U.S. SECURITIES AND EXCHANGE COMMISSION

FORM 10-Q

For the quarterly period ended June 30, 2004

For the transition period from                      to                     

Commission file number 1-14131

ALKERMES, INC.

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.

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ALKERMES, INC. AND SUBSIDIARIES

INDEX

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PART 1. FINANCIAL INFORMATION

Item 1. Consolidated Financial Statements:

ALKERMES, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

See notes to condensed consolidated financial statements.

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ALKERMES, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

See notes to condensed consolidated financial statements.

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ALKERMES, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

See notes to condensed consolidated financial statements.

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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.

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2. COMPREHENSIVE LOSS

Comprehensive loss for the three months ended June 30, 2004 and 2003 is as follows:

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:

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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:

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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:

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.

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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:

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:

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.

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7. DERIVATIVES

2½% Subordinated Notes — In August and September 2003, the Company issued an aggregate of $100.0 million and $25.0 million, respectively, principal amount of 2½% Convertible Subordinated Notes due 2023 (the “2½% Subordinated Notes”). The 2½% 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 2½% Subordinated Notes bear interest at 2½% 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 2½% Subordinated Notes. The Three-Year Interest Make-Whole provision represents an embedded derivative which is required to be accounted for apart from the underlying 2½% Subordinated Notes. At issuance of the 2½% 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 2½% Subordinated Notes and is being accreted to interest expense over five years through September 1, 2008, the first date on which holders of the 2½% Subordinated Notes have the right to require the Company to repurchase the 2½% 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 2½% Subordinated Notes, approximately $3.1 million at

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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

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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:

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.

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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 disconti