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U.S. SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549
 FORM 10-Q þ
    
    QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 For the quarterly period ended September 30, 2004 o
    
    TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 For the transition period from  to Commission file number 1-14131 ALKERMES, INC. 
  PENNSYLVANIA
    
    23-2472830(State or other jurisdiction of
incorporation or organization)
    
    (I.R.S. Employer
Identification No.)
 88 Sidney Street, Cambridge, MA
    
    02139-4136(Address of principal executive offices)
    
    (Zip Code)
 Registrants telephone number including area code: (617) 494-0171    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. þ o
 Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act). þ o
 The number of shares outstanding of each of the issuers classes of common
stock was: Class
    
    As of October 29, 2004Common Stock, $.01 par value
    
    
    89,734,798Non-Voting Common Stock, $.01 par value
    
    
    382,632




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ALKERMES, INC. AND SUBSIDIARIES INDEX  
 Page No.PART I  FINANCIAL INFORMATIONItem 1. Condensed Consolidated Financial Statements (Unaudited):Condensed Consolidated Balance Sheets  September 30, 2004 and March 31, 2004
    
    
    3Condensed Consolidated Statements of Operations  For the three and six months ended September 30, 2004 and 2003
    
    
    4Condensed Consolidated Statements of Cash Flows  For the six months ended September 30, 2004 and 2003
    
    
    5Notes to Condensed Consolidated Financial Statements
    
    
    6Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
    
    
    12Item 3. Quantitative and Qualitative Disclosures About Market Risk
    
    
    22Item 4. Controls and Procedures
    
    
    22PART II  OTHER INFORMATIONItem 1. Legal Proceedings
    
    
    23Item 4. Submission of Matters to a Vote of Security Holders
    
    
    23Item 6. Exhibits and Reports on Form 8-K
    
    
    24Signatures
    
    
    25Exhibit Index
    
    
    26EX-10.1 1999 STOCK OPTION PLAN, AS AMENDEDEX-31.1 SECTION 302 CERTIFICATION OF C.E.O.EX-31.2 SECTION 302 CERTIFICATION OF C.F.O.EX-32.1 SECTIOM 906 CERTIFICATION OF C.E.O & C.F.O.




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PART 1. FINANCIAL INFORMATION 
 Item 1. Condensed Consolidated Financial Statements (Unaudited): ALKERMES, INC. AND SUBSIDIARIES 
 CONDENSED CONSOLIDATED BALANCE SHEETS
(Unaudited) September 30,
    
    March 31,2004
    
    2004A S S E T SCurrent Assets:Cash and cash equivalents
    
    $
    19,633,686
    
    
    $
    9,898,648Investments  short term
    
    
    78,201,902
    
    
    
    134,037,415Receivables
    
    
    9,258,019
    
    
    
    11,526,280Prepaid expenses and other current assets
    
    
    1,982,713
    
    
    
    2,155,941Inventory
    
    
    2,919,271
    
    
    
    2,604,851Total current assets
    
    
    111,995,591
    
    
    
    160,223,135Property, Plant and Equipment:Land
    
    
    235,000
    
    
    
    235,000Building
    
    
    16,184,609
    
    
    
    15,718,268Furniture, fixtures and equipment
    
    
    63,717,497
    
    
    
    69,016,366Equipment under capital lease
    
    
    463,610
    
    
    
    463,610Leasehold improvements
    
    
    45,957,203
    
    
    
    56,808,710Construction in progress
    
    
    7,789,347
    
    
    
    3,489,296134,347,266
    
    
    
    145,731,250Less accumulated depreciation and amortization
    
    
    (44,046,974
    )
    
    
    (49,988,460
    )90,300,292
    
    
    
    95,742,790Restricted Investments  Long Term
    
    
    4,920,558
    
    
    
    5,011,630Other Assets
    
    
    7,055,631
    
    
    
    9,051,949Total Assets
    
    $
    214,272,072
    
    
    $
    270,029,504L I A B I L I T I E S  A N D  S H A R E H O L D E R S  E Q U I T YCurrent Liabilities:Accounts payable and accrued expenses
    
    $
    24,605,635
    
    
    $
    18,209,061Accrued interest
    
    
    264,370
    
    
    
    264,370Accrued restructuring costs
    
    
    1,502,727
    
    
    
    1,137,741Deferred revenue
    
    
    3,777,593
    
    
    
    17,173,618Derivative liability related to convertible subordinated notes
    
    
    1,960,000
    
    
    
    4,650,000Obligation under capital lease
    
    
    85,143
    
    
    
    81,596Total current liabilities
    
    
    32,195,468
    
    
    
    41,516,386Accrued Restructuring Costs
    
    
    2,443,639
    
    
    
    Obligation Under Capital Lease
    
    
    294,051
    
    
    
    337,52821⁄2% Convertible Subordinated Notes
    
    
    121,957,983
    
    
    
    121,569,64133⁄4% Convertible Subordinated Notes
    
    
    676,000
    
    
    
    676,000Convertible Preferred Stock, par value $.01 per share: authorized and issued, 3,000
shares at September 30, 2004 and March 31, 2004 (at liquidation preference)
    
    
    30,000,000
    
    
    
    30,000,000Shareholders Equity:Capital stock, par value, $.01 per share; authorized, 4,550,000 shares; issued, none;
(includes 2,997,000 shares of preferred stock)
    
    
    
    
    
    
    Common stock, par value $.01 per share;
authorized, 160,000,000 shares; issued and outstanding, 89,724,502 and
89,305,261 shares at September 30, 2004 and March 31, 2004, respectively
    
    
    897,246
    
    
    
    893,053Non-voting common stock, par value $.01 per share;
authorized, 450,000 shares; issued and outstanding, 382,632 shares at September 30, 2004
and March 31, 2004
    
    
    3,826
    
    
    
    3,826Additional paid-in capital
    
    
    628,998,738
    
    
    
    627,445,609Deferred compensation
    
    
    (62,899
    )
    
    
    (275,802
    )Accumulated other comprehensive income
    
    
    427,841
    
    
    
    1,010,621Accumulated deficit
    
    
    (603,559,821
    )
    
    
    (553,147,358
    )Total Shareholders Equity
    
    
    26,704,931
    
    
    
    75,929,949Total Liabilities and Shareholders Equity
    
    $
    214,272,072
    
    
    $
    270,029,504
 See Notes to Condensed Consolidated Financial Statements. (3)




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ALKERMES, INC. AND SUBSIDIARIES 
 CONDENSED CONSOLIDATED STATEMENT OF OPERATIONS
(Unaudited) Three Months
    
    Three Months
    
    Six Months
    
    Six MonthsEnded
    
    Ended
    
    Ended
    
    EndedSeptember 30,
    
    September 30,
    
    September 30,
    
    September 30,2004
    
    2003
    
    2004
    
    2003Revenues:Manufacturing and royalty revenues
    
    $
    9,937,799
    
    
    $
    5,309,654
    
    
    $
    17,902,705
    
    
    $
    6,854,408Research and development revenue under collaborative arrangements
    
    
    8,096,553
    
    
    
    2,140,374
    
    
    
    11,606,083
    
    
    
    4,897,080Total revenues
    
    
    18,034,352
    
    
    
    7,450,028
    
    
    
    29,508,788
    
    
    
    11,751,488Expenses:Cost of goods manufactured
    
    
    2,389,834
    
    
    
    4,566,686
    
    
    
    7,631,090
    
    
    
    7,127,356Research and development
    
    
    22,589,911
    
    
    
    23,404,563
    
    
    
    46,721,939
    
    
    
    45,077,527Sales, general and administrative
    
    
    7,379,194
    
    
    
    5,918,053
    
    
    
    14,418,105
    
    
    
    11,698,651Restructuring
    
    
    
    
    
    
    
    
    
    
    11,896,341
    
    
    
    Total expenses
    
    
    32,358,939
    
    
    
    33,889,302
    
    
    
    80,667,475
    
    
    
    63,903,534Net operating loss
    
    
    (14,324,587
    )
    
    
    (26,439,274
    )
    
    
    (51,158,687
    )
    
    
    (52,152,046
    )Other income (expense):Interest income
    
    
    659,972
    
    
    
    668,248
    
    
    
    1,290,485
    
    
    
    1,643,409Other (expense) income, net
    
    
    (585,257
    )
    
    
    1,097,933
    
    
    
    (859,630
    )
    
    
    2,507,411Derivative income (losses) related to convertible notes
    
    
    1,172,000
    
    
    
    (900,000
    )
    
    
    2,690,000
    
    
    
    (4,664,437
    )Interest expense
    
    
    (1,186,582
    )
    
    
    (646,703
    )
    
    
    (2,374,631
    )
    
    
    (4,126,504
    )Total other income (expense)
    
    
    60,133
    
    
    
    219,478
    
    
    
    746,224
    
    
    
    (4,640,121
    )Net loss
    
    ($
    14,264,454
    )
    
