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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K
/X/ ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
OR
/ / TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED JANUARY 3, 1999
COMMISSION FILE NO. 0-12798
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CHIRON CORPORATION
(Exact name of Registrant as specified in its charter)
DELAWARE 94-2754624
(State of Incorporation) (IRS Employer Identification No.)
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4560 HORTON STREET
EMERYVILLE, CALIFORNIA 94608
(Address of principal executive offices) (Zip Code)
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Registrant's telephone number, including area code: (510) 655-8730
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act:
COMMON STOCK, $0.01 PAR VALUE
WARRANTS TO PURCHASE COMMON STOCK, $0.01 PAR VALUE
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 by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of Registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. / /
The aggregate market value of voting stock held by nonaffiliates of the
Registrant as of February 28, 1999, was $2.1 billion.
The number of shares outstanding of each of the Registrant's classes of
common stock as of February 28, 1999:
TITLE OF CLASS NUMBER OF SHARES
Common Stock, $0.01 par value 180,897,487
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Proxy Statement to be filed in connection with the
solicitation of proxies for the Annual Meeting of Stockholders to be held on May
13, 1999 are incorporated by reference into Part III of this Report.
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ITEM 1. BUSINESS
THIS ANNUAL REPORT ON FORM 10-K 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 FROM THOSE EXPRESSED IN THE
FORWARD-LOOKING STATEMENTS ARE DISCUSSED IN ITEM 7 OF THIS REPORT, "MANAGEMENT'S
DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS", 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 HEREOF.
OVERVIEW AND CERTAIN RECENT DEVELOPMENTS
Chiron is a biotechnology company that participates in three global
healthcare businesses: biopharmaceuticals, blood testing and vaccines.
The Company's products include Proleukin(R) (aldesleukin), a recombinant
form of interleukin-2, which the Company markets as a treatment for metastatic
renal cell carcinoma and metastatic melanoma. The Company manufactures
recombinant human platelet-derived growth factor, the active ingredient in
Regranex(R) (becaplermin), which is marketed by Ortho-McNeil Pharmaceutical,
Inc. ("Ortho-McNeil"), a Johnson & Johnson ("J&J") company, as a treatment for
foot ulcers related to diabetes. Chiron also manufactures Betaseron(R)
(interferon beta-1b) for Berlex Laboratories, Inc. and its parent company,
Schering AG, which is marketed by Berlex and Schering as a treatment for relapse
remitting multiple sclerosis. In addition, the Company sells a line of
traditional pediatric and adult vaccines. The Company has an interest in a
number of other products through collaborations and joint businesses, including
a joint immunodiagnostics business with Ortho-Clinical Diagnostics, Inc., a J&J
company, which sells a full line of tests required to screen blood for hepatitis
viruses and retroviruses, and a separate collaboration with Gen-Probe
Incorporated, which is developing products using nucleic acid testing technology
to screen blood in blood banks and plasma in the plasma industry for infection
by viruses.
Chiron has a strong commitment to research as an essential component of its
product development effort. The Company focuses its research and development
activities primarily on areas in which it has particular strengths, including
infectious diseases, cancer and cardiovascular diseases. An important part of
the Company's research and development effort is undertaken through
collaborations with third parties who are able to contribute significant
enabling technologies and other resources to the development and
commercialization of the product, including in some cases marketing and sales
expertise.
In January 1995 the Company established an alliance with Novartis AG
("Novartis"), a life sciences company headquartered in Basel, Switzerland. As of
February 28, 1999, Novartis held shares representing approximately 44% of the
outstanding common stock of the Company. For more on the Novartis alliance, see
"Relationship With Novartis", below.
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The Company recently sold certain businesses as it continued to focus on its
core activities. On November 30, 1998, the Company completed the sale of its IN
VITRO diagnostics business to Bayer Corporation ("Bayer") for approximately
$1,013.8 million in cash, subject to certain adjustments. Chiron retained its
blood testing business, including its joint business with Ortho-Clinical
Diagnostics, Inc. and its collaboration with Gen-Probe Incorporated. On December
31, 1998, the Company completed the sale of its interest in General Injectables
& Vaccines, Inc. ("GIV"), a distribution business, to Henry Schein, Inc. and
received payment in full of certain advances made by the Company to GIV, for a
total of $31.7 million in cash. On December 29, 1997, the Company completed the
sale of its ophthalmics business to Bausch & Lomb Incorporated ("Bausch & Lomb")
for approximately $300.0 million in cash.
The Company was incorporated in California in 1981 and was merged into a
Delaware corporation in November 1986. The Company's principal executive offices
are located at 4560 Horton Street, Emeryville, California 94608, and its
telephone number at that address is (510) 655-8730.
PRODUCTS
BIOPHARMACEUTICALS
The Company's leading therapeutic product is Proleukin(R) (aldesleukin), a
recombinant form of interleukin-2 ("IL-2"). IL-2 is a protein produced naturally
in the body in very small quantities. IL-2 stimulates the immune system to
increase the production of lymphocytes (white blood cells) that help fight
certain cancers and may help fight viral infections. While the precise mechanism
of anti-tumor action of Proleukin(R) is unknown, research has demonstrated that
it induces the proliferation of immune cells, natural killer and cytotoxic T
cells that can recognize and mobilize against tumor-specific antigens on the
surface of malignant cells. Proleukin(R) is marketed by the Company directly or
through distributors in the United States and over 40 other countries in North
America, Europe, and South America, for the treatment of metastatic renal cell
carcinoma (a type of kidney cancer) and, in the United States and Canada, for
the treatment of metastatic melanoma (a form of skin cancer).
Chiron manufactures recombinant human platelet-derived growth factor
(rhPDGF-BB), the active ingredient in Regranex(R) (becaplermin) Gel, developed
with Ortho-McNeil through a collaboration in growth factor research that began
in 1984. Ortho-McNeil markets Regranex(R) in the United States as a treatment
for foot ulcers related to diabetes. Regranex(R) works by enhancing the body's
natural wound healing processes. It stimulates the migration of cells to the
site of the ulcer, encouraging the patient's body to grow new tissue that helps
heal these open wounds. Regranex(R) is the first product demonstrated to assist
in the healing of diabetic foot ulcers. Regranex(R) also has been approved for
marketing in Canada, and has been recommended by the European Union regulatory
authority, the Committee for Proprietary Medicinal Products (the "CPMP"), for
approval for marketing in Europe.
Chiron manufactures Betaseron(R) (interferon beta-1b) for Berlex
Laboratories, Inc. ("Berlex") and its parent company, Schering AG of Germany.
Berlex markets Betaseron(R) primarily in the United States and Canada to treat
patients with relapsing remitting multiple sclerosis. Multiple sclerosis is an
autoimmune disease in which the patient's immune system attacks and destroys an
element of the patient's own central nervous system. The Company also receives
royalties from the sale of a similar product in Europe, Betaferon(R), which is
manufactured by Boehringer Ingelheim and marketed by Schering AG for the
treatment of patients with relapsing remitting or secondary progressive multiple
sclerosis.
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Sales of Proleukin(R) (IL-2) accounted for approximately 13%, 12% and 11% of
consolidated total revenues in 1998, 1997 and 1996, respectively, and sales of
Betaseron(R) (interferon beta-1b) accounted for approximately 13% of total
revenues in 1996. No other single therapeutic product or class of therapeutic
products accounted for 10% or more of consolidated total revenues of the Company
in any of the last three fiscal years.
VACCINES
Through its subsidiary Chiron S.p.A., based in Siena, Italy, the Company
manufactures and markets in Italy vaccines for diphtheria, tetanus, pertussis,
meningococcus, haemophilus influenzae, flu, measles, mumps, rubella, hepatitis A
and an oral polio vaccine and, under license, markets a vaccine for typhoid
fever. Through its subsidiary Chiron Behring GmbH & Co ("Chiron Behring"), based
in Marburg, Germany, the Company manufactures and markets in Germany vaccines
for diphtheria, tetanus, pertussis, flu, rabies, tick-borne encephalitis,
tuberculosis, cholera and an oral polio vaccine and, under distribution
agreements with other manufacturers, markets vaccines for hepatitis A, measles,
mumps, rubella, typhoid fever, pneumococcal disease, haemophilus influenzae type
b, an inactivated polio vaccine, an acellular pertussis vaccine and a
recombinant vaccine for hepatitis B. Certain of these vaccines are marketed in
other European countries and in the Middle East, the Far East, Africa and South
America, and to international health agencies such as the World Health
Organization. The Company markets its rabies vaccine in the United States.
The Company also has developed an adjuvanted flu vaccine, which it markets
in Italy. The Company currently is considering its regulatory approval strategy
for this vaccine in other European countries and elsewhere.
The Company has developed a genetically engineered acellular vaccine for
pertussis (whooping cough), which currently is marketed in Italy both as a
monovalent vaccine and in combination with diphtheria and tetanus ("DTaP"). In
February 1999, the Company announced that it had received approval from the
European Medicines Evaluation Agency to market its DTaP vaccine for infants and
toddlers in Europe, and also announced that it had withdrawn its application to
market the DTaP vaccine in the United States. Several business factors
influenced the Company's decision to withdraw the application, including the
U.S. competitive landscape and the Company's continued effort to review and
refocus its product development portfolio.
In addition to revenues from the sale of the vaccine products described
above, the Company receives royalties from the sale of vaccines against
hepatitis B developed, manufactured and marketed by Merck & Co., Inc. ("Merck")
and SmithKline Beecham Biologics ("SmithKline") using technology developed by
Chiron. Merck's hepatitis B vaccine was the first vaccine produced using genetic
engineering licensed by the Food and Drug Administration ("FDA") for human use.
BLOOD TESTING
Chiron's blood testing business comprises two separate collaborations: an
alliance with Gen-Probe Incorporated ("Gen-Probe") and a separate joint business
with Ortho-Clinical Diagnostics, Inc. ("Ortho"), an affiliate of Johnson &
Johnson.
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Chiron's joint business with Ortho was formed in 1989, based largely on the
screening of blood in blood banks and other similar settings for the potential
presence of human immunodeficiency virus ("HIV") and hepatitis viruses using
immunodiagnostics technology. The joint business sells a full line of tests
required to screen blood for hepatitis viruses and retroviruses, and provides
supplemental tests and microplate-based instrument systems to automate test
performance and data collection. Chiron performs certain research and antigen
manufacturing functions, while Ortho manufactures and sells assays and
instrument systems. Chiron and Ortho share equally in the pretax operating
earnings generated by the joint business. The joint business holds the
immunodiagnostic rights to Chiron's hepatitis and retrovirus technology and
receives royalties from the sale of hepatitis C virus ("HCV") and HIV tests by
Abbott Laboratories ("Abbott"), and from sales of HCV tests by Pasteur Sanofi
Diagnostics and Genelabs Diagnostic, Inc.
Chiron's collaboration with Gen-Probe is focused on developing and
commercializing products using nucleic acid testing technology to screen blood
in blood banks and plasma in the plasma industry for infection by viruses.
