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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 June 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. Yes X No Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act). Yes X No Indicate the number of shares outstanding of each of the issuers classes
of common stock, as of the latest practicable date. Class
    
    Shares Outstanding as of August 2, 2004Common Stock, par value $.01
    
    
    89,675,247Non-Voting Common Stock, par value $.01
    
    
    382,632
    (1)




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ALKERMES, INC. AND SUBSIDIARIES INDEX Page No.PART I  FINANCIAL INFORMATIONItem 1.
    
    Consolidated Financial StatementsCondensed Consolidated Balance Sheets
    
    
    3- June 30, 2004 and March 31, 2004Condensed Consolidated Statements of Operations
    
    
    4- Three months ended June 30, 2004 and 2003Condensed Consolidated Statements of Cash Flows
    
    
    5- Three months ended June 30, 2004 and 2003Notes to Condensed Consolidated Financial Statements
    
    
    6Item 2.
    
    Management's Discussion and Analysis ofFinancial Condition and Results of Operations
    
    
    14Item 3.
    
    Quantitative and Qualitative Disclosures About Market Risk
    
    
    25Item 4.
    
    Controls and Procedures
    
    
    26PART II  OTHER INFORMATIONItem 1.
    
    Legal Proceedings
    
    
    27Item 6.
    
    Exhibits and Reports on Form 8-K
    
    
    27SIGNATURES
    
    
    28EXHIBIT INDEX
    
    
    29EX-31.1 Section 302 CEO CertificationEX-31.2 Section 302 CFO CertificationEX-32.1 Section 906 CEO and CFO Certifications
  (2)




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PART 1. FINANCIAL INFORMATION 
 Item 1. Consolidated Financial Statements: ALKERMES, INC. AND SUBSIDIARIES 
 CONSOLIDATED BALANCE SHEETS  June 30,
    
    March 31,2004
    
    2004ASSETSCurrent Assets:Cash and cash equivalents
    
    $
    5,286,743
    
    
    $
    9,898,648Investments  short term
    
    
    116,616,112
    
    
    
    134,037,415Receivables
    
    
    6,971,381
    
    
    
    11,526,280Prepaid expenses and other current assets
    
    
    2,395,945
    
    
    
    2,155,941Inventory
    
    
    2,042,538
    
    
    
    2,604,851Total current assets
    
    
    133,312,719
    
    
    
    160,223,135Property, Plant and Equipment:Land
    
    
    235,000
    
    
    
    235,000Building
    
    
    15,904,529
    
    
    
    15,718,268Furniture, fixtures and equipment
    
    
    63,101,724
    
    
    
    69,016,366Equipment under capital lease
    
    
    463,610
    
    
    
    463,610Leasehold improvements
    
    
    45,946,280
    
    
    
    56,808,710Construction in progress
    
    
    4,933,795
    
    
    
    3,489,296130,584,938
    
    
    
    145,731,250Less accumulated depreciation and amortization
    
    
    (41,759,270
    )
    
    
    (49,988,460
    )88,825,668
    
    
    
    95,742,790Investments  long term
    
    
    5,010,265
    
    
    
    5,011,630Other Assets
    
    
    8,102,321
    
    
    
    9,051,949Total Assets
    
    $
    235,250,973
    
    
    $
    270,029,504LIABILITIES AND SHAREHOLDERS EQUITYCurrent Liabilities:Accounts payable and accrued expenses
    
    $
    20,383,960
    
    
    $
    18,209,061Accrued interest
    
    
    1,051,958
    
    
    
    264,370Accrued restructuring costs
    
    
    4,437,506
    
    
    
    1,137,741Deferred revenue
    
    
    12,849,251
    
    
    
    17,173,618Derivative liability related to convertible subordinated notes
    
    
    3,132,000
    
    
    
    4,650,000Obligation under capital lease
    
    
    83,351
    
    
    
    81,596Total current liabilities
    
    
    41,938,026
    
    
    
    41,516,386Obligation under capital lease
    
    
    316,021
    
    
    
    337,5282 1⁄2% Convertible Subordinated Notes
    
    
    121,763,812
    
    
    
    121,569,6413.75% Convertible Subordinated Notes
    
    
    676,000
    
    
    
    676,000Convertible Preferred Stock, par value $.01 per share: authorized and issued, 3,000
shares at June 30, 2004 and March 31, 2004, respectively (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,
89,623,932 and
89,305,261 shares at June 30, 2004 and March 31, 2004,
respectively
    
    
    896,240
    
    
    
