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U.S. SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

     For the quarterly period ended December 31, 2003

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 I.   FINANCIAL INFORMATION

Item 1.   Consolidated Financial Statements:

ALKERMES, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS
(Unaudited)

See notes to condensed consolidated financial statements.

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ALKERMES, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)

See notes to condensed consolidated financial statements.

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ALKERMES, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)

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 consolidated financial statements of Alkermes, Inc. (the “Company”) for the three and nine months ended December 31, 2003 and 2002 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, 2003, 2002 and 2001, which are contained in the Company’s Annual Report for the year ended March 31, 2003 filed on Form 10-K. 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 (“ADC II”), 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 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 INCOME (LOSS)

Comprehensive loss for the three and nine months ended December 31, 2003 and 2002 is as follows:

3.   NET INCOME (LOSS) PER SHARE

Basic net income (loss) per share is computed using the weighted average number of common shares outstanding during the period. For the three and nine months ended December 31, 2003 and the nine months ended December 31, 2002, 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 income (loss) per share excludes any dilutive effect from stock options and awards, convertible preferred stock and convertible subordinated notes. Certain common shares potentially issuable were not included in the computation of diluted net loss per share for the three and nine months ended December 31, 2003 and the nine months ended December 31, 2002 because they would have an antidilutive effect due to net losses for such periods.

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3.   NET LOSS PER SHARE (Continued)

Common shares potentially issuable but excluded from the calculation of net loss per share for the three and nine months ended December 31, 2003 and the nine months ended December 31, 2002 consist of the following:

For the three months ended December 31, 2002, the difference between basic and diluted shares used in the computation of earnings per common share was 2,650,114 common equivalent shares. These securities include stock options and awards to purchase 1,258,002 shares of common stock; 382,632 shares of common stock issuable upon conversion of non-voting common stock; 247,033 shares of common stock issuable upon conversion of the 6.52% Convertible Senior Subordinated Notes; and 762,447 shares of common stock issuable upon conversion of the Convertible Preferred Stock.

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 income (loss) and basic and diluted income (loss) per common share for the three and nine months ended December 31, 2003 and 2002 has been determined as if the Company had accounted for its employee stock options under the fair-value method.

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4.   STOCK BASED COMPENSATION (Continued)

Using the Black-Scholes option-pricing model, the weighted average fair value of options granted in the three months ended December 31, 2003 and 2002 was $7.31 and $4.13, and in the nine months ended December 31, 2003 and 2002 was $6.43 and $3.66, 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.

Pro forma information for the three and nine months ended December 31, 2003 and 2002 is as follows:

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:

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5.   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 at:

6.   CONVERTIBLE NOTES

Conversion of 6.52% Senior Notes – In June 2003, the Company announced that it had exercised its right to automatically convert all of its outstanding 6.52% Convertible Senior Subordinated Notes due December 31, 2009 (the “6.52% Senior Notes”) into shares of the Company’s common stock, par value $0.01 per share, in July, 2003. During June and July 2003, $150,707,000 principal amount of 6.52% Senior Notes were exchanged for, and $23,882,000 principal amount of such notes were converted into, the Company’s common stock. In aggregate, the Company issued 24,043,329 shares of common stock in connection with the exchanges and conversions and paid approximately $2,300,000 in cash to satisfy a two-year interest make-whole provision in the bond indenture. None of the 6.52% Notes are currently outstanding and no gain or loss was recorded on the conversion of the 6.52% Senior Notes, which was done in accordance with the underlying indenture.

Issuance of 2½% Subordinated Notes – In August and September 2003, the Company issued an aggregate of $100 million and $25 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

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6.   CONVERTIBLE NOTES (Continued)

immediately preceding the second trading day prior to the conversion date. See discussion of the embedded derivative related to the Three-Year Interest Make-Whole in Note 7 below.

As a part of the sale of the 2½% Subordinated Notes, the Company incurred approximately $4,000,000 of offering costs which were recorded as other assets in the consolidated balance sheets and are being amortized 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.

7.   DERIVATIVES

6.52% Senior Notes – The Company recorded a derivative liability related to the 6.52% Senior Notes. Pursuant to the terms of the 6.52% Senior Notes, the Company would pay additional interest equal to two full years of interest on the 6.52% Senior Notes (the “Two-Year Interest Make-Whole”) if the 6.52% Senior Notes were automatically converted on or prior to December 30, 2004 or if the holders voluntarily converted prior to December 30, 2004. The Two-Year Interest Make-Whole represented an embedded derivative which was required to be accounted for apart from the underlying 6.52% Senior Notes. In June 2003, the Company announced that it exercised its 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. A $3.8 million charge to “Derivative income (loss) related to convertible notes” was recorded in the consolidated statements of operations in the quarter ended June 30, 2003 to account for the increase of this derivative liability. 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.

