10-Q 1 a10-q.txt 10-Q SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-Q X QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF --------- THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended June 30, 2000 OR TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF --------- THE SECURITIES EXCHANGE ACT OF 1934 (NO FEE REQUIRED) For the transition period from ________ to ________. COMMISSION FILE NUMBER: 000-23501 SPIROS DEVELOPMENT CORPORATION II, INC. (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER) DELAWARE 33-0774288 (State or other jurisdiction (I.R.S. Employer or incorporation or organization) Identification No.) 7475 LUSK BLVD., SAN DIEGO, CALIFORNIA 92121 (Address of principal executive offices) (zip code) Registrant's telephone number, including area code (858) 457-2553 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 --- --- The number of shares of the Registrant's Callable Common Stock and Special Common Stock outstanding as of July 31, 2000 were 6,325,000 and 1,000, respectively. PART I - FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS SPIROS DEVELOPMENT CORPORATION II, INC. (A DEVELOPMENT STAGE ENTERPRISE) BALANCE SHEETS IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS --------------------------------------------------------------------------------

See accompanying notes to financial statements. 2 SPIROS DEVELOPMENT CORPORATION II, INC. (A DEVELOPMENT STAGE ENTERPRISE) STATEMENTS OF OPERATIONS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS (UNAUDITED) --------------------------------------------------------------------------------

See accompanying notes to financial statements. 3 SPIROS DEVELOPMENT CORPORATION II, INC. (A DEVELOPMENT STAGE ENTERPRISE) STATEMENTS OF CASH FLOWS IN THOUSANDS (UNAUDITED) --------------------------------------------------------------------------------

See accompanying notes to financial statements. SPIROS DEVELOPMENT CORPORATION II, INC. (A DEVELOPMENT STAGE COMPANY) NOTES TO FINANCIAL STATEMENTS (UNAUDITED) 1. BASIS OF PRESENTATION The accompanying unaudited financial statements have been prepared by Spiros Development Corporation II, Inc. ("Spiros Corp. II" or the "Company") in accordance with the instructions to Form 10-Q. The financial statements reflect all adjustments, consisting of only normal recurring accruals, which are, in the opinion of management, necessary for a fair statement of the results of the periods presented. For more complete financial information, these financial statements and notes thereto should be read in conjunction with the audited financial statements and notes thereto for the periods ended December 31, 1999 included in the Company's Annual Report on Form 10-K filed with the Securities and Exchange Commission. The results of operations for the interim periods are not necessarily indicative of results to be expected for any other interim periods or for the year as a whole. The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect amounts reported in the financial statements and related notes. Changes in those estimates may affect amounts reported in future periods. 2. ORGANIZATION Spiros Corp. II was incorporated in the state of Delaware on September 23, 1997 for the purpose of continuing the development of Spiros(R), a dry powder pulmonary drug delivery system, and to conduct formulation work, clinical trials and commercialization for certain specified leading asthma and chronic obstructive pulmonary disease drugs for use with Spiros. The Company commenced operations on December 22, 1997. On December 22, 1997, the Company and Dura Pharmaceuticals, Inc. ("Dura") completed an initial public offering (the "Offering") of 6,325,000 Units, each Unit consisting of one share of callable common stock of the Company and one warrant to purchase one-fourth of one share of Dura common stock at a price per share of $54.84. The offering resulted in net proceeds to the Company of approximately $94 million. Concurrently, Dura contributed $75 million to the Company. Substantially all funds from the Offering, the $75 million contribution and interest earned thereon are expected to be paid to Dura for the development and commercialization of Spiros and the use of Spiros with certain drugs pursuant to various agreements with Dura. Through December 31, 1999, each share of the Company's callable common stock traded publicly as a unit with the warrant to purchase one-fourth of one share of Dura's common stock. As of January 1, 2000, the warrant began trading as a separate security. 