    893,053Non-voting common stock, par value $.01 per share;
authorized, 450,000 shares; issued and outstanding, 382,632
shares at June 30, 2004 and
March 31, 2004
    
    
    3,826
    
    
    
    3,826Additional paid-in capital
    
    
    628,552,863
    
    
    
    627,445,609Deferred compensation
    
    
    (158,499
    )
    
    
    (275,802
    )Accumulated other comprehensive income
    
    
    558,051
    
    
    
    1,010,621Accumulated deficit
    
    
    (589,295,367
    )
    
    
    (553,147,358
    )Total shareholders equity
    
    
    40,557,114
    
    
    
    75,929,949Total Liabilities and Shareholders Equity
    
    $
    235,250,973
    
    
    $
    270,029,504
 See notes to condensed consolidated financial statements. (3)




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ALKERMES, INC. AND SUBSIDIARIES 
 CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS  Three Months
    
    Three MonthsEnded
    
    EndedJune 30,
    
    June 30,2004
    
    2003Revenues:Manufacturing and royalty revenues
    
    $
    7,964,906
    
    
    $
    1,544,754Research and development revenue under collaborative arrangements
    
    
    3,509,530
    
    
    
    2,756,706Total revenues
    
    
    11,474,436
    
    
    
    4,301,460Expenses:Cost of goods manufactured
    
    
    5,241,256
    
    
    
    2,560,670Research and development
    
    
    24,132,028
    
    
    
    21,672,964General and administrative
    
    
    7,038,911
    
    
    
    5,780,598Restructuring
    
    
    11,896,341
    
    
    
    Total expenses
    
    
    48,308,536
    
    
    
    30,014,232Net operating loss
    
    
    (36,834,100
    )
    
    
    (25,712,772
    )Other income (expense):Interest income
    
    
    630,513
    
    
    
    975,161Other (expense) income, net
    
    
    (274,373
    )
    
    
    1,409,478Derivative income (losses) related to convertible notes
    
    
    1,518,000
    
    
    
    (3,764,437
    )Interest expense
    
    
    (1,188,049
    )
    
    
    (3,479,801
    )Total other income (expense)
    
    
    686,091
    
    
    
    (4,859,599
    )Net loss
    
    
    ($36,148,009
    )
    
    
    ($30,572,371
    )Basic and diluted loss per common share
    
    
    ($0.40
    )
    
    
    ($0.47
    )Weighted average number of common shares outstanding
    
    
    89,409,116
    
    
    
    64,736,097
 See notes to condensed consolidated financial statements. (4)




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ALKERMES, INC. AND SUBSIDIARIES 
 CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS  Three Months
    
    Three MonthsEnded
    
    EndedJune 30,
    
    June 30,2004
    
    2003Cash flows from operating activities:Net loss
    
    
    ($36,148,009
    )
    
    
    ($30,572,371
    )Adjustments to reconcile net loss to net cash used by
operating activities:Depreciation and amortization
    
    
    2,939,529
    
    
    
    2,426,522Restructuring charges
    
    
    11,896,341
    
    
    
    Other noncash charges
    
    
    581,353
    
    
    
    1,046,228Losses (gains) on warrants held
    
    
    274,373
    
    
    
    (1,409,478
    )Derivative (gains) losses related to convertible notes
    
    
    (1,518,000
    )
    
    
    3,764,437Changes in assets and liabilities:Receivables
    
    
    4,554,899
    
    
    
    4,150,604Prepaid expenses and other current assets
    
    
    322,309
    
    
    
    (829,988
    )Accounts payable, accrued expenses and accrued interest
    
    
    2,962,487
    
    
    
    (2,127,162
    )Accrued restructuring costs
    
    
    (446,580
    )
    
    
    (535,669
    )Deferred revenue
    
    
    (4,324,367
    )
    
    
    (1,024,988
    )Net cash used by operating activities
    
    
    (18,905,665
    )
    
    
    (25,111,865
    )Cash flows from investing activities:Additions to property, plant and equipment
    
    
    (4,128,739
    )
    
    
    (5,531,184
    )Purchases of available-for-sale investments
    
    
    (1,298,365
    )
    
    
    (39,514,266
    )Sales of available-for-sale investments
    
    
    18,612,414
    
    
    
    37,797,890Decrease in other assets
    
    
    (22,039
    )
    
    
    (150,022
    )Net cash provided by (used by) investing activities
    
    
    13,163,271
    
    
    