2½% Subordinated Notes – In August and September 2003, the Company issued $125 million principal amount of 2½% Subordinated Notes. The Three-Year Interest Make-Whole provision, included in the note indenture and described in Note 6, 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 Three-Year Interest Make-Whole amount will be adjusted to its fair value on a quarterly basis until it expires or is paid and such adjustments will be charged to “Derivative income (loss) related to convertible notes” in the consolidated statements of operations. In the three months ended December 31, 2003, the Company recorded income of $0.65 million under the caption “Derivative income (loss) related to convertible notes” in the consolidated statements of operations to account for the decrease of this derivative liability from September 30, 2003 through December 31, 2003. The recorded value of the derivative liability related to the 2½% Subordinated Notes can fluctuate significantly based on fluctuations in the market value of the Company’s common stock.

Warrants – The Company has recorded net charges of approximately $0.75 million and net gains of approximately $1.8 million in the three and nine months ended December 31, 2003,

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7.   DERIVATIVES (Continued)

respectively, in other (expense) income in the consolidated statements of operations in connection with the changes in the fair value of warrants of publicly traded companies received by us from licensees. 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 December 31, 2003, the warrants had a fair value of approximately $2.8 million and were recorded under the caption “Other assets” in our consolidated balance sheets.

8.   INVESTMENT IN RELIANT PHARMACEUTICALS, LLC

In December 2001, the Company purchased approximately 63% of an offering by Reliant of its Series C Convertible Preferred Units, which represented approximately 19% of the equity interest in Reliant, for a purchase price of $100,000,000. The investment has been accounted for under the equity method of accounting because Reliant is organized as a limited liability company, which is treated in a manner similar to a partnership. Because, at the time of the Company’s investment, Reliant had an accumulated deficit from operations and a deficit in members’ capital, under applicable accounting rules, the Company’s share of Reliant’s losses from the date of the Company’s investment has been 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 records its equity in the income or losses of Reliant three months in arrears. For the three and nine months ended December 31, 2003, this charge amounted to $0 and $0, respectively as compared to $24.5 million and $84.0 million for the same periods of the prior year, and is recorded in the Company’s consolidated statements of operations under the caption “Equity in losses of Reliant Pharmaceuticals, LLC.”

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 $100,000,000 investment was reduced to $0 during the fiscal year ended March 31, 2003. Since the Company has no further funding commitments to Reliant, it will not record any further share of losses of Reliant in its consolidated statements of operations. To the extent Reliant has net income in the future, the Company would record its proportional share of Reliant’s net income.

During the period from September 2003 through December 2003, Reliant closed on offerings of its Series D Convertible Preferred Units at a price of $20 per unit totaling approximately $271.4 million, including the exchange of approximately $65.9 million of existing secured debt under its credit facility. The Series D Convertible Preferred Units rank senior to the Series A, B and C Preferred Units and the common units.

The Series D Convertible Preferred Unit holders are entitled to receive a preferred return at an annual rate of 8.5%, compounded quarterly.

As a result of the Series D offering by Reliant, Alkermes’ ownership percentage in Reliant has been reduced from approximately 19% to approximately 12.5%.

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8.   INVESTMENT IN RELIANT PHARMACEUTICALS, LLC (Continued)

Summarized unaudited financial information of Reliant for the three and nine months ended September 30, 2003 and 2002 is as follows:

9.   RESTRUCTURING OF OPERATIONS

In August 2002, the Company announced a restructuring program to reduce the Company’s cost structure as a result of the Company’s expectations regarding the financial impact of a delay in the U.S. launch of Risperdal Consta by the Company’s collaborative partner, Janssen. The restructuring program reduced the Company’s workforce by 122 employees, representing 23% of the Company’s total workforce, and includes 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. The workforce reductions were made across all functions of the Company. Under the restructuring plan, the Company is focusing development activities on those programs that are in the later stages of clinical development and those programs that involve the most productive collaborations.