5 3. DEFINITIVE MERGER AGREEMENT WITH DURA PHARMACEUTICALS, INC. In March 2000 the Company entered into a merger agreement with Dura. Under the agreement, each holder of our callable common stock will receive $13.25 in cash and a warrant to purchase a fractional share of Dura's common stock for each share of callable common stock held. The warrant will be immediately exercisable at $17.94 per share, which represents a 25% premium over the average closing price of Dura's common stock for the ten trading days prior to the date of the merger agreement, and will expire five years from the date the merger is completed. The exact fraction of a share of Dura's common stock purchasable under the warrant will be determined based on the average closing price of Dura's common stock for the ten trading days prior to the vote of the Company's stockholders on the merger and will result in a calculated value, using the Black-Scholes option pricing model, for each warrant between $3.22 and $1.81. Closing of the transaction is subject to the Company's stockholder approval. The Company and Dura have received voting agreements in favor of the merger from holders of approximately 22% of our outstanding callable common stock. A special committee of independent members of the Company's board, formed in December 1999 to evaluate our strategic alternatives, has approved the merger agreement and is recommending that our stockholders approve the merger. The Company has delivered a proxy statement describing the terms of the merger agreement in greater detail to our stockholders. A special meeting of the Company's stockholders will be held on August 31, 2000 to vote on the proposed merger. On July 24, 2000, Dura announced the implementation of a refocused strategy. As part of this strategy, Dura will, upon the successful completion of the proposed merger, discontinue the development of all motorized Spiros cassette programs, including drugs being developed by the Company. Dura intends to focus its development efforts on next generation, motorless Spiros systems which are designed to be smaller, lighter, and significantly less costly to manufacture. With this change in strategy, all future development by Dura of the drugs it is acquiring from the Company will be for use in the motorless Spiros systems. The Company's current development plan and budget for 2000 may result in the Company expending all cash during the second half of the year. The development plan and budget for the second half of 2000 are subject to change in the event the merger with Dura is not completed. 4. REPORTING COMPREHENSIVE LOSS Comprehensive loss includes net loss and unrealized gains and losses on investments. The accumulated balance of other comprehensive loss is disclosed as a separate component of stockholders' equity. For the three and six months ended June 30, 1999 and 2000, and the period September 23, 1997 (date of incorporation) through June 30, 2000, comprehensive loss consisted of (in thousands): 6

ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS This information should be read in conjunction with the financial statements and the notes thereto included in Item 1 of this Quarterly Report and the audited financial statements and notes thereto and Management's Discussion and Analysis of Financial Condition and Results of Operations for the year ended December 31, 1999 included in the Company's Annual Report on Form 10-K filed with the Securities and Exchange Commission. This report on Form 10-Q may contain certain forward-looking statements concerning our business. See "Risks and Uncertainties" for a discussion of factors known to us that could cause reported financial information not to be indicative of future results. We undertake no obligation to release publicly the results of any revisions to these forward-looking statements to reflect events and circumstances arising after the date hereof. GENERAL Spiros Development Corporation II, Inc. was incorporated in the state of Delaware on September 23, 1997 for the purpose of continuing the development of Spiros(R), a dry powder pulmonary drug delivery system, and to conduct formulation work, clinical trials and commercialization for certain specified leading asthma and chronic obstructive pulmonary disease drugs for use with Spiros(R). We commenced operations on December 22, 1997. On December 22, 1997, we and Dura completed an initial public offering of 6,325,000 units, each unit consisting of one share of our callable common stock and one warrant to purchase one-fourth of one share of Dura common stock at a price of $54.84 per share. The offering resulted in net proceeds to us of approximately $94 million. Concurrently, Dura contributed $75 million to us. We expect to pay to Dura substantially all funds from the offering and the $75 million contribution from Dura and interest earned on these funds for the development and commercialization of Spiros and the use of Spiros with specified drugs under our various agreements with Dura. 7 In December 1997, we entered into a technology license agreement