    (7,397,582
    )Cash flows from financing activities:Proceeds from issuance of common stock
    
    
    1,150,241
    
    
    
    455,591Payment of long-term obligations
    
    
    (19,752
    )
    
    
    (975,000
    )Net cash provided by (used by) financing activities
    
    
    1,130,489
    
    
    
    (519,409
    )Effect of exchange rate changes on cash
    
    
    
    
    
    
    (17,450
    )Net decrease increase in cash and cash equivalents
    
    
    (4,611,905
    )
    
    
    (33,046,306
    )Cash and cash equivalents, beginning of period
    
    
    9,898,648
    
    
    
    72,478,675Cash and cash equivalents, end of period
    
    $
    5,286,743
    
    
    $
    39,432,369Supplementary information:Cash paid for interest
    
    $
    
    
    
    $
    5,418,375Conversion of 6.52% Convertible Senior Subordinated Notes and interest into common stock
    
    $
    
    
    
    $
    100,861
 See notes to condensed consolidated financial statements. (5)




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ALKERMES, INC. AND SUBSIDIARIES 
 CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 1. BASIS OF PRESENTATION The condensed consolidated financial statements of Alkermes, Inc. (the
Company) for the three months ended June 30, 2004 and 2003 are unaudited and
include all adjustments which, in the opinion of management, are necessary to
present fairly the results of operations for the periods then ended. These
financial statements should be read in conjunction with the Companys
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. In addition, the 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. 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. The preparation of the Companys condensed consolidated financial statements in
conformity with accounting principles generally accepted in the United States
of America (GAAP) necessarily requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the consolidated
financial statements and the reported amounts of revenues and expenses during
the reporting period. Actual results could differ from those estimates. (6)




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2. COMPREHENSIVE LOSS  Comprehensive loss for the three months ended June 30, 2004 and 2003 is as
follows: Three Months
    
    Three MonthsEnded
    
    EndedJune 30, 2004
    
    June 30, 2003Net loss
    
    
    ($36,148,009
    )
    
    
    ($30,572,371
    )Foreign currency translation adjustments
    
    
    (10
    )
    
    
    (7,977
    )Unrealized (loss) gain on marketable securities
    
    
    (452,560
    )
    
    
    761,373Comprehensive loss
    
    
    ($36,600,579
    )
    
    
    ($29,818,975
    )
 3. NET LOSS PER SHARE Basic and diluted net loss per share are computed using the weighted-average
number of common shares outstanding during the period. For the three months
ended June 30, 2004 and 2003, the Company was in a net loss position and,
therefore, diluted net loss per share is the same amount as basic net loss per
share. Basic net loss per share excludes any dilutive effect from stock
options and awards, convertible preferred stock, convertible senior
subordinated notes and convertible subordinated notes. The following potentially issuable common shares were not included in the
computation of diluted net loss per share for the three months ended June 30,
2004 and 2003 because they had an antidilutive 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 $15.80)
    
    
    15,145,346
    
    
    
    14,618,925Shares issuable on conversion of
3.75% Convertible Subordinated Notes
    
    
    9,978
    
    
    
    9,978Shares issuable on conversion of
21⁄2% Convertible Subordinated Notes
    
    
    9,025,275
    
    
    
    Shares issuable on conversion of
6.52% Convertible Senior Subordinated Notes
    
    
    
    
    
    
    22,713,226Shares issuable on conversion of
Convertible Preferred Stock
    
    
    2,268,774
    
    
    
    2,824,859Shares issuable on conversion of
Non-voting common stock
    
    
    382,632
    
    
    
    382,63226,832,005
    
    
    
    40,549,620
 (7)




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4. STOCK BASED COMPENSATION The Company uses the intrinsic value method to measure compensation expense
associated with the grants of stock options and awards to employees. The
Company accounts for stock options and awards to nonemployees using the
fair-value method. Under the intrinsic value method, compensation associated with stock 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 nonemployees 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
nonemployee awards is generally the date performance of certain services is
complete. Pro forma information regarding net loss and basic and diluted loss
per common share for the three months ended June 30, 2004 and 2003 has been
determined as if the Company had accounted for its employee stock options under
the fair-value method. Using the Black-Scholes option-pricing model, the weighted average fair value
of options granted in the three months ended June 30, 2004 and 2003 was $8.56
and $5.48, respectively. For purposes of pro forma disclosures, the estimated
fair value of options is amortized to pro forma expense over the vesting period
of the option. Compensation for employee awards is measured on the grant date
for purposes of the fair value method used to prepare this pro forma
information. Pro forma information for the three months ended June 30, 2004 and 2003 is as
follows: Three Months EndedJune 30,2004
    
