, after taking into account federal deferred tax
assets recognized and the tax impact attributable to restructuring and the sale
of the Puerto Rico facility. The actual 1998 annual effective tax rate of 20%
reflects the recognition of the deferred tax assets that were recognized during
the second half of 1998 resulting from 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 could 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.
8
CHIRON CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
JUNE 30, 1999
(UNAUDITED)
NOTE 1--THE COMPANY AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
The following table sets forth the computation for basic and diluted
earnings per share for the three and six months ended June 30 (in thousands):
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
-------------------- --------------------
1999 1998 1999 1998
--------- --------- --------- ---------
Weighted-average common shares outstanding............................ 181,585 177,308 181,064 176,725
Effect of dilutive securities:
Options and equivalents............................................. 2,996 2,585 3,578 2,703
Warrants............................................................ 223 187 239 188
--------- --------- --------- ---------
Weighted-average common shares outstanding plus assumed conversions... 184,804 180,080 184,881 179,616
--------- --------- --------- ---------
--------- --------- --------- ---------
For the three months ended June 30, 1999 and 1998, options to purchase
6,685,000 and 13,500,000 shares, respectively, and for the six months ended June
30, 1999 and 1998, options to purchase 3,786,000 and 13,456,000 shares,
respectively, with exercise prices greater than the average market prices of
common stock, 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 and six months ended June 30, 1999
and 1998.
NOTE 2--DISCONTINUED OPERATIONS
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 provided
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 June 30, 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" (see Note 7).
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. The results of operations for Chiron Diagnostics are reported
as a discontinued
9
CHIRON CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
JUNE 30, 1999
(UNAUDITED)
NOTE 2--DISCONTINUED OPERATIONS (CONTINUED)
operation for the three and six months ended June 30, 1998 in the accompanying
Condensed Consolidated Statements of Operations. Chiron has provided customary
indemnities under the terms of the Bayer Agreement.
For the three and six months ended June 30, 1998, Chiron Diagnostics
recognized total revenues of $142.7 million and $278.3 million, respectively.
For the three and six months ended June 30, 1998, "Income (loss) from
discontinued operations" are reported net of income tax provisions of $4.0
million and $2.9 million, respectively. For the three months ended June 30, 1999
and for the six months ended June 30, 1999 and 1998, "Gain on disposal of
discontinued operations" are reported net of income tax (benefits) provisions of
($0.7) million; ($0.7) million and $31.2 million, respectively.
For the three months ended June 30, 1999, basic and diluted income per
common share from discontinued operations was $0.01 and $0.02, respectively. For
the three months ended June 30, 1998, basic and diluted income per common share
was $0.03. For the six months ended June 30, 1999, basic and diluted income per
common share from discontinued operations was $0.01 and $0.02, respectively. For
the six months ended June 30, 1998, basic and diluted income per common share
from discontinued operations was $0.29.
NOTE 3--RESTRUCTURING AND REORGANIZATION CHARGES
In the first half of 1999, the Company recorded restructuring and
reorganization charges of $3.4 million principally 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. As of June 30, 1999, 11 of these 28 positions had been
eliminated.
In fiscal year 1998, the Company recorded restructuring and reorganization
charges of $26.8 million, of which $4.9 million was recognized in the first half
of the year. In the second quarter of 1998, the Company recognized a benefit of
$3.6 million related to a revised estimate of property and other tax-related
accruals recorded in 1995 in connection with the idling of the Puerto Rico
facility, offset in part, by $1.0 million of other facility and lease
termination costs. The $26.8 million charge 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
June 30, 1999, 311 of these 400 positions had been eliminated.
10
CHIRON CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
JUNE 30, 1999
(UNAUDITED)
NOTE 3--RESTRUCTURING AND REORGANIZATION CHARGES (CONTINUED)
The current status of the accrued restructuring charges is summarized as
follows (in thousands):
RESTRUCTURING AMOUNT OF AMOUNT AMOUNT TO
ACCRUAL TOTAL UTILIZED BE UTILIZED
DECEMBER 31, RESTRUCTURING THROUGH JUNE IN FUTURE
1998 CHARGE 30, 1999 PERIODS
------------- ------------- ------------ -----------
Employee-related costs................................... $ 15,390 $ 2,826 $ 8,631 $ 9,585
Other facility-related costs............................. 3,931 526 1,942 2,515
------------- ------ ------------ -----------
19,321 3,352 10,573 12,100
Discontinued operations.................................. 4,475 -- 2,569 1,906
------------- ------ ------------ -----------
$ 23,796 $ 3,352 $ 13,142 $ 14,006
------------- ------ ------------ -----------
------------- ------ ------------ -----------
The liabilities related to restructuring and reorganization charges are
expected to be substantially settled within 12 months of accruing the related
charges.