with Dura. Dura granted us an exclusive, worldwide, perpetual royalty-bearing license to use technology owned by Dura relating to the use of Spiros with the asthma and chronic obstructive pulmonary disease drugs albuterol, beclomethasone, ipratropium, budesonide, and a combination of albuterol and ipratropium. We also executed a series of agreements with Dura, which provide for the development, marketing, and manufacturing of Spiros with specified compounds and for the provision of general and administrative services by Dura. Since Dura conducts all of our current activities under these agreements, we do not maintain any research staff or occupy any research facilities. In March 2000 we entered into a merger agreement with Dura. Under the agreement, each holder of our callable common stock will receive $13.25 in cash and a warrant to purchase a fractional share of Dura's common stock for each share of callable common stock held. The warrant will be immediately exercisable at $17.94 per share, which represents a 25% premium over the average closing price of Dura's common stock for the ten trading days prior to the date of the merger agreement, and will expire five years from the date the merger is completed. The exact fraction of a share of Dura's common stock purchasable under the warrant will be determined based on the average closing price of Dura's common stock for the ten trading days prior to the vote of our stockholders on the merger and will result in a calculated value, using the Black-Scholes option pricing model, for each warrant between $3.22 and $1.81. Closing of the transaction is subject to our stockholders approval. We and Dura have received voting agreements in favor of the merger from holders of approximately 22% of our outstanding callable common stock. A special committee of independent members of the Company's board, formed in December 1999 to evaluate our strategic alternatives, has approved the merger agreement and is recommending that our stockholders approve the merger. We have delivered a proxy statement describing the terms of the merger agreement in greater detail to our stockholders. A special meeting of our stockholders will be held on August 31, 2000 to vote on the proposed merger. On July 24, 2000, Dura announced the implementation of a refocused strategy. As part of this strategy, Dura will, upon the successful completion of the proposed merger, discontinue the development of all motorized Spiros cassette programs, including drugs being developed by us. Dura intends to focus its development efforts on next generation, motorless Spiros systems which are designed to be smaller, lighter, and significantly less costly to manufacture. With this change in strategy, all future development by Dura of the drugs it is acquiring from us will be for use in the motorless Spiros systems. Our current development plan and budget for 2000 may result in us expending all cash during the second half of the year. The development plan and budget for the second half of 2000 are subject to change in the event the merger with Dura is not completed. In the event the merger is not completed, Dura, as holder of 100% of the outstanding shares of our special common stock, still has an irrevocable option to purchase all, but not less than all, of the issued and outstanding shares of our callable common stock at predetermined prices. Dura may exercise the purchase option at any time through the earlier of: 8 - December 31, 2002; - the 90th day after the date we provide Dura with our quarterly financial statements showing cash or cash equivalents of less than $5 million, although Dura may extend such period by providing additional funding for the continued development of Spiros, but in no event beyond December 31, 2002; or - upon termination of the technology license, development, or the manufacturing agreements with Dura. The purchase option exercise price per share is $27.96 through September 30, 2000, and increases on a quarterly basis to $45.95 per share through December 31, 2002. The purchase price may be paid, at Dura's discretion, in cash, shares of Dura common stock, or any combination thereof. RESULTS OF OPERATIONS THREE MONTHS ENDED JUNE 30, 1999 AND 2000 We incurred net losses of $12.2 million and $17.1 million for the three months ended June 30, 1999 and 2000, respectively. Research and development costs totaled $13.3 million and $16.4 million for the second quarter of 1999 and 2000, respectively, and general and administrative expenses totaled $279,000 and $1.4 million, respectively, for the same periods. The research and development expenses were for Spiros-related activities performed by Dura under agreements with us. The increase in general and administrative expenses was primarily attributable to legal, accounting, and financial