    2003Net lossas reported
    
    
    ($36,148,009
    )
    
    
    ($30,572,371
    )Add: Stock-based employee compensation expense as reported
in the consolidated statements of operations
    
    
    77,503
    
    
    
    563,872Deduct: Total stock-based employee
compensation expense determined
under fair-value method for all options and awards
    
    
    (4,545,039
    )
    
    
    (5,019,799
    )Pro forma net loss
    
    
    ($40,615,545
    )
    
    
    ($35,028,298
    )Basic and diluted loss per common shareas reported
    
    
    ($0.40
    )
    
    
    ($0.47
    )Basic and diluted loss per common sharepro-forma
    
    
    ($0.45
    )
    
    
    ($0.54
    )
 (8)




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4. STOCK BASED COMPENSATION (CONTINUED) The fair value of options was estimated at the date of grant using the
Black-Scholes option-pricing model with the following weighted average
assumptions: Three Months
    
    Three MonthsEnded
    
    EndedJune 30,
    
    June 30,2004
    
    2003Expected life (years)
    
    
    4
    
    
    
    4Interest rate
    
    
    3.85
    %
    
    
    2.46
    %Volatility
    
    
    72
    %
    
    
    73
    %
 5. RESTRUCTURING 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,
Jannsen-Cilag (Janssen), a division of Johnson & Johnson (the 2002
Restructuring). The restructuring program reduced the Companys 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. In June 2004, the Company announced a restructuring program in connection with
the decision by the Company 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 its
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 June 30, 2004, in connection with the 2002 Restructuring, the Company had
paid in cash or written off an aggregate of approximately $1.5 million in
employee separation costs and approximately $4.1 million in facility closure
costs and approximately $8.2 million in facility closure costs in connection
with the 2004 Restructuring. The amounts remaining in the 2002 Restructuring
accrual at June 30, 2004 relate to facility lease costs and are expected to be
paid through fiscal 2006. The amounts remaining in the 2004 Restructuring
accrual at June 30, 2004
are expected to be paid out through fiscal 2009 and relate primarily to
estimates of lease costs associated with the exited facility. (9)




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5. RESTRUCTURING (CONTINUED) Pursuant to the 2002 Restructuring and the 2004 Restructuring, the following
charges, payments and write-offs have been recorded during the three months
ended June 30, 2004: Balance
    
    
    
    
    
    
    
    
    
    BalanceMarch 31,
    
    
    
    
    
    Payments/
    
    June 30,Type of Liability
    
    2004
    
    Charges
    
    Write-offs
    
    20042002 RestructuringEmployee separation costs
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    Facility closure costs
    
    
    1,137,741
    
    
    
    
    
    
    
    (400,129
    )
    
    
    737,612$
    1,137,741
    
    
    $
    
    
    
    $
    (400,129
    )
    
    $
    737,6122004 RestructuringEmployee separation costs
    
    $
    
    
    
    $
    146,112
    
    
    $
    (25,393
    )
    
    $
    120,719Facility closure costs
    
    
    
    
    
    
    11,750,229
    
    
    
    (8,171,054
    )
    
    
    3,579,175
    
    
    
    11,896,341
    
    
    
    (8,196,447
    )
    
    
    3,699,894Total
    
    $
    1,137,741
    
    
    $
    11,896,341
    
    
    $
    (8,596,576
    )
    
    $
    4,437,506
 6. INVENTORY Inventory is stated at the lower of cost or market and consists of currently
marketed products. Cost is determined in a manner that approximates the
first-in, first-out method. Inventory consists of the following: June 30,
    
    March 31,2004
    
    2004Raw materials
    
    $
    922,367
    
    
    $
    1,146,854Work in process
    
    
    257,048
    
    
    
    1,037,045Finished goods
    
    
    863,123
    
    
    
    420,952$
    2,042,538
    
    
    $
    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 consolidated statements of
operations. See Note 5 for discussion of restructuring charges. (10)




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7. DERIVATIVES 21⁄2% Subordinated Notes In August and September 2003, the Company issued an
aggregate of $100.0 million and $25.0 million, respectively, principal amount
of 21⁄2% Convertible Subordinated Notes due 2023 (the 21⁄2% Subordinated
Notes). The 21⁄2% Subordinated Notes are convertible into shares of the
Companys 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 the Company. The Company may elect to automatically convert the notes anytime the closing
price of its common stock has exceeded 150% of the conversion price ($20.78),
for at least 20 trading days during any 30-day trading period. The Company may
redeem some or all of the notes on or after September 6, 2006. Holders of the
notes have the right to require the Company 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, the Company
will 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. If the Company elects 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 the Companys common stock for
the five trading days immediately preceding the second trading day prior to the
conversion date. The Company recorded a derivative liability related to the 21⁄2% Subordinated
Notes. The Three-Year Interest Make-Whole provision represents an embedded
derivative which is required to be accounted for apart from the underlying
21⁄2% Subordinated Notes. At issuance of the 21⁄2% Subordinated Notes, 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 has been
recorded as a derivative liability in the 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 value of the Three-Year Interest Make-Whole feature is carried in the
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
consolidated statements of operations. During the quarter ended June 30, 2004,
the Company recorded income of approximately $1.5 million in the 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 $3.1 million at (11)




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7. DERIVATIVES (CONTINUED) June 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 $0.3 million and gains
of approximately $1.4 million in the periods ending June 30, 2004 and 2003,
respectively, in other
(expense) income, net in the consolidated statements of
operations in connection with the changes in the fair value of warrants held by
the Company 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 June 30,
2004, the warrants had a fair value of approximately $2.6 million and were
recorded under the caption other assets in the consolidated balance sheets. 8. INVESTMENT IN RELIANT PHARMACEUTICALS, INC. In December 2001, the Company purchased approximately 63% of an offering by
Reliant Pharmaceuticals, LLC (Reliant) of its Series C convertible,
redeemable preferred units, representing approximately 19% of the equity
interest in Reliant, for a purchase price of $100.0 million. Through March 31,
2004, the investment had been accounted for under the equity method of
accounting because Reliant was organized as a limited liability company, which
is treated in a manner similar to a partnership. At the time of the Companys
investment, Reliant
had an accumulated deficit from operations and a deficit in members capital;
as a result, under applicable accounting rules, the Companys share of
Reliants losses from the date of the Companys investment was being recognized
in proportion to the Companys percentage participation in the Series C
financing, and not in proportion to the Companys percentage ownership interest
in Reliant. The Company recorded its equity in the losses of Reliant three
months in arrears. Reliant is a privately held company over which the Company does not exercise
control and the Company has relied on the unaudited and audited financial
statements prepared by Reliants management and provided to the Company to
calculate the Companys share of Reliants losses. The Companys $100.0
million investment was reduced to $0 during the fiscal year ended March 31,
2003. During the period from September 2003 through December 2003, Reliant closed on
offerings of its Series D convertible, redeemable preferred units (the Series
D preferred units) at a price of $20 per unit totaling approximately $271.4
million, including the exchange of approximately $65.9 million of existing
debt. The Series D preferred units rank senior to the Series A, B and C
convertible, redeemable preferred units and the common units. The Series D
preferred unit
holders are entitled to receive a preferred return at an annual rate of 8.5%,
compounded quarterly, of the contributed capital to acquire each unit when and
if declared by the Board of Directors. As a result of the Series D preferred
unit offering by Reliant, Alkermes ownership percentage in Reliant was reduced
from approximately 19% to approximately 12%. Effective April 1, 2004, Reliant converted from a limited liability company to
a corporation under Delaware state law. Because of this change from a limited
liability company to a corporation, Alkermes investment in Reliant will
henceforth be accounted for under the cost (12)




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##### Table of Contents



8. INVESTMENT IN RELIANT PHARMACEUTICALS, INC. (CONTINUED) method effective April 1, 2004.
Alkermes therefore will not record any share of Reliants future net income or
losses. Summarized unaudited financial information of Reliant for the three months
ended March 31, 2004 and 2003 is as follows: Three Months Ended
    
    Three Months Ended(In thousands)
    
    March 31, 2004
    
    March 31, 2003Revenues
    
    $
    55,125
    
    
    $
    47,476Costs and expenses
    
    
    79,372
    
    
    
    59,951Net Loss
    
    
    (24,247
    )
    
    
    (12,475
    )
 9. 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. 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. (13)




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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 division 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 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 June 30, 2004, we had an
accumulated deficit of $589.3 million. We expect to incur substantial
additional operating losses over the next few years. 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 (14)