NOTE 4--AGREEMENT WITH HOECHST AG
Effective July 1, 1996, Chiron purchased a 49% interest in the human vaccine
business of Behringwerke AG, a subsidiary of 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 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 six months ended June 30, 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)
-----------
Liabilities assumed............................................ $ 33,815
-----------
-----------
11
CHIRON CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
JUNE 30, 1999
(UNAUDITED)
NOTE 4--AGREEMENT WITH HOECHST AG (CONTINUED)
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 six months ended June
30, 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 (in
thousands, except per share data):
SIX MONTHS ENDED
JUNE 30, 1998
-----------------
Total revenues............................................................. $ 330,138
Income from continuing operations.......................................... $ 31,457
Pro forma income per share from continuing operations:.....................
Basic.................................................................... $ 0.18
Diluted.................................................................. $ 0.18
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 of an alliance with Gen-Probe Incorporated ("Gen-Probe") and
Chiron's one-half interest in the pretax operating earnings of its joint
business with Ortho-Clinical Diagnostics, Inc. ("Ortho"), a Johnson & Johnson
company. Chiron's alliance with Gen-Probe is focused on developing and selling
products using nucleic acid testing ("NAT") to screen blood and plasma for
infection by viruses. Chiron's joint business with Ortho sells a line of
immunodiagnostics, other than NAT 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").
12
CHIRON CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
JUNE 30, 1999
(UNAUDITED)
NOTE 5--SEGMENT INFORMATION (CONTINUED)
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 the write-off of purchased in-process technologies and 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 (in thousands):
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
---------------------- ----------------------
1999 1998 1999 1998
---------- ---------- ---------- ----------
REVENUES
Biopharmaceuticals, includes equity in earnings of unconsolidated
joint businesses of ($33) for the three and six months ended June
30, 1998......................................................... $ 87,914 $ 69,810 $ 155,655 $ 153,095
Vaccines, includes equity in earnings of unconsolidated joint
businesses of $401 and ($647) for the three months ended June 30,
1999 and 1998, respectively, and $644 and $789 for the six months
ended June 30, 1999 and 1998, respectively....................... 47,707 53,233 104,181 70,078
Blood testing, includes equity in earnings of unconsolidated joint
businesses of $16,647 and $18,044 for the three months ended June
30, 1999 and 1998, respectively, and $34,490 and $29,482 for the
six months ended June 30, 1999 and 1998, respectively............ 26,021 24,247 50,651 41,404
Other.............................................................. 27,468 15,600 54,183 31,600
---------- ---------- ---------- ----------
Total revenues....................................................... $ 189,110 $ 162,890 $ 364,670 $ 296,177
---------- ---------- ---------- ----------
---------- ---------- ---------- ----------
13
CHIRON CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
JUNE 30, 1999
(UNAUDITED)
NOTE 5--SEGMENT INFORMATION (CONTINUED)
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
---------------------- ----------------------
1999 1998 1999 1998
---------- ---------- ---------- ----------
INCOME FROM CONTINUING OPERATIONS
Biopharmaceuticals................................................. $ (75) $ (2,282) $ (4,767) $ 13,647
Vaccines........................................................... (9,972) (20,524) (16,280) (35,039)
Blood testing...................................................... 12,083 17,746 26,598 28,334
Other.............................................................. 26,846 14,257 41,717 19,195
---------- ---------- ---------- ----------
Segment income from operations................................... 28,882 9,197 47,268 26,137
Reconciling items:
Write-off of purchased in-process technologies................... -- 1,645 -- 1,645
Restructuring and reorganization charges......................... -- (2,610) 3,352 4,938
---------- ---------- ---------- ----------
Income from operations............................................. 28,882 10,162 43,916 19,554
Gain on sale of assets........................................... -- 6,241 -- 6,241
Interest expense................................................. (5,863) (6,049) (11,708) (12,629)
Other income, net................................................ 20,816 7,566 43,376 16,161
---------- ---------- ---------- ----------
Income from continuing operations, before income taxes............. $ 43,835 $ 17,920 $ 75,584 $ 29,327
---------- ---------- ---------- ----------
---------- ---------- ---------- ----------
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.
NOTE 7--SUBSEQUENT EVENT
In July 1999, the Company sold a portion of its Claremont facility, which
was retained upon the completion of the sale of Chiron Vision. The Company
anticipates that it will recognize a net gain upon the sale of these assets in
the third quarter of 1999. As of June 30, 1999 and December 31, 1998, these
assets were recorded as "Other current assets" in the accompanying Condensed
Consolidated Balance Sheets.