    ($
    26,219,796
    )
    
    ($
    50,412,463
    )
    
    ($
    56,792,167
    )Net loss per common share, basic and diluted
    
    
    ($0.16
    )
    
    
    ($0.31
    )
    
    
    ($0.56
    )
    
    
    ($0.76
    )Weighted average number of common shares outstanding, basic and diluted
    
    
    90,066,806
    
    
    
    84,984,004
    
    
    
    89,930,029
    
    
    
    74,915,372
 See Notes to Condensed Consolidated Financial Statements. (4)




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ALKERMES, INC. AND SUBSIDIARIES 
 CONDENSED CONSOLIDATED STATEMENT OF CASH FLOWS
(Unaudited) Six Months
    
    Six MonthsEnded
    
    EndedSeptember 30,
    
    September 30,2004
    
    2003Cash flows from operating activities:Net loss
    
    
    ($50,412,463
    )
    
    
    ($56,792,167
    )Adjustments to reconcile net loss to net cash used by
operating activities:Depreciation and amortization
    
    
    5,440,647
    
    
    
    5,286,290Restructuring charges
    
    
    11,896,341
    
    
    
    Other noncash charges
    
    
    1,200,698
    
    
    
    2,240,859Losses (gains) on warrants held
    
    
    859,630
    
    
    
    (2,507,411
    )Derivative (gains) losses related to convertible notes
    
    
    (2,690,000
    )
    
    
    4,664,437Changes in assets and liabilities:Receivables
    
    
    2,268,261
    
    
    
    3,413,077Prepaid expenses and other current assets
    
    
    (141,207
    )
    
    
    (1,635,751
    )Accounts payable, accrued expenses and accrued interest
    
    
    6,396,574
    
    
    
    (1,225,549
    )Accrued restructuring costs
    
    
    (937,710
    )
    
    
    (919,783
    )Deferred revenue
    
    
    (13,396,025
    )
    
    
    (5,737,769
    )Net cash used by operating activities
    
    
    (39,515,254
    )
    
    
    (53,213,767
    )Cash flows from investing activities:Additions to property, plant and equipment
    
    
    (8,076,299
    )
    
    
    (9,755,515
    )Proceeds from sale of fixed assets
    
    
    13,900
    
    
    
    Proceeds from equipment sale-leaseback
    
    
    
    
    
    
    463,611Purchases of available-for-sale investments
    
    
    (12,909,948
    )
    
    
    (157,419,972
    )Sales of available-for-sale investments
    
    
    68,712,383
    
    
    
    57,331,448Increase in other assets
    
    
    (27,039
    )
    
    
    (248,491
    )Net cash provided by (used by) investing activities
    
    
    47,712,997
    
    
    
    (109,628,919
    )Cash flows from financing activities:Proceeds from issuance of common stock
    
    
    1,577,225
    
    
    
    1,199,421Proceeds
from issuance of 21⁄2% Convertible Subordinated Notes
    
    
    
    
    
    
    125,000,000Payment of long-term obligations
    
    
    (39,930
    )
    
    
    (7,806,221
    )Payment of
financing costs in connection with the 21⁄2% Subordinated Notes
    
    
    
    
    
    
    (3,861,863
    )Net cash provided by financing activities
    
    
    1,537,295
    
    
    
    114,531,337Effect of exchange rate changes on cash
    
    
    
    
    
    
    (31,626
    )Net increase (decrease) in cash and cash equivalents
    
    
    9,735,038
    
    
    
    (48,342,975
    )Cash and cash equivalents, beginning of period
    
    
    9,898,648
    
    
    
    72,478,675Cash and cash equivalents, end of period
    
    $
    19,633,686
    
    
    $
    24,135,700Supplementary information:Cash paid for interest
    
    $
    1,575,175
    
    
    $
    5,568,783Conversion of 6.52% Convertible Senior Subordinated Notes and interest into common stock
    
    $
    
    
    
    $
    177,264,308
 See Notes to Condensed Consolidated Financial Statements. (5)




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ALKERMES, INC. AND SUBSIDIARIES 
 NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Basis of Presentation The accompanying condensed consolidated financial statements of Alkermes, Inc.
(the Company) are unaudited and have been prepared on a basis substantially
consistent with the audited financial statements. The condensed consolidated
financial statements, in the opinion of management, include all adjustments
which are necessary to present fairly the results of operations for the
reported periods. The Companys condensed consolidated financial statements
are prepared in conformity with accounting principles generally accepted in the
United States of America (GAAP) and follow the requirements of Securities and
Exchange Commission (SEC) for interim reporting. These financial statements should be read in conjunction with the Companys
audited consolidated financial statements and notes thereto for the years ended
March 31, 2004, 2003 and 2002, which are contained in the Companys Annual
Report on Form 10-K for the year ended March 31, 2004, filed with the SEC. The results of the Companys operations for any interim period are not
necessarily indicative of the results of the Companys operations for any other
interim period or for a full fiscal year. Principles of Consolidation The condensed consolidated financial statements include the accounts of
Alkermes Controlled Therapeutics, Inc., Alkermes Controlled Therapeutics Inc.
II, Advanced Inhalation Research, Inc. (AIR®), Alkermes Investments, Inc.,
Alkermes Europe, Ltd and Alkermes Development Corporation II (ADCII), wholly
owned subsidiaries of the Company. Material intercompany accounts and
transactions have been eliminated. Use of Estimates The preparation of financial statements in conformity with GAAP necessarily
requires management to make estimates and assumptions that affect the
following: (1) reported amounts of assets and liabilities; (2) disclosure of
contingent assets and liabilities at the date of the consolidated financial
statements and (3) the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates. Reclassification Certain prior period amounts have been reclassified to conform to the current
period presentation. (6)




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2. COMPREHENSIVE LOSS Comprehensive loss for the three and six months ended September 30, 2004 and
2003 is as follows: Three Months


    
    Three Months
    

    Six Months
    

    Six MonthsEnded
    
    Ended
    
    Ended
    
    EndedSeptember 30,
    
    September 30,
    
    September 30,
    
    September 30,2004
    
    2003
    
    2004
    
    2003Net loss
    
    
    ($14,264,454
    )
    
    
    ($26,219,796
    )
    
    
    ($50,412,463
    )
    
    
    ($56,792,167
    )Foreign currency translation adjustments
    
    
    
    
    
    
    (13,341
    )
    
    
    
    
    
    
    (21,318
    )Unrealized (loss) gain on marketable securities
    
    
    (130,205
    )
    
    
    696,415
    
    
    
    (582,780
    )
    
    
    1,457,788Comprehensive loss
    
    
    ($14,394,659
    )
    
    
    ($25,536,722
    )
    
    
    ($50,995,243
    )
    
    
    ($55,355,697
    )
 3. NET LOSS PER COMMON SHARE Net loss per common share is computed by dividing the weighted-average number
of common shares outstanding for the period into net loss. For the three and
six months ended September 30, 2004 and 2003, the Company was in a net loss
position and, therefore, common equivalent shares are not included in the per
share calculation because their effect would be anti-dilutive. As such,
diluted net loss per common share is the same amount as basic net loss per
common share. Common stock equivalents result from the assumed exercise of
stock options and awards, and the assumed conversion of convertible preferred
stock, convertible senior subordinated notes and convertible subordinated
notes. The following table sets forth common stock equivalents which were excluded
from the computation of diluted net loss per common share for the three and six
months ended September 30, 2004 and 2003 as they would have had an
anti-dilutive effect due to net losses for such periods: 2004
    
    2003Stock options and awards (exercise prices
ranging from $0.30 to $96.88, with a weighted
average exercise price of $15.56 and $15.90 for
2004 and 2003, respectively)
    
    
    15,894,464
    
    
    
    14,248,312Shares
issuable on conversion of 33⁄4%
Convertible Subordinated Notes
    
    
    9,978
    
    
    
    9,978Shares
issuable on conversion of 21⁄2%
Convertible Subordinated Notes
    
    
    9,025,275
    
    
    
    9,025,275Shares issuable on conversion of Convertible
Preferred Stock
    
    
    2,547,879
    
    
    
    2,186,58927,477,596
    
    
    
    25,470,154
 4. STOCK-BASED COMPENSATION The Company grants stock options for a fixed number of shares to employees with
an exercise price equal to the fair market value of the shares at the date of
grant. The Company accounts for stock option and award grants to employees
using the intrinsic value method. The Company accounts for stock options and
awards to non-employees using the fair-value method. (7)




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Under the intrinsic value method, compensation associated with stock options
and awards to employees is determined as the difference, if any, between the
current fair value of the underlying common stock on the date compensation is
measured and the price an employee must pay to exercise the award. The
measurement date for employee awards is generally the grant date. Under the fair-value method, compensation associated with stock awards to
non-employees is determined based on the estimated fair value of the award
itself, measured using either current market data or an established option
pricing model. The measurement date for non-employee awards is generally the
date performance of certain services is complete. The following table illustrates the effect on net loss and net loss per common
share, basic and diluted, as if the fair-value based method had been applied to
all outstanding and stock options and awards in each period. Pro forma
information for the three and six months ended September 30, 2004 and 2003 is
as follows: Three Months Ended
    