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##### Table of Contents



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, 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) 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; (xii) the time and expense required to discontinue commercialization
of Nutropin Depot may be greater than we anticipate; (xiii) we may not recoup
any of our $100 million investment in Reliant Pharmaceuticals, LLC (Reliant);
(xiv) the securities litigation brought against us may result in financial
losses or require the dedication of significant management resources; (xv) 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; (xvi)
technological change in the biotechnology or pharmaceutical industries could
render our product candidates obsolete or noncompetitive; (xvii) difficulties
or set-backs in obtaining and enforcing our patents and difficulties with the
patent rights of others could occur; (xviii) we may not become profitable and
could continue to incur losses for the foreseeable future; and (xix) 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. (15)




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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
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 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). The employee separation costs and the facility consolidation and closure costs
recorded in the 2002 Restructuring were accrued under Emerging Issues Task
Force (EITF) No. 94-3 Liability Recognition for Certain Employee Termination
Benefits and Other Costs to Exit an Activity (Including Certain Costs Incurred
in a Restructuring). In June 2002, the Financial Accounting Standards Board
(FASB) issued Statement of Financial Accounting Standards (SFAS) No. 146,
Accounting for Costs Associated with Exit of Disposal Activities, (SFAS No.
146), which was effective for exit or disposal activities initiated after
December 31, 2002. The employee separation costs and the facility closure
costs related to the 2004 Restructuring were accrued under SFAS No. 146. Charges recorded in the consolidated statements of operations in connection
with the 2002 Restructuring and the 2004 Restructuring required that management
make estimates related 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. The estimates included in the 2002
Restructuring and the 2004 Restructuring are subject to adjustment as facility
subleases and sales or leasing of fixed assets are negotiated. See Results of
Operations below for additional information related to the 2002 Restructuring
and the 2004 Restructuring. (16)




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Results of Operations The net loss in accordance with accounting principles generally accepted
in the United States of America (known as GAAP) for the three months ended
June 30, 2004 was $36.1 million or $0.40 per share as compared to a net loss of
$30.6 million or $0.47 per share for the three months ended June 30, 2003. Total revenues were $11.5 million for the three months ended June 30, 2004
compared to $4.3 million for the three months ended June 30, 2003. Total manufacturing and royalty revenues were $8.0 million and $1.5
million for the three months ended June 30, 2004 and 2003, respectively. Total manufacturing revenues were $6.2 million and $1.0 million for the
three months ended June 30, 2004 and 2003, respectively, including $6.2 million
and $0.7 million, respectively, of manufacturing revenues for Risperdal Consta.
The increase in manufacturing revenues for the three months ended June 30,
2004 as compared to the three months ended June 30, 2003 was due to increased
shipments of Risperdal Consta to Janssen following launch of the product in the
U.S. in December 2003 as well as to supply product to additional countries
around the world. 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 months ended June 30, 2004
related to Nutropin Depot. Total royalty revenues were $1.8 million and $0.6 million for the three
months ended June 30, 2004 and 2003, respectively, including $1.7 million and
$0.4 million, respectively, of royalty revenues for Risperdal Consta. The
increase in royalty revenues for the three months ended June 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 $3.5
million and $2.8 million for the three months ended June 30, 2004 and 2003,
respectively. The increase in research and development revenue for the three
months ended June 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 human growth hormone (hGH) program and
to the 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 $5.2 million for the three months ended
June 30, 2004, consisting of approximately $2.9 million for Risperdal Consta
and $2.3 million for Nutropin Depot. Cost of goods manufactured was $2.6
million in the three months ended June 30, 2003, consisting of approximately
$1.4 million for Risperdal Consta and $1.2 million for Nutropin (17)




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Depot. The increase in cost of goods manufactured in the three months
ended June 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. In addition, on June 1, 2004, Alkermes and Genentech
announced the decision to discontinue commercialization of Nutropin Depot. In
connection with this decision, we ceased commercial manufacturing of Nutropin
Depot and recorded a one time write-off of Nutropin Depot inventory of $1.3
million under the caption cost of goods manufactured in our 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 $24.1 million for the three months
ended June 30, 2004 as compared to $21.7 million for the three months ended
June 30, 2003. Research and development expenses were higher in the three
months ended June 30, 2004 as compared to the three months ended June 30, 2003
primarily because of an increase in personnel costs related to our proprietary
and collaborator product candidates, as well as an increase in occupancy costs
and depreciation expense related to the expansion of our facilities in both
Massachusetts and Ohio. 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. (18)




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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 IIProLease r-hFSH
    