14
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 consists of an alliance with
Gen-Probe Incorporated ("Gen-Probe") and Chiron's one-half interest in the
pretax operating earnings of its joint business with Ortho-Clinical Diagnostics,
Inc. ("Ortho"), a Johnson & Johnson company. Chiron's alliance with Gen-Probe is
focused on developing and selling products using nucleic acid testing ("NAT") to
screen blood and plasma for infection by viruses. Chiron's joint business with
Ortho sells a line of immunodiagnostic tests other than NAT 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 as discontinued operations for the three and six months ended June
30, 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 For the three months ended June 30, 1999
and 1998, product sales from the biopharmaceuticals segment were $55.0 million
and $47.0 million, respectively. For the six months ended June 30, 1999 and
1998, biopharmaceutical product sales were $98.1 million and $97.3 million,
respectively. In 1999 and 1998, biopharmaceutical product sales consisted
principally of Proleukin-Registered Trademark-
15
(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. For the three months ended June 30, 1999 and 1998, sales of
Proleukin-Registered Trademark- were $37.2 million and $23.0 million,
respectively. For the six months ended June 30, 1999 and 1998, sales of
Proleukin-Registered Trademark- were $63.1 million and $43.9 million,
respectively. Management believes that the second quarter 1999 increase in
Proleukin-Registered Trademark- product sales as compared with 1998 is primarily
due to a shift in sales from the third quarter to the second quarter in
anticipation of a July 1999 price increase. As a result of this shift,
management anticipates that sales of Proleukin-Registered Trademark- in the
third quarter of 1999 will be substantially below the $37.2 million recognized
in the second quarter of 1999. Also impacting the increase in
Proleukin-Registered Trademark- product sales are continued volume growth in
existing indications and price increases which occurred during the year. The
Company continues to pursue the use of Proleukin-Registered Trademark- for
additional indications, including human immunodeficiency virus ("HIV"). 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 June 30, 1999 and 1998, revenues from
Betaseron-Registered Trademark- were $14.0 million and $17.2 million,
respectively. For the six months ended June 30, 1999 and 1998, revenues from
Betaseron-Registered Trademark- were $28.6 million and $31.3 million,
respectively. Management believes that the decrease in
Betaseron-Registered Trademark- revenues in 1999 as compared with 1998 is
primarily related to shipments that were postponed due to an anticipated label
change by Berlex. Also contributing to the decrease in
Betaseron-Registered Trademark- revenues was the October 1998 contractual
decrease in the transfer price received by Chiron for the manufacture of
Betaseron-Registered Trademark-.
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 to J&J were $4.6
million for the three months ended June 30, 1998 and $0.5 million and $17.9
million for the six months ended June 30, 1999 and 1998, respectively. There
were no sales of PDGF recognized during the second quarter of 1999. As
Regranex-Registered Trademark- 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 until the second quarter of 2000.
VACCINE PRODUCT SALES Chiron sells pediatric and adult vaccines in Germany,
Italy, certain 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 quarter of the year. For the three
months ended June 30, 1999 and 1998, vaccine product sales were $38.7 million
and $43.9 million, respectively. The decrease in product sales for the three
months ended June 30, 1999 as compared with the same period in 1998 is primarily
due to a recall and inventory write-off of a portion of the Company's tick-borne
encephalitis vaccine inventory that failed to meet manufacturing specifications
for purity during the first quarter of 1999. The Company subsequently retested
all remaining tick-borne encephalitis vaccine inventory and found it to meet
specifications. The Company has since received approval from the relevant
regulatory authority and is selling the product.
16
Also contributing to the decrease in product sales is the seasonality of
certain of the Company's vaccine products. Historically, the results of the
Company's Italian subsidiary were reported on a one-month lag; however, during
the first quarter of 1999, the Company eliminated the lag such that these
results are now reported on a current basis. As a result of this change, the
Company expects certain fluctuations in product sales and in particular,
anticipates that a significant amount of flu vaccine sales which were
historically recorded during the fourth quarter to now be recorded during the
third quarter of each year.
For the six months ended June 30, 1999 and 1998, vaccine product sales were
$83.2 million and $58.4 million, respectively. The increase in sales for the six
months ended June 30, 1999 as compared with the same period in 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. Also impacting vaccine
product sales for the six months ended June 30, 1999 was a $4.2 million sale of
adult influenza vaccine to Argentina in the first quarter of 1999.
BLOOD TESTING PRODUCT SALES During the second quarter of 1999, the Company
began recognizing revenues for sales of its nucleic acid tests that are used to
screen blood and plasma under an investigational new drug (IND) application in
the U.S. Product sales related to these tests were $1.9 million for the three
months ended June 30, 1999.