    Six Months EndedSeptember 30,
    
    September 30,2004
    
    2003
    
    2004
    
    2003Net lossas reported
    
    ($
    14,264,454
    )
    
    ($
    26,219,796
    )
    
    ($
    50,412,463
    )
    
    ($
    56,792,167
    )Add: Stock-based employee
compensation expense as
reported in the condensed
consolidated statements
of operations
    
    
    83,500
    
    
    
    571,526
    
    
    
    161,003
    
    
    
    1,135,398Deduct: Total stock-based
employee compensation
expense determined under
fair-value based method
for all stock options and
awards
    
    
    (4,735,117
    )
    
    
    (5,326,649
    )
    
    
    (9,202,653
    )
    
    
    (10,910,320
    )Pro forma net loss
    
    ($
    18,916,071
    )
    
    ($
    30,974,919
    )
    
    ($
    59,454,113
    )
    
    
    ($66,567,089
    )Net loss per common share:Basic and diluted net
loss per common shareas
reported
    
    
    ($0.16
    )
    
    
    ($0.31
    )
    
    
    ($0.56
    )
    
    
    ($0.76
    )Basic and diluted net
loss per common sharepro
forma
    
    
    ($0.21
    )
    
    
    ($0.36
    )
    
    
    ($0.66
    )
    
    
    ($0.89
    )
 The fair value of stock options was estimated at the date of grant using the
Black-Scholes option-pricing model, assuming no dividends, and with the
following weighted average assumptions and the resulting weighted average fair
value per share of option granted during the period: Three Months
    
    Three Months
    
    Six Months
    
    Six MonthsEnded
    
    Ended
    
    Ended
    
    EndedSeptember 30,
    
    September 30,
    
    September 30,
    
    September 30,2004
    
    2003
    
    2004
    
    2003Expected life
(years)
    
    
    4
    
    
    
    4
    
    
    
    4
    
    
    
    4Risk-free interest
rate
    
    
    3.33
    %
    
    
    3.11
    %
    
    
    3.59
    %
    
    
    2.79
    %Expected stock
price volatility
    
    
    71
    %
    
    
    73
    %
    
    
    71
    %
    
    
    73
    %Weighted average
fair value per
share of options
granted during the
period
    
    $6.41
    
    $1.15
    
   $6.96
    
    $4.91
 (8)




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##### Table of Contents



5. RESTRUCTURINGS In August 2002, the Company announced a restructuring program to reduce the
Companys cost structure as a result of the financial impact of a delay in the
U.S. launch of Risperdal Consta by the Companys collaborative partner, Janssen
(the 2002 Restructuring). The restructuring program reduced our workforce by
122 employees, representing 23% of the Companys total workforce at that time,
and included consolidation and closure of certain leased facilities in
Cambridge, Massachusetts, closure of the Companys medical affairs office in
Cambridge, England, write-off of leasehold improvements at leased facilities
being vacated and reductions of other expenses. As of September 30, 2004, the
Company had paid in cash or written off an aggregate of approximately $1.5
million in employee separation costs and approximately $4.2 million in facility
closure costs in connection with the 2002 Restructuring. The amounts remaining
in the 2002 Restructuring accrual at September 30, 2004 related to facility
lease costs and are expected to be paid through fiscal 2006. In June 2004, the Company announced a restructuring program in connection with
the decision by Alkermes and Genentech to discontinue commercialization of
Nutropin Depot (the 2004 Restructuring). The decision was based on the
significant resources required by both companies to continue manufacturing and
commercializing the product. In connection with this decision, the Company
ceased commercial manufacturing of Nutropin Depot in June 2004, reduced the
Companys workforce by 17 employees, representing approximately 3% of the
Companys total workforce, and recorded restructuring charges in the quarter
ended June 30, 2004 of approximately $11.9 million under the caption
Restructuring in the consolidated statements of operations. The
restructuring charges consisted of approximately $0.2 million in employee
separation costs, including severance and related benefits, and approximately
$11.7 million in facility closure costs, including fixed asset write-offs and
estimates of future lease costs relating to the Companys ability to sublease
the exited facility through the end of its lease term, August 2008. In
addition to the restructuring charges recorded in the quarter ended June 30,
2004, the Company also recorded a one-time write-off of Nutropin Depot
inventory of approximately $1.3 million, which was recorded under the caption
Cost of goods manufactured in the consolidated statements of operations. As of September 30, 2004, the Company had paid in cash or written off an
aggregate of approximately $8.5 million in facility closure costs and $0.2
million in employee separation costs in connection with the 2004 Restructuring.
The amounts remaining in the 2004 Restructuring accrual at September 30, 2004
are expected to be paid out through fiscal 2009 and relate primarily to
estimates of lease costs associated with the exited facility. The following table displays the restructuring activities and liability
balances included in accrued restructuring costs: Balance
    
    
    
    
    
    
    
    
    
    
    
    
    
    BalanceMarch 31,
    
    
    
    
    
    
    
    
    
    Non-cash
    
    September 30,Type of Liability
    
    2004
    
    Charges
    
    Payments
    
    Write-downs
    
    20042002 RestructuringEmployee separation costs
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    Facility closure costs
    
    
    1,137,741
    
    
    
    
    
    
    
    (552,216
    )
    
    
    
    
    
    
    585,525$
    1,137,741
    
    
    $
    
    
    
    $
    (552,216
    )
    
    $
    
    
    
    $
    585,5252004 RestructuringEmployee separation costs
    
    $
    
    
    
    $
    146,112
    
    
    $
    (136,448
    )
    
    $
    
    
    
    $
    9,664Facility closure costs
    
    
    
    
    
    
    11,750,229
    
    
    
    (249,046
    )
    
    
    (8,150,006
    )
    
    
    3,351,177$
    
    
    
    $
    11,896,341
    
    
    $
    (385,494
    )
    
    $
    (8,150,006
    )
    
    $
    3,360,841Total
    
    $
    1,137,741
    
    
    $
    11,896,341
    
    
    $
    (937,710
    )
    
    $
    (8,150,006
    )
    
    $
    3,946,366
 (9)




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##### Table of Contents



6. INVENTORY Inventory is stated at the lower of cost or market. Cost is determined in a manner that approximates the first-in,
first-out method. The components of inventory consist of the following: September 30,
    
    March 31,2004
    
    2004Raw materials
    
    $
    1,090,044
    
    
    $
    1,146,854Work-in-process
    
    
    256,847
    
    
    
    1,037,045Finished goods
    
    
    1,572,380
    
    
    
    420,952$
    2,919,271
    
    
    $
    2,604,851
 In connection with the 2004 Restructuring,
the Company recorded a one-time
write-off of Nutropin Depot inventory of approximately $1.3 million in the
quarter ended June 30, 2004, which was recorded under the caption Cost of
goods manufactured in the condensed consolidated statements of operations. See
Note 5 for discussion on restructuring charges. 7. DERIVATIVES 21⁄2% Subordinated
Notes - In the event that an automatic conversion of the
21⁄2% Subordinated Notes due 2023 (the 21⁄2% Subordinated Notes) occurs
on or prior to September 1, 2006, the Company would be required
to pay additional interest in
cash or, at the Companys option in common stock, equal to three full years of
interest on the converted notes (the Three Year Interest Make-Whole), less
any interest actually paid or provided for on the notes prior to automatic
conversion. This Three-Year Interest Make-Whole provision represents an
embedded derivative that is required to be accounted for apart from the
underlying 21⁄2% Subordinated Notes. When the 21⁄2% Subordinated Notes were
issued, the Three-Year Interest Make-Whole had an estimated initial aggregate
fair value of $3.9 million, which reduced the amount of the outstanding debt
and was recorded as a derivative liability in the condensed consolidated
balance sheets. The $3.9 million initially allocated to the Three-Year Interest
Make-Whole feature has been treated as a discount on the 21⁄2% Subordinated
Notes and is being accreted to interest expense over five years through
September 1, 2008, the first date on which holders of the 21⁄2% Subordinated
Notes have the right to require the Company to repurchase the 21⁄2%
Subordinated Notes. The estimated fair value of the Three-Year Interest Make-Whole
feature is carried in the condensed consolidated balance sheets under
Derivative liability related to convertible subordinated notes and will be
adjusted to its fair value on a quarterly basis until it expires or is paid.
Quarterly adjustments to the fair value of the Three-Year Interest Make-Whole
are charged to Derivative income (losses) related to convertible notes in the
condensed consolidated statements of operations. During the three and six months ended September 30, 2004, the Company recorded
income of approximately $1.2 million and $2.7 million, respectively, in the
condensed consolidated statements of operations for changes in the estimated
value of the feature after issuance. The recorded value of the derivative
liability related to the 21⁄2% Subordinated Notes, approximately $2.0 million
at September 30, 2004, can fluctuate significantly based on fluctuations in the
market value of the Companys common stock. Warrants The Company recorded charges of approximately
$0.6 million and $0.9 million in the three and six months ended September 30,
2004, respectively, and gains of $1.1 million and $2.5 million in the
three and six months ended September 30, 2003, respectively, in other (expense) income, net in the condensed
consolidated statements of operations in connection with the changes in the
fair value of warrants held by the Company which were granted in connection
with licensing arrangements. The recorded value of such warrants can fluctuate
significantly based on fluctuations in the market value of the underlying
securities of the issuer of the warrants. At September 30, 2004, the warrants
had a fair value of approximately $2.1 million and were recorded under the
caption Other assets in the condensed consolidated balance sheets. (10)