    Infertility
    
    Phase IbAIR 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. General and administrative expenses were $7.0 million and $5.8 million for
the three months ended June 30, 2004 and 2003 respectively. General and
administrative expenses for the three months ended June 30, 2004 were higher
than in the three months ended June 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 Note 9 to consolidated financial
statements on Form 10-Q for the three months ended June 30, 2004. 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. In June 2004, we announced a restructuring program in connection with the
decision by Alkermes and Genentech to stop 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 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 (19)




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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 June 30, 2004, we had paid in cash or written off an aggregate of
approximately $1.5 million in employee separation costs and approximately $4.1
million in facility closure costs in connection with the 2002 Restructuring and
approximately $8.2 million in facility closure costs in connection with the
2004 Restructuring. The amounts remaining in the 2002 Restructuring accrual at
June 30, 2004 relate to facility lease costs and are expected to be paid
through fiscal 2006. The amounts remaining in the 2004 Restructuring accrual
at June 30, 2004 are expected to be paid out through fiscal 2009 and relate
primarily to estimates of lease costs associated with the exited facility. Pursuant to the 2002 Restructuring and the 2004 Restructuring, the
following charges, payments and write-offs have been recorded during the three
months ended June, 2004: Balance,
    
    
    
    
    
    
    
    
    
    Balance,March 31,
    
    
    
    
    
    Payments/
    
    June 30,Type of Liability
    
    2004
    
    Charges
    
    Write-offs
    
    20042002 RestructuringEmployee separation costs
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    Facility closure costs
    
    
    1,137,741
    
    
    
    
    
    
    
    (400,129
    )
    
    
    737,612$
    1,137,741
    
    
    $
    
    
    
    $
    (400,129
    )
    
    $
    737,6122004 RestructuringEmployee separation costs
    
    $
    
    
    
    $
    146,112
    
    
    $
    (25,393
    )
    
    $
    120,719Facility closure costs
    
    
    
    
    
    
    11,750,229
    
    
    
    (8,171,054
    )
    
    
    3,579,175
    
    
    
    11,896,341
    
    
    
    (8,196,447
    )
    
    
    3,699,894Total
    
    $
    1,137,741
    
    
    $
    11,896,341
    
    
    $
    (8,596,576
    )
    
    $
    4,437,506
 Interest income was $0.6 million and $1.0 million for the three months
ended June 30, 2004 and 2003 respectively. The decrease was primarily the
result of lower average cash and investment balances held during the three
months ended June 30, 2004 as compared to the three months ended June 30, 2003. Other (expense) income, net was an expense of $0.3 million in the three
months ended June 30, 2004 as compared to income of $1.4 million for the three
months ended June 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 consolidated balance sheets. The recorded value of such
warrants can fluctuate significantly (20)




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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 $1.5
million and a loss of $3.8 million for the three months ended June 30, 2004 and
2003, respectively. During
the three months ended June 30, 2004 and June 30 2003, we
recorded charges of $0 and $3.8
million, respectively, in the consolidated statements of operations for changes in the
estimated value of the Two-Year Interest Make-Whole provision of our 6.52%
Senior Notes. These charges were recorded in connection with a derivative
liability related to the 6.52% Senior Notes. The Two-Year Interest Make-Whole
provision, included in the note indenture and described in Note 6 to our
consolidated financials statements included on Form 10-K for the year ended
March 31, 2004, represented an embedded derivative which was required to be
accounted for apart from the underlying 6.52% Senior Notes. At issuance of the
6.52% Senior Notes, the Two-Year Interest Make-Whole feature was estimated to
have a fair value of $9.0 million and the initial recorded value of the 6.52%
Senior Notes was reduced by this allocation. The estimated value of the
Two-Year Interest Make-Whole feature was carried in the consolidated balance
sheets under the caption derivative liability related to convertible notes
and was adjusted quarterly through derivative losses related to convertible
notes in the consolidated statements of operations and comprehensive losses
for changes in the estimated market value of the feature. 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. We also recorded a derivative liability related to the 21⁄2% Convertible
Subordinated Notes due 2023 (the 21⁄2% Subordinated Notes). The Three-Year
Interest Make-Whole, included in the note indenture and described in Note 6 to
our consolidated financial statements on Form 10-K for the year ended March 31,
2004, represented an embedded derivative which was required to be accounted for
apart from the underlying 21⁄2% Subordinated Notes. At issuance of the
21⁄2% Subordinated Notes, 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 has been recorded as a derivative liability in the
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 us to repurchase 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
consolidated statements of operations until it is paid out or expires. During
the three months ended June 30, 2004, we recorded net income of $1.5 million in
the consolidated statements of operations and comprehensive loss 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
$3.1 million June 30, 2004, can fluctuate significantly based on fluctuations
in the market value of our common stock. (21)