EQUITY IN EARNINGS OF UNCONSOLIDATED JOINT BUSINESSES For the three months
ended June 30, 1999 and 1998, Chiron recognized equity in earnings of
unconsolidated joint businesses of $17.0 million and $17.4 million,
respectively. For the six months ended June 30, 1999 and 1998, Chiron recognized
equity in earnings of unconsolidated joint businesses of $35.1 million and $30.2
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 one quarter of earnings from Chiron's 49% share of the
after-tax operating results of Chiron Behring.
CHIRON-ORTHO JOINT BUSINESS For the three months ended June 30, 1999 and
1998, Chiron's earnings from its joint business with Ortho were $16.7 million
and $18.1 million, respectively. For the six months ended June 30, 1999 and
1998, these earnings were $34.5 million and $29.5 million, respectively. The
overall fluctuations in earnings from the joint business are primarily due to
certain adjustments made during the first quarters of 1999 and 1998, offset in
part, by lower affiliate profits in 1999. In the first quarter of 1999, an
annual inventory adjustment resulted in a charge of $0.7 million as compared
with a charge of $4.1 million recognized in the first quarter of 1998. Also
contributing to the increase in earnings in 1999 as compared with 1998, were
higher foreign affiliate profits and a first-quarter 1998 one-time contract
termination fee.
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 from
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 the achievement of specified milestones. For the three months
ended June 30, 1999 and 1998, Chiron recognized collaborative agreement revenues
of $18.7 million and $24.4 million, respectively. For the six months ended June
30, 1999 and 1998, collaborative agreement revenues were $41.2 million and $48.8
million, respectively. The decrease in collaborative agreement revenues in 1999
as compared with 1998 is partially due to a contractual decrease in payments
received by the Company under a November 1996 consent agreement
17
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).
The remaining decrease is primarily due to an agreement with Novartis, 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, for the three months ended June 30, 1999 and 1998, Chiron recognized
collaborative agreement revenues of $13.0 million and $15.6 million,
respectively. For the six months ended June 30, 1999 and 1998, revenues
recognized under this agreement were $29.0 million and $31.6 million,
respectively.
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 that may 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 revenue 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 June 30, 1999 and 1998, Chiron
recognized royalty and license fee revenues of $27.3 million and $15.5 million,
respectively. For the six months ended June 30, 1999 and 1998, royalty and
license fee revenues were $59.8 million and $31.6 million, respectively. The
increase in royalty and license fee revenues in 1999 as compared with 1998 is
primarily due to a cross-license agreement with Bayer whereby Chiron agreed to
grant to Bayer rights under certain Chiron patents, including rights under
patents relating to HIV and hepatitis C virus. In exchange for these rights,
Bayer paid to Chiron a license fee of $100.0 million, which is refundable in
decreasing amounts over a period of three years. During the three and six months
ended June 30, 1999, Chiron recognized license fee revenues of $10.0 million and
$20.0 million, respectively, which represent the portions of the $100.0 million
payment that became nonrefundable during the periods. For the three months ended
June 30, 1999, other items contributing to royalty and license fee revenues were
$7.2 million of royalties generated from Schering AG's European sales of
Betaferon-Registered Trademark- and $4.0 million of royalties related to other
vaccine products. For the six months ended June 30, 1999, other items
contributing to royalty and license fee revenues were $14.1 million of royalties
generated from Schering AG's European sales of Betaferon-Registered Trademark-,
$8.0 million of royalties related to insulin products, and $9.5 million related
to vaccine products. In the first quarter of 1998, Chiron recognized $5.0
million related to a license fee received from Pharmacia & Upjohn Company to
research, develop, manufacture, and commercialize therapeutic products for the
treatment of hepatitis C virus 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 revenue will not decline.
OTHER REVENUES For the three months ended June 30, 1999 and 1998, Chiron
recognized other revenues of $24.7 million and $9.5 million, respectively. For
the six months ended June 30, 1999 and 1998, these revenues were $34.3 million
and $20.3 million, respectively. The increase in other revenues in 1999 as
compared with 1998 is primarily due to $9.7 million of revenues earned upon the
FDA's approval of DepoCyt-Registered Trademark- in April 1999. Also contributing
to the increase in other revenues were contract manufacturing revenues which
increased to $5.8 million in the second quarter of 1999 from $0.9 million in the
comparable
18
period in 1998 as a result of a new contract manufacturing agreement and a
cancellation fee recognized upon the termination of an existing agreement. Also
included in other revenues during the second quarters of 1999 and 1998 were $6.2
million and $6.3 million, respectively, of commission revenues received on sales
of hepatitis B products and immunoglobulin products.