Compared to immunodiagnostic testing, testing directly for the presence of viral
nucleic acid both improves the sensitivity of detection and enables infection to
be detected earlier in the viral lifecycle. Under the terms of the collaboration
agreement, Gen-Probe performs certain product development and assay and
instrument manufacturing functions while Chiron and Gen-Probe jointly
participate in new assay research and development and Chiron will sell the
collaboration's products. Gen-Probe will receive a fixed percentage of Chiron's
sales revenues. The commercial market for nucleic acid testing products in the
blood banking and plasma industries is developing very rapidly as regulatory
agencies begin in 1999 to require that blood banks and plasma centers implement
nucleic acid testing. The Chiron/Gen-Probe collaboration's first product, a
combined test for HIV-1 and HCV using a multiplexed assay and a semi-automated
instrument system is being used to screen blood under an Investigative New Drug
("IND") pretrial in the United States. See "Research and Development--Blood
Testing".
No single blood testing product or class of blood testing products accounted
for 10% or more of consolidated total revenues of the Company in any of the last
three fiscal years.
RESEARCH AND DEVELOPMENT
Chiron has a strong commitment to research as an essential component of its
product development effort. Technologies developed in collaborations with third
parties, as well as technologies licensed from outside parties, also are sources
of potential products.
BIOPHARMACEUTICALS
FUNCTIONAL GENOMICS. Genomics and other technologies are used to discover
new genes and to determine their role and the role of the encoded proteins in a
target disease. With this information, the Company then identifies and develops
potential products utilizing a variety of approaches, including recombinant
proteins, gene therapy and small molecule drug discovery for treatment of the
disease and vaccines with recombinant antigens for prevention of the disease.
RECOMBINANT PROTEINS. Proteins produced naturally by the human body play a
variety of roles in controlling disease. When administered as therapeutic
agents, certain proteins can enhance the patient's natural ability to fight
disease. However, traditional methods of isolating
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or producing proteins can be cost-prohibitive, particularly in the quantities
needed for pharmaceutical use. Through genetic engineering, certain proteins
which might not otherwise be available can be produced in relatively large
quantities at reasonable cost.
The Company and its collaborators have a number of recombinant proteins in
clinical development. Proleukin(R) (IL-2), already approved for marketing as a
treatment for certain forms of kidney and skin cancer, is being clinically
evaluated for other indications, including treatment of patients with HIV
infection, treatment of acute myelogenous leukemia and as a treatment for
non-Hodgkins lymphoma in patients with AIDS. Fibroblast Growth Factor ("FGF"), a
growth factor which can stimulate the formation of new blood vessels, is in
clinical studies for use as a treatment for coronary artery disease. Tissue
Factor Pathway Inhibitor ("TFPI"), a coagulation inhibitor, is being developed
in collaboration with G.D. Searle & Co. ("Searle"), a subsidiary of the Monsanto
Company; the Company and Searle are conducting clinical studies on the use of
TFPI as a treatment for patients with sepsis. Myotrophin(R) (mecasermin), a
recombinant form of Insulin-Like Growth Factor-I (IGF-I), is being developed by
the Company in collaboration with Cephalon, Inc. ("Cephalon") as a treatment for
amyotrophic lateral sclerosis (also known as ALS or Lou Gehrig's disease) and is
being developed by Chiron for other indications. In 1997, an FDA advisory
committee found that there was not sufficient evidence of efficacy as a
treatment for ALS to warrant approval. In May 1998, Chiron and Cephalon received
a letter from the FDA indicating that Myotrophin(R) (IGF-I) is potentially
approvable, contingent upon additional evidence of efficacy and safety. It is
uncertain whether additional evidence satisfactory to the FDA can be delivered.
Chiron and Cephalon are continuing to work with the FDA on outstanding issues.
In September 1998, Chiron and Cephalon withdrew their application to market
Myotrophin(R) (IGF-I) in Europe.
GENE THERAPY. Traditional recombinant protein therapeutics are produced
outside the patient's body and administered to the patient, typically through
injection. Gene therapy enables the patient's own body to produce a desired
protein by inserting the gene for that protein into the patient's cells.
Currently there are no gene therapy products on the market; many studies suggest
that the technology is promising but considerable further study is required to
determine whether this technology can be safely and effectively utilized to
treat disease. An example of a potential application of gene therapy currently
in preclinical development at the Company is Factor VIII. Factor VIII is a
protein that causes blood to clot. Hemophiliacs, as a result of a hereditary
defect, are born with faulty copies of the gene that produces Factor VIII.
Through gene therapy, it may be possible to insert into a hemophiliac's cells
the normal Factor VIII gene, so that the patient's own cells can produce the
blood clotting protein.
A key component of any gene therapy treatment will be the mechanism for
"inserting" the gene into the patient's cells. The Company is developing several
gene transfer systems, including retroviral and other viral vectors as well as
the Company's proprietary ELVS-TM- DNA vector system. Each gene transfer system
has different properties, including cell specificity (the type of cells it can
enter) as well as durability of expression (how long it will continue to make
the therapeutic protein). Different gene transfer systems are likely to be
required to meet different therapeutic needs. Viral vectors are derived from
viruses. The vectors have the "coat" of the original virus, which allows them to
enter the targeted cell. Certain viral genes are removed and therapeutic genes
are added so that the vector can no longer cause the disease characteristic of
the original virus and instead expresses the desired therapeutic protein. DNA
vectors include only the therapeutic gene and the control elements required to
express that
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gene. Studies have shown that certain types of cells, including muscle cells,
will take up the DNA and express the gene contained on the DNA.
The Company also is investigating whether gene therapy may be used as part
of a two-step treatment which combines gene therapy with more traditional
therapeutics. For example, HSV-tk is a gene encoding thymidine kinase derived
from herpes simplex virus. It may be possible to use a gene transfer system to
insert the HSV-tk gene into targeted cells (such as cancer cells), and then kill
the cells that have taken up the HSV-tk gene by treating the patient with
Gancyclovir, an antiviral for herpes. The Company is conducting clinical studies
on the use of HSV-tk gene therapy for the treatment of melanoma (a form of skin
cancer) and, in collaboration with Baxter Healthcare Corporation, for the
treatment of graft-versus-host disease.
SMALL MOLECULE DRUG DISCOVERY. Chiron's small molecule drug discovery
program combines multiple disciplines, including combinatorial and computational
chemistry, robotic screening and selection, and molecular biology, to screen,
identify and refine compounds which may be used as drugs for treating medical
conditions or disorders. In addition to drug discovery against specific disease
targets of interest to the Company, from time to time the Company enters into
collaboration agreements with third parties under which the Company utilizes its
proprietary technologies to identify drug candidates directed at specific
disease targets of interest to the partner. Certain compounds which may be of
interest have been identified and are being further optimized and tested prior
to moving into clinical development.
OTHER. The Company has other products under development directly and in
collaboration with other companies, including a collaboration with DepoTech
Corporation ("DepoTech") to develop DepoCyt-TM- sustained-release
chemotherapeutic formulation. DepoCyt-TM- consists of cytarabine (a generic
chemotherapy product) encapsulated in a novel delivery system, called
Depofoam-TM-. In December 1997, an FDA advisory committee declined to recommend
approval of DepoCyt-TM- for neoplastic meningitis associated with solid tumors.
Chiron and DepoTech subsequently reached agreement with the FDA to amend the
application with additional clinical trial data from lymphomatous meningitis
patients and seek approval for this indication. In November 1998, an FDA
advisory committee recommended that DepoCyt-TM- be approved for treatment of
lymphomatous meningitis. Final FDA approval for this indication is expected in
1999 and will require a post-approval (phase IV) clinical study commitment.
VACCINES
PROPHYLACTIC VACCINES. Chiron is developing a new generation of vaccines
for the prevention of disease utilizing genetic engineering and other techniques
of modern biotechnology, including vaccines based on recombinant antigens as
well as DNA-based vaccines. The Company currently is conducting clinical studies
of a number of vaccine candidates, including vaccines for HCV, HIV and
meningococcus C, and is conducting preclinical studies on vaccines for a number
of other targets. The Company also is developing novel adjuvants. Adjuvants are
compounds that amplify the immune response generated by vaccine antigens. One of
Chiron's adjuvants, MF-59, is a component of Chiron's new flu vaccine, which
currently is marketed in Italy, and is also a component of a number of other
candidate vaccines currently in clinical development by Chiron. In addition,
Chiron is conducting preclinical investigations of alternative delivery systems
for vaccines that may be used in lieu of injection, such as nasally or orally
delivered vaccines.
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THERAPEUTIC VACCINES. The Company is investigating the potential use of
vaccines for therapeutic purposes, in which antigens are used to stimulate an
immune response against established infections and cancer. The Company is
collaborating with Biomira, Inc. in the development of Theratope(R) vaccine for
breast cancer. This vaccine, which is in clinical trials, consists of a
synthetic mimic of a breast cancer-associated antigen conjugated to a carrier
protein.
BLOOD TESTING
The Chiron/Gen-Probe collaboration has two instrument systems in
development, both of which will test blood and plasma for HIV-1 and HCV nucleic
acid in a single multiplexed assay. The semi-automated component system is
currently operating under IND in the United States while the fully automated
Tigris-TM- system is under development. Gen-Probe is widening the menu from
HIV-1/HCV to include other transfusion transmitted agents and continuing
development of the fully automated Tigris-TM- instrument.
Ortho is developing a range of hepatitis and retrovirus assays for IN-VITRO
clinical diagnostics use on its immunodiagnostics instrument system.
RESEARCH REVENUES AND EXPENSES
Collaborative arrangements with third parties are also a source of revenue
for the Company. In general, collaboration revenues include fees for research
services as they are performed or completed and milestone payments upon
attainment of specified benchmarks.
Novartis and the Company have entered into an agreement under which Novartis
has agreed to provide research funding for certain projects. The funded projects
currently consist of certain adult and pediatric vaccines, Insulin-Like Growth
Factor-I, Factor VIII and HSV-tk. Novartis has agreed to fund, at Chiron's
request and subject to certain annual and aggregate limits, 100% of the
development costs of these projects incurred between January 1, 1995 and
December 31, 1999. In exchange for providing this funding, Novartis has certain
co-promotion rights for certain vaccines as well as an interest in certain
royalties on sales of certain products resulting from the funded research.
Research and development expense for the years ended December 31, 1998, 1997
and 1996 for Company-sponsored research, including payments to collaboration
partners, was $294.2 million, $259.4 million and $248.8 million, respectively.
Of that, $61.9 million, $79.5 million and $103.8 million in 1998, 1997 and 1996,
respectively, was reimbursed by third parties.
COMMERCIALIZATION
Technologies arising out of the Company's research and development efforts
are commercialized in a variety of ways. Certain products are marketed and
distributed by the Company, either directly or through distributors. See
"Distribution", below. Other technologies are developed by the Company in
collaboration with third parties, and under the collaboration agreement
marketing rights may be allocated to the Company or to the collaborator or
shared by both parties. In the event marketing rights are allocated to the
collaborator, the Company generally retains the right to manufacture and supply
key raw materials to the collaborator. Still other technologies are licensed by
the Company to third parties, with the licensee assuming responsibility for
further development and the Company receiving royalties on sales of the
resulting product. Agreements under which the Company currently derives revenues
for
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technologies licensed to third parties include an agreement with Bayer relating
to, among other things, use of the Company's HCV and HIV technologies for IN
VITRO diagnostics; an agreement with F. Hoffman La-Roche Limited and Hoffman
La-Roche, Inc. ("Roche"), relating to polymerase chain reaction ("PCR")
technology; agreements with Merck and SmithKline relating to technology used in
their respective hepatitis B vaccines and an agreement with Novo Nordisk A/S
relating to technology used in the manufacture of recombinant human insulin.