In connection with the restructuring program, the Company recorded charges of approximately $6.5 million in the consolidated statements of operations and comprehensive loss for the year ended March 31, 2003, which consisted of approximately $1.5 million in employee separation costs, including severance and related benefits, and approximately $5.0 million in facility consolidation and closure costs, including significant estimates relating to a lease cancellation fee, the length of time it will take to sublease certain of the Company’s facilities and the lease rates at which the Company may negotiate sublease agreements with third parties. As of December 31, 2003, the Company had paid an aggregate of approximately $1.5 million in employee separation costs and $3.3 million in facility closure costs under the restructuring program.

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9.   RESTRUCTURING OF OPERATIONS (Continued)

The amounts in the accrual are expected to be paid through fiscal 2006. Pursuant to the restructuring plan, the following charges and payments have been recorded during the nine months ended December 31, 2003:

The Company substantially completed its restructuring program during fiscal 2003 and the remaining activity consists solely of payments associated with abandoned facilities. However, the Company’s remaining restructuring accrual is an estimate of costs associated with leases of closed facilities and may require adjustment in the future.

10.   LITIGATION

Beginning in October 2003, the Company and certain of its current and former officers and directors have been named as defendants in purported securities class action lawsuits filed in the United States District Court for the District of Massachusetts. The cases are 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.). These actions were allegedly filed on behalf of purchasers of the Company’s common stock during the period April 22, 1999 to July 1, 2002 and generally allege, among other things, that, during such period, the defendants made misstatements to the investing public relating to FDA approval of the Company’s Risperdal Consta product. The complaints seek unspecified damages. Although the Company believes these allegations lack 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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11.   RECENT ACCOUNTING PRONOUNCEMENTS

In July 2000, the Emerging Issues Task Force (“EITF”) released EITF Issue No. 00-21, “Accounting for Revenue Arrangements with Multiple Deliverables,” for comment which addresses revenue recognition for arrangements with multiple deliverables. EITF Issue No. 00-21 is effective for revenue arrangements entered into in fiscal periods beginning after June 15, 2003. The Company adopted EITF Issue No. 00-21 on June 1, 2003 and it did not have a material impact on the Company’s financial position and results of operations.

In May 2003, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards (“SFAS”) No. 150, “Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity.” This Statement establishes standards for how an issuer classifies and measures certain financial instruments with characteristics of both liabilities and equity. It requires that an issuer classify a financial instrument that is within its scope as a liability (or an asset in some circumstances). Many of those instruments were previously classified as equity. This statement is effective for financial instruments entered into or modified after May 31, 2003, and otherwise is effective at the beginning of the first interim period beginning after June 15, 2003. It is to be implemented by reporting the cumulative effect of a change in an accounting principle for financial instruments created before the issuance date of the Statement and still existing at the beginning of the interim period of adoption. Restatement is not permitted. The adoption of FASB 150 did not have a material impact on the Company’s financial position and results of operations.

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Item 2.  Management’s Discussion and Analysis of Financial Condition and Results of Operations

Introduction

Alkermes, Inc. (as used in this section, together with our subsidiaries, “us”, “we” or “our”), a Pennsylvania corporation organized in 1987, is an emerging pharmaceutical company developing products based on applying our proprietary drug delivery technologies. Our areas of focus include: controlled, extended-release of injectable drugs using our ProLease^® and Medisorb^® delivery systems and the development of inhaled pharmaceuticals based on our proprietary Advanced Inhalation Research, Inc. (“AIR^®”) pulmonary delivery system. Our business strategy is two-fold. 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. We have a pipeline of products and product candidates in various stages of development, including our proprietary product candidate, Vivitrex^®, for which we announced successful Phase III clinical trial results in December 2003 and two marketed products, Risperdal Consta™ and Nutropin Depot^®. In addition to our Massachusetts corporate headquarters, research and manufacturing facilities, we operate research and manufacturing facilities in 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 December 31, 2003, we had an accumulated deficit of $528.4 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, manufacturing revenues, research and development spending, capital expenditures 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 contained in this document are neither promises or guarantees and our business is subject to significant risks 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, Nutropin Depot and our product candidates (including our proprietary product candidate,

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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 Nutropin Depot; (iii) after the completion of clinical trials for our product candidates (including our proprietary product candidate, Vivitrex) and the submission to the FDA of a New Drug Application (“NDA”) for marketing approval and requests for marketing approval to other health authorities, 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 our first products, Risperdal Consta and Nutropin Depot, or to manufacture or scale-up our future products, including our proprietary product candidate, Vivitrex, on a commercial scale or economically; (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, Nutropin Depot 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 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) unexpected events could interrupt manufacturing operations at our Risperdal Consta and Nutropin Depot facilities, which are, in each case, the sole source of supply for these products; (xi) clinical trials are a time-consuming and expensive process; (xii) our product candidates could be ineffective or unsafe during preclinical studies and clinical trials and we and our collaborators may not be permitted by regulatory authorities to undertake new or additional clinical trials for product candidates incorporating our technologies, or clinical trials could be delayed; (xiii) 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 need to spend substantial funds to become profitable and will, therefore, 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.