For the six months ended June 30, 1999, other revenues primarily consisted
of $9.7 million related to the approval of DepoCyt-Registered Trademark-, $8.4
million related to contract manufacturing and $11.2 million related to
commission revenues. For the six months ended June 30, 1998, other revenues
primarily consisted of $9.8 million of revenues related to
Aredia-Registered Trademark- (pamidronate disodium for injection) recognized
under an arrangement which terminated in April 1998 pursuant to which Chiron
promoted Aredia-Registered Trademark- on behalf of Novartis and $6.3 million of
commission revenues.
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 For the three months ended June 30, 1999 and 1998, gross
profit as a percentage of net product sales was 60% and 53%, respectively. For
each of the six months ended June 30, 1999 and 1998, gross profit as a
percentage of net product sales was 56%. In the second quarter of 1998, Chiron
recognized a $6.0 million reduction in cost of goods sold related to a change in
estimated property tax accruals created in prior periods. Excluding this
reduction, gross profit as a percentage of net product sales would have been 47%
and 52% for the three and six months ended June 30, 1998, respectively. The
increase in gross profit is primarily related to (i) a favorable mix of product
sales, which includes a higher proportion of biopharmaceutical products in
relation to total product sales in the second quarter of 1999; (ii) certain
charges incurred during the second quarter of 1998 related to vaccine inventory
reserves and one-time repackaging expenses; (iii) a favorable mix of
Betaseron-Registered Trademark- revenues, which includes a higher proportion of
secondary revenues recognized upon Berlex and Schering AG's sales to end users;
and (iv) manufacturing efficiencies resulting from increased production. In
addition, for the six months ended June 30, 1999, improvements in gross profit
margins resulted from a reduction in idle facility costs and price increases on
sales of Proleukin-Registered Trademark-.
Also impacting the Company's gross profit margin during the six months ended
June 30, 1999 was the write-off of a portion of the Company's tick-borne
encephalitis vaccine inventory that failed to satisfy manufacturing
specifications for purity. The total charge that related to this inventory was
$3.1 million recognized during the first half of 1999.
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 June 30, 1999 and 1998,
Chiron recognized research and development expenses of $73.8 million and $66.1
million, respectively. For the six months ended June 30, 1999 and 1998, Chiron's
research and development expenses were $141.3 million and $128.9 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. The increase in research and development
spending in 1999 as compared with 1998 was due, in part, to a $3.0 million
milestone payment made during the second quarter of 1999 related to the
Company's collaboration agreement with Medivir AB and the acquisition and
consolidation of Chiron Behring, which contributed $2.8 million to research and
development expenses during the first three months of 1999. Also contributing to
the increase in research and development expense was the furtherance of the
Company's clinical trials related to Proleukin-Registered Trademark- for HIV,
IGF-1 for osteoarthritis, and Fibroblast Growth Factor (FGF) for coronary artery
disease.
19
SELLING, GENERAL, AND ADMINISTRATIVE For the three months ended June 30,
1999 and 1998, Chiron recognized selling, general, and administrative ("SG&A")
expenses of $45.2 million and $38.7 million, respectively. For the six months
ended June 30, 1999 and 1998, Chiron recognized SG&A expenses of $86.8 million
and $62.8 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
three months 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, certain patent defense legal costs, and the worldwide
implementation of its integrated information system in April 1999.
OTHER OPERATING EXPENSES In the first half 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. As of June 30, 1999, 11 of these positions had been
eliminated. In the first half of 1998, the Company recorded restructuring and
reorganization charges of $4.9 million which included a second quarter benefit
of $3.6 million related to a revised estimate of property and other tax-related
accruals recorded in 1995 in connection with the idling of the Puerto Rico
facility, offset in part, by $1.0 million of other facility and lease
termination costs. In fiscal year 1998, the Company recorded restructuring and
reorganization charges of $26.8 million primarily related to 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 June 30, 1999,
311 of these positions had been eliminated.
During the second quarter of 1999, Chiron recognized a reduction in other
operating expenses of $6.4 million resulting from a change in estimated tax
accruals related to certain employee payments recorded in 1995 under a series of
agreements between Chiron and Novartis (for more information, refer to the
Company's Annual Report on Form 10-K for the year ended January 3, 1999).
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 June 30, 1999 and 1998, Chiron recognized
interest and investment income of $20.4 million and $7.9 million, respectively.