DISTRIBUTION
To remain competitive in an intensely competitive environment, Chiron
maintains several specialized marketing and sales forces that concentrate on
individual classes of customers.
The Company's vaccine marketing organization is based in Siena, Italy and
Marburg, Germany. Direct sales efforts are focused on pediatricians and general
practitioners. Products are also sold to the public sector through tenders and
to private sector pharmacies through wholesalers and distributors.
Chiron's biopharmaceuticals marketing, sales and distribution organization
for the U.S. is based in Emeryville, California and for Europe is headquartered
in Amsterdam, The Netherlands. Sales efforts are focused on specialist
physicians, principally oncologists, who are based in hospitals and large
clinics. In general, products are sold to wholesalers, distributors, and
hospital pharmacies.
RAW MATERIALS
Raw materials and other supplies used in the manufacture of the Company's
products (both commercial and investigational) generally are available from
multiple commercial sources. Certain processes, however, use materials that are
available from sole sources or that are in short supply or that are difficult
for the supplier to produce and certify in accordance with the Company's
specifications. The Company's biopharmaceutical products are biologics; from
time to time concerns are raised with respect to potential contamination of
biological materials that are supplied to the Company for use in various
production processes. These concerns can further tighten market conditions for
materials that may be in short supply or available from limited sources.
Moreover, regulatory approvals to market the Company's products may be
conditioned upon obtaining certain materials from specified sources; the
Company's ability to substitute material from an alternate source may be subject
to delay pending regulatory approval of such alternate source. Although the
Company monitors the ability of certain suppliers to meet the Company's needs
and the market conditions for these materials, there is a risk that material
shortages could impact production.
PATENTS
Patents are very important to the business of the Company. Chiron has a
policy of seeking patents on inventions arising from its extensive research and
development activities. The time and expense required to develop and obtain
regulatory approval to market human healthcare products is significant. Without
the protection of patents or trade secrets, 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. Chiron has a substantial number of granted patents and pending patent
applications in the United States and other important markets, and a number of
patents and patent applications owned by third parties have been licensed to
Chiron.
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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 United States and
other important markets. It is not known how many of the Company's pending
patent applications will be granted, nor the effective coverage of those that
grant. In the United States and other important markets, the issuance of a
patent is not conclusive as to its validity or 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.
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. Furthermore, most countries do not
provide discovery so the Company may not be able to meet its burden of proving
infringement; nor can it be guaranteed that the Company will even become aware
of infringement of its patents.
To a lesser extent, trade secrets and confidential information are important
to Chiron's commercial success. Although the Company seeks to protect trade
secrets and confidential information, there can be no assurance that others will
not obtain access to such information or develop the same or similar information
independently, or that third parties will not obtain patent protection that
precludes Chiron from using its trade secrets or confidential information.
Chiron is aware that third parties, including competitors, educational
institutions and governmental organizations, have patents and patent
applications in the United States and other significant markets that may be
useful or necessary for the manufacture, use or sale of certain of the Company's
products (commercial and investigational). There may be other such patents and
patent applications of which the Company is not currently aware. 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
practicing necessary technology, including 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.
TRADEMARKS
Proleukin(R) is a registered trademark of the Company and its subsidiaries.
ELVS-TM-, Polioral-TM- and Triacelluvax-TM- are trademarks of the Company and
its subsidiaries. DepoCyt-TM- is a
10
trademark owned by Chiron and DepoTech. The following registered trademarks are
owned by the indicated companies: Betaseron(R) and Betaferon(R) (Schering AG),
Myotrophin(R) (Cephalon), Regranex(R) (J&J), Theratope(R) (Biomira, Inc.),
Apligraf(R) (Novartis), Dermagraf(R) (Advanced Tissue Sciences, Inc.),
Copaxone(R) (Teva Pharmaceutical Industries, Ltd.), Avonex(R) (Biogen, Inc.),
Aredia(R) (Novartis), and Amplicor(R) (Roche). Tigris-TM- is a trademark owned
by Gen-Probe.
SEASONALITY
Sales of certain of the Company's vaccine products, in particular flu
vaccine, are seasonal, with higher sales in the third and fourth quarters of the
year.
The Company receives royalties on sales of PCR products by Roche. Under the
terms of the Company's agreement with Roche, royalties are payable after Roche's
annual net sales of PCR products exceed $200 million. This $200 million
threshold resets at the beginning of each year. Accordingly, the Company does
not expect to receive any royalties on Roche's PCR sales until the last half of
each year.
MAJOR CUSTOMERS
The Company has a strategic alliance with Novartis and in connection
therewith has entered into a series of arrangements with Novartis. See
"Relationship With Novartis", below. These arrangements contributed 12%, 21% and
21% of total revenues in 1998, 1997 and 1996, respectively. The Company has a
joint immunodiagnostics business with Ortho. See "Products-Blood Testing",
above. The Ortho joint business, together with certain other arrangements with
J&J and its affiliates, contributed 18%, 24%, and 23% of total revenues in 1998,
1997 and 1996, respectively. The Company has a supply agreement with Berlex and
its parent company, Schering AG of Germany. Revenues recognized under this
agreement contributed 13%, 14% and 15% to total revenues in 1998, 1997 and 1996,
respectively.
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. The technologies applied by the Company and
its competitors are rapidly evolving, and new developments frequently result in
price competition and product obsolescence. Substantial consolidation is
underway in the global healthcare industry, and is expected to produce greater
efficiencies and even more intense competition.
To compete effectively, Chiron invests heavily in research and development,
maintains specialized sales forces that concentrate on individual classes of
customers, and spends significant amounts on advertising, promotion and selling.
11
Important biotechnology research is performed in universities and nonprofit
research organizations. These entities are becoming more active in seeking
patent protection and licensing revenues for their discoveries. The competition
among large pharmaceutical companies and smaller biotechnology companies to
acquire technologies from these entities also is intensifying. While Chiron
actively collaborates with such entities in research, and has and will continue
to license their technologies for further development, these institutions also
compete with Chiron to recruit scientific personnel and to establish proprietary
positions in technology.
BIOPHARMACEUTICALS
Proleukin(R) competes with alpha interferon sold by Schering Plough
Corporation and by Roche as a treatment for metastatic kidney cancer and
metastatic melanoma, although many patients are treated with both products. The
Company estimates that Proleukin(R) has approximately a 50% market share for
these indications. The principal method of competition is product performance.
Several other companies are developing immune-system-based therapies for cancers
and infectious diseases, including Roche, Genentech, Inc., Amgen, Inc., Immunex
and Immune Response/Agouron.
Regranex(R) was the first product approved by the FDA for treatment of
diabetic foot ulcers. It competes with Dermagraft(R), a product from Advanced
Tissue Sciences & Smith and Nephew, and with Apligraf(R), a product from
Novartis which has been approved by the FDA for treatment of venous leg ulcers
and is in clinical trials for treatment of diabetic foot ulcers. Several other
companies, including Genzyme and Novartis, are developing transforming growth
factor-beta (TGF-Beta), which may compete with Regranex(R) in the future.
Betaseron(R), as a treatment for multiple sclerosis, competes with
Avonex(R), a recombinant interferon beta sold by Biogen, Inc., and with
Copaxone(R) from Teva Pharmaceuticals. In certain European countries, Schering
AG's product, Betaferon(R), faces competition from Ares Serono, which sells an
extracted form of beta interferon that is used for, among other purposes,
treatment of multiple sclerosis. Other companies have treatments for multiple
sclerosis in clinical development.
VACCINES
Four large companies hold the greatest share of the worldwide vaccine
market: Merck, SmithKline, Wyeth Lederle Vaccines & Pediatrics, a division of
American Home Products Corporation ("Lederle"), and Pasteur Merieux Connaught
("PMC"). PMC separately has a strategic alliance with Merck. All four of these
companies, as well as other biotechnology companies, have substantial research
and development programs. The Company estimates that it has approximately a 38%
and 37% market share in Germany and Italy, respectively, and an aggregate market
share of approximately 8% outside of the United States, Europe and Japan. The
principal methods of competition in vaccines are price and introduction of new
products, including vaccines against diseases for which no vaccine was
previously available as well as new combination vaccines that combine existing
vaccines for several diseases into a single product. Combination vaccines
frequently are favored by public health authorities, medical practitioners and
patients, particularly in the case of pediatric vaccines, because they eliminate
the need for multiple injections and may increase overall compliance with
recommended vaccination schedules. As new combination vaccines are introduced,
older combinations and single products often become obsolete. The Company may be
limited in its ability to develop and market
12
certain combination vaccines if one of the vaccines which would otherwise be
included in the combination is covered by valid and enforceable patent or other
proprietary rights held by third parties.
BLOOD TESTING
Chiron is the sole manufacturer of HCV antigens for use in immunodiagnostic
assays of both Abbott and the Chiron-Ortho joint businesses. In the immunoassay
blood testing market, the Chiron-Ortho joint business competes with Abbott with
each having, in total, approximately 45% market share of the major world
markets. The joint business anticipates increased competitive pressures from
Abbott with the introduction of the Abbott Prism(R) instrument system. The joint
business is also developing immunodiagnostic instruments and assays to detect
hepatitis, retrovirus and other agents in clinical diagnostic applications. Many
other companies, including Roche, Abbott and Bayer have substantial positions in
the market segment.
Currently, there are no approved, probe-based tests for commercial use in
blood testing. Chiron/Gen-Probe nucleic acid testing products are expected to
compete primarily with PCR-based products supplied by Roche or developed
in-house by customers (homebrew). The commercial market for nucleic acid testing
products in the blood banking and plasma industries is developing very rapidly
as regulatory agencies begin in 1999 to require that customers implement this
new technology.
GOVERNMENT REGULATION
Regulation by governmental authorities in the United States and other
important markets is a significant factor in the manufacture and sale of the
Company's products and in its research and development activities.
BIOPHARMACEUTICALS AND VACCINES. In the United States, Chiron's therapeutic
and vaccine products (both commercial and investigational) are regulated
primarily under federal law and are subject to rigorous FDA approval procedures.
No product can be marketed in the United States until an appropriate application
is approved by the FDA. The approval procedures are applied on a
product-by-product basis and require, among other things, an extensive three-
phase human clinical testing program. In phase 1, studies are conducted with a
relatively small number of subjects to assess the safety of the product. In
phase 2, the product is evaluated in a larger group of subjects to begin to
assess efficacy. Phase 3 studies are conducted in the target population with a
number of subjects that is large enough to provide sufficient data to establish
statistically the safety and efficacy of the product. FDA approval of a product
is limited to treatment for specified medical conditions or disorders, and
further studies would be required to market the product for other indications.
All facilities used to manufacture, fill, test and distribute biologic products
are required to be inspected and approved by the FDA. If any change is made in
manufacturing facilities or processes after FDA approval is obtained, additional
regulatory review and possibly additional clinical studies may be required.
Licensing procedures in Europe are comparable to those in the United States.