advisory costs incurred in connection with the proposed merger with Dura. Interest income for the second quarter of 1999 and 2000 totaled $1.4 million and $692,000, respectively. The decline results from lower balances of cash and short-term investments during the second quarter of 2000 versus the second quarter of 1999. We expect our interest income to continue to decrease in future periods as our funds are used in the development of Spiros products. SIX MONTHS ENDED JUNE 30, 1999 AND 2000 We incurred net losses of $24.2 million and $31.4 million for the six months ended June 30, 1999 and 2000, respectively. Research and development costs totaled $26.6 million and $31.1 million for the first six months of 1999 and 2000, respectively, and general and administrative expenses totaled $556,000 and $1.9 million, respectively, for the same periods. The research and development expenses were for Spiros-related activities performed by Dura under agreements with us. The increase in general and administrative expenses was primarily attributable to legal, accounting, and financial advisory costs incurred in connection with the proposed merger with Dura. Interest income for the first six months of 1999 and 2000 totaled $3 million and $1.6 million, respectively. The decline results from lower balances of cash and short-term investments during the first six months of 2000 versus the first six months of 1999. We expect our interest income to continue to decrease in future periods as our funds are used in the development of the Spiros products. 9 LIQUIDITY AND CAPITAL RESOURCES Our initial capitalization totaled $169 million, consisting of net proceeds from our initial public offering of approximately $94 million and a $75 million contribution from Dura. At June 30, 2000, we had cash, cash equivalents, and short-term investments totaling $39.4 million and working capital totaling $33.2 million, a decrease of $31.7 million and $31 million, respectively, from December 31, 1999. Based on our current development plan and budget for the Spiros products, we expect to expend all of our existing cash during the second half of 2000. Further, we do not believe that our existing cash will be sufficient to complete the development of any Spiros product. In the event the merger with Dura is not consummated, the use of our existing funds will require Dura to consider whether to exercise its option to purchase our callable common stock under the contractual terms, which it may not be prepared to do at that time. Until the expiration of Dura's option, we are restricted from raising additional funds without Dura's consent. While Dura may, at its sole option, provide funds for further development of the Spiros products or infuse additional capital into us through the exercise of Dura's product purchase options, it is not obligated to do so. In addition, on July 24, 2000, Dura announced its refocused growth strategy including an immediate reduction in overall development spending. Upon the successful completion of the proposed merger, Dura will discontinue the development of all motorized Spiros cassette programs, including Beclomethasone Spiros(TM) and Budesonide Spiros(TM). If Dura fails to provide additional funding, we will explore the other strategic alternatives available to us, including liquidation, sale to a third party, or licensing of the technology. There can be no assurance that any of these alternatives will be successful. As noted above, in March 2000, we entered into a definitive merger agreement with Dura for the acquisition by Dura of all the outstanding shares of our callable common stock. Under the merger agreement, Dura will purchase each share of callable common stock for $13.25 in cash plus one five-year warrant to purchase a fractional share of Dura common stock at $17.94 per share. Closing of the acquisition is subject to approval by our stockholders. RISKS AND UNCERTAINTIES FORWARD-LOOKING STATEMENTS. We caution readers that the statements in this quarterly report that are not descriptions of historical facts may be forward-looking statements that are subject to risks and uncertainties. Actual results could differ from those currently anticipated due to a number of factors, including those identified below. WE FACE RISKS ASSOCIATED WITH THE PENDING MERGER WITH DURA. THE FRACTIONAL SHARES OF DURA COMMON STOCK UNDERLYING EACH WARRANT WILL VARY AS DURA'S STOCK PRICE CHANGES AND OUR STOCKHOLDERS MAY NOT BE SURE HOW MANY SHARES WILL BE ISSUABLE UNDER EACH WARRANT UNTIL AFTER THEY HAVE CAST THEIR VOTE. Under the merger agreement, each share of our callable common stock will be converted into the right to receive $13.25 in cash and a warrant to purchase a fractional share of Dura common 10 stock. The fraction of a share of Dura common stock issuable under the