The forward-looking statements made in this document are made only as of the date hereof and we do not intend to update any of these factors or to publicly announce the results of any revisions to any of our forward-looking statements other than as required under the federal securities laws.

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Critical Accounting Policies

While our significant accounting policies are more fully described in Note 2 to our consolidated financial statements on Form 10-K for the year ended March 31, 2003, we believe the following accounting policies to be important to the portrayal of our financial condition and results of operations and can require estimates from time to time.

Revenue Recognition – Manufacturing and royalty revenues consist of revenue earned under certain manufacturing and supply and license agreements for our two commercial products, Risperdal Consta and Nutropin Depot. Manufacturing revenues are earned when product is shipped to our collaborative partners. Royalty revenues are earned on product sales made by our collaborative partners and are recorded in the period the product is sold by our collaborative partners. Manufacturing revenues recognized by us are based on information supplied to us by our collaborative partners and may require estimates to be made.

Research and development revenue consists of nonrefundable research and development funding under collaborative arrangements with various collaborative partners. Research and development funding generally compensates us for formulation, preclinical and clinical testing related to the collaborative research programs, and is generally recognized as revenue at the time the research and development activities are performed under the terms of the related agreements, when the corporate partner is obligated to pay and when no future performance obligations exist.

Fees for the licensing of technology or intellectual property rights on initiation of collaborative arrangements are recorded as deferred revenue upon receipt and recognized as income on a systematic basis (based upon the timing and level of work performed or on a straight-line basis if not otherwise determinable) over the period that the related products or services are delivered or obligations, as defined in the agreement, are performed. Revenue from milestone or other upfront payments is recognized as earned in accordance with the terms of the related agreements. These agreements may require deferral of revenue recognition to future periods.

Equity Method Investment in Reliant – In December 2001, we purchased 63% of an offering by Reliant of its Series C Convertible Preferred Units, representing approximately 19% of the equity interest in Reliant, for a purchase price of $100 million. The investment has been accounted for under the equity method of accounting because Reliant is organized as a limited liability company, which is treated in a manner similar to a partnership. Because, at the time of our investment, Reliant had an accumulated deficit from operations and a deficit in members capital, under applicable accounting rules, our share of Reliant’s losses from the date of our investment has been recognized in proportion to our percentage participation in the Series C financing, and not in proportion to our percentage ownership interest in Reliant. We record our equity in the income or losses of Reliant three months in arrears. For the three and nine months ended December 31, 2003, this charge amounted to $0 and $0, respectively. For the three and nine months ended December 31, 2002, this charge amounted to $24.5 million and $84.0 million and was recorded in our consolidated statements of operations under the caption “Equity in losses of Reliant Pharmaceuticals, LLC.” Our $100 million investment was reduced to $0 during the fiscal year ended March 31, 2003. Since we have no further funding commitments to Reliant, we will not record any further share of losses in Reliant in our consolidated statement of operations. To the extent Reliant has net income in the future, we would record our proportional share of Reliant’s net income. Reliant is a privately held company over which we do not exercise control and we have relied on the unaudited and audited financial statements prepared by Reliant’s management and provided to us to calculate our share of Reliant’s losses.

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During the period from September 2003 through December 2003, Reliant closed on offerings of its 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 secured debt under its credit facility. The Series D Preferred Units rank senior to the Series A, B and C 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.

As a result of the Series D offering by Reliant, Alkermes’ ownership percentage in Reliant has been reduced from approximately 19% to approximately 12.5%.

Derivatives Embedded in Certain Debt Securities – Certain of our debt securities have contained features providing for cash payments to be made in the event of our stock price exceeding certain levels and triggering conversions of the debt to common stock. In general, these features call for make-whole payments equal to two or three years of interest on the debt less any amounts paid or accrued prior to the date conversion is triggered. These features expire once the holder has received a defined number of interest payments.