In 1995, the European Union ("EU") established a centralized procedure for
licensing of products derived from the use of high technology/biotechnology
processes. This procedure leads to the grant of a single license for the entire
EU. Effective January 1, 1998, the EU has also adopted a
13
decentralized procedure under which a license granted in one member state is
mutually recognized by the other member states, leading to a grant of licenses
in member states recognizing the original license. This procedure is expected to
replace independent national licensing of products in the EU. In addition, each
product must receive individual country pricing approvals before it can be
marketed in that country.
BLOOD TESTING. Blood testing products, whether based upon immunodiagnostics
or nucleic acid testing technologies, may only be used pursuant to the terms of
approval of specific license applications in which the product's safety and
effectiveness must be demonstrated based upon well controlled studies. Upon
approval of the license application, the product may be marketed for the
specific indications of use, which were identified in the approval. Facilities,
processes and operations used for the manufacture, testing, storage and
distribution of Chiron's blood testing products in the U.S. are subject to FDA
approval and periodic inspection.
For both biopharmaceutical and blood testing products, the time and expense
needed to complete the required clinical studies, prepare and submit the
required applications and supporting documentation, and respond to inquiries
generated by regulatory review can far exceed the time and expense of the
research and development initially required to create the product. These factors
largely determine the speed with which a successful research program is
translated into a marketed product.
ENVIRONMENT
Expenses for compliance with environmental laws have not had and are not
expected to have a material impact upon the Company's capital expenditures,
earnings or competitive position.
EMPLOYEES
On December 31, 1998, Chiron and its subsidiaries had 3,247 employees.
RELATIONSHIP WITH NOVARTIS
As noted above, the Company has an alliance with Novartis. Novartis is a
life sciences company headquartered in Basel, Switzerland which was formed as a
result of the December 1996 merger between Ciba-Geigy Limited ("Ciba") and
Sandoz Limited. Through a series of transactions that became effective in
January 1995, Ciba acquired shares of the Company's common stock which, when
combined with shares already held by Ciba, represented 49.9% of the
then-outstanding common stock of the Company. As a result of dilution stemming
primarily from the issuance of common stock under the Company's employee stock
option and stock purchase plans and in connection with certain acquisitions, as
of February 28, 1999, Novartis held shares representing approximately 44% of the
Company's outstanding common stock.
In connection with these transactions, Chiron and Novartis entered into a
series of agreements which provide, among other things and subject to certain
conditions and exceptions, that Novartis will not increase its ownership
interest in the Company above 49.9% before January 5, 2000 and thereafter will
not increase its ownership interest above 55% unless it acquires all of the
outstanding capital stock of the Company in a "buy-out" transaction; that
Novartis may not propose or consummate a "buy-out transaction" before January 5,
2001; that Novartis may exceed these standstill amounts and increase its
ownership interest up to 79.9% if
14
the transaction is approved by a majority of the independent members of the
Company's Board of Directors; that Novartis has the right to nominate three
members to Chiron's eleven member Board of Directors; that Novartis will provide
certain funding to the Company for research services (see "Research and
Development--Research Revenues and Expenses" above) and will guarantee certain
bank lines of credit on behalf of the Company; that Chiron may require Novartis
to purchase shares of the Company's common stock directly from the Company at
fair market value, up to a maximum subscription amount (initially $500 million,
subject to adjustment); that Novartis has an option to purchase newly issued
shares of the Company's common stock directly from the Company at fair market
value, subject to the standstill restrictions described above; and that Chiron
and Novartis will cooperate in research, development, manufacturing and
marketing of biotechnology products on an arm's-length basis while remaining
independent to pursue other opportunities.
ITEM 2. PROPERTIES
EMERYVILLE CAMPUS. Chiron's principal executive offices are located in
Emeryville, California. The campus consists of 26 buildings, of which 14 are
leased and 12 are owned. In 1998, the Company completed development of a new
research and development facility in Emeryville under an operating lease
arrangement. The Emeryville facilities include research and development,
manufacturing and administrative facilities for the Company's biopharmaceutical,
vaccine and blood testing businesses.
OTHER R&D AND MANUFACTURING FACILITIES. The Company also owns manufacturing
facilities in Vacaville, California and Amsterdam, The Netherlands used
principally in connection with the Company's biopharmaceutical and vaccines
businesses. Certain of these facilities have available capacity due to lower
than expected demand for certain of the Company's products and improved
production yields from other facilities. In January 1999, the Company announced
its intention to discontinue manufacturing in the Amsterdam facility after 1999.
The Amsterdam facility currently is being marketed for sale.
The Company has research and development, manufacturing and administrative
facilities in Siena, Italy and Marburg, Germany and manufacturing facilities in
Rosia, Italy relating to its vaccine operations. The Siena and Rosia facilities
are owned and the Marburg facility is leased.
The Company leases research and development facilities in San Diego,
California in connection with its gene therapy activities.
The Company owns research and development, manufacturing and administrative
facilities in Claremont, California. The facilities were used principally in
connection with the Company's former ophthalmic products business, which was
sold to Bausch & Lomb in December 1997. Bausch & Lomb occupies a significant
portion of the facilities under a three-year lease which expires in December
2000. The Claremont campus currently is being marketed for sale.
The Company leases a number of other facilities in North America, Europe,
Asia and Australia, primarily for sales and service offices.
The Company believes that its facilities are in good operating condition and
are adequate for its current needs. The Company continually evaluates future
requirements for its facilities.
15
ITEM 3. LEGAL PROCEEDINGS
CONNAUGHT LABORATORIES, LIMITED
Chiron is involved in litigation in Italy, Germany and The Netherlands with
Connaught Laboratories, Limited ("Connaught") relating to TriAcelluvax-TM-, the
Company's diphtheria/ tetanus/acellular pertussis vaccine.
Chiron manufactures and sells TriAcelluvax-TM- in Italy. Connaught alleges
that TriAcelluvax-TM- infringes the Italian counterpart of its European Patent 0
527 753 (the "'753 patent"). The '753 patent contains claims which relate to the
pertactin protein of BORDETELLA PERTUSSIS. In June 1997, Chiron S.p.A. filed an
action against Connaught in the Tribunale di Milano, Italy, challenging the
validity of the Italian counterpart of the '753 patent. Connaught subsequently
filed a claim for infringement in the Milan court and sought injunctive relief,
which was denied. The Milan court has appointed a technical expert and briefing
is ongoing.
The Company does not sell TriAcelluvax-TM- in Germany. However, in July
1997, Connaught filed suit against Chiron Behring and Chiron S.p.A. in the
Landgericht Dusseldorf, Germany, asserting imminent infringement of its European
Patent 0 322 115 (the "'115 patent"). The '115 patent contains claims which
relate to pertussis toxin mutants. The '115 patent was opposed by Chiron in the
European Patent Office. In November 1998 the EPO Opposition Division upheld the
'115 patent in an amended form. In the German action, Connaught seeks damages
and an order enjoining Chiron S.p.A. from manufacturing and selling
TriAcelluvax-TM- in both Germany and Italy. A hearing on this matter took place
in August 1998 but a ruling has not yet issued. A decision is expected in the
first half of 1999.
In December 1997, Chiron filed an action in the District Court of The Hague,
The Netherlands, against Connaught to revoke the Dutch counterpart of the '115
patent on grounds of invalidity. Connaught filed a motion to stay proceedings
which was denied in November 1998.
It is not known when nor on what bases these matters will be resolved.
F. HOFFMANN LA-ROCHE A.G.
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,
Ltd., several of its affiliated companies (collectively, "Roche") and Daniel
Bradley in the United States District Court for the Northern District of
California. The Company asserts that Roche's manufacture and sale of Amplicor(R)
HCV Test and Amplicor(R) HCV Monitor Test constitutes infringement of Chiron's
U.S. Patent Nos. 5,712,088 (the "'088 patent") and 5,714,596 (the "'596
patent"). The action also asserts that Bradley breached a settlement agreement,
that Roche wrongfully induced this breach, and that Bradley committed slander of
title with respect to Chiron's HCV technology. The action seeks damages,
injunctive relief, and a declaratory judgment that Chiron is the sole and
exclusive owner of its HCV technology. Roche filed a counterclaim requesting a
declaratory judgment of non-infringement and invalidity and also alleging
infringement of U.S. Patent No. 5,580,718 (the "'718 patent"), owned by
Hoffmann-
16
LaRoche, Inc., which allegedly relates to nucleic acid-based assays for the
detection of HCV. The counterclaim of infringement seeks damages and injunctive
relief. Chiron is defending on the basis of invalidity and non-infringement of
the '718 patent, and seeks a declaration of invalidity of U.S. Patent No.
5,527,669 (the "'669 patent"), a related patent also owned by Hoffmann-LaRoche.
Trial in this matter is expected to be scheduled in 2000.
In April 1998, Chiron filed suit against Nippon Roche K.K. in the Tokyo
District Court in Japan for infringement of Japanese patent number 2,656,995
(the "'995 patent"), relating to HCV nucleic acid technology. The suit seeks
injunctive relief preventing the sale of Roche AG's Amplicor(R) HCV Test and
Amplicor(R) HCV Monitor Test by Nippon Roche and damages. Roche has also
challenged the validity of the '995 patent in the Japanese Patent Office.
In February 1998, Chiron filed an action in The District Court of The Hague,
The Netherlands against F. Hoffmann-LaRoche AG, several of its affiliated
companies (collectively, "Roche AG"), and one of Roche AG's Dutch customers
asserting Roche AG's infringement of the Company's European Patent 0 318 216
(the "'216 patent") relating to HCV nucleic acid technology. Chiron seeks a
cross-border injunction with effect in a number of European countries,
prohibiting the sale of Roche AG's Amplicor(R) HCV Test and Amplicor(R) HCV
Monitor Test. Roche AG has asserted certain defenses and counterclaims in this
matter. Following a trial in October 1998, with respect to certain of these
issues, the Court declined to exercise jurisdiction outside The Netherlands and
therefore dismissed certain defendants from the case. For procedural reasons,
the Court limited its consideration to the Amplicor(R) HCV Monitor Test. Also,
the Court requested expert advice from the Het International Jurisch Instituut
regarding interpretation under U.S. law of certain contractual issues raised as
an affirmative defense by Roche AG. Those issues relate to Roche AG's 1991
purchase of certain Cetus Corporation assets. In December 1998, the Company
filed a parallel, new action before the Dutch Court concerning the Amplicor(R)
HCV Test. In a separate proceeding, Roche AG and Chiron are appealing the
European Patent Office's Opposition Division's decision upholding the '216
patent in amended form.
In January 1997, Chiron, together with Ortho-Clinical Diagnostics, Inc.
(formerly known as "Ortho Diagnostics Systems, Inc."), filed suit against F.
Hoffmann-LaRoche AG ("Roche Germany") in the Regional Court, 4(th) Civil
Division, Dusseldorf, Germany, for infringement of immunoassay technology under
the '216 patent. The suit seeks damages and injunctive relief preventing further
manufacture or sale of infringing HCV immunoassay kits by Roche Germany. Roche
Germany has asserted certain claims and defenses in this matter. Trial was held
in March 1999; a decision is forthcoming.
Roche also filed suit against Chiron in Munich seeking a pan-European
declaration of non-infringement of Chiron's European Patent number 0 181 10
relating to HIV probes technology. That suit has been dismissed by the Munich
court. Chiron had filed a countersuit in Dusseldorf for infringement and the
matter is expected to go forward during 1999.