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Interest expense was $1.2 million for the three months ended June 30, 2004
as compared to $3.5 million for the three months ended June 30, 2003. The
decrease was primarily the result of a decrease in the average outstanding debt
balance and 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. We expect to incur
significant additional research and development and other costs in connection
with collaborative arrangements and as we expand the development of our
proprietary product candidates, including costs related to preclinical studies,
clinical trials and facilities expansion. We expect that our costs, including
research and development costs for our product candidates and sales, marketing
and promotion expenses for any future products to be marketed by us, will
exceed revenues significantly for the next few years, which will result in
continuing losses from operations. Liquidity and Capital Resources Cash and cash equivalents and short-term investments were approximately
$121.9 million at June 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 three months ended June 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 June 30, 2004 consist of U.S. Government obligations
held as collateral under certain letters of credit and lease agreements. All of our investments in debt securities are classified as
available-for-sale and are recorded at fair value. Fair value is determined
based on quoted market prices. In August and September 2003, we issued an aggregate of $100.0 million and
$25.0 million, respectively, 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. (22)




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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 recognized
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. 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, approximately $24.9 million of the $25.0 million of funding from the
Convertible Preferred Stock related to the Lilly insulin program had been spent
and the entire $5.0 million of funding from the Convertible Preferred Stock
related to the Lilly hGH program had been spent. Thus, in the quarter ended
June 30, 2004, we recognized revenue of approximately $0.9 million related to
work performed on the hGH development program. 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 June 30,
2004, we had recognized approximately $44.2 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 (23)




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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
June 30, 2004, approximately $6.7 million of this prepayment was unearned and
was recorded as a current liability under the caption deferred revenue in the
consolidated balance sheets. Capital expenditures were approximately $4.1 million for the three months
ended June 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 interest income, manufacturing and
royalty revenues and research and development revenues under collaborative
arrangements, will be sufficient to meet our anticipated capital requirements
through at least March 31, 2006. 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. (24)




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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 marketable securities are sensitive to changes in
interest rates. Interest rate changes would result in a change in the fair
value of these financial instruments due to the difference between the market
interest rate and the rate at the date of purchase of the financial instrument.
A 10% decrease in year-end market interest rates would result in no material
impact on the net fair value of such interest-sensitive financial instruments. A 10% increase or decrease in market interest rates on our 2 1/2%
Subordinated Notes and our 3.75% Subordinated Notes would result in no material
impact on our notes. Foreign Currency Exchange Rate Risk The royalty revenues we receive on Risperdal Consta are a percentage of
the net sales made by our collaborative partner. Some of these sales are made
in foreign countries and are denominated in foreign currencies. The royalty
payment on these foreign sales is calculated initially in the foreign currency
in which the sale is made and is then converted into U.S. dollars to determine
the amount that our collaborative partner pays us for royalty revenues.
Fluctuations in the exchange ratio of the U.S. dollar and these foreign
currencies will have the effect of increasing or decreasing our royalty
revenues 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 will decrease given a constant amount of sales in such
foreign currency. The impact on our royalty revenues from foreign currency exchange rate
risk is based on a number of factors, including the amount of sales in any
foreign currency, the exchange ratio (and the change in the 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. (25)




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Item 4.
    Controls and Procedures As of June 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 June 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. (26)




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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. 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 6. Exhibits and Reports on Form 8-K  (a)
    
    List of Exhibits: Exhibit No.  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.
  (b)
    
    During the quarter ended June 30, 2004, the Registrant filed
or furnished Current Reports on Form 8-K as follows: Date of 8-K CurrentReport
    
    Description
    
    Filed or FurnishedMay 13, 2004
    
    Results of Operations
and Financial Condition
pursuant to Item 12
    
    FurnishedJune 1, 2004
    
    Other Events and Regulation FD Disclosure
and Financial Statements
pursuant to Items 5, 7
and 9
    
    Item 5 Filed andItem 9
Furnished
 (27)




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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: August 6, 2004
    By:
    /s/  Richard F. PopsRichard F. PopsChief Executive Officer and
Director
(Principal Executive Officer) Date: August 6, 2004
    By:
    /s/  James M. FratesJames M. FratesVice President, Chief
Financial Officer and
Treasurer
(Principal Financial and
Accounting Officer) (28)




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Exhibit Index Exhibit No.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.
 (29)