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8. LITIGATION Beginning in October 2003, the Company and certain of its current and former
officers and directors were named as defendants in six purported securities
class action lawsuits filed in the United States District Court for the
District of Massachusetts. The cases were captioned: Bennett v. Alkermes, Inc.,
et. al., 1:03-CV-12091 (D. Mass.); Ragosta v. Alkermes, Inc., et. al.,
1:03-CV-12184 (D. Mass.); Barry Family LP v. Alkermes, Inc., et. al.,
1:03-CV-12243 (D. Mass.); Waltzer v. Alkermes, Inc., et. al., 1:03-CV-12277 (D.
Mass.); Folkerts v. Alkermes, Inc., et. al., 1:03-CV-12386 (D. Mass.); and
Slavas v. Alkermes, Inc., et. al., 1:03-CV-12471 (D. Mass.). On May 14, 2004,
the six actions were consolidated into a single action captioned: In re
Alkermes Securities Litigation, Civil Action No. 03-CV-12091-RCL (D. Mass.). On
July 12, 2004, a single consolidated amended complaint was filed on behalf of
purchasers of the Companys common stock during the period April 22, 1999 to
July 1, 2002. The consolidated amended complaint generally alleges, among other
things, that, during such period, the defendants made misstatements to the
investing public relating to the manufacture and FDA approval of the Companys
Risperdal Consta product. The consolidated amended complaint seeks unspecified
damages. On September 10, 2004, the Company and the individual defendants filed
a motion to dismiss all claims asserted against them in the consolidated
amended complaint in their entirety. Although the Company believes these
allegations are without merit and intends to vigorously defend against them,
the litigation process is inherently uncertain and there can be no guarantee as
to the ultimate outcome of these matters. From time to time, we may be subject to other legal proceedings and claims in
the ordinary course of business. We are not currently aware of any such
proceedings or claims that we believe will have, individually or in the
aggregate, a material adverse effect on our business, financial condition or
results of operations. 11




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##### Table of Contents



Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations Alkermes, Inc. (as used in this section, together with our subsidiaries, us,
we or our), a Pennsylvania corporation organized in 1987, is a
pharmaceutical company that develops products based on sophisticated drug
delivery technologies to enhance therapeutic outcomes in major diseases. Our
lead commercial product, Risperdal® Consta [(risperidone) long-acting
injection], is the first and only long-acting atypical antipsychotic medication
approved for use in schizophrenia, and is marketed worldwide by Jannsen-Cilag
(Janssen), a subsidiary of Johnson & Johnson. Our lead proprietary product
candidate, Vivitrex® [(naltrexone) long-acting injection], is a once-a-month
injection for the treatment of alcohol dependence. We have a pipeline of
extended-release injectable products and pulmonary drug products based on our
proprietary technology and expertise, ProLease and Medisorb for
extended-release of injectable drug products, and AIR® for inhaled drug
products. Our product development strategy is twofold: we partner our
proprietary technology systems and drug delivery expertise with several of the
worlds finest pharmaceutical companies and we also develop novel, proprietary
drug candidates for our own account. Our headquarters are in Cambridge,
Massachusetts, and we operate research and manufacturing facilities in
Massachusetts and Ohio. Since our inception in 1987, we have devoted a
significant portion of our resources to research and development programs and
the purchase of property, plant and equipment. At September 30, 2004, we had an
accumulated deficit of $603.6 million. We have funded our operations primarily through public offerings and private
placements of debt and equity securities, bank loans and payments under
research and development agreements with collaborators. We historically have
developed our product candidates in collaboration with others on whom we rely
for funding, development, manufacturing and/or marketing. While we continue to
develop product candidates in collaboration with others, we also develop
proprietary product candidates for our own account that we fund on our own. Forward-Looking Statements Any statements herein or otherwise made in writing or orally by us with regard
to our expectations as to financial results and other aspects of our business
may constitute forward-looking statements within the meaning of the Private
Securities Litigation Reform Act of 1995, including, but not limited to,
statements concerning future operating results, the achievement of certain
business and operating goals, manufacturing revenues, research and development
spending, plans for clinical trials and regulatory approvals, financial goals
and projections of capital expenditures, recognition of revenues, restructuring
charges in connection with the discontinuation of Nutropin Depot and future
financings. These statements relate to our future plans, objectives,
expectations and intentions and may be identified by words like believe,
expect, may, will, should, seek, or anticipate, and similar
expressions. Although we believe that our expectations are based on reasonable assumptions
within the bounds of our knowledge of our business and operations, the
forward-looking statements are neither promises or guarantees and our business
is subject to significant risk and uncertainties and there can be no assurance
that our actual results will not differ materially from our expectations.
Factors which could cause actual results to differ materially from our
expectations set forth in our forward-looking statements include, among others:
(i) Risperdal Consta and our product candidates (including our proprietary
product candidate, Vivitrex), if approved for marketing, may not be launched
successfully in one or all indications for which marketing is approved, and, if
launched, may not produce significant revenues; (ii) we rely on our partners to
determine the regulatory and marketing strategies for Risperdal Consta and our
other partnered programs; (iii) after the completion of clinical trials for our
product candidates (including our proprietary product candidate, Vivitrex) and
the submission for marketing approval, the FDA or other health authorities
could refuse to accept such filings or could request additional preclinical or
clinical studies be conducted, each of which could result in significant
delays, or such authorities could refuse to approve the product at all; (iv) we
may be unable to manufacture Risperdal Consta or to manufacture or scale-up our
future products, including our proprietary product candidate, Vivitrex, on a
commercial scale or economically and in addition, unexpected events could
interrupt manufacturing operations at our Risperdal Consta facility, which is
the sole source of supply for that product; (v) whether additional regulatory
approvals will be received or whether commercial launches of Risperdal Consta
in countries where it has been or may be approved occur in a timely or
successful manner; (vi) Risperdal Consta and our product candidates (including
our proprietary product candidate, Vivitrex), in commercial use, may have
unintended side effects, adverse reactions or incidents of misuse; (vii) we may
enter into a collaboration with a third party to market or fund a proprietary
product candidate, including our proprietary product candidate, Vivitrex, 12




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##### Table of Contents



and the terms of such a collaboration may not meet our expectations; (viii) our
delivery technologies or product development efforts may not produce safe,
efficacious or commercially viable products; (ix) our collaborators could elect
to terminate or delay programs at any time and disputes with collaborators or
failure to negotiate acceptable new collaborative arrangements for our
technologies could occur; (x) clinical trials may take more time or consume
more resources than initially envisioned; (xi) the risk that results of earlier
clinical trials are not necessarily predictive of the safety and efficacy
results in larger clinical trials; (xii) our product candidates could be
ineffective or unsafe during preclinical studies and clinical trials and we and
our collaborators may not be permitted by regulatory authorities to undertake
new or additional clinical trials for product candidates incorporating our
technologies, or clinical trials could be delayed; (xiii) the time and expense
required to discontinue commercialization of Nutropin Depot may be greater than
we anticipate; (xiv) we may not recoup any of our $100 million investment in
Reliant Pharmaceuticals, LLC (Reliant); (xv) the securities litigation
brought against us may result in financial losses or require the dedication of
significant management resources; (xvi) even if our product candidates appear
promising at an early stage of development, product candidates could fail to
receive necessary regulatory approvals, be difficult to manufacture on a large
scale, be uneconomical, fail to achieve market acceptance, be precluded from
commercialization by proprietary rights of third parties or experience
substantial competition in the marketplace; (xvii) technological change in the
biotechnology or pharmaceutical industries could render our product candidates
obsolete or noncompetitive; (xviii) difficulties or set-backs in obtaining and
enforcing our patents and difficulties with the patent rights of others could
occur; (xix) we may not become profitable and could continue to incur losses
for the foreseeable future; and (xx) we may need to raise substantial
additional funding to continue research and development programs and clinical
trials and could incur difficulties or setbacks in raising such funds. Critical Accounting Policies As fully described in the Management Discussion and Analysis section of the
Companys Annual Report on Form 10-K for the year ended March 31, 2004, we
consider our critical accounting policies to be:  
    