It is not known when nor on what bases any of these litigation matters will
be concluded.
ORTHO-CLINICAL DIAGNOSTICS, INC.
On February 17, 1998, Chiron filed a lawsuit against Ortho-Clinical
Diagnostics, Inc. (formerly known as "Ortho Diagnostics Systems, Inc.") in the
United States District Court for the Northern District of California. The suit
concerns certain issues relating to the conduct of the parties' joint business
and seeks to compel arbitration of those issues. Chiron's motion to
17
compel arbitration was granted by the Court in December 1998 and the matter is
expected to proceed, pending appointment of an arbitrator, during 1999. It is
not known when nor on what basis this matter will be concluded.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were brought to a vote of Chiron's stockholders in the quarter
ended January 3, 1999.
EXECUTIVE OFFICERS OF THE REGISTRANT
The executive officers of the Company, who serve at the discretion of the
Board of Directors, are as follows, in alphabetical order:
NAME AGE TITLE
- -------------------------------------------------- --- --------------------------------------------------
Richard W. Barker, Ph.D........................... 50 Senior Vice President, Corporate Development
Rajen K. Dalal.................................... 45 Vice President; President, Chiron Blood Testing
Renato P. Fuchs, Ph.D............................. 56 Senior Vice President, Manufacturing and Process
Development
William G. Green, Esq............................. 54 Senior Vice President, General Counsel and
Secretary
David T. Kingsbury, Ph.D.......................... 58 Vice President, Chief Information Officer
Sean P. Lance..................................... 51 President and Chief Executive Officer
Philip K. Moody................................... 47 Vice President, Financial Operations
Edward E. Penhoet, Ph.D........................... 58 Vice Chairman
Heino von Prondzynski............................. 49 President, Chiron Vaccines
William J. Rutter, Ph.D........................... 70 Chairman
Linda W. Short.................................... 53 Vice President, Human Resources
David V. Smith.................................... 39 Vice President, Controller
James R. Sulat.................................... 48 Vice President, Chief Financial Officer
Lewis T. Williams, M.D., Ph.D..................... 49 Chief Scientific Officer; President, Chiron
Technologies
DR. BARKER joined the Company in May 1996, as Senior Vice President, and
President of Chiron Diagnostics Corporation, a wholly-owned subsidiary of the
Company ("Diagnostics"). He served as the President of Diagnostics until
November 1998, when Diagnostics was sold to Bayer. From 1994 to 1996, he was
General Manager of IBM Worldwide Healthcare Solutions. From 1980 to 1993, Dr.
Barker served as a consultant with McKinsey & Company, leading the European
Healthcare Practice also serving healthcare clients in North America and Asia,
on issues of corporate strategy and alliances, organizational change and
international marketing. He has a Ph.D. in biophysics. Dr. Barker joined the
Board of Sunquest Information Systems in August 1996.
MR. DALAL joined the Company in December 1991 as Vice President, Corporate
Development. In 1998, he was appointed President of Chiron's Blood Testing
Division. From 1983 until joining the Company, he was employed by the
international consulting firm of McKinsey & Company, where he performed general
management consulting in the firm's pharmaceuticals, medical devices and
diagnostics industries practice.
18
DR. FUCHS joined the Company in 1993 as Senior Vice President, Manufacturing
and Development Operations, and is responsible for international operations of
the Company's manufacturing, process development, materials management, quality
control, validation and engineering activities. Such operations include
development and manufacturing of therapeutic rDNA proteins, vaccines and
antigens for diagnostics. Prior to joining Chiron, Dr. Fuchs worked for over
twenty years in the pharmaceutical industry, and served as the Vice President of
Process Development of Centocor from 1988 to 1993, where he was responsible for
development of large-scale processes for production of antibodies in cell
culture. Dr. Fuchs has a Ph.D. in biochemical engineering.
MR. GREEN joined the Company as Vice President and General Counsel in
October 1990, having served as Secretary or Assistant Secretary since the
Company's inception in 1981. In February 1992, he became Senior Vice President,
General Counsel and Secretary. From 1981 to 1990, he was a partner in the San
Francisco law firm of Brobeck, Phleger & Harrison.
DR. KINGSBURY joined the Company as Vice President and Chief Information
Officer in January 1997. Prior to joining Chiron, he was on the faculty at The
Johns Hopkins School of Medicine where he was the Director of the Division of
Biomedical Information Sciences, the Genome Data Base, and the Welch Biomedical
Library. Dr. Kingsbury joined Johns Hopkins University in 1993, and from 1995
until his resignation, also served as its Chief Information Officer.
MR. LANCE joined the Company as President and Chief Executive Officer in May
1998. During the previous thirteen years, Mr. Lance held various executive
positions with Glaxo Holdings plc, London, England. In October 1996 he was
appointed Managing Director of Glaxo Wellcome plc and in January 1997 he was
appointed Chief Operating Officer and Chief Executive Designate of Glaxo
Wellcome plc. From 1993 to 1996, Mr. Lance was Executive Director of Glaxo
Holdings, responsible for commercial operations in the Middle East, Africa,
Europe and Latin America. Mr. Lance was also President of the International
Federation of Pharmaceutical Manufacturers Associations from October 1996 to
February 1998, an Executive Member of the International Committee of
Pharmaceutical Research and Manufacturers of America, and a director of the
British Pharma Group. He also served on the Steering Committee of Healthcare
2000.
MR. MOODY joined the Company in February 1995, as Corporate Director,
Financial Planning. He was appointed Vice President, Financial Operations, in
December 1997, and served as the principal financial accounting officer of the
Company from February 1998 to February 1999, until he was appointed Divisional
Vice President, Finance and Operations. Prior to joining the Company, Mr. Moody
was the Director of Corporate Planning of APL, Ltd., from May 1988 to February
1995.
DR. PENHOET, a co-founder of Chiron and a Director since its inception in
1981, served as the Chief Executive Officer of the Company from 1981 to May
1998, and became Vice Chairman, effective May 1, 1998, upon the appointment of
Sean P. Lance as President and CEO of the Company. He has been a faculty member
at the Biochemistry Department at the University of California, Berkeley for 26
years, and currently serves as the Dean of the School of Public Health at the
University of California at Berkeley. From March 1997 to January 1999, Dr.
Penhoet served as the Chairman of California Healthcare Institute, a public
policy research and advocacy organization located in La Jolla, California. He is
a member of the Board of Directors of Onyx Pharmaceuticals, Inc.
19
MR. VON PRONDZYNSKI joined the Company as Chief Executive Officer of Chiron
Behring GmbH & Co in October 1996. He is also the Chief Executive Officer of
Chiron S.p.A., the Italian vaccine subsidiary of the Company. Prior to joining
the Company, Mr. von Prondzynski held various positions with Bayer AG from 1976
to 1996. From 1991 to 1996, he was the General Manager of Bayer Diagnostics GmbH
in Munich, Germany, responsible for Germany and Eastern Europe; from 1988 to
1991, he was Head of Healthcare Business in Brazil (Scope Manufacturing,
Marketing & Sales, Development); and from 1985 to 1988, he was the General
Manager in Austria. Since October 1998, Mr. von Prondzynski has served as a
member of the Regional Advisory Board of Commerzbank.
DR. RUTTER, a co-founder of the Company, has served as its Chairman since
the Company's inception in 1981. He was Director of the Hormone Research
Institute at the University of California, San Francisco Medical Center
("UCSF"), from 1983 to May 1989, and has been on the faculty at UCSF since 1969,
becoming a Professor Emeritus in 1991. Dr. Rutter was appointed to the board of
Novartis AG in 1995, and having reached the statutory age of retirement, will
step down at Novartis AG's annual shareholders meeting in April 1999. Since
1992, Dr. Rutter has served on the Board of Overseers, Harvard University. He
has also served on the Board of Trustees, Carnegie Institution of Washington
since 1995.
MS. SHORT joined the Company in November 1997, as Vice President, Human
Resources. Prior to that she was the Director of Human Resources of Industrial
Indemnity from 1994 to 1997. From 1989 to 1994, Ms. Short held various
managerial positions with the Bank of America, most recently in 1994, as Project
Manager in charge of the merger of Continental Bank into Bank of America, and as
Director of Human Resources for Wholesale Banking from 1993 to 1994, and
Director of Human Resources of the Asia Division from 1989 to 1993.
MR. SMITH joined the Company as Vice President, Controller in February 1999,
and was designated the Company's principal financial accounting officer. Mr.
Smith served as the Vice President, Finance and Chief Financial Officer of
Anergen, Inc. from 1997 until he joined the Company. From 1988 to 1997, Mr.
Smith held various financial management positions with Genentech, Inc., in both
the United States and Europe, most recently as Director of Accounting.
MR. SULAT joined the Company as Vice President, Chief Financial Officer in
April 1998. He was the Chief Financial Officer of Stanford Health Services, the
clinical healthcare delivery arm of the Stanford University Medical Center, from
1993 to October 1997. In November 1997, Stanford Health Services merged with the
hospital facilities of the University of California, San Francisco, and Mr.
Sulat served as the Treasurer of the merged entity, UCSF Stanford Health Care,
until joining the Company. From 1990 to 1993, Mr. Sulat was the Chief Financial
Officer and Vice President, Operations, of Esprit de Corp, a privately-owned
apparel manufacturer. Mr. Sulat is also a director of Vans, Inc., a shoe
manufacturer, and General Surgical Innovations, Inc., a medical device
manufacturer.
DR. WILLIAMS joined the Company in August 1994 as Senior Vice President and
President of Chiron Technologies. In 1998, he was promoted to Chief Scientific
Officer of the Company. From 1988 until joining the Company, he was a professor
of medicine at the University of California, San Francisco. Prior to joining
UCSF, he was on the faculty of Harvard Medical School. In addition, he was a
co-founder and director of COR Therapeutics, Inc. from 1988 until joining the
Company. From 1992 to 1994, Dr. Williams served on the Scientific Advisory Board
of Geron Corporation.
20
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS
The common stock of Chiron Corporation is traded in the NASDAQ National
Market System under the symbol CHIR. As of December 31, 1998, there were 6,513
holders of record of Chiron common stock, 63 remaining holders of record of
Cetus Corporation common stock and 6 remaining holders of Viagene Inc. common
stock. The Company has declared no cash dividends since its inception and does
not expect to pay any dividends in the foreseeable future. The quarterly high
and low closing sales price of Chiron common stock for 1998 and 1997 are shown
below.
1998 1997
------------------ ------------------
HIGH LOW HIGH LOW
------- ------- ------- -------
First Quarter..................................................... $22 $16 9/16 $21 1/4 $17 7/8
Second Quarter.................................................... 22 15 11/16 21 17 1/2
Third Quarter..................................................... 21 1/16 13 3/4 24 5/16 19 7/8
Fourth Quarter.................................................... 26 5/8 18 1/16 23 16 5/8
ITEM 6. SELECTED FINANCIAL DATA
The Company has not paid cash dividends on its common stock and does not
expect to do so in the foreseeable future.
YEAR ENDED DECEMBER 31,
--------------------------------------------------------------------
1998 1997 1996 1995 1994
------------ ------------ ------------ ------------ ------------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
Total revenues................. $ 736,673 $ 574,599 $ 537,149 $ 393,566 $ 345,211
Income (loss) from continuing
operations................... 75,998 25,782 45,658 (469,802) 18,613
Basic income (loss) from
continuing operations........ 0.43 0.15 0.27 (2.89) 0.14
Diluted income (loss) from
continuing operations........ 0.42 0.14 0.26 (2.89) 0.14
Total assets................... 2,524,255 1,768,478 1,688,670 1,489,847 1,049,742
Long-term debt................. 338,158 397,217 419,589 413,248 338,061
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
OVERVIEW
Chiron is a biotechnology company that participates in three global
healthcare businesses: biopharmaceuticals, blood testing and vaccines. The
Company is applying a broad and integrated scientific approach to the
development of innovative products for preventing and treating cancer,
infectious diseases, and cardiovascular diseases. This approach is supported by
research strengths in recombinant proteins, genomics, small molecules, gene
therapy and vaccines. Chiron Biopharmaceuticals consists of products and
services related to therapeutics,
21
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.
Chiron's blood testing revenues primarily relate to Chiron's one-half interest
in the pretax operating earnings of its joint business with Ortho-Clinical
Diagnostics, Inc., which sells a full line of tests required to screen blood for
hepatitis viruses and retroviruses, and provides supplemental tests and
microplate-based instrument systems to automate test performance and data
collection. Chiron Vaccines consists principally of adult and pediatric vaccines
sold primarily in Germany, Italy, certain other international markets and in the
U.S.
On December 29, 1997, Chiron completed the sale of its ophthalmics business
unit, Chiron Vision Corporation ("Chiron Vision"), to Bausch & Lomb Incorporated
("B&L") and on November 30, 1998, Chiron completed the sale of its IN VITRO
diagnostics business to Bayer Corporation ("Bayer"). As a result of these
transactions, the Company's Consolidated Statements of Operations reflect the
after-tax results of Chiron Vision and Chiron Diagnostics, and the related gains
on disposals thereof, as discontinued operations for all periods presented.
RESULTS OF OPERATIONS
REVENUES
BIOPHARMACEUTICAL PRODUCT SALES Product sales from Chiron
Biopharmaceuticals were $201.9 million, $150.6 million and $135.7 million in
1998, 1997 and 1996, respectively. In 1998 and 1997, product sales consisted
principally of Proleukin(R) (aldesleukin, interleukin-2), Betaseron(R)
(interferon beta-1b) and PDGF (recombinant human platelet-derived growth factor
- -rhPDGF-BB). In 1996, biopharmaceutical product sales consisted primarily of
Proleukin(R) and Betaseron(R).
PROLEUKIN(R) Chiron sells Proleukin(R) directly in the U.S. and certain
international markets. Sales of Proleukin(R) were $93.2 million, $70.5 million
and $60.9 million in 1998, 1997 and 1996, respectively. The overall increase in
sales from year-to-year is primarily due to (i) continued volume growth in
existing indications; (ii) higher prices; and (iii) in 1998, the geographic
expansion into other countries and the expanded use of Proleukin(R) for the new
indication of metastatic melanoma. The Company continues to pursue additional
indications related to human immunodeficiency virus ("HIV"), acute myelogenous
leukemia and HIV related non-Hodgkin's lymphoma. The Company also anticipates
further geographic expansion of Proleukin(R) into additional countries.
BETASERON(R) Chiron manufactures Betaseron(R) for Berlex Laboratories, Inc.
("Berlex") and its parent company Schering AG of Germany. Chiron earns a partial
payment for Betaseron(R) upon shipment to Berlex and Schering AG (the "initial
revenues") and a subsequent secondary payment upon sales by Berlex and Schering
AG (the "secondary revenues"). Accordingly, Chiron's revenues from Betaseron(R)
tend to fluctuate based upon the inventory management practices of Berlex and
Schering AG. In addition, in July 1997, the terms of payment changed whereby the
initial payment received upon shipment decreased and the secondary payment due
upon sales to patients increased equivalently. Although total revenues did not
change, the revised payment terms resulted in a timing difference whereby Chiron
recognized a decrease in initial revenues in 1997 and an increase in secondary
revenues in 1998.
22
In 1998, 1997 and 1996, revenues from Betaseron(R) were $63.4 million, $54.8
million and $67.2 million, respectively. In 1998, Chiron's shipments of
Betaseron(R) to Berlex and Schering AG increased significantly over shipments in
1997. The actual number of vials sold by Berlex and Schering AG to patients in
1998 remained relatively constant with the number of vials sold in 1997. As a
result, the increase in revenues in 1998 as compared with 1997 is primarily due
to replenishing inventories at Berlex and Schering AG and to the change in
payment terms discussed above. In October 1998, the contractual rate upon which
Chiron recognizes revenues decreased by 2.5% of Berlex's sales. The impact of
this decrease did not impact revenues until December 1998 when Chiron began
recognizing the subsequent secondary revenues. In 1997, the decrease in revenues
as compared with 1996 is primarily due to the change in payment terms discussed
above and the introduction of a competing product in the second quarter of 1996.
PDGF Chiron manufactures PDGF for Ortho-McNeil Pharmaceutical, Inc., a
Johnson & Johnson ("J&J") company. PDGF is the active ingredient in Regranex(R)
(becaplermin) Gel, a treatment for diabetic foot ulcers. Regranex(R) Gel was
approved by the Food and Drug Administration ("FDA") in December 1997 and was
launched commercially in early 1998. Sales of PDGF were $36.4 million and $18.3
million, in 1998 and 1997, respectively. As Chiron's shipments of PDGF remained
fairly constant in 1998 and 1997, the increase in revenues between 1998 and 1997
is primarily due to retroactive price increases recognized in 1998 for shipments
made in 1997. The Company does not expect future price adjustments, if any, to
be commensurate with those in 1998.
As PDGF is the first product of its kind, the Company believes it will take
time for the market to fully develop. In addition, Chiron's sales of PDGF will
tend to fluctuate based upon the inventory management practices of J&J.
Regranex(R) Gel was recently approved for use in the treatment of diabetic foot
ulcers in Canada and the Company expects European approval for the same
indication during the first half of 1999. However, even with these approvals,
Chiron's sales to date have largely filled J&J's inventory requirements, and as
a result, no sales of PDGF to J&J are expected during the first three quarters
of 1999.
VACCINE PRODUCT SALES Chiron sells pediatric and adult vaccines in Germany,
Italy, other international markets and in the U.S. Certain of the Company's
vaccine products, particularly its flu vaccine, are seasonal and have higher
sales in the third and fourth quarters of the year. In 1998, 1997 and 1996,
vaccine product sales were $176.8 million, $82.0 million and $91.9 million,
respectively. The increase in sales in 1998 as compared with 1997 is primarily
due to Chiron's acquisition of the remaining 51% interest in, and consolidation
of, Chiron Behring GmbH & Co ("Chiron Behring") in the second quarter of 1998
(see CHIRON BEHRING below). In 1997, the decrease in product sales as compared
with 1996 reflects the supply constraints related to Polioral-TM-, the Company's
pediatric oral polio vaccine, which were resolved during 1998. The Company
expects the competitive pressures related to many of its vaccine products to
continue into the foreseeable future, as a result of the introduction of
competing products into the market, including new combination vaccines.
EQUITY IN EARNINGS OF UNCONSOLIDATED JOINT BUSINESSES In 1998, 1997 and
1996, Chiron recognized equity in earnings of unconsolidated joint businesses of
$74.0 million, $106.4 million and $102.1 million, respectively. In each of these
years, equity in earnings of unconsolidated joint businesses consisted
substantially of revenues generated by Chiron's joint businesses with
23
Ortho-Clinical Diagnostics, Inc. ("Ortho"), a Johnson & Johnson company
("Chiron-Ortho joint business") and Hoechst AG ("Chiron Behring").
CHIRON-ORTHO JOINT BUSINESS In 1998, 1997 and 1996, Chiron's 50% share of
the pretax operating earnings of the Chiron-Ortho joint business was $73.5
million, $92.9 million and $95.8 million, respectively. At the end of each year,
the joint business records an annual inventory adjustment. As Chiron recognizes
revenues from the joint business on a lag basis, this adjustment is typically
made during the first quarter of each year. In 1998, the annual inventory
adjustment for 1997 resulted in a $4.1 million charge as compared with $0.8
million of income in 1997 and $3.8 million of income in 1996. Other items
contributing to the decrease in earnings in 1998 as compared with 1997 were (i)
lower foreign profits of the joint business due to the adverse impact of changes
in foreign currency exchange rates between years and higher manufacturing costs;
(ii) certain one-time contract termination fees; and (iii) certain joint
business asset write-offs related to the implementation of certain processes to
comply with stricter FDA guidelines mandated throughout the industry.
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 5 of NOTES TO CONSOLIDATED FINANCIAL STATEMENTS). From
July 1, 1996 through the first quarter of 1998, equity in earnings of
unconsolidated joint businesses included Chiron's 49% share of the after-tax
operating results of Chiron Behring. Chiron's share of earnings of the joint
venture, including amortization of intangibles, was $2.4 million for the three
months ended March 31, 1998, $13.8 million for the year ended December 31, 1997
and $4.2 million for the six months ended December 31, 1996. Beginning March 31,
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 attainment of specified milestones. 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 year are not necessarily indicative of results to be achieved in the
future. The Company's ability to generate additional collaborative agreement
revenues may depend, in part, on its ability to initiate and maintain
relationships with potential and current collaborative partners. There can be no
assurance that such relationships will be established or that current
collaborative agreement revenues will not decline. Significant fluctuations in
collaborative agreement revenues from year-to-year are discussed below.
NOVARTIS AG Chiron and Novartis AG ("Novartis") entered into an agreement
under which Novartis agreed to provide research funding for certain projects.
The funded projects currently consist of adult and pediatric vaccines,
Insulin-Like Growth Factor-I, Factor VIII and Herpes Simplex Virus-thymidine
kinase ("HSV-tk"). Novartis has agreed to fund, at Chiron's request and subject
to certain annual and aggregate limits, up to 100% of the development costs of
these projects incurred between January 1, 1995 and December 31, 1999. Under
this agreement, in 1998, 1997 and 1996, Chiron recognized collaborative
agreement revenues of $54.4 million, $53.3 million and $72.0 million,
respectively.
Under the terms of a November 1995 agreement with Novartis, Chiron granted
Novartis a license to utilize Chiron's combinatorial chemistry techniques. In
exchange for this license,
24
Novartis agreed to pay Chiron $26.0 million over a five-year period, subject to
certain adjustments. In addition, this agreement provides for research funding
by Novartis, and certain upfront, milestone and royalty payments, as well as
product commercialization rights for both parties. In connection with this
agreement, Chiron recognized collaborative agreement revenues of $6.0 million,
$10.2 million and $9.4 million, in 1998, 1997 and 1996, respectively.
In November 1996, Chiron and Novartis entered into a consent order with the
Federal Trade Commission pursuant to which Chiron agreed to grant a
royalty-bearing license to Rhone-Poulenc Rorer, Inc. under certain Chiron
patents related to the HSV-tk gene in the field of gene therapy. Chiron and
Novartis entered into a separate agreement which provided, among other things,
for certain cross licenses between Chiron and Novartis, and under which,
Novartis agreed to pay Chiron up to $60.0 million over five years. In connection
with this agreement, Chiron recognized collaborative agreement revenues of $15.0
million in both 1998 and 1997.
JAPAN TOBACCO In 1996, Japan Tobacco licensed Chiron's combinatorial
chemistry technologies for use in its research and development programs. The
agreement, which was terminated in 1998, included certain funding for Chiron's
effort in transferring the technology. Revenues recognized under this agreement
were $1.0 million, $7.8 million and $7.7 million in 1998, 1997 and 1996,
respectively.
GREEN CROSS OF JAPAN In 1995, Green Cross of Japan agreed to reimburse
Chiron for certain HIV research, product development and clinical trials. In
1998, the clinical trials related to this collaboration were discontinued. In
1998, 1997 and 1996, Chiron recognized revenues related to this agreement of
$1.2 million, $5.4 million and $9.2 million, respectively.
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. In 1998, 1997 and 1996, Chiron recognized royalty and license fee
revenues of $125.3 million, $50.4 million and $36.6 million, respectively.
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
year are not necessarily indicative of results to be achieved in the future. In
addition, the Company's ability to generate additional royalty and license fee
revenues may depend, in part, on its ability to market and capitalize on its
technologies. There can be no assurance that the Company will be able to do so
or that future royalty and license fee revenues will not decline. Significant
fluctuations in royalty and license fee revenue from year-to-year are discussed
below.
ROCHE PCR AGREEMENT In accordance with a July 1991 agreement with F.
Hoffman-LaRoche Ltd. and its affiliates ("Roche"), the Company receives
royalties on sales of polymerase chain reaction ("PCR") products sold by Roche.
In 1998, Chiron recognized $15.2 million of royalty and license fee revenues
related to this agreement. Based on the terms of the agreement, Chiron does not
earn royalties on PCR products until Roche's annual net sales of PCR products
and services exceed $200.0 million (the "threshold amount"). As the threshold
amount resets at the beginning of each year, Roche's annual net sales must
exceed $200.0 million before Chiron will earn any royalties. As a result, the
Company does not expect to recognize royalties under this agreement until the
last half of each year. This agreement expires upon the earlier of December 31,
2000 or Chiron's recognition of an aggregate net present value of $30.0 million
as of the date of the agreement (discounted at 14.0%).
25
BAYER CROSS-LICENSE AGREEMENT In connection with the sale of Chiron
Diagnostics to Bayer, Chiron granted to Chiron Diagnostics rights under certain
Chiron patents, including patents relating to HIV and hepatitis C virus. In
exchange for these rights, Chiron Diagnostics paid to Chiron a license fee of
$100.0 million which is refundable in decreasing amounts over a period of three
years. In 1998, Chiron recognized revenues of $13.3 million which represents the
portion of the $100.0 million payment which became non-refundable during 1998.
The Company anticipates recognizing the remaining revenue over a period of three
years as follows: $39.2 million in 1999, $29.2 million in 2000, and $18.3
million in 2001.
LICENSE FEE REVENUES In January 1998, Chiron recognized $5.0 million of
revenues from a license fee related to an exclusive collaboration to research,
develop, manufacture and commercialize therapeutic and prophylactic products for
the treatment of hepatitis C in humans. In August 1998, Chiron recognized a
$24.0 million license fee under an agreement related to certain technologies
used in human vaccine products, including hepatitis B vaccine. Chiron will
receive future royalties related to this agreement and recognized $3.7 million
of such royalties in 1998.
OTHER In 1998, Chiron recognized $9.4 million of royalty and license fee
revenues due to the acquisition and consolidation of Chiron Behring in the
second quarter of 1998. In addition, royalties earned on Schering AG's European
sales of Betaferon(R) (interferon beta-1b) increased $4.5 million in 1998 as
compared with royalties earned in 1997 due to continued market expansion. The
increase in royalty and license fee revenues in 1997 as compared with 1996 is
primarily due to (i) an increase of $10.5 million related to royalties earned on
Schering AG's European sales of Betaferon(R), which sales began in the second
quarter of 1996; and (ii) an increase of $5.7 million from royalties received
from Merck & Co., Inc. for sales of hepatitis B recombinant vaccines.
OTHER REVENUES In 1998, 1997 and 1996, Chiron recognized other revenues of
$48.3 million, $50.1 million and $33.9 million, respectively. 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
other revenues will not decline. Significant fluctuations in other revenues from
year-to-year are discussed below.
COMMISSION REVENUES In 1998, other revenues included $18.0 million of
commission revenues generated by Chiron Behring, whose operations were
consolidated with those of the Company beginning in the second quarter of 1998.
These revenues consist of commissions received on sales made by Chiron Behring
of Pasteur Merieux Merck's hepatitis B product and of Centeon Pharma GmbH's
immunoglobulines products.
INFORMATICS TECHNOLOGY In connection with the sale of Chiron Diagnostics to
Bayer, Chiron recognized net revenues of $12.5 million in exchange for granting
Bayer a license to use, reproduce and sell certain technology developed by
Chiron's informatics business. The Company does not anticipate future revenues
from this technology, if any, to be commensurate with that achieved in 1998.
AREDIA(R) (PAMIDRONATE DISODIUM FOR INJECTION) From 1994 through April
1998, Chiron promoted Aredia(R) on behalf of Novartis. In April 1998, this
arrangement was terminated. In
26
connection with this arrangement, Chiron recognized other revenues of $9.8
million, $43.6 million and $30.2 million in 1998, 1997 and 1996, respectively.
COSTS AND EXPENSES
GROSS PROFIT Gross profit as a percentage of net product sales was 55.4%,
55.1% and 51.8%, in 1998, 1997 and 1996, respectively. Although 1998 gross
profit as a percentage of net product sales remained relatively constant with
that in 1997, the Company's 1998 gross profit percentage was impacted by (i) a
reduction in cost of sales of $6.0 million due to a change in estimated property
tax accruals created in prior periods; and (ii) an unfavorable mix of vaccine
products which, beginning in the second quarter of 1998, includes low margin
products manufactured and sold by Chiron Behring. In 1997, improvements in gross
profit as compared with 1996 primarily related to the mix of products sold,
which reflects the Company's first sales of PDGF. The increase in gross profit
percentage was partially offset, however, by charges recorded in 1996 related to
inventory reserves and temporarily idled manufacturing facilities in Italy. The
Company's gross profit percentages may fluctuate significantly in future periods
as the Company's product mix continues to evolve.
RESEARCH AND DEVELOPMENT In 1998, 1997 and 1996, Chiron recognized research
and development expenses of $294.2 million, $259.4 million and $248.8 million,
respectively. The Company's research and development expenses may fluctuate from
year-to-year depending upon the level of clinical trial-related activities. In
1998, the increase in research and development spending as compared with 1997
was primarily related to several of the Company's projects entering into later
stage clinical development. In addition, included in research and development
expense in 1998 was $14.1 million of expense generated by Chiron Behring, which
was acquired and consolidated during the second quarter of 1998. These increases
were partially offset by decreased spending related to Myotrophin(R) (rhIGF-I or
mecasermin [recombinant DNA origin]) due to the uncertainty surrounding the
FDA's approval of this product (refer to Item 1. Business).
In 1997, the Company incurred an aggregate increase of $10.6 million in
research and development expenses, as compared with 1996, related to
collaborative agreements regarding Myotrophin(R) and certain genetic targets for
the treatment of cancer. In addition, in 1997, the Company incurred increased
spending related to genomics and gene therapies research as compared with 1996.
These increases in research and development expenses in 1997 were partially
offset by decreased spending related to Tissue Factor Pathway Inhibitor (TFPI)
which was in a phase 1 clinical trial in 1996.
OTHER OPERATING EXPENSES In 1998, 1997 and 1996, Chiron recognized selling,
general and administrative ("SG&A") expenses of $140.4 million, $106.9 million
and $103.5 million, respectively. The increase in SG&A expenses in 1998 as
compared with 1997 is primarily due to the acquisition and consolidation of
Chiron Behring, which contributed $34.3 million to SG&A expenses in 1998.
As circumstances dictate, the Company reviews the carrying amount of its
manufacturing facilities by comparing the facilities' projected undiscounted net
cash flows against their respective carrying values. In 1997, the Company
recognized a $31.3 million impairment loss to record the Puerto Rico facility
and related machinery and equipment assets at their individual estimated fair
market values, determined on the basis of independent appraisals. There can be
27
no assurances that future impairment losses will not be incurred as the Company
continues to assess its operational efficiencies.
During 1998, Chiron incurred net restructuring and reorganization charges of
$26.8 million related to (i) the integration of the Company's worldwide vaccines
operations; (ii) the closure of the Puerto Rico and St. Louis, Missouri
facilities; and (iii) the Company's ongoing rationalization of its U.S. business
operations. The restructuring and reorganization charges consisted of $23.3
million of employee-related costs to eliminate 400 positions in sales, marketing
and other administrative, manufacturing and research and development functions
and $7.1 million of facility-related costs. These charges were partially offset
by a benefit of $3.7 million 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. The Company anticipates that it will record additional
restructuring and reorganization liabilities in future periods as it continues
to create a simpler, more efficient operating structure for the organization.
The liabilities related to the restructuring and reorganization expenses are
expected to be substantially settled within one year of accruing the related
charges.
NON-OPERATING INCOME AND EXPENSE
In August 1998, Chiron completed the sale of its manufacturing facility in
St. Louis, Missouri, resulting in a gain on sale of assets of $1.5 million. In
addition, in June 1998, the Company sold its fill and finishing facility in
Puerto Rico, resulting in a gain of $6.2 million.
In 1998, 1997 and 1996, Chiron recognized interest expense of $24.7 million,
$31.6 million and $29.5 million, respectively. The decrease in interest expense
in 1998 as compared with 1997 is primarily due to the repayment of $100.0
million on the Company's lines of credit in January 1998. The borrowings were
outstanding under the Company's U.S. credit facilities and were repaid with a
portion of the proceeds received from the sale of Chiron Vision.
Other income, net, consists primarily of investment income on the Company's
cash and investment balances and other non-operating gains and losses. In 1998,
1997 and 1996, Chiron recognized interest income of $29.6 million, $12.0 million
and $5.9 million, respectively. The increase in interest income in 1998 as
compared with 1997 is primarily due to higher average cash and investment
balances attributable to the net cash proceeds received from the sale of Chiron
Vision in the first quarter of 1998 and Chiron Diagnostics in the fourth quarter
of 1998.
In connection with its research and development collaborations, the Company
may invest in equity securities of its collaborative partners. The price of
these securities is subject to significant volatility. In 1998, 1997 and 1996,
Chiron recognized a loss attributable to the other-than-temporary impairment of
certain of these equity securities of $8.4 million, $1.2 million and $1.5
million, respectively.
In 1998 and 1997, Chiron recognized gains of $4.5 million and $5.5 million
related to the sale of certain equity securities. No significant gains related
to equity securities were recognized in 1996.
On December 31, 1998, Chiron completed the sale of its 30% interest in
General Injectibles & Vaccines, Inc. ("GIV"), a distribution business, to Henry
Schein, Inc. and received payment in full of certain advances made by the
Company to GIV, for a total of $31.7 million in cash. The sale resulted in a net
gain of $1.8 million. In 1996, Chiron sold its 50% interest in a
28
generic cancer chemotherapeutics business to Ben Venue Laboratories, Inc. for
$14.0 million in cash, resulting in a gain of $12.2 million.
In 1998, the annual tax provision was 25.8% of pretax income from continuing
operations, excluding restructuring and reorganization charges, a financial
reporting gain on sale of the Puerto Rico facility, and $6.0 million of
financial reporting income recognized in 1998 due to a change in estimated
property tax accruals. The reported effective tax rate for 1998 was 20.0% of
pretax income from continuing operations, including the impact of certain
prepaid income subject to tax in the current year ($31.5 million), the tax
effect of the reversal of certain accruals and the tax loss on the sale of the
Puerto Rico facility ($6.0 million) and the recognition of additional domestic
deferred tax benefits ($39.7 million). The Company has utilized substantially
all of its net operating loss and tax credit carryforwards for federal income
tax purposes as a result of the sales of Chiron Vision and Chiron Diagnostics.
The actual 1997 annual effective tax rate was 20.2%, exclusive of the impact of
the impairment loss which did not create a corresponding income tax benefit. The
increase in the effective tax rate of 5.6% in 1998 as compared with 1997, as
adjusted above, is primarily due to the tax effect of certain prepaid income,
partially offset by a higher proportion of non-U.S. income subject to tax at
lower rates and additional recognition of deferred tax assets. In 1996, the
provision for income taxes consisted primarily of foreign taxes related to the
Company's vaccines operations and U.S. alternative minimum taxes.
NEW ACCOUNTING STANDARD
In June 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards ("SFAS") No. 133, "Accounting for Derivative
Instruments and Hedging Activities" ("SFAS 133"), which is effective for all
quarters of fiscal years beginning after June 15, 1999. SFAS 133 establishes
accounting and reporting standards for derivative instruments, including certain
derivative instruments embedded in other contracts, and for hedging activities.
In accordance with SFAS 133, an entity is required to recognize all derivatives
as either assets or liabilities in the statement of financial position and
measure those instruments at fair value. SFAS 133 requires that changes in the
derivative's fair value be recognized currently in earnings unless specific
hedge accounting criteria are met. Special accounting for qualifying hedges
allows a derivative's gains and losses to offset related results on the hedged
item in the income statement, and requires that a company formally document,
designate, and assess the effectiveness of transactions that receive hedge
accounting. The Company is currently evaluating the effect that implementation
of SFAS 133 will have on its results of operations and financial position and
anticipates that it will implement SFAS 133 during the first quarter of 2000.
LIQUIDITY AND CAPITAL RESOURCES
Chiron's capital requirements have generally been funded from operations,
cash and investments on hand, debt borrowings, issuance of common stock and
off-balance sheet financing. Chiron's cash and investments in marketable debt
securities, which totaled $1.6 billion at December 31, 1998, 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.
29
SOURCES AND USES OF CASH Chiron had cash and cash equivalents of $513.3
million and $98.5 million at December 31, 1998 and 1997, respectively. In 1998,
net cash provided by operating activities was $231.7 million as compared with
$149.5 million in 1997. The increase in cash provided by operating activities
was largely due to increased profitability in 1998 as compared with 1997.
In 1998, net cash provided by investing activities consisted of proceeds of
$1.3 billion from the sale of Chiron Vision and Chiron Diagnostics, $282.7
million from the sale and maturity of investments in marketable debt securities
and an aggregate $62.7 million from the sale of assets, equity securities and
interest in an affiliated company. These inflows of cash were partially offset
by the purchase of Chiron Behring of $54.8 million (net of cash acquired),
capital expenditures of $126.3 million and purchases of investments in
marketable debt securities of $1.2 billion. In 1997, the Company sold its
interest in its worldwide Quality Controls business for $29.9 million and had
proceeds of $120.3 million from the sale and maturity of investments in
marketable debt securities. These inflows of cash were offset by purchases of
investments in marketable debt securities of $219.5 million and capital
expenditures of $77.5 million.
In 1998, net cash used in financing activities primarily consisted of the
repayment of $137.5 million of short-term borrowings offset, in part, by $66.6
million from the issuance of common stock. In 1997, net cash provided by
financing activities consisted of $61.5 million from the issuance of common
stock and $20.6 million from the issuance of short-term debt, offset, in part,
by the repayment of $32.3 million on the Company's notes payable and capital
leases.
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 and provides
various borrowing rate options, as defined in the agreement. This credit
facility matures in February 2003. There were no borrowings outstanding under
this credit facility at December 31, 1998. The Company had an additional credit
agreement which expired unused in March 1999. Chiron also has credit facilities
outside the U.S. which allow for total borrowings of $64.2 million. Under these
credit facilities, $17.6 million of borrowings were outstanding at December 31,
1998.
LEASES Chiron leases laboratory, office and manufacturing facilities, land
and equipment under noncancelable operating leases, which expire through 2037.
Future minimum lease payments are estimated to be approximately $115.7 million
in the aggregate, excluding a residual value guarantee of $172.6 million due
upon termination of an operating lease in 2003. As of December 31, 1998,
Novartis had guaranteed $152.9 million of the Company's operating lease
commitments (refer to Note 8 of the NOTES TO CONSOLIDATED FINANCIAL STATEMENTS).
OTHER COMMITMENTS Effective July 1, 1998, Chiron and International Business
Machines Corporation ("IBM") entered into a ten-year information technology
services agreement under which IBM will provide Chiron with a full range of
information services. Chiron can terminate this agreement beginning July 1,
1999, subject to certain termination charges. If Chiron does not terminate this
agreement prior to its expiration, payments to IBM are expected to be
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approximately $138.8 million in the aggregate. Through July 1, 1999, Chiron's
payments to IBM will total $19.3 million. Payments to IBM are subject to
adjustment depending upon the level of services and infrastructure equipment
provided by IBM.
In future periods, the Company expects to incur substantial capital
spending. At December 31, 1998, the Company had various firm purchase
commitments totaling approximately $3.4 million. Contingent liabilities, both
individually and in the aggregate, were insignificant at December 31, 1998.
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. These activities are discussed in further detail in Item
7A., "Quantitative and Qualitative Disclosures About Market Risk."
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 example, "00" may be read as the year 1900 when the year 2000 is intended).
This could result in significant system failures or miscalculations.
Accordingly, the Company has developed a comprehensive risk-based plan designed
to make its computer hardware and communication systems, software applications,
and facilities and other non-information technology-related functions Year 2000
compliant. The plan covers three phases including (i) planning, (ii) assessment,
and (iii) implementation. The Company has completed the planning and assessment
phases, and expects to complete the implementation phase by mid-1999. With
regard to the Company's computer hardware and communication systems, Chiron is
in the process of implementing a technology refresh program which was developed
in conjunction with IBM to update and standardize the Company's computer
hardware and communication systems. As a result of this program, the Company
expects its computer hardware and communication systems to be Year 2000
compliant by mid-1999. With regard to the Company's software applications, the
Company has identified critical and non-critical software applications and is in
the process of updating and/or developing software applications or certifying,
in a test environment, that the software applications are Year 2000 compliant. A
major component of remediating non-compliant software applications is the design
and implementation of an integrated information system. The Company anticipates
that implementation of this integrated information system will be completed by
mid-1999. With regard to the Company's facilities and other non-information
technology-related functions, including research, manufacturing, and inventory
management practices, the Company has performed an assessment and has begun
remediation which is intended to make its facilities and other non-information
technology-related functions Year 2000 compliant by mid-1999.
The Company is currently utilizing both internal and external resources to
prepare for the year 2000. 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. However, even with
substantial completion of internal remediation plans, the Company's customers,
suppliers and distributors also present risk of their own Year 2000 compliance
over which the Company has no control. The Company has initiated communications
with its critical suppliers and other external relationships to determine the
extent to which the Company may
31
be vulnerable to such parties' failure to resolve their own Year 2000 issues.
Where practicable, the Company is assessing and attempting to mitigate its risks
with respect to the failure of these entities to be Year 2000 compliant. The
effect, if any, on the Company's results of operations from the failure of such
parties to be Year 2000 compliant, cannot be reasonably estimated.
The Company is also implementing contingency plans to address any Year 2000
issues that do arise. As part of the Company's contingency plans, the Company is
implementing specific plans for each critical system to ensure that the
necessary precautions are taken to prevent and/or address an unexpected system
failure. Many of these contingency plans are already in place as they are based
on existing plans that are required for the safe and proper operation of the
Company's business, including its research and manufacturing facilities.
The SEC has requested that companies disclose the most likely worst case
scenario that could occur as a result of the Year 2000. The Company believes
that its most likely worst case scenario would be delays in product shipments
due to a complete or partial manufacturing shutdown and/or the delayed
implementation of the Company's integrated information system. To address the
manufacturing shutdown scenario, the Company plans, among other things, to
increase its inventory and re-prioritize staff assignments, as needed, and does
not believe that such a scenario is likely to occur. With regard to the delayed
implementation of the Company's integrated information system, the Company has
established a contingency plan to remediate its non-compliant business systems
if scheduled milestones are not met. To date, all significant milestones have
been met, and as a result, the Company has not implemented its contingency plan.
Although the Company is maintaining its ability to implement this contingency
plan, based on the Company's progress to date, and in consideration of the
amount of resources allocated to this project, the Company believes that
implementation of its integrated information system will occur substantially as
scheduled.
The Company may incur significant costs in identifying and resolving Year
2000 issues, including internal staffing costs as well as consulting and other
expenses. In addition, in certain instances, the appropriate course of action
includes replacing or upgrading systems or equipment at a substantial cost to
the Company. Failure of the Company to successfully complete its implementation
of an integrated information system, which is a key element in the Company's
Year 2000 remediation program, may have a material adverse impact on the
Company's operations. The Company currently estimates that the costs associated
with preparing for the year 2000 will approximate $7.5 million. The costs
associated with 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. Costs incurred through December 31, 1998 have been funded through
operations and approximate $1.0 million. The Company anticipates that most of
its Year 2000 costs will be incurred during the first half of 1999. These costs
are anticipated to be funded with cash on hand and cash generated through
operations.
EURO CONVERSION On January 1, 1999, eleven European Union member countries
established fixed conversion rates between their existing currencies ("legacy
currencies") and one common currency, the Euro. The Euro is currently traded on
currency exchanges and can be used in business transactions. The Company's
financial systems are Euro ready as of December 31, 1998. However, the Company
is still in the process of evaluating the effect, if any, of the Euro on the
Company's product pricing and gross profit percentages.
32
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, that 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 which appear promising.
These technologies 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 which 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 effect), or that it raises safety concerns or
has other side effects which outweigh the intended benefit. Success in
preclinical or early clinical trials (which generally focus on safety issues)
may not translate into success in large scale clinical trials (which are
designed to show efficacy), often for reasons that are not fully understood. And
even after a product is approved and launched, general usage or post-marketing
studies may identify safety or other previously unknown problems with the
product which may result in regulatory approvals being suspended, limited to
narrow indications or revoked or which otherwise prevent successful
commercialization.
REGULATORY APPROVALS
The Company is required to obtain and maintain regulatory approval in order
to market most of its products. Generally, these approvals are on a
product-by-product and country-by-country basis and, in the case of therapeutic
products, a separate approval is required for each therapeutic indication. See
Item 1, "Business--Government Regulation".