warrant will be determined based on the average closing price of Dura common stock for the 10 trading days prior to the special meeting and will result in a calculated value, using the Black-Scholes option pricing model, for each warrant of between $3.22 and $1.81. As of July 31, 2000, the fraction of a share purchasable under each warrant would be 0.2652 with a Black-Scholes calculated value of $3.22. There can be no assurance, however, that the fraction issuable will be the same at the closing date or that the market price of the warrant will equal the Black-Scholes calculated value of the warrant. The price of Dura common stock at the date of the special meeting may vary from the price on the date of this document and on the date of the closing of the merger and that variance could affect the value of the warrant. The trading price of Dura's common stock may vary because of: - changes in Dura's or our business, operations or prospects; - market assessments of the likelihood that the merger will be completed; - the timing of the completion of the merger; - the prospects of post-merger operations; - regulatory considerations; and - general market and economic conditions and other factors. FAILURE TO COMPLETE THE MERGER COULD NEGATIVELY IMPACT OUR STOCK PRICE AND FUTURE BUSINESS AND OPERATIONS. If the merger is not completed for any reason, we may be subject to a number of material risks, including the following: - our existing working capital and expected interest income may not be sufficient to fund our cash requirements through the end of 2000; - raising additional cash to fund our ongoing activities is likely to be very difficult in light of the contractual arrangements between us and Dura; - the price of our callable common stock may decline to the extent that the current market price of our callable common stock reflects a market assumption that the merger will be completed; and - various costs of the merger, such as legal and accounting fees and the expenses and fairness opinion fees of our financial advisor, must be paid even if the merger is not completed. Further, if the merger is terminated and our board of directors determines to seek another merger or business combination, we may not be able to find a partner willing to pay an equivalent or more attractive price than the price to be paid in the merger. These risks are magnified by Dura's announcement on July 24, 2000 of its intent to terminate the motorized cassette programs following completion of the proposed merger. 11 WE FACE RISKS ASSOCIATED WITH OUR OPERATIONS. SPIROS TECHNOLOGY REQUIRES SIGNIFICANT ADDITIONAL DEVELOPMENT, WHICH IS COSTLY, TIME-CONSUMING AND MAY NEVER BE COMMERCIALLY SUCCESSFUL. Spiros, our proprietary dry powder pulmonary drug delivery system, will require significant additional development efforts as well as clinical testing. This work is very costly and time consuming. Even after spending significant amounts of money and time, the development and commercialization, if any, of any Spiros product may not be successful. WE MAY NOT HAVE SUFFICIENT FUNDS TO COMPLETE THE DEVELOPMENT OF ANY SPIROS PRODUCT. If the merger with Dura is not completed, we do not believe that our current available funds will be adequate to complete the development or regulatory review process for any of the Spiros products. Until the expiration of Dura's purchase option, we are significantly restricted from raising additional funds without Dura's consent. While Dura may, at its sole option, provide funds for further development of the Spiros products or provide additional cash to us through the exercise of the albuterol or product purchase options, it is not obligated to do so. In addition, on July 24, 2000, Dura announced its refocused growth strategy including an immediate reduction in overall development spending. Upon the successful completion of the proposed merger, Dura will discontinue the development of all motorized Spiros cassette programs, including Beclomethasone Spiros(TM) and Budesonide Spiros(TM). Dura may not have adequate information available to it when our funds are depleted to make a decision on the exercise of the albuterol or product option. If the purchase option or either the albuterol or product options is not exercised by Dura, and the merger agreement is not completed, we would have to raise substantial funding while hiring, or otherwise obtaining access to, research and management personnel to perform the work now performed by Dura. We may not be successful in doing any of these tasks. DURA MAY NOT EXERCISE ITS OPTIONS. In the event the merger with Dura is not completed, Dura is not obligated to exercise its stock purchase option, the albuterol purchase option or the second product purchase option, and it will exercise these options only if Dura's board of