    Revenue recognition;
    
    Equity method investment in Reliant Pharmaceuticals, Inc.;
    
    Derivatives embedded in certain debt securities;
    
    Warrant valuations;
    
    Cost of goods manufactured and
    
    Research and development expenses. We recorded restructuring charges in the consolidated statements of operations
during the quarter ended June 30, 2004. As discussed below, we now consider our
accounting policy on restructuring to be a critical accounting policy. Restructuring We recorded restructuring charges in our consolidated
statements of operations in August 2002 in connection with a restructuring
program to reduce our cost structure as a result of the financial impact of a
delay in the U.S. launch of Risperdal Consta by our collaborative partner,
Jannsen (the 2002 Restructuring). We also recorded restructuring charges in
June 2004 in connection with the decision by Alkermes and Genentech to stop
commercialization of Nutropin Depot (the 2004 Restructuring). Charges recorded in the condensed consolidated statements of operations in
connection with the 2002 Restructuring and the 2004 Restructuring required that
management make estimates related to our ability to sublease exited facilities,
the rates at which we may be able to sublease exited facilities and the net
realizable value of certain fixed assets. See Results of
Operations below for additional information related to the 2002 Restructuring
and the 2004 Restructuring. 13




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##### Table of Contents



Results of Operations The net loss for the three months ended September 30,
2004 was $14.3 million or $0.16 per basic and diluted share as compared to a
net loss of $26.2 million or $0.31 per basic and diluted share for the three
months ended September 30, 2003. The net loss for the six months ended September 30,
2004 was $50.4 million or $0.56 per basic and diluted share as compared to a
net loss of $56.8 million or $0.76 per basic and diluted share for the six
months ended September 30, 2003. Total revenues were $18.0 million and $29.5 million for the three and six
months ended September 30, 2004, respectively, as compared to $7.5 million and
$11.8 million for the three and six months ended September 30, 2003,
respectively. Total manufacturing and royalty revenues were $9.9 million and $17.9 million
for the three months and six months ended September 30, 2004, respectively, as
compared to $5.3 million and $6.9 million for the three and six months ended
September 30, 2003, respectively. Total manufacturing revenues were $7.7 million and $13.9 million for the three
and six months ended September 30, 2004, respectively, all related to
manufacturing for Risperdal Consta. This is compared to $4.6 million and $5.6
million for the three and six months ended September 30, 2003, respectively,
including $4.5 million and $5.3 million, respectively, of manufacturing
revenues for Risperdal Consta. The increase in manufacturing revenues for the
three and six months ended September 30, 2004 as compared to the three months
ended September 30, 2003 was due to increased shipments of Risperdal Consta to
Janssen. Risperdal Consta is marketed in more than 35 countries. Under our
manufacturing and supply agreement with Janssen, we earn manufacturing revenues
upon shipment of product by Alkermes to Janssen based on a percentage of
Janssens net selling price. These percentages are based on the volume of
units shipped to Janssen in any given calendar year, with a minimum
manufacturing fee of 7.5%. We anticipate that we will earn manufacturing
revenues at an average of 8.2% of Janssens net sales price for Risperdal
Consta in the fiscal year ending March 31, 2005 as compared to 9.8% in the
fiscal year ended March 31, 2004. As discussed below, in the quarter ended
June 30, 2004, we ceased commercial production of Nutropin Depot and there were
therefore no manufacturing revenues earned during the three and six months
ended September 30, 2004 related to Nutropin Depot. Total royalty revenues were $2.2 million and $4.0 million for the three and six
months ended September 30, 2004, respectively, including $2.1 million and $3.8
million, respectively, of royalty revenues for Risperdal Consta. This is
compared to $0.7 million and $1.3 million for the three and six months ended
September 30, 2003, respectively, including $0.5 million and $0.9 million,
respectively, of royalty revenues from Risperdal Consta. The increase in
royalty revenues for the three and six months ended September 30, 2004 as
compared to the same period in 2003 was due to an increase in global sales of
Risperdal Consta by Janssen. Under our license agreements with Janssen, we
record royalty revenues equal to 2.5% of Janssens net sales of Risperdal
Consta in the quarter when the product is sold by Janssen. Research and development revenue under collaborative arrangements was $8.1
million and $11.6 million for the three and six months ended September 30,
2004, respectively. This compares to $2.1 million and $4.9 million for the
three and six months ended September 30, 2003, respectively. The increase in
research and development revenue for the three and six months ended September
30, 2004 as compared to the same period in 2003 was primarily due to an
increase in revenues earned related to work performed on the Eli Lilly and
Company (Lilly) AIR insulin and AIR human growth hormone (hGH) programs and
to work performed on several other collaborative programs. See discussion of
the funding of our Lilly development programs in Liquidity and Capital
Resources below. Cost of goods manufactured was $2.4 million and $7.6 million for the three and
six months ended September 30, 2004, consisting of approximately $2.4 million
and $5.3 million, respectively, for Risperdal Consta and $0 and $2.3 million
for Nutropin Depot. Cost of goods manufactured was $4.6 million and $7.1
million for three and six months ended September 30, 2003, consisting of
approximately $3.5 million and $4.8 million, respectively, for Risperdal Consta
and $1.1 million and $2.3 million, respectively, for Nutropin Depot. The
decrease in cost of goods manufactured in the three months ended September 30,
2004 as compared to the same period in 2003 was primarily the
result of manufacturing efficiencies and increased volumes that
resulted in a lower per unit cost for Risperdal Consta for the
three months ended September 30, 2004 as compared to the three months ended
September 30, 2003, as well as the June 2004 decision 14




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##### Table of Contents



to discontinue commercialization of Nutropin Depot. Our per unit cost for
Risperdal Consta will fluctuate from quarter to quarter. The increase in cost
of goods manufactured in the six months ended September 30, 2004 as compared to
the same period in 2003 was primarily the result of an increase in the
production of Risperdal Consta for shipment to our partner, Janssen as well as
a one-time write-off of Nutropin Depot inventory of $1.3 million recorded under
the caption Cost of goods manufactured in our condensed consolidated
statement of operations in the quarter ended June 30, 2004. We also recorded
restructuring charges of $11.9 million in the quarter ended June 30, 2004 in
connection with the decision to discontinue commercialization of Nutropin
Depot. See discussion of restructuring charges below. Research and development
expenses were $22.5 million and $46.7 million for the
three and six months ended September 30, 2004 as compared to $23.4 million and
$45.1 million for the three and six months ended September 30, 2003. Research
and development expenses were lower in the three months ended September 30,
2004 as compared to the three months ended September 30, 2003 primarily due to
a decrease in external research costs related to the clinical trials of
Vivitrex, partially offset by an increase in personnel costs related to our
proprietary and collaborator product candidates and increases in occupancy
costs. The increase in research and development costs for the six months ended
September 30, 2004 as compared to the six months ended September 30, 2003 was
primarily due to increases in personnel costs related to our proprietary and
collaborator product candidates and increases in occupancy costs, partially
offset by a decrease in external research costs related to the clinical trials
of Vivitrex. A significant portion of our research and development expenses (including
laboratory supplies, travel, dues and subscriptions, recruiting costs,
temporary help costs, consulting costs and allocable costs such as occupancy
and depreciation) are not tracked by project as they benefit multiple projects
or our drug delivery technologies in general. Expenses incurred to purchase
specific services from third parties to support our collaborative research and
development activities are tracked by project and are reimbursed to us by our
partners. We generally bill our partners under collaborative arrangements
using a single full-time equivalent or hourly rate. This rate has been
established by us based on our annual budget of salaries, employee benefits and
the billable non-project-specific costs mentioned above and is generally
increased annually based on increases in the consumer price index. Each
collaborative partner is billed using a full-time equivalent or hourly rate for
the hours worked by our employees on a particular project, plus any direct
external research costs. We account for our research and development expenses
on a departmental and functional basis in accordance with our budget and
management practices. Below is a summary of our proprietary and collaborators commercial products
and product candidates and their respective stages of clinical development. Product
    
    
    
    Phase of ClinicalCandidate
    
    Indication
    
    Development (1)Risperdal Consta
    
    Schizophrenia
    
    MarketedVivitrex
    
    Alcohol dependence
    
    Phase IIIVivitrex
    
    Opioid dependence
    
    Phase IIAIR Insulin
    
    Diabetes
    
    Phase IIExenatide LAR (AC2993)
    