For the six months ended June 30, 1999 and 1998, interest and investment income
totaled $40.7 million and $14.3 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 $5.9 million and $6.0 million for the three months
ended June 30, 1999 and 1998, respectively, and $11.7 million and $12.6 million
for the six months ended June 30, 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 establishes accounting and reporting
standards for derivative instruments, including certain derivative instruments
embedded in other contracts, and for hedging activities. In June 1999, SFAS 133
was amended by SFAS No. 137, "Accounting for Derivative Instruments and Hedging
Activities--Deferral of the Effective Date of SFAS 133." As a result of this
amendment, SFAS 133 shall be effective for all fiscal quarters of all fiscal
years beginning after June 15, 2000.
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
20
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 2001.
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 $1.5 billion at June 30, 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 $47.5
million and $158.1 million at June 30, 1999 and 1998, respectively. For the
first half of 1999, net cash used in operating activities was $125.2 million as
compared with net cash provided by operating activities of $46.7 million in
1998. In the first half 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 $60.5 million
for the six months ended June 30, 1999.
In the first half 1999, net cash used in investing activities consisted of
purchases of investments in marketable debt securities of $1.0 billion, capital
expenditures of $42.4 million, and other uses of cash of $15.5 million.
Partially offsetting these uses of cash were proceeds from the sale and maturity
of investments in marketable debt securities of $684.7 million and proceeds from
disposal of discontinued operations of $35.4 million.
In the first half of 1999, net cash provided by financing activities
primarily consisted of $31.5 million from the issuance of common stock related
to stock option exercises and $8.1 million related to short-term borrowings.
This was partially offset by $1.2 million related to the repayment of certain
notes payable and short-term leases, and $6.7 million related to the acquisition
of treasury stock.
In February 1999, the Company's Board of Directors authorized the repurchase
of up to 2.5 million shares of Chiron common stock from time to time on the open
market 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 March 2000. As of
June 30, 1999, 329,500 shares had been repurchased.
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 June 30, 1999. Chiron also
has credit facilities outside the U.S. which allow for total borrowings of $62.6
million. Under these credit facilities, $24.1 million of borrowings were
outstanding at June 30, 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 21(st) and 20(th) century dates
(for
21
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 has substantially completed the implementation phase. 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
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 and has remediated all mission critical
applications in all material respects. Non-critical applications are currently
being remediated and are targeted for substantial completion during the third
quarter of 1999. The Company implemented its integrated information system
during the second quarter of 1999.
With regard to the Company's key facilities and other non-information
technology-related functions, including research, manufacturing, and inventory
management practices, the Company has substantially completed its remediation
plans for its critical systems. However, certain upgrades related to its
facility control systems have been rescheduled from the second quarter to the
third quarter of 1999. The Company believes that it will also substantially
complete the remediation of other non-critical systems during the third quarter
of 1999.
The Company has a facility in Amsterdam, The Netherlands, which is currently
being marketed for sale. Due to the Company's manufacturing requirements, the
Company plans to operate this facility until the end of 1999, at which time, the
Company intends to complete certain upgrades within its embedded systems. The
Company believes that it will be able to sell the facility in its current state
and does not consider this facility to be a significant Year 2000 risk.
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 surveyed and assessed 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 attempting to mitigate its risks with respect to the
failure of these entities to be Year 2000 compliant and has prepared contingency
plans accordingly. The Company cannot reasonably estimate the effect, if any,
from the failure of such parties to be Year 2000 compliant. However, the Company
believes that its contingency plans will substantially mitigate all material
risks resulting from such parties' failure to resolve their Year 2000 issues.
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.
In addition to the Company's remediation efforts, the Company is also
implementing contingency plans and preparing for the year-end rollover and leap
year. The Company's contingency plans include, among other things, the
implementation of specific plans to ensure that the necessary precautions are
taken to prevent and/or address an unexpected system failure. The Company also
intends to increase certain raw material and finished goods inventories to
mitigate external and internal risks. The Company's plans also include placing
teams in all critical locations to monitor and protect critical systems during
the year-end rollover period. The Company intends to monitor its computer
hardware and communication
22
systems, software applications, and facilities and other non-information
technology-related functions for Year 2000 issues through March 2000.
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
may include replacing or upgrading systems or equipment at a substantial cost to
the Company. Costs associated with preparing for the year 2000 are not expected
to exceed $5.5 million, and include costs related to contingency plans, which
may not require execution. 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 June 30, 1999, total costs incurred to date
have been funded through operations and approximate $2.4 million. The Company
anticipates funding its remaining Year 2000 expenditures 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,
that the Euro may have on its 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.
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 may 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.
23
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 that
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 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.
24
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.
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 purchased 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
25
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.
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
26
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 half 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 and in Part II, Item 1.,
"Legal Proceedings," of the Company's Form 10-Q for the period ended March 31,
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 and the first quarter report on Form 10-Q.