These features represent embedded derivatives which are required to be accounted for separately from the related debt securities. The estimated fair value of these features is valued using a simulation model that incorporates factors such as the current price of our common stock, its volatility, and time to expiration. Changes in the estimated fair value of the liability represented by these factors are charged to the consolidated statements of operations under the caption “Derivative income (loss) related to convertible notes.” These adjustments will be required until the features are either triggered or expire. The recorded value of these liabilities can fluctuate significantly based on changes in the value of our common stock.

Warrant Valuation – We hold warrants to acquire shares of certain publicly held companies, received in connection with our collaboration and licensing activities. The warrants are valued using an established option pricing model and changes in value are recorded in the consolidated statements of operations under the caption “Other (expense) income, net.” The recorded value of these warrants can fluctuate significantly based on changes in the value of the underlying common stock of the issuer. At December 31, 2003, the warrants had a fair value of approximately $2.8 million and were recorded under the caption “Other assets” in our consolidated balance sheets.

Cost of Goods Manufactured – Our cost of goods manufactured includes estimates made with respect to allocations of salaries and related benefits, occupancy costs, depreciation expense and other allocable costs directly related to our manufacturing activities. Costs of goods manufactured are incurred in connection with the manufacture of Risperdal Consta and Nutropin Depot.

Research and Development Expenses – Our research and development expenses include salaries and related benefits, laboratory supplies, temporary help costs, external research costs, consulting costs, occupancy costs, depreciation expense and other allocable costs directly related to our research and development activities. Research and development expenses are incurred in conjunction with the development of our technologies, proprietary product candidates, collaborators’ product candidates and in-licensing arrangements. External research costs relate to toxicology studies, pharmacokinetic studies and clinical trials that are performed for us under

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contract by external companies, hospitals or medical centers. All such costs are charged to research and development expenses as incurred.

Results of Operations

The net loss for the three months ended December 31, 2003 provided in accordance with accounting principles generally accepted in the U.S. (known as “GAAP”) was $20.9 million or $0.23 per share as compared to net income of $41.2 million or $0.64 per share in the same period of the prior year. Included in net income for the three months ended December 31, 2002 are a non-recurring gain of approximately $80.9 million related to the exchange of our 3.75% Subordinated Notes for our 6.52%% Senior Notes in December 2002 and a $24.5 million noncash charge related to the equity investment we made in Reliant in December 2001. Our investment in Reliant has been reduced to $0, and since no further funding commitments exist to Reliant, we have not recorded any share of Reliant’s losses in the current quarter.

The net loss for the nine months ended December 31, 2003 provided in accordance with GAAP was $77.7 million or $0.97 per share as compared to a net loss of $71.9 million or $1.12 per share in the same period of the prior year. Included in the net loss for the nine months ended December 31, 2002 are the non-recurring gain of approximately $80.9 million and an $84.0 million noncash charge related to the equity investment we made in Reliant in December 2001.

Total manufacturing and royalty revenues for the three and nine months ended December 31, 2003 were $8.6 million and $15.5 million, including manufacturing and royalty revenues for Risperdal Consta of $8.2 million and $14.4 million, respectively. Beginning in the first quarter of fiscal 2004, as manufacturing and royalty revenues became material to our quarterly results, we began reporting royalty and manufacturing revenues separate from research and development revenues under collaborative arrangements. The increase in manufacturing and royalty revenues as compared to the three months ended September 30, 2003 was due to an increase in product shipped to our partner, Janssen Pharmaceutica, Inc. (“Janssen”), a wholly owned subsidiary of Johnson & Johnson, as well as an increase in royalties earned on worldwide sales of Risperdal Consta by our partner. Alkermes developed the delivery technology for Risperdal Consta, which is an injectable, long-acting formulation of Risperdal^®, a Janssen Pharmaceutica, Inc. (“Janssen”) drug. Johnson & Johnson has filed for approval of Risperdal Consta around the world. On October 29, 2003, Johnson & Johnson Pharmaceutical Research and Development (“J&J PRD”) received a letter from the FDA approving Risperdal Consta for sale in the U.S. for the treatment of schizophrenia. Janssen Pharmaceutica Products, L.P. launched Risperdal Consta in the U.S. on December 3, 2003. To date the product has been approved for sale in approximately 50 countries outside the U.S. and is currently being marketed in more than 25 of such countries.