    Diabetes
    
    Phase IIAIR hGH
    
    Growth hormone deficiency
    
    Phase IAIR Epinephrine
    
    Anaphylaxis
    
    Phase IOthers
    
    Various
    
    Preclinical
 (1) Phase I clinical trials indicates that the compound is being tested in
humans for safety and preliminary indications of biological activity in a
limited patient population. Phase II clinical trials indicates that the
trial is being conducted in patients and is to provide information on dosing
and is testing for safety and preliminary evidence of efficacy. Phase III
clinical trials indicates that the trial is being conducted in patients and is
testing the safety and efficacy of the compound. Preclinical indicates that
we or our partners are conducting formulation, efficacy, pharmacology and/or
toxicology testing of a compound in animal models or biochemical assays. In August 2004, we announced that Lilly made a positive product decision to
proceed with significant investment for the further development of an inhaled
formulation of insulin. The decision follows the successful execution of
several critical steps: the completion and analysis of data from a Phase II
study; the achievement of commercial manufacturing powder production scale-up;
and the development and testing of the commercial pulmonary insulin inhaler
system. Development activities will include both clinical trials and
additional manufacturing activities for the inhaler system and the production
facility. 15




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##### Table of Contents



In October 2004,
Alkermes and Serono discontinued development
of the sustained-release version of recombinant human follicle stimulating
hormone (r-hFSH) for the treatment of infertility. Despite positive clinical
trial results, this decision was based on a shift of priorities within Serono. In November 2004, we, along with partners Amylin Pharmaceuticals, Inc. and
Lilly made the decision to initiate a Phase II multi-dose study of exenatide
LAR (long-acting release), in type 2 diabetes patients using a
once-a-week
dosing regimen, expected to begin in the first quarter of 2005. Data from the
ongoing Phase II single-dose study have demonstrated sustained release of
exenatide with no dose-limiting effects. Sales, general and administrative expenses were $7.4 million and $14.4 million
for the three and six months ended September 30, 2004 as compared to $5.9
million and $11.7 million for the three and six months ended September 30,
2003. Sales, general and administrative expenses for the three and six months
ended September 30, 2004 were higher than in the three and six months ended
September 30, 2003 primarily as a result of an increase in personnel-related
costs, notably within sales and marketing as we prepare for commercialization
of Vivitrex, as well as legal costs associated with the pending litigation
described in the condensed consolidated financial statements. In August 2002, we announced a restructuring program to reduce our cost
structure as a result of the financial impact of a delay in the U.S. launch of
Risperdal Consta by our collaborative partner, Janssen (the 2002
Restructuring). The restructuring program reduced our workforce by 122
employees, representing 23% of our total workforce at that time, and included
consolidation and closure of certain leased facilities in Cambridge,
Massachusetts, closure of our medical affairs office in Cambridge, England,
write-off of leasehold improvements at leased facilities being vacated and
reductions of other expenses. As of September 30, 2004, we had paid in cash or
written off an aggregate of approximately $1.5 million in employee separation
costs and approximately $4.2 million in facility closure costs in connection
with the 2002 Restructuring. The amounts remaining in the 2002 Restructuring
accrual at September 30, 2004 related to facility lease costs and are expected
to be paid through fiscal 2006. In June 2004, we announced a restructuring program in connection with the
decision by Alkermes and Genentech to discontinue commercialization of Nutropin
Depot (the 2004 Restructuring). The decision was based on the significant
resources required by both companies to continue manufacturing and
commercializing the product. In connection with this decision, we ceased
commercial manufacturing of Nutropin Depot in June 2004, reduced our workforce
by 17 employees, representing approximately 3% of our total workforce, and
recorded restructuring charges in the quarter ended June 30, 2004 of
approximately $11.9 million under the caption Restructuring in the
consolidated statements of operations. The restructuring charges consisted of
approximately $0.2 million in employee separation costs, including severance
and related benefits, and approximately $11.7 million in facility closure
costs, including fixed asset write-offs and estimates of future lease costs
relating to our ability to sublease the exited facility through the end of its
lease term, August 2008. In addition to the restructuring charges recorded in
the quarter ended June 30, 2004, we also recorded a one-time write-off of
Nutropin Depot inventory of approximately $1.3 million, which was recorded
under the caption Cost of goods manufactured in the consolidated statements
of operations. As of September 30, 2004, we had paid in cash or written off an aggregate of
approximately $8.5 million in facility closure costs and $0.2 million in
employee separation costs in connection with the 2004 Restructuring. The
amounts remaining in the 2004 Restructuring accrual at September 30, 2004 are
expected to be paid out through fiscal 2009 and relate primarily to estimates
of lease costs associated with the exited facility. 16




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##### Table of Contents



The following table displays the restructuring activities and liability
accounts included in accrued restructuring costs: Type of Liability
    
    Balance
March 31, 
2004
    
    Charges
    
    Payments
    
    Non-cash
Write-downs
    
    BalanceSeptember, 30

20042002 RestructuringEmployee separation costs
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    Facility closure costs
    
    
    1,137,741
    
    
    
    
    
    
    
    (552,216
    )
    
    
    
    
    
    
    585,525$
    1,137,741
    
    
    $
    
    
    
    $
    (552,216
    )
    
    $
    
    
    
    $
    585,5252004 RestructuringEmployee separation costs
    
    $
    
    
    
    $
    146,112
    
    
    $
    (136,448
    )
    
    $
    
    
    
    $
    9,664Facility closure costs
    
    
    
    
    
    
    11,750,229
    
    
    
    (249,046
    )
    
    
    (8,150,006
    )
    
    
    3,351,177$
    
    
    
    $
    11,896,341
    
    
    $
    (385,494
    )
    
    $
    (8,150,006
    )
    
    $
    3,360,841Total
    
    $
    1,137,741
    
    
    $
    11,896,341
    
    
    $
    (937,710
    )
    
    $
    (8,150,006
    )
    
    $
    3,946,366
 Interest income was $0.7 million and $1.3 million for the three and six months
ended September 30, 2004 as compared to $0.7 million and $1.6 million for the
three and six months ended September 30, 2003. The decrease for the six month
periods was primarily the result of lower average cash and investment balances
held during the six months ended September 30, 2004 as compared to the six
months ended September 30, 2003. Other (expense) income, net was an expense of $0.6 million and $0.9 million in
the three and six months ended September 30, 2004 as compared to income of $1.1
million and $2.5 million for the three and six months ended September 30, 2003.
Other (expense) income, net represents expense or income recognized on the net
changes in the fair value of warrants of public companies held by us in
connection with collaboration and licensing arrangements, which are recorded as
derivatives under the caption Other Assets in the condensed consolidated
balance sheets. The recorded value of such warrants can fluctuate significantly
based on fluctuations in the market value of the underlying securities of the
issuer of the warrants. Derivative income (losses) related to convertible notes was income of $1.2
million and $2.7 for the three and six months ended September 30, 2004 as
compared to derivative losses of $0.9 million and $4.7 million for the three
months and six months ended September 30, 2003. During the three and six months ended September 30, 2004, we recorded
derivative income of $1.2 million and $2.7 million, respectively, for changes
in the estimated value of the Three-Year Interest Make-Whole feature of the
21⁄2% Convertible Subordinated Notes due 2023 (the 21⁄2% Subordinated
Notes). The estimated value of the Three-Year Interest Make-Whole feature is
carried in the consolidated balance sheets under the caption Derivative
liability related to convertible notes and will be adjusted to its fair value
on a quarterly basis until it expires or is paid. Quarterly adjustments to the
fair value of the Three-Year Interest Make-Whole will be charged to Derivative
income (losses) related to convertible notes in the condensed consolidated
statements of operations until it is paid out or expires. The recorded value
of the derivative liability related to the 21⁄2% Subordinated Notes,
approximately $2.0 million September 30, 2004, can fluctuate significantly
based on fluctuations in the market value of our common stock. During the three months and six months ended September 30, 2003, we recorded
derivative losses of $0.9 million and $4.7 million, respectively, in the
condensed consolidated statements of operations. The losses recorded for the
three and six months ended September 30, 2003 consisted of $0.9 million and
$0.9 million, respectively, related to changes in the estimated value of the
21⁄2% Subordinated Notes, and $0 and $3.8 million, respectively, related to
changes in the estimated value of the 6.52% Senior Notes. In June 2003, we
announced that we had exercised our automatic conversion right for the 6.52%
Senior Notes. The embedded derivative was adjusted to the value of the
remaining balance of the Two-Year Interest Make-Whole payment, or approximately
$17.1 million, at June 30, 2003 and was accounted for as a liability on the
consolidated balance sheets. In July 2003, upon conversion of the then
outstanding 6.52% Senior Notes and payment of the Two-Year Interest Make-Whole,
the embedded derivative was settled in full and the balance was reduced to
zero. 17




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##### Table of Contents



Interest expense was $1.2 million and $2.4 million for the three and six months
ended September 30, 2004, respectively, as compared to $0.6 million and $4.1
million for the three and six months ended September 30, 2003. The increase for
the three months ended September 30, 2004 as compared to the three months ended
September 30, 2004 was primarily the result of an increase in the average
outstanding debt balance during the respective periods, partially offset by a
lower interest rate payable on the convertible debt outstanding during the
respective periods. The decrease for the six months ended September 30, 2004
as compared to the six months ended September 30, 2004 was primarily the result
of a lower interest rate payable on the convertible debt outstanding during the
respective periods. We do not believe that inflation and changing prices have had a material impact
on our results of operations. We have funded our operations primarily through public offerings and private
placements of debt and equity securities, bank loans and payments under
research and development agreements with collaborators. 18




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##### Table of Contents



Liquidity and Capital Resources Cash and cash equivalents and total investments were approximately $102.8
million at September 30, 2004 as compared to $143.9 million at March 31, 2004.
The decrease in cash and cash equivalents and short-term investments during the
six months ended September 30, 2004 was primarily a result of cash outflows to
fund our operations and to acquire fixed assets. We invest in cash equivalents, U.S. Government obligations, high-grade
corporate notes and commercial paper, with the exception of our $100 million
investment in Reliant. Our investment objectives for our investments, other
than our investment in Reliant, are, first, to assure liquidity and
conservation of capital and, second, to obtain investment income. Investments
classified as long-term at September 30, 2004 consist of U.S. Government
obligations held as collateral under certain irrevocable standby letters of
credit required under certain lease agreements, including the lease for our
corporate headquarters. In August and September 2003, we issued an aggregate of $125.0 million
principal amount of 21⁄2% Subordinated Notes. The 21⁄2% Subordinated Notes
are convertible into shares of our common stock at a conversion price of $13.85
per share, subject to adjustment in certain events. The 21⁄2% Subordinated
Notes bear interest at 21⁄2% per year, payable semiannually on March 1 and
September 1, commencing on March 1, 2004 and are subordinated to existing and
future senior indebtedness of Alkermes. We may elect to automatically convert the notes anytime the closing price of
our common stock has exceeded 150% of the conversion price ($20.78), for at
least 20 trading days during any 30-day trading period. We may redeem some or
all of the notes on or after September 6, 2006. Holders of the notes have the
right to require us to repurchase some or all of their notes on September 1,
2008, 2013, and 2018 and upon certain events, including a change in control. If an automatic conversion occurs on or prior to September 1, 2006, we will pay
additional interest in cash or, at our option, in common stock, equal to three
full years of interest on the converted notes or Three-Year Interest
Make-Whole, less any interest actually paid or provided for on the notes prior
to automatic conversion. If we elect to pay the additional interest in common
stock, the shares of common stock will be valued at 97.5% of the average
closing price of our common stock for the five trading days immediately
preceding the second trading day prior to the conversion date. In December 2002, we and Lilly expanded the collaboration for the development
of inhaled formulations of insulin and hGH based on our AIR pulmonary drug
delivery technology. At that time, Lilly purchased $30.0 million of our
Convertible Preferred Stock, the proceeds from which represented $25.0 million
and $5.0 million in funding for the Lilly insulin and Lilly hGH development
programs, respectively, for the period starting January 1, 2003 and into
calendar 2004. As a result of this transaction, we did not recognize research
and development revenue related to work performed on the Lilly development
programs while the proceeds from the sale of the Convertible Preferred Stock
were being spent. In addition, the royalty rate payable to us based on
revenues of potential inhaled insulin products was increased. Lilly has the
right to return the Convertible Preferred Stock to us in exchange for a
reduction in this royalty rate back to its original rate. The Convertible
Preferred Stock is convertible into our common stock at the market price at the
time of conversion at our option or automatically upon the filing of a new drug
application with the FDA for a pulmonary insulin product. The collaboration
cannot terminate without cause until January 2005. We will register for resale
all of our shares of common stock issued upon conversion of the Convertible
Preferred Stock. In December 2003, Lilly made additional payments to us totaling approximately
$7.0 million in order to fund an increase in the scope of our joint development
programs, $3.0 million of which represented funding for the Lilly insulin
development program and the remaining $4.0 million represented funding for the
Lilly hGH development program. The $7.0 million payment was recorded as
deferred revenue in the consolidated balance sheets in the quarter ended
December 31, 2003. When the funding for a program provided for by the proceeds
from the sale of Convertible Preferred Stock has been spent, we will begin to
recognize revenue on that program as work is performed. As of June 30, 2004,
the entire $5.0 million of funding from the Convertible Preferred Stock related
to the Lilly hGH program had been spent. As of September 30, 2004, the entire
$25.0 million of funding from the Convertible Preferred Stock related to the
Lilly insulin program had been spent. Therefore, beginning in the quarter 19




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##### Table of Contents



ended June 30, 2004 for the Lilly hGH program and beginning in the quarter
ended September 30, 2004 for the Lilly insulin program, we recorded revenue for
work performed on the Lilly hGH and Lilly insulin programs in our condensed
consolidated statements of operations. As of September 30, 2004, approximately
$0.4 million of the $7.0 million in additional funding was unearned and was
recorded as a current liability under the caption of Deferred revenue in the
condensed consolidated balance sheets. In August 2002, we announced the regulatory approval and expected commercial
launch of Risperdal Consta in Germany and the United Kingdom. Under a
manufacture and supply agreement with Janssen and based on the foregoing,
Janssen is required to pay us certain minimum amounts of manufacturing revenues
relating to our sales of Risperdal Consta to Janssen. The actual amount of
such minimum manufacturing revenues will be determined by a formula and is
currently estimated to aggregate approximately $150.0 million. As of September
30, 2004, we had recognized approximately $51.9 million of cumulative
manufacturing revenues against the estimated $150.0 million minimum. Janssens
minimum revenue obligation will be satisfied when Alkermes reaches
approximately $150.0 million in cumulative manufacturing revenues earned from
sales of Risperdal Consta to Janssen. While the manufacture and supply
agreement with Janssen specifies annual minimum revenues expected to be paid to
Alkermes over a ten year period beginning in calendar 2003, we expect our
annual manufacturing revenues to exceed those annual minimums. In December
2002, Janssen prepaid the first two years of minimum manufacturing revenues to
us, totaling $23.9 million and these amounts were recorded as deferred revenue
in our consolidated balance sheets. As of September 30, 2004, approximately
$3.4 million of this prepayment was unearned and was recorded as a current
liability under the caption Deferred revenue in the condensed consolidated
balance sheets. We do not have any off-balance sheet arrangements other than operating leases
in the ordinary course of business. Capital expenditures were approximately
$8.1 million for the six months ended September 30, 2004, principally reflecting
equipment purchases and building expansion and improvements. We expect our
capital expenditures to total approximately $25.0 million during fiscal year
2005, primarily to expand our manufacturing infrastructure for Risperdal
Consta, exenatide LAR and Vivitrex in addition to continued improvements to our
manufacturing and development facilities in Massachusetts and Ohio. Our
capital expenditures for equipment, facilities and building improvements have
been financed to date primarily with proceeds from bank loans and the sales of
debt and equity securities. Under the provisions of the existing loans, General
Electric Capital Corporation (GECC) and Johnson & Johnson Finance Corporation
have security interests in certain of our assets. We will continue to pursue opportunities to obtain additional financing in the
future. Such financing may be sought through various sources, including debt
and equity offerings, corporate collaborations, bank borrowings, arrangements
relating to assets or other financing methods or structures. The source,
timing and availability of any financings will depend on market conditions,
interest rates and other factors. Our future capital requirements will also
depend on many factors, including continued scientific progress in our research
and development programs (including our proprietary product candidates), the
magnitude of these programs, progress with preclinical testing and clinical
trials, the time and costs involved in obtaining regulatory approvals, the
costs involved in filing, prosecuting and enforcing patent claims, competing
technological and market developments, the establishment of additional
collaborative arrangements, the cost of manufacturing facilities and of
commercialization activities and arrangements and the cost of product
in-licensing and any possible acquisitions and, for any future proprietary
products, the sales, marketing and promotion expenses associated with marketing
products. We believe that our current cash and cash equivalents and short-term
investments combined with
anticipated manufacturing and royalty revenues, research and development
revenues under collaborative arrangements and interest income, will be
sufficient to meet our anticipated capital requirements through at least March
31, 2006. 20




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##### Table of Contents



The contractual cash obligations disclosure included in our annual report on
Form 10-K for the year ended March 31, 2004 has not materially changed since we
filed that report, except for purchase obligations as follows: Less Than
    
    One to Three
    
    Four to Five
    
    After FiveContractual Cash
    
    
    
    
    
    One Year
    
    Years (Fiscal
    
    Years (Fiscal
    
    Years (AfterObligations (in
thousands)
    
    Total
    
    (Fiscal 2005)
    
    2006 - 2008)
    
    2009 - 2010)
    
    Fiscal 2010)Purchase Obligations
    
    
    $4,450
    
    $
    4,450
    
    
    $
    
    
    
    $
    
    
    
    $
    
 We may need to raise substantial additional funds for longer-term product
development, including development of our proprietary product candidates,
regulatory approvals and manufacturing and sales and marketing activities that
we might undertake in the future. There can be no assurance that additional
funds will be available on favorable terms, if at all. If adequate funds are
not available, we may be required to curtail significantly one or more of our
research and development programs and/or obtain funds through arrangements with
collaborative partners or others that may require us to relinquish rights to
certain of our technologies, product candidates or future products. 21