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 that Roche's manufacture and sale of Amplicor HCV Test and Amplicor HCV
Monitor Test constitutes infringement of Chiron's U.S. Patent Nos. 5,712,088
(the "'088 patent"), 5,714,596 (the "'596 patent"), and 5,863,719 (the "'719
patent"). The action seeks damages, injunctive relief, and a declaratory
judgment that Chiron is the sole and exclusive owner of its HCV technology.
Roche asserted various license-based defenses to Chiron's infringement claims
based upon a provision of a 1991 Asset Purchase Agreement between Roche and
Cetus Corporation. Chiron, Roche asserted, is bound by those provisions as
Cetus' successor-in-interest. The parties' cross-motions for summary judgment on
Roche's license based defenses were resolved in Chiron's favor by a Court order
dated June 23, 1999. The order, which is subject to appeal and possible
reconsideration, holds that Roche has neither express nor implied license rights
to Chiron's HCV technology. Roche also 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.
27
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
(a) The Annual Meeting of Stockholders for Chiron Corporation was held on May
13, 1999.
(b) Omitted pursuant to Instruction 3 to Item 4 of Form 10-Q.
(c) The two matters voted upon at the meeting were: (i) to elect four directors
to hold office for three years until the Annual Meeting of Stockholders in
the year 2002, and one director to hold office for one year until the Annual
Meeting of Stockholders in the year 2000; and (ii) to ratify the selection
of KPMG LLP as the independent auditors of the Company for the year ending
December 31, 1999.
(i) The following votes were cast for or were withheld with respect to each
of the nominees for director:
DIRECTORS FOR WITHHELD
- ------------------------------------------------------------------ ------------- ----------
Mr. Lewis W. Coleman.............................................. 164,968,254 597,446
Dr. Paul L. Herrling.............................................. 162,509,987 3,055,713
Dr. William J. Rutter............................................. 164,964,922 600,778
Mr. Jack W. Schuler............................................... 164,758,683 807,017
Dr. Raymund Breu.................................................. 164,989,432 576,268
All nominees were declared to have been elected as directors to hold office
until the Annual Meeting of Stockholders in the years 2002 and 2000 as noted
above. No abstentions or broker non-votes were cast for the election of
directors.
The following directors shall continue in office after the Company's Annual
Meeting of Stockholders held on May 13, 1999: Donald A. Glaser, Sean P. Lance
and Pieter J. Strijkert shall continue in office until the Annual Meeting of
Stockholders in the year 2000, and Vaughn D. Bryson, Pierre E. Douaze and Edward
E. Penhoet shall continue in office until the Annual Meeting of Stockholders in
the year 2001. Effective May 14, 1999, the Company's Bylaws were amended to
increase the number of directors from 11 to 12 until the first Annual Meeting of
Stockholders at which directors are elected in or after the year 2000. Effective
May 24, 1999, Dr. Lewis T. "Rusty" Williams, Senior Vice President and Chief
Scientific Officer of the Company, was elected a member of the Board of
Directors, to serve a two-year term until the Annual Meeting of Stockholders in
the year 2001 and until his successor is elected and qualified, or until his
earlier death, resignation or removal.
(ii) With respect to the proposal to ratify the selection of KPMG LLP as the
Company's independent auditors, 165,134,851 votes were cast for the proposal,
287,429 votes were cast against the proposal, and 143,420 votes abstained. No
broker non-votes were cast in connection with the proposal. The selection of
KPMG LLP as the Company's independent auditors for the year ending December 31,
1999 was declared to have been ratified.
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
report on Form 10-K for fiscal year 1996.
28
EXHIBIT
NUMBER EXHIBIT
- ----------- --------------------------------------------------------------------------------------------------------
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 report on Form 10-K 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 report on Form 10-Q for the period ended June 30, 1996.
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
(initially filed as Exhibit 4.01 to the Registrant's report on Form 10-Q 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 report on Form
10-K 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 report on Form 10-Q 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 (initially filed as Exhibit 4.03 of the Registrant's report on Form 10-K for fiscal year 1993),
incorporated by reference to Exhibit 4.04 of the Registrant's report on Form 10-K for fiscal year 1998.
10.102 Guaranty, dated as of September 29, 1994, made by Registrant, in favor of Bankers Trust Company, as
trustee (initially filed as Exhibit 10.52 of the Registrant's report on Form 10-Q for the period ended
September 30, 1994).
10.103 Guaranty, dated as of September 29, 1994, made by Cetus Corporation, in favor of The First National Bank
of Boston, as trustee (initially filed as Exhibit 10.53 of the Registrant's report on Form 10-Q for the
period ended September 30, 1994).