Our research and development revenue under collaborative arrangements for the three and nine months ended December 31, 2003 was $2.6 million and $7.5 million compared to $15.2 million and $35.0 million for the corresponding periods of the prior year. The decrease in such revenue was primarily the result of the restructuring of our AIR insulin and AIR hGH programs with Eli Lilly and Company (“Lilly”), changes in our partners, as well as changes in the stage of several other collaborative programs. Beginning January 1, 2003, we no longer record research and development revenue for work performed on the Lilly programs but instead use the proceeds from Lilly’s purchase of $30.0 million of our convertible preferred stock in December 2002 to pay for development costs into calendar year 2004. Also, in December 2002, the royalty payable to us based on revenues of potential inhaled insulin products was increased. Lilly has the right to

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return the convertible preferred stock to us in exchange for a reduction in this royalty rate. At December 31, 2003, approximately $18.8 million of the proceeds from the sale of $30.0 million of our convertible preferred stock had been spent. In December 2003, Lilly made payments to us totaling approximately $7.0 million in order to fund an increase in the scope of our Lilly development programs. This funding has been recorded as deferred revenue in the consolidated balance sheets and we expect to recognize the $7.0 million as revenue after the proceeds from the sale of $30.0 million of our convertible preferred stock have been spent.

For the three and nine months ended December 31, 2003, the cost of goods manufactured was $4.1 million and $11.2 million, consisting of approximately $2.7 million and $7.5 million, respectively, for Risperdal Consta and approximately $1.4 million and $3.7 million, respectively, for Nutropin Depot.

Research and development expenses for the three and nine months ended December 31, 2003 were $21.1 million and $66.2 million as compared to $21.2 million and $74.0 million for the corresponding periods of the prior year. Beginning in the first quarter of fiscal 2004, as the cost of goods manufactured became material to our quarterly results, we began reporting such costs separate from research and development expenses. The decrease in research and development expenses for the three and nine months ended December 31, 2003 compared to the three and nine months ended December 31, 2002 is primarily because we now separately report the cost of goods manufactured for our commercial products, Risperdal Consta and Nutropin Depot. As a result, certain costs that were previously reported as research and development expenses are now reported as cost of goods manufactured. The decrease in research and development expenses for the three and nine months ended December 31, 2003 compared to the three and nine months ended December 31, 2002 was partially offset by an increase in occupancy costs and depreciation expense related to the expansion of our facilities in both Massachusetts and Ohio. There was also an increase in research and development costs in fiscal 2004 as compared to fiscal 2003 resulting from an increase in personnel and related costs and external research expenses related to the continuing development of our proprietary product candidates and our collaborators’ product candidates.

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 was established by us annually based on our annual budget of salaries, employee benefits and the billable non-project-specific costs mentioned above and is often increased annually thereafter 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.

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Below is a summary of our key proprietary and collaborators’ commercial products and product candidates and their respective stages of clinical development.

General and administrative expenses for the three and nine months ended December 31, 2003 were $6.5 million and $18.2 million as compared to $5.4 million and $20.6 million for the corresponding periods of the prior year. The increase for the three months ended December 31, 2003 compared to the same period of the prior year was primarily the result of increased personnel and related costs as well as increases in consulting and insurance costs. The decrease for the nine months ended December 31, 2003 as compared to the nine months ended December 31, 2002 was primarily the result of the write off in the quarter ended September 30, 2002 of approximately $2.7 million in deferred merger costs in connection with the termination of our proposed merger with Reliant. However, there was an increase in personnel and insurance costs in the nine months ended December 31, 2003 as compared to the same periods of the prior year.

In August 2002, we announced a restructuring program to reduce our cost structure as a result of our expectations regarding the financial impact of a delay in the U.S. launch of Risperdal Consta by our collaborative partner, Janssen. The restructuring program reduced our workforce by 122 employees, representing 23% of our total workforce and includes 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 other expenses. The workforce reductions were made across all functions of the Company.

In connection with the restructuring program, we recorded charges of approximately $6.5 million in the consolidated statements of operations and comprehensive loss for the year ended March 31, 2003, which consisted of approximately $1.5 million in employee separation costs, including

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severance and related benefits, and approximately $5.0 million in facility consolidation and closure costs, including significant estimates relating to a lease cancellation fee, the length of time it will take to sublease certain of our facilities and the lease rates at which we may negotiate sublease agreements with third parties. As of December 31, 2003, we had paid an aggregate of approximately $1.5 million and $3.3 million in employee separation costs and facility closure costs, respectively.

The amounts in the accrual are expected to be paid through fiscal 2006. Pursuant to the restructuring plan, the following charges and payments have been recorded during the nine months ended December 31, 2003: