Novartis AG (NVS) 2003 Q4 法說會逐字稿

Good afternoon.

My name is Shayla (ph), and I will be your competence facilitator today.

At this time, I would like to welcome everyone to the Chiron fourth-quarter full year 2003 financial results conference call.

All lines have been placed on mute to prevent any background noise. (Operator Instructions).

I would now like to turn the call over to Martin Forrest, VP of Corporate Communications and Investor Relations.

Please go ahead, sir.

Thank you, Shayla.

Good afternoon and welcome to Chiron's fourth-quarter 2003 conference call.

On behalf of the Chiron team, I would like to introduce you to our principal speakers, Howard Pien, Chiron's CEO and President; and David Smith Chiron's CFO.

I'm Martin Forrest from the Investor Relations and Corporate Communications group.

Marty Vier (ph) and the Investor Relations team will be available after the call today to answer any questions that you might have.

Before I turn the call over to Howard for his discussion of Chiron's results, I would like to remind you that our remarks today will include forward-looking statements relating to future events in the financial performance of the Company.

Actual events and performance may differ materially from our expectations.

We refer you to the documents that the Company has filed with the Securities and Exchange Commission which are available through our website at Chiron.com.

These include the 2002 10-K reports and the third quarter 10-Q report.

For 2003 10-K report will be available shortly.

All the filings include information under the headings factors that affect future results in the end G&A portion of the documents.

This information identifies important factors that could cause the Company's actual performance to differ from current expectations.

Please note that where we indicate a number to be pro forma in today's discussion, we have made a reconciliation of pro forma to GAAP in the condensed consolidated statement of operations attached to our press issued today.

The reconciliation for the fourth quarter, along with a reconciliation of pro forma to GAAP for prior courses is also available on website.

Consisting with SEC regulation FD, we did not undertake any obligation to update the forward-looking information we're giving today.

Finally, please note that this call is being electronically recorded and is copyrighted by Chiron.

No reproduction, retransmissions, transcripts or copies of this conference call can be made without written permission of Chiron.

With that as a preface, I will turn the call over to you, Howard.

Thank you.

Good afternoon and thank you for joining our call.

Today, Chiron announced its fourth quarter earnings results.

In today's call I want to talk to you about our accomplishments in 2003 and the goals by which you can measure us by in 2004.

Following these, David Smith will walk you through the details from the quarter and full year.

But, let me start with just a remark on earnings.

Today, we reported fourth quarter pro forma net income from continuing operations of 29 cents per share.

Our results for the full year were $1.54, up 19 percent from 2002.

Revenues increased 7 percent year-over-year to $1.8 billion -- the highest in Chiron's 22-year history.

All three business units performed well this quarter and our earnings for the year reflected growth with each one of our business units.

Our strong sharing is a tribute to our ability to deliver great financial results while making key investments in our business units to create future value for shareholders.

At the same time, we were able to invest in the areas that we discussed in the last quarter's call.

As we move into 2004, we will continue to fulfill our investment agenda while aiming for long-term EPS growth rate of 20 percent.

We recognize that we exceeded our stated earnings for 2003.

We will providing you with updated guidance on the third quarter call, we explained that it was predicated upon our commitment to an investment agenda.

Nearly all of the items on that investment agenda which ended in our guidance in October, had revealed themselves and expenses have been or will be taken in relationship to where these items actually fell -- either before or after the end of the year.

We have began the year with important developments that portend a bright year ahead.

I will now outline a few of these developments.

To start with, the current core of our sliding broadcasting business is our NTT franchise.

We have multiple goals and milestones to achieve in 2004.

One, were expecting geographic growth for the Procleix HIV HCV assay and several new countries including Poland, Greece, Korea, and Thailand.

Two, the Procleix assay has received CE markings (ph), thus opening the way to full commercialization of the product in Europe.

The addition of the Hep-B test, the assay will be an important advantage for the test and we expand into the Pacific Rim and Latin America where HIV is (indiscernible).

Three, we have begun clinical trials for our trio in the U.S., and expect to file a VLA for our trio this year.

Four -- we're expecting a clinical trial to begin in the U.S., for our West Nile virus assay.

Five, with our partner GenProbe (ph), we're expecting clinical trials to begin for the Tigress (ph) fully automated system, a key in enabling technology for individual builder testing.

Clinical trials for our trio will be conducted on Tigress.

Beyond (indiscernible), we have made investments to expand our business into the broader realm blood safety.

Since we already have 80 percent of the U.S.

NAT market, we clearly understand the need of our customers and we are rising to meet them.

Our agreement with IDI brings us a bacterial detection system in platelets.