10.104 Stock Purchase and Warrant Agreement dated May 9, 1989, between Cetus Corporation and Hoffmann-La Roche
Inc. (initially filed as Exhibit 10.36 of the Registrant's report on Form 10-Q for the period ended
September 30, 1994).
10.507 Form of Option Agreement (with Purchase Agreements attached thereto) between Cetus Corporation and each
former limited partner of Cetus Healthcare Limited Partnership, a California limited partnership
(initially filed as Exhibit 10.31 of the Registrant's report on Form 10-Q for the period ended September
30, 1994).
10.508 Form of Option Agreement (with forms of Purchase Agreements attached thereto), dated December 30, 1986,
between Cetus Corporation and each former limited partner of Cetus Healthcare Limited Partnership II, a
California limited partnership (initially filed as Exhibit 10.32 of the Registrant's report on Form 10-Q
for the period ended September 30, 1994).
10.601 Indemnification Agreement between the Registrant and Dr. William J. Rutter, dated as of February 12,
1987 (which form of agreement is used for each member of Registrant's Board of Directors) (initially
filed as Exhibit 10.21 of the Registrant's report on Form 10-Q for the period ended September 30, 1994).
29
EXHIBIT
NUMBER EXHIBIT
- ----------- --------------------------------------------------------------------------------------------------------
10.602 Supplemental Benefits Agreement, dated July 21, 1989, between the Registrant and Dr. William J. Rutter
(initially filed as Exhibit 10.27 of the Registrant's report on Form 10-Q for the period ended September
30, 1994).*
10.604 Letter Agreements dated September 11, 1992, July 15, 1994 and September 14, 1994 between the Registrant
and Lewis T. Williams (initially filed as Exhibit 10.54 of the Registrant's report on Form 10-Q for the
period ended September 30, 1994).*
10.614 Letter Agreement dated May 28, 1999 between Registrant and Paul J. Hastings.*
10.701 Investment Agreement dated as of November 20, 1994 among Ciba-Geigy Limited, Ciba-Geigy Corporation,
Ciba Biotech Partnership, Inc. and Chiron Corporation (initially filed as Exhibit 10.54 of the
Registrant's current report on Form 8-K dated November 20, 1994).
10.702 Governance Agreement dated as of November 20, 1994 among Ciba-Geigy Limited, Ciba-Geigy Corporation and
Chiron Corporation (initially filed as Exhibit 10.55 of the Registrant's current report on Form 8-K
dated November 20, 1994).
10.703 Subscription Agreement dated as of November 20, 1994 among Ciba-Geigy Limited, Ciba-Geigy Corporation,
Ciba Biotech Partnership, Inc. and Chiron Corporation (initially filed as Exhibit 10.56 of the
Registrant's current report on Form 8-K dated November 20, 1994).
10.704 Cooperation and Collaboration Agreement dated as of November 20, 1994, between Ciba-Geigy Limited and
Chiron Corporation (initially filed as Exhibit 10.57 of the Registrant's current report on Form 8-K
dated November 20, 1994).
10.705 Registration Rights Agreement dated as of November 20, 1994 between Ciba Biotech Partnership, Inc. and
Chiron Corporation (initially filed as Exhibit 10.58 of the Registrant's current report on Form 8-K
dated November 20, 1994).
10.706 Market Price Option Agreement dated as of November 20, 1994 among Ciba-Geigy Limited, Ciba-Geigy
Corporation, Ciba Biotech Partnership, Inc. and Chiron Corporation (initially filed as Exhibit 10.59 of
the Registrant's current report on Form 8-K dated November 20, 1994).
27 Financial Data Schedule for the Six Months ended June 30, 1999.
27.1 Financial Data Schedule for the Three Months ended March 31, 1999.
27.2 Financial Data Schedule for Fiscal Year ended January 3, 1999.
27.3 Finanical Data Schedule for the Six Months ended June 28, 1998.
27.4 Financial Data Schedule for the Three Months ended March 29, 1998.
- ------------------------
* Management contract, compensatory plan or arrangement.
(b) Reports on Form 8-K.
None.
30
CHIRON CORPORATION
JUNE 30, 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: August 12, 1999 BY: /s/ SEAN P. LANCE
------------------------------------------
Sean P. Lance
Chairman; President and
Chief Executive Officer
DATE: August 12, 1999 BY: /s/ JAMES R. SULAT
------------------------------------------
James R. Sulat
Vice President; Chief Financial Officer
DATE: August 12, 1999 BY: /s/ DAVID V. SMITH
------------------------------------------
David V. Smith
Vice President; Controller and
Principal Accounting Officer
31