directors determines that it is in Dura's best interest to do so. Even if the Spiros products are developed and approved, if Dura does not exercise any of its options, we will be required to find alternative ways to commercially market or exploit the Spiros products. We may not be able to do so. If we attempt to develop or market the Spiros products ourselves, we will require substantial additional funds. We may not be able to raise funds when needed. Similarly, if we elect to license the Spiros products to third parties, such arrangements, if available, may be on terms less favorable to us than the terms of our arrangements with Dura. 12 BEFORE WE CAN MARKET ANY SPIROS PRODUCT, WE WILL HAVE TO OBTAIN REQUIRED GOVERNMENTAL APPROVALS, WHICH IS NOT ASSURED. The development, testing, manufacturing and marketing of pharmaceutical products are subject to extensive regulation by governmental authorities, including the FDA. The FDA must approve each Spiros product before that product can be manufactured or marketed for commercial sale. Failure to obtain such approvals could result in Dura not exercising its purchase option for our callable common stock. The review and approval process mandated by the FDA is very rigorous, requiring extensive preclinical and clinical testing as well as determining manufacturing capability and product performance. None of the products currently in development may ever be approved by the FDA. WE ARE DEPENDENT ON DURA FOR ALL ACTIVITIES IN THE DEVELOPMENT OF SPIROS PRODUCTS. We do not have manufacturing or marketing capabilities. We and Dura will determine specified activities to be undertaken under the development agreement. In all events Dura will have substantial influence over all activities and procedures, including the timing and priorities of these activities and procedures, to be undertaken under our agreements with Dura. Dura has no obligation to complete any development or other activity after all of our funds have been spent. Dura's own projects and other third party projects may compete for time and resources with our projects. The resources that Dura uses for our projects may therefore be limited. Under our agreements with Dura, we are obligated to use only Dura's facilities for manufacturing in the U.S. during the term of the manufacturing and marketing agreement. Dura has the right to use contract manufacturers and currently plans to rely on third parties to manufacture certain components of Spiros. Dura's facilities or those of its contract manufacturers may not be adequate for our needs. In addition, Dura or its contract manufacturers may require additional FDA approvals prior to commencing manufacturing of Spiros products. The Spiros products may not be manufacturable, whether by Dura or a contract manufacturer, on a commercial scale, for commercially reasonable cost or on a timely basis. We have no experience in sales, marketing or distribution. Under the manufacturing and marketing agreement, Dura has exclusive worldwide marketing rights to the Spiros products. Dura's sales and marketing force may not be able to establish commercially successful sales and distribution capabilities for the Spiros products. DURA WILL NEED TO SIGNIFICANTLY EXPAND ITS MANUFACTURING CAPABILITY AND COMPLY WITH GOVERNMENT REGULATIONS BEFORE IT CAN MANUFACTURE ANY SPIROS PRODUCTS ON OUR BEHALF. If Dura or other third parties are not successful in attaining acceptable manufacturing quality levels or meeting regulatory requirements, our ability to commercialize the Spiros products will be adversely affected. Dura will need to significantly expand its current manufacturing operations and comply with regulations prescribed by various regulatory agencies to achieve the quality and required levels of production of our products to obtain marketing approval. In addition, Dura's manufacturing facility must be registered with and licensed by various regulatory authorities and must comply with current good manufacturing practice requirements prescribed by the FDA and the State of California. Any third parties used in manufacturing Spiros will be required to 13 significantly scale up their activities and to produce components which meet applicable specifications on a timely and consistent basis. THE PHARMACEUTICAL INDUSTRY IS EXTREMELY COMPETITIVE. Many companies, including large pharmaceutical firms with financial and marketing resources and development capabilities substantially greater than ours, are engaged in developing, marketing and selling products that compete with those that we plan to offer. Our failure to effectively respond to the competitive pressures of our industry would have an adverse effect on our ability to effectively sell our products. The selling prices of such products typically decline as competition increases. Further, other