With the potential to reduce time for results from two days to one -- an important advantage for clinical tests to be processed, shipped and used with in just five days.

This system could be on the market as soon as 2005.

As we are in collaboration -- also recently announced -- with XyQuest (ph), we have the potential to develop a system to preserve blood to universal donor type O. This technology could greatly reduce mismatching of blood, helping to reduce blood shortages and reduce the number of donations (indiscernible) if the blood type is not matched against the patient's need.

Combining these expansions into blood safety with our existing NAC franchise, should help our blood testing business reach $800 million in revenue in the next five years.

Now, on to our vaccine system.

As you all know, Chiron's entry into the U.S. flu market flue markets during a season of heightened awareness of the dangers of flu has made the Company nearly a household name.

The public is increasingly conscious of the value vaccination presenting a common and potentially deadly disease.

And we are working to help meet the public health needs.

Our flu virus production for the '03 '04 season in the U.S. represented a 50 percent increase over production of the previous season.

And this was achieved while the powder jack (ph) acquisition was being integrated.

This is a significant accomplishment and testimony to the dedication and professionalism of our employees.

The next '04 '05 season, we project that we will be able to produce approximately 50 million doses of the virin (ph), the vast majority of which is destined for the US.

Chiron is committing approximately $100 million to our Liverpool flu vaccination manufacturing facility.

The investment will allow for an incremental increase in our production, with greater efficiency and greater capacity.

Chiron is also preparing to enter phase III testing for our flu cell culture vaccine.

Cell culture vaccine production potentially has greater flexibility.

Cell culture will be an important complement to the existing egg base technology which is likely to remain a key component of the flu vaccine manufacturing for many years to come.

We provide -- and not only have we acquired a great product with tremendous potential for growth, we have also established a beachhead in the important U.S. market.

One of our goals for '04 is to strengthen a commercial vaccine organization in the U.S., in preparation for the advancement of our intucrokal (ph) vaccine.

We anticipate that we will be filing a VLA for Menjugate, our mencine (ph) vaccine in 2004.

Our next step forward will be to continue to advance the program for our ACWY vaccine through which phase III.

And finally were continuing development of a broad coverage menbe (ph) vaccine to complete a full suite of Menjugate coccal (ph) vaccines that represent a $1 billion plus opportunity.

Now, on to our biopharmaceutical business.

With our new leadership team in place, we believe that the biopharma pipeline line now represents a clear set of opportunities for a short-term and long-term growth.

In 2004, we're focusing on two major phase III programs a potential pivotal phase II program, and an NDA submission.

The aerosol cyclosporine or CSI is a potential treatment for lung transplant rejection.

With about 1,100 lung transplants in the U.S. each year, and a five-year mortality rate approaching 50 percent, this is a well-defined population with a significant unmet medical need.

Preliminary analysis of the data indicate the possibility of a substantial reduction in mortality after lung transplant with the use of CSI.

Our goal is to submit the NDA for CSI this year.

Another important near-term opportunity is bathroom license (ph), for which we license commercialized last year, in Europe and several other ex-U.S. territories.

We are in the process of determining the regulatory past with European registration and will soon reach a decision with our partner cubists (ph).

Again, this is a hospital-based process that will leverage our sales force's existing relationship with existing customers.

We will also investing to expand our TOBI franchise and (indiscernible) CS patients.

TPI, a dry powder formulation of TOBE, will reduce administration time and increase convenience, which will encourage greater compliance amongst CS patients.

We are anticipating phase I results for TBN in the first half of the year and -- based on our understanding from the FDA -- may move directly into phase III testing by year's and.

In the longer term, we have several significant opportunities.

Hiebert Kogen (ph) for patients with severe community acquired pneumonia could address a major unmet need.

The plan to initiate phase III trials in the spring and in March we will be holding a conference called the Details of Program, and the protocol for you.

Besides an infectious disease, we have four developments in oncology.

We just announced our progress with Proleukin in combination with in patients with non-Hodgkin's lymfola (ph).

In the current phase II trial with epoxy Matlin's flactre (ph) patients, we have seen endurable responses in the population in which this responses are not (technical difficulty) effective.

We studied the patients and have identified a specific subpopulation with particular genotypes.

Based on these high-quality responses, we're our expanding enrollment of this trial to confirm our hypotheses on which patients are best suited for treatment.

We have submitted an abstract to Asco (ph) to detail these findings.

In addition, we are broadening the scope of our development of Proleukin plus etoxinad (ph) by initiating a randomized controlled base II trial in the tuskinad naease (ph) patients in this particular patient subgroup.

We want to determine if Proleukin plus or teximad (ph) as potential as an early treatment option.

Another significant development in oncology is GFKI 258 growth fact kardos inhibitors (ph), 258.

Our first small molecule oncology compound.

Phase I trials for this compound began this month.

We expect to file an AND for a spec and oncology compound the anti CD 40 (ph) this year.

These advances, we believe, strongly foretell the vibrancy of our pipeline.

In 2004, we will have 20 (ph) important goals and milestones, of which 10 will be pipeline advances and progressions. 6 of these 10 will be advances for biopharmaceutical.

Representing the early but convincing strength of our labor to sharpen the focus of our development effort.

As you can see, 2004 promises to be an exciting year for us in all three of our businesses.

We are off to a great start.

Now, I would like to turn the call over to David, for a detailed discussion of the fourth quarter financial results.

Thanks, Howard.

I will begin with a review of the results for both the quarter and the full year, which were released today at approximately 1 PM Pacific standard time.

All earnings per share amounts discussed today refer to the pro forma diluted per share earnings.

As we have discussed previously, we present our financial results on both an as reported GAAP basis and a pro forma basis.

The adjustments we made this year to arrive at pro forma earnings consist of a write-off of purchase and process technologies.

Related to the powder jet acquisition, the amortization expense on acquired identifiable intangible assets, related to acquisitions, plus the Biogen and Ceyrona (ph) settlements in connection with the McCormick patent and discontinued operations.

The adjustments in 2002 consisted of the write-off of purchased and process technologies related to the matrix acquisition, the amortization expense, and acquired identifiable intangible assets related to acquisitions and discontinued operations.

A reconciliation between our GAAP and pro forma results can be found on our website at Chiron.com.

For the year, Chiron reported pro forma income from continuing operations of 297 million, or $1.54 per share.

This result exceeded our guidance and was approximately 19 percent higher than the earnings per share of $1.29 reported in 2002.

For the fourth quarter, Chiron reported pro forma income from continuing operations of 29 cents per share.

Total revenues for 2003 increased 37 percent, or 1.8 billion from 1.3 billion for 2002.

Product revenues increased 47 percent to 1.3 billion from 914 million, reflecting our acquisition of powder jack during the third quarter.

The continued weakening of the dollar against the Euro had a favorable impact on our topline.

Net of foreign exchange revenues increased 29 percent year-over-year.

Total revenues for powder jets for 2003 were 245 million.

Net of powder jet and FX, our total revenues increased 11 percent year-over-year.

Increases in product sales were seen across all three of our business units, in particular, flu vaccines and Procleix.

Revenues from our joint business arrangement with Ortho clinical diagnostics were also up.

Royalty and license fees, collaborative agreement revenues, and other revenues, increased 16 percent, primarily due to HCV and HIV product royalties, and license fees, from our intellectual property portfolio and Betaseron royalties.

Gross margins decreased to 58 percent from last year's gross margins of 63 percent, largely due to change in the product mix from our three business units.

Research and development expenses for 2003 totaled 410 million, up 26 percent from 2002 with powder jack contributing about 5 percent.

This is an indication of our increased level of investment across all three of our business units.

The main beneficiaries of this increase include our Menjugate coccal (ph) vaccines franchise, flu cell culture, typikogen (ph), and interleukin II in combination with various monoclonal antibody's.

The additional components of the investment agenda, includes expenses related to the in licensing of daptamaricine (ph) and technology from Seng quest XyQuest and IDI.

SG&A expenses for 2003 totaled 379 million, up 34 percent for 2002, with powder jacks contributing approximately 40 percent of the increase for the current year.

Integration related expenses were 12 million for the year -- approximately half of our total expected integration expenses.

We expect that we will continue to incur integrated related expenses through mid 2004.

Our full year effective tax rate was 25 percent.

Now, I would like to move onto a review of the business unit financial results, starting with our blood testing units.

Blood testing total revenues, including product sales, Chiron's share of revenues from our joint business arrangement with Ortho, collaborative agreement revenues, and royalty and license fees, increased to 422 million in 2003 from 316 million in 2002, a 34 percent increase.

Driving this growth was a full year commercial pricing for product sales of Procleix in the United States, the Procleix West Nile virus available assay investigational only basis in the U.S.

Market share gains in the U.S. for product sales of Procleix, a continued penetration into several markets abroad.

Also contributing to the increase was higher royalty revenue for the use of HCV and HIV intellectual property, related to NAT testing, and higher revenues from our joint business arrangement.

Turning now to vaccines -- we saw excellent results in vaccines this year, returning the value of our purchase of powder jack.

In 2003, total product revenues for the vaccines business were 678 million, versus 357 million last year.

Powder jack products revenues were 243 million in 2003.

Total flu sales for 2003 increased 269 percent to 332 million over 2002.

Total Fluad sales were 219 million for the year, while Chiron flu vaccine sales were 113 million for the year.

On a pro forma basis, the year-over-year increase in flu sales was 44 percent.

Menjugate performed well in 2003, primarily as a result of sales to Australia.

Menjugate sales were 66 million, up 19 percent from 2002.

Sales of our travel vaccines were 88 million in 2003, up 37 percent in 2002.

The instapur (ph) vaccine was the principal growth driver, as it had a very successful year in the German market.

Sales of pediatric and other vaccines were 192 million in 2003, up 30 percent from 2002.

The increase was largely driven by tender sales of our pediatric vaccines and increased sales following our acquisition of powder jack.

Gross profit for vaccines was 53 percent, down from 58 percent in 2002.

The decrease was primarily due to the onetime effect of additional costs reflected in 2003, associated with a fair value of inventory acquired during the acquisition of powder jack.

Moving to our third business, biopharmaceutical.

Total biopharmaceuticals product revenues -- including Betaseron royalties -- were 503 million in 2003, up from 456 million in 2002, a 10 percent increase.

We saw increases in TOBI and Betaseron sales, while Proleukin sales were consistent with 2002.

Our TOBI sales were 172 million, up 17 percent from 2002, largely due to the progress of TOBI across Europe and price increases.

2003 sales of Betaseron, including the royalty earned from sale of Betaseron by sharing in Europe, were 189 million, versus 165 million last year -- an increase of 14 percent.

This increase was primarily driven by increased patient demand, price increases, and the benefit of foreign exchange rates.

These increases were partially offset by a decline in product sales, and Betaseron royalties, in the fourth quarter of 2003.

Pursuant to our agreement with sharing and changes in wholesale ordering patterns.

Sales of Proleukin were 115 million, essentially consistent with 2002 -- mostly due to price increases and increased patient demand in the U.S., offset by wholesale ordering patterns.

Wholesaler inventory levels remained in line with our expectations.

Gross margins in the biopharmaceutical segment were 72 percent.

Now, in summary, let me take a moment to highlight our view of 2003 and what to look forward to in 2004.

2003 was an important year for Chiron, a year in which we delivered solid financial growth, while advancing long-term value creation propositions.

The acquisition of powder jacks positioned us as a major player in the growing U.S. flu market.

Blood testing saw the introduction of testing for the Procleix West Nile virus assay under an AND (ph).

And growth in key markets, including the United Kingdom.

We strengthened our biopharma management team, and enlicensed CSI and dapta Meyerson (ph) two products with near-term market potential.

We beat our guidance for 2003 by 4 cents, and in doing so performed ahead of our expectations.

There were two principal reasons for this.

The first relates to the timing of certain tenders from vaccines that we had expected in 2004.

Secondly as Howard mentioned, we began execution of our enhanced investment agenda, some of which occurred in 2003.

Our achievements during the year testified to Chiron's unique ability to deliver solid financial results while funding exciting new opportunities.

We're pleased with our accomplishments so far and look forward to discussing additional opportunities as 2004 moves along.

We have no change in our 2004 EPS guidance of $1.80 to $1.90 -- but I would be remiss if I didn't mentioned, as I have in the past, that given the seasonal nature of our business, and the edition of powder jack related expenses, and our investment agenda, we expect second half earnings per share to be significantly higher than the first half.

Indeed, 2004 is shaping up to be another strong year.

We have already announced two important investments in our blood testing business, have secured CD (ph) marking for our Procleix Oltrio (ph) and AT test.

We have announced our goal to produce 50 million doses of flu Verein (ph) for 2004 and 2005 flu seasons.

And I have made plans to launch a pilot universal program against MD (ph) in New Zealand (ph).

We've also seen encouraging phase II data from our Proleukin retoxymad (ph) trial.

Underlying all of our achievements is our investment agenda.

As we did in 2003, we will invest in opportunities to grow all three businesses.

And we will do so while aiming for 20 percent long-term EPS growth.

The power of Chiron's business model will allow us to deliver solid financial results, while creating long-term value for our shareholders.

At this point, I will turn back over to Martin for Q&A.

Thinks David.

That includes our prepared remarks.

Now I would like to open up the call for questions.

In order to accommodate as many individuals as possible, we will answer only one question from each caller.

We're joined for the Q&A session by Jack Goldstein, President of our blood testing business, Trey Wheeler, President of our biopharmaceuticals business, John Lambert President of Chiron vaccines, Pieter Strijkert, VP of scientific affairs for vaccines, and Stephen Willy (ph), SVP for development of biopharmaceuticals.

Operator, we will take our first question

At this time (Operator Instructions).

Thomas Wei, Piper Jaffray.

I wanted to ask, just in terms of the quarters -- you've clearly always had a much heavier second half EPS balance than the first half.

I'm just curious, given the very third and fourth quarter addition of the powder jack sales and the additional R&D and SG&A infrastructure for powder jack, that would be more of a year-round expense -- is it reasonable to assume that the first and second quarter EPS should be a lot lower this year than in previous years?

I think, certainly, Thomas -- we are the skewing of the seasonality is likely to be more pronounced -- we are more revenue loaded on the backside and probably more expense loaded on the front end.

I think this year's 40 percent first half and a 60 percent second half -- or something that range.

So, when you look at the advancement of the investment agenda, you look at the opportunities in our investment -- in our own organic growth -- the commercial opportunities for vaccines for the U.S. -- things of that nature.

In my mind, it would be expected that we would be the first half the lower contributions than the second half.

But we're still obviously very comfortable with our overall guidance for the year.

Craig Parker, Lehman Brothers.

I'm trying to understand what the sort of the run rate for the R&D expense is.

So is it possible to quantify, I guess, the -- what you might call the onetime partnering component of R&D expense for the quarter?

Craig, the way that we're looking at the guidance for operating expenses in total, we're talking about 10 percent growth on a year-over-year basis.

So the best base I would be to use the full year operating expense and then extrapolate off of that.

Jennifer Chao, RBC Capital Markets.

With respect to flu Viren, could you just discuss what manufacturing improvements are assumed for producing the projected 50 million doses for the '04, '05 flu season?

And whether these improvements are subject to critical FDA inspections and approvals and if so, when are these expected to take place?

Since these improvements come about by using (indiscernible) Chiron expertise in producing flu and using the same processes within (indiscernible) within (inaudible) Liverpool.

We're fairly confident we're going to reach the 50 million doses level.

During the time of the acquisition, we had an FDA inspection of Liverpool, which confirmed that the facilities were really in very good order.

We don't expect any reinspections next year.

So we're confident of the 50 million doses this year.

Mike King, Banc of America Securities.

I wanted to ask you to perhaps put into perspective the competitive situation with Menjugate vis a vis manactra (ph) -- and given that manactra is already quadravalent (ph), does it make sense to file Menjugate when you have a ACYW on track for filing later in the year?

This is John here.

I'm fine with that.

Menjugate is going to be filed in 2004.

And we're going to file its outbreak situation.

I think this situation in the U.S., as many countries face, is a shortage of the numbers of clients of (ph) vaccines.

You need slightly more people you have to producing vaccines -- I think the better it is to help the people.

So bearing in mind that we're launching Menjugate for a breakout situation, important thing also for us the good entry into the meningitis market in the U.S.

We are in the use of a -- something through (inaudible) build on from that.

Geoffrey Porges, Sanford Bernstein.

Follow up question on the expenses.

Could you just give me some guidance as to the change in the gross margins in the vaccine business and how much of that is a function of the onetime effect of the powder jack acquisition and the inventory there?

And what sort of gross margins we should be looking at in the vaccine business overall going forward?

Thank you.

I will answer that on kind of an overall basis.

Obviously, there was an effect for the fair value of inventory as it relates to the powder jack acquisition.

For the overall corporation, that was probably about 2 points (indiscernible) and for vaccines it was about somewhere around 3 plus points in that regard.

So if you're looking at margins for the Corporation on a go forward basis, our guidance would be kind -- was at or slightly lower -- it would be reasonable to take that 2 points of downdraft out when making that type of a calculation.

Eric Schmidt, SG Cowen & Co.

Good afternoon, my question is for Howard on the long-term growth guidance of 20 percent.

Could you comment on whether that's completely from organic growth, or maybe includes some mixed acquisitions and if so, what you might think the organic growth for the Company is?

Look, I (technical difficulty) if you just look at we have done in 2003 and maybe 2002, there is ample indications as to the ways that we're going to achieve growth.

Certainly, a big part of the growth engine will be the intern (ph) opportunities that we talked about the drivers in the vaccines business, in terms of flu and in terms of the Menjugate coccal (ph) franchise, and then we talked about NAT, and the blood testing business and how that is now going to be adjacent area of blood safety and donation -- universalization.

And our pharmaceutical business with highlight these opportunities both short-term in terms of line extension, claim extensions, and long-term in terms of new products -- especially with ipecoven (ph) and with the oncology pipeline, which we have a great deal of excitement.

So, that's one big bucket -- the internal opportunities -- as there are, certainly, acquisitions of products and rights and businesses, that our recent history has suggested that we have the capability of being successful.

In the rights and products area, you saw the microsporin (ph) you saw the rapper meisen (ph).

I think both of these examples demonstrate our capability to identify opportunities with which we can exploit value creation with of very small amount of incremental resources.

So that's -- certainly in the case of business acquisition you saw this -- what is announced to a transforming acquisition, in the form of powder jack, which is not just financial importance, but also important in strategic terms.

And then of course -- there's the opportunity of going after the partnership of licenses.

And the two most recent ones in the blood testing area was Unquest (ph) and IDI -- speak to that kind of intended capability of executing a very clever deals where we know how value can be created and with a minimal amount of competition that can see actual value.

So, it's not going to come from one single area.

In all three realms -- rights, businesses and then partnership alliances, and the internal growth.

I think we have clear opportunities and clear capabilities of creating value.

So, thank you, Eric, for the question.

Mark Augustine, Credit Suisse First Boston Corporation.

I thought a comment was made about the timing of tenders for vaccines that had been expected in '04 landing in '03.

Can you elaborate and then tell us what growth rate you forecast for the vaccine revenues in '04?

Sure, let me take that first, and John, if you have anything you want to add, go ahead.

There was -- there were -- there was a tender that did occur in 2003 that we had anticipated in 2004, that related to insafor (ph).

The guidance that we gave on the third quarter was that we would see the vaccines organization for non-flu related in the mid teens, in terms of growth, and we still think that that's a reasonable growth rate.

Caroline Lowy, Morgan Stanley.

Caroline, are you there?

Sorry about that.

I was just curious if you could expound a little more on what your plans are for expanding the vaccine sales and marketing operations and whether direct sales of flu vaccine would be dependent on expanded product line ads like the Mense (ph), and what we might see in terms of spending and ramp up of that process?

I look at the (indiscernible) from the commercial side.

We're currently setting up an operation on the East Coast in Philadelphia -- we just chose the brand-new head of the U.S. operation.

As you quite rightly say -- the main business would be through flu, then meningitis as we go forward.

We're studying flu very successfully at the moment through our distributor networks.

We're very pleased that situation.

The new head of New York operations will be developing our future strategy for the global vaccine business in the U.S., so I'm still very positive at the moment.

The new office in Philadelphia should be operational -- April, May this year.

Fully starts out.

And just (indiscernible) the clarification.

Can you tell us what we might see in terms of timing and amount of both ramp up and cost, or a step up in revenues related to price increase catch-ups, or better value that you're able to extract?

I think that would be looking somewhere way head for 2004.

We're very much, in terms of pricing -- we have price agreements.

We have contractual agreements with our distributors.

So we won't see an increase in pricing there.

We do have this opportunity that if prices do increase in the free market, there is a sharing of the additional pricing.

Mirad Tobad (ph), CBS.

I know people have asked this question in different versions, but when I look and compare your third quarter to your fourth quarter of '03 the number I'm sort of seeing is almost identical -- and you even have more high margin of Menengal (ph) vaccine in the fourth quarter and therapeutics was slightly higher.

So, I find it somewhat striking that your growth margin have declined so dramatically.

Relative to fourth quarter, relative to the third quarter.

So my basic question is, what is the correct run rate, or the correct measurement, the third or the fourth?

Mirad, this is David.

I think you have to look at it on a full year basis.

A couple of factors that occurred from the third to the fourth quarter one, the biopharmaceuticals margins are down.

This is the beginning as it relates doing one syringe, which we have highlighted in the past, which is at a higher cost of goods rate, as well as the effect that happened in the fourth quarter of the contractual reduction in the rate as it relates to Betaseron.

So that both of those have an effect at bringing down some of the margins as well.

And in vaccines we also saw the absorption of the flu facility in terms of the timing of the cost related to that flu facility over in the UK.

So you have to look at on a full year basis, and that's why we said, really, when you look at the margin at about 58, you've got to factor out about 2 points related to the fair value of inventory to get a more prospective run rate.

But you need to take into consideration the effect on Betaseron on a full year basis next year, and what it will mean with the margins, which is why we got it to at or slightly lower.

Elise Wang (ph), Smith Barney.

Can you hear me?

Just to come back on some of the comments on operating expenses.

I know what your overall guidance is, but, just to fine-tune that a little bit -- coming back to the R&D trends we're seeing on spending.

Obviously there was a fairly sizable number that you recorded this past quarter.

And just to understand -- what is the appropriate run rate to look upon for the R&D spending sides, and do have a number of significant clinical studies that you've been talking about either conducting or about to start?

Again, I will go back to what we talked about a little bit earlier where the guidance that we gave on an overall operating expense basis was off of the full year of 2004, up by approximately 10 percent, so it's about -- you can look at on a line by line basis, but our guidance would be on overall basis to look at it that way.

So there's no -- I'm just try to get a better sense of the pattern, because it does imply that spending level on the R&D side will go down quarter-by-quarter from the fourth quarter.

Was there some one timers that you recorded in the fourth quarter?

Well, there certainly were some events -- as we highlighted, Daptdemiasine (ph) and the XyQuest and IDI are in that, but we think that the overall full year number depends -- if you take that up, as we have guided on overall operating expenses, about 10 percent -- that's probably reasonable.

All right.

Okay.

Alright, thank you very much.

Greg West from A.G. Edwards.

It's actually Alex here.

I'm curious about the Betaferon (ph) deal term change.

Did that hit and did it apply fully across the quarter, or did it come into play either in a ramp or part way into the quarter.

Alex, it's David, it actually came into play during the quarter.

So you didn't see a full quarter's effect as it came into play.

Okay, so we should see more?

Well, the expectation is that you know you'll see a full year, obviously, next year of it and we didn't have a full quarter so -- depending upon run rates, some of the opportunities, again, we're just launching Julio and syringe (ph) and there is some -- there is obviously some mitigating factors that we may see, but we're still pretty comfortable with the guidance that we gave off of product sales that mathematically down about 18 percent in royalties, down in the 30 percent range.

Thank you.

May-Kin Ho, Goldman Sachs.

Can you tell me for the market that you intend to go into this year for the phase tests -- for example, Korea and all that outlined, what is the opportunity there?

Jack?

Sure.

Of the total -- the total opportunity in the countries that we talked about -- that's Korea, Thailand, Poland and Greece.

Korea collects 2.5 million units of blood.

Thailand 1.2 million.

Poland about 1 million and Greece about 600,000.

So, all told, it's a fairly significant opportunity.

Having said that, most of these countries are not going to go all at once.

I think that they will start in some of the larger cities and then rollout to some of the smaller cities over the next couple of years.

What about pricing?

Worldwide pricing is holding.

Probably a little bit less than the U.S., but overall not significantly different.

Thank you.

Michael Myers, Serbian capital.

Simple question.

When is the earliest that we might see Chiron in Japan for blood screening vis-a-vis the Roche contract?

Jack?

Well I will take that one too.

Well, we're currently selling "blood screening products" that are used by the Japanese Red Cross for confirmation of positive tests that are gotten both with competitive NAT tests as well as with Siyrology (ph) tests.

They are currently using our HCV and HIV individual tests for confirmation.

They're currently in the trial with our altrio (ph) for blood screening, as well as our HBB for confirmation.

We expect that we'll probably see some additional confirmatory testing this year, and probably through 2005 -- until the Roche contract is up in 2006 for the blood screening segment.

And Jack, just as a corollary to that, if the confirmatory tests are earlier than through '05, is it possible that we could see you in Japan in '05?

Well (multiple speakers).

You'll see us in confirmatory testing in -- in currently in '04 and in 05.

We can't predict what is going to happen with blood screening in Japan.

Obviously, we're there, and as soon as we are able to get some business, we are ready to service the Japanese Red Cross and they understand that.

Thank you.

Thomas Wei, Piper Jaffray.

I had a follow-up question on the Fuji H3 and 2 strain (ph).

Can you just confirmed for us that there is a commercial strain that is available, if it's chosen for the '04, '05 vaccine, and whether or not you have any metrics on how well that strain grows?

Bruce?

We do it for to project, Thomas, at a strain would be available, and don't at this point foresee issues with respect to flow ability.

I'm sorry Bruce, could you take another try it that.

You came through garbled and maybe you could get a little bit closer to the microphone?

Sorry.

Thomas.

Thanks for the question.

Yes, a strain would be available and we don't, at this point, project problems in terms of growability.

In fact, some of those factors are taken into account in making the public health recommendations.

Thanks.

Geoffrey Porges, Sanford Bernstein.

Just another question on market expansion for the twisting (ph) business.

Could you describe the process for securing royalties from the home brew testers in Germany, and give us some sense of, realistically, how long that could take, and how much incremental revenue it could contribute?

I'll let you take that one.

We have Jack on a remote line -- Jack, did you hear the question?

Otherwise we will restate it.

Yes, the question was with regard to royalties from home breweries in Germany?

Can you hear?

Can you hear me?

Okay.

So we're currently in discussions with the German Red Cross and all of the home brewers in Germany as well as in Scotland, and some other countries in the European Union.

We believe that we will receive some royalties from licenses in some of those countries -- some of the German blood banks are have already signed licenses agreements with us, and we will see some royalties in 2004 from those centers.

We believe we will see them from some centers from the centers in Scotland as well, and we will see what happens with the German Red Cross.

I believe that we will come to some agreement with the German Red Cross sometime this year.

And we will see a combination of royalty revenues as well as commercial revenues from some of those centers.

Germany represents a little over 4 million units of blood

Great.

Thanks a lot.

Mere Octobat (ph), UPS.

This sort of a follow-up question but going back to the 05 time period, where the distribution is going with power jets had signed with Henry Schein (ph) expires.

I was wondering -- could we expect a significant improvement or some improvement in economics, considering that the agreement with Henry Schein was signed with power jet many years ago -- where power jets has no way to distribute it themselves?

John?

The strategy after 2005, is under review with our new head of the U.S.

But we still have a very good agreement in place with Scheiner and the other distributors.

We're for the most part, as I said, very happy with the arrangement.

But could there be improved economics, not in '04 but 05?

I think if you renegotiate any contract, there can always be improvement to economics.

But this is going the under review by our new head.

Okay, thank you.

Mark Augustine, Credit Suisse First Boston Corporation.

That Eugene strain (ph) sounds vaguely familiar.

I wanted to ask a question about the testing with Proleukin and Retuxin (ph).

Can you tell us more about what your genotypic analysis has identified in the subset of patients most likely to respond to the combination and what percentage of total treated patients you estimate that to include?

well I -- it's a Stephen Willy here.

I'm not going to comment on the specifics of it because this is a subject of an abstract that we have into Ascot (ph) and I want preserve the ability to talk about it there and publish it fully.

What I will say is that we have really been following a very logical scientific track here.

We have identified a subgroup, based on a very plausible argument around the mechanism of action of (indiscernible) in combination with antibodies that work via the (indiscernible) mechanism.

So it really does fit with the translational biology that the people are talking about at the moment.

It is significant subset of the population, both in the refractory setting, and also in the first line -- the exact distribution is also going to be part of the subject of our astral abstract.

So really it's much (indiscernible) talking much more detail in the middle of the year.

Great.

Look forward to it.

Thank you.

Jennifer Chao, RBC capital markets.

Jack, I was just wondering -- in order to help us quantify progress, could you just provide current Procleix penetration rates in your key EU and Pacific Rim markets and any notable increases seen in the fourth quarter?

Thanks.

Well I think at the J.P.

Morgan conference, we've talked about a worldwide share of 33 percent.

North of 80 percent in the U.S.

Approximately 27 percent in EU.

And 11 percent in Asia-Pacific.

But that does not include additional business in Thailand, and Korea that we are expecting, and also in the E.U. -- Poland and Greece.

Great thanks.

Andrew Gop (ph), OSS capital.

I just noticed that the royalties from Roche were down sequentially quite a bit, and that regarding that -- I just wonder if you could comment on that?

Sure, the royalties were down -- one thing you need to look at when you look at royalties, is really look at it on a full year over full year basis.

Royalties are up sharply for blood screening, related to Roche in that perspective and the -- the swings from quarter-to-quarter depend upon trueups and what we'll call a truedown since we book royalties on an estimated and then true it up the following quarter.

So, we are actually comfortable with the type of growth pattern we have seen out of the royalties on a 2003 over 2002 perspective.

So it doesn't mean that you are taking a lot of share from Roche?

We are 80 percent share in the U.S.

No, I mean worldwide.

We obviously continue to look for opportunities to take share, but I would not look at the sequential as being a hallmark of a substance of share gain in that perspective.

That's the longer-term.

Okay, thanks.

Operator, that concludes our question-and-answer period.

I'll now turn the call back to Howard for some closing remarks.

As we move forward in 2004, I just like you to think of Chiron as four numbers. 5,500, 20, 20, and 1. 5,500 stands for the number of Chiron employees that are dedicated to improving human health worldwide.

The first 20 stands for the 20 milestones that we have for 2004 to measure our own progress as a Company.

The second 20 stands for our 20 percent growth from EPS growth targets.

And the 1 stands for 1 Company committed to delivering financial results and long-term value creation.

On that note, I just want to thank you very, very much for joining us, and we look forward to being (indiscernible) 2004 to have more dialogue with you.