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##### Table of Contents



Item 3. Quantitative and Qualitative Disclosures about Market Risk As part of our investment portfolio we own financial instruments that are
sensitive to market risks. The investment portfolio, excluding our December
2001 $100 million investment in Reliant, is used to preserve our capital until
it is required to fund operations, including our research and development
activities. Our short-term investments and investments consist of U.S.
Government obligations, high-grade corporate notes and commercial paper. All of
our investments in debt securities are classified as available-for-sale and
are recorded at fair value. Our investments, excluding our investment in
Reliant, are subject to interest rate risk, and could decline in value if
interest rates increase. Due to the conservative nature of our short-term
investments and investments policy we do not believe that we have a material
exposure to interest rate risk. Although our investments, excluding our
investment in Reliant, are subject to credit risk, our investment policies
specify credit quality standards for our investments and limit the amount of
credit exposure from any single issue, issuer or type of investment. Our available-for-sale investments are sensitive to changes in interest
rates. Interest rate changes would result in a change in the net fair value of
these financial instruments due to the difference between the market interest
rate and the market interest rate at the date of purchase of the financial
instrument. A 10% decrease in market interest rates would not result in a
material impact on the net fair value of such interest-sensitive financial
instruments. A 10% increase or decrease in market interest rates on our 21⁄2%
Subordinated Notes and our 33⁄4% Subordinated Notes would not result in a
material impact on our notes. We hold warrants of public companies received in connection with collaboration
and licensing arrangements, which are recorded as derivatives under the caption
Other Assets in the condensed consolidated balance sheets. The recorded value
of such warrants can fluctuate significantly based on fluctuations in the
market value of the underlying securities of the issuer of the
warrants. Foreign Currency Exchange Rate Risk The royalty revenues we recognize and report in our condensed consolidated
statements of operations and the related payments we receive on our Risperdal
Consta product are calculated as a percentage of the net sales made by our
collaborative partner. Some of these sales made by our collaborative partner
are made in foreign countries. These foreign sales are initially denominated
in foreign currency in which the sale is made and subsequently converted into
U.S. dollars at the then foreign currency spot rate to determine the amount
that our collaborative partner pays us as royalties. Fluctuations in the
foreign currency exchange ratio between the U.S. dollar and these foreign
currencies will have the effect of increasing or decreasing our recognized and
reported royalty revenues and the related payments we receive even if there is
a constant amount of sales in foreign currencies. For example, if the U.S.
dollar strengthens against a foreign currency, then our royalty revenues and
related payments will decrease given a constant amount of sales in such foreign
currency. The impact on our royalty revenues and related payment from fluctuations in
foreign currency exchange rates is based on a number of factors, including the
amount of sales in any foreign currency, the exchange ratio (and the change in
the foreign currency exchange ratio from the prior period) between a foreign
currency and the U.S. dollar, and the amount of sales by our collaborative
partner that are denominated in foreign currencies. We do not currently hedge
our foreign currency exchange rate risk. 
 Item 4. Controls and Procedures As of September 30, 2004, Alkermes management, with the participation of
Alkermes Chief Executive Officer and Chief Financial Officer, evaluated the
effectiveness of Alkermes disclosure controls and procedures pursuant to Rule
13a-15(b) promulgated under the Securities Exchange Act of 1934, as amended
(the Exchange Act). Based upon that evaluation, Alkermes Chief Executive
Officer and Chief Financial Officer concluded that, as of September 30, 2004,
Alkermes disclosure controls and procedures were effective in ensuring that
material information required to be disclosed by Alkermes in the reports that
it files or submits under the Exchange Act is recorded, processed, summarized
and reported within the time periods specified in the Securities and Exchange
Commissions rules and forms, including ensuring that such material information
is accumulated and communicated to Alkermes management, including Alkermes
Chief Executive Officer and Chief Financial Officer, as appropriate to allow
timely decisions regarding required disclosure. During the period covered by
this report, there have been no changes in Alkermes internal control over
financial reporting that have materially affected, or are reasonably likely to
materially affect, Alkermes internal control over financial reporting. 22




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##### Table of Contents



PART II. OTHER INFORMATION 
 Item 1. Legal Proceedings Beginning in October 2003, the Company and certain of its current and former
officers and directors were named as defendants in six purported securities
class action lawsuits filed in the United States District Court for the
District of Massachusetts. The cases were captioned: Bennett v. Alkermes,
Inc., et. al., 1:03-CV-12091 (D. Mass.); Ragosta v. Alkermes, Inc., et. al.,
1:03-CV-12184 (D. Mass.); Barry Family LP v. Alkermes, Inc., et. al.,
1:03-CV-12243 (D. Mass.); Waltzer v. Alkermes, Inc., et. al., 1:03-CV-12277 (D.
Mass.); Folkerts v. Alkermes, Inc., et. al., 1:03-CV-12386 (D. Mass.); and
Slavas v. Alkermes, Inc., et. al., 1:03-CV-12471 (D. Mass.). On May 14, 2004,
the six actions were consolidated into a single action captioned: In re
Alkermes Securities Litigation, Civil Action No. 03-CV-12091-RCL (D. Mass.). On
July 12, 2004, a single consolidated amended complaint was filed on behalf of
purchasers of the Companys common stock during the period April 22, 1999 to
July 1, 2002. The consolidated amended complaint generally alleges, among
other things, that, during such period, the defendants made misstatements to
the investing public relating to the manufacture and FDA approval of the
Companys Risperdal Consta product. The consolidated amended complaint seeks
unspecified damages. On September 10, 2004, the Company and the individual
defendants filed a motion to dismiss all claims asserted against them in a
consolidated amended complaint in their entirety. Although the Company
believes these allegations are without merit and intends to vigorously defend
against them, the litigation process is inherently uncertain and there can be
no guarantee as to the ultimate outcome of these matters. From time to time, we may be subject to other legal proceedings and claims in
the ordinary course of business. We are not currently aware of any such
proceedings or claims that we believe will have, individually or in the
aggregate, a material adverse effect on our business, financial condition or
results of operations. 
 Item 4. Submission of Matters to a Vote of Security Holders At the Annual Meeting of Shareholders of Alkermes held on September 23, 2004,
the holders of common stock approved an amendment to the 1999 Stock Option Plan
to increase to 16,900,000 the number of shares issuable upon exercise of
options granted thereunder, an increase of 2,500,000 shares. There were
46,692,844 votes for, and 8,103,495 votes against, the amendment of the plan,
19,915,767 broker non-votes and 50,687 abstentions. Also at the Annual Meeting of Shareholders, the holders of common stock elected
the following nominees as directors for terms of one year expiring on the date of the
2004 Annual Meeting or until their respective successors are duly elected and
shall qualify: Nominee
    
    Votes
For
    
    Authority
WithheldFloyd E. Bloom
    
    54,002,307
    
    20,760,486Robert A. Breyer
    
    56,872,964
    
    17,889,829Gerri Henwood
    
    73,814,934
    
    947,859Paul J. Mitchell
    
    70,287,034
    
    4,475,759Richard F. Pops
    
    57,531,922
    
    17,230,871Alexander Rich
    
    53,997,202
    
    20,765,591Paul Schimmel
    
    52,601,620
    
    22,161,173Mark B. Skaletsky
    
    73,451,701
    
    1,311,092Michael A. Wall
    
    56,672,062
    
    18,090,731
 23




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##### Table of Contents



Item 6. Exhibits and Reports on Form 8-K (a) List of Exhibits: Exhibit No.10.1
    
    1999 Stock Option Plan, as amended31.1
    
    Rule 13a-14(a)/15d-14(a) Certification.31.2
    
    Rule 13a-14(a)/15d-14(a) Certification.32.1
    
    Certification pursuant to 18 U.S.C. Section 1350, as adopted
pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
 (b) During the quarter ended September 30, 2004, the Registrant filed or
furnished Current Reports on Form 8-K as follows: Date of 8-K CurrentReport
    
    Description
    
    Filed or FurnishedAugust 5, 2004
    
    Results of Operations and
Financial Condition pursuant to
Item 12
    
    Furnished
 24




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##### Table of Contents



SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized. ALKERMES, INC.(Registrant)Date: November 5, 2004
    
    By:
    
    /s/ Richard F. PopsRichard F. PopsChief Executive Officer and Director(Principal Executive Officer)Date: November 5, 2004
    
    By:
    
    /s/ James M. FratesJames M. FratesVice President, Chief Financial Officer andTreasurer(Principal Financial and Accounting Officer)
 25




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##### Table of Contents



Exhibit Index Exhibit No.10.1
    
    1999 Stock Option Plan, as amended.31.1
    
    Rule 13a-14(a)/15d-14(a) Certification.31.2
    
    Rule 13a-14(a)/15d-14(a) Certification.32.1
    
    Certification pursuant to 18 U.S.C. Section 1350, as adopted
pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
 26