products now in use or under development by others may be more effective than our current or future products. The industry is characterized by rapid technological change, and competitors may develop their products more rapidly than us. Competitors may also be able to complete the regulatory process sooner, and therefore, may begin to market their products in advance of our products. WE DO NOT HAVE A LONG OPERATING HISTORY AND WE MAY NEVER ACHIEVE PROFITABILITY OR PAY DIVIDENDS. We have a limited operating history upon which investors may base an evaluation of our likely financial performance. We anticipate that substantially all of our available funds will be expended prior to the receipt of any significant revenues, resulting in significant losses. Further, even if the Spiros products are developed or marketed under the agreements with Dura, they may not be able to be marketed profitably. Even if such Spiros products are commercialized profitably, we may never recover our initial losses. We are prevented from paying dividends on our common stock without the approval of Dura, and accordingly, do not expect to pay any dividends. POTENTIAL COMPETITION FROM DURA MAY HAVE AN ADVERSE EFFECT ON OUR BUSINESS. Dura is engaged in ongoing licensing and development of new products. While Dura has exclusively licensed to us the rights to develop, manufacture and commercialize the specified Spiros products, Dura is not prohibited from developing other products using Spiros, including those products that may compete with our Spiros products, or from in-licensing or acquiring products that may compete with the Spiros products. Dura's activities may lead to the development, in-licensing or acquisition of products that compete with our Spiros products. It is possible that Dura's rights with respect to such competitive products could reduce Dura's incentive to exercise the albuterol option, the other product option or the stock purchase option. DURA HAS THE ABILITY TO LIMIT SPECIFIED ACTIVITIES. Until the expiration of the purchase option, Dura must approve specified activities, including: - information regarding our proposed merger with Dura; - issuing our securities; 14 - borrowing an aggregate of more than $1 million at any one time; - selling a material part of our business or assets; - declaring or paying dividends or making any other distributions to our stockholders; - merging or consolidating with any other corporation; and - adopting, amending or repealing our bylaws. Accordingly, Dura could preclude our stockholders and board of directors from taking any of these actions prior to the expiration of the purchase option. Dura, as holder of all of our outstanding special common stock, may transfer or sell all, but not less than all, of its shares. As a result, an unrelated third party may acquire rights associated with the special common stock, including the rights discussed in this section and the right to exercise the albuterol option, the product option and the purchase option. An acquiror of the special common stock may not have the same financial resources or development, manufacturing or marketing capabilities as Dura, which may reduce the likelihood of the exercise of the albuterol option, the other product option or the stock purchase option. OUR ABILITY TO OBTAIN PATENTS AND PROTECT OUR PROPRIETARY RIGHTS IS UNCERTAIN AND COULD HAVE AN ADVERSE EFFECT ON OUR BUSINESS. Our ability to obtain patents on current or future products or technologies, defend our patents, maintain trade secrets and operate without infringing upon the proprietary rights of others both in the U.S. and abroad is uncertain. Patents may never issue. Even if issued or licensed to us, patents may not be enforceable, provide substantial protection from competition or be of commercial benefit to us. Even if all these are true, we may not possess the financial resources necessary to enforce or defend any patent rights we hold or obtain. Our commercial success will also depend upon avoiding the infringement of patents issued to competitors and upon maintaining the technology licenses upon which specified Dura products are based. Litigation, which is costly, may be necessary to enforce our patent and license rights or to determine the scope and validity of proprietary rights of third parties. If any of our products or technologies are found to infringe upon patents or other rights owned by third parties, we could be required to obtain a license to continue to manufacture or market such products or technologies. Licenses to such patent rights may not be available to us on commercially reasonable terms, if at all. If we do not obtain such licenses, we could encounter delays in marketing affected products or technologies or we could find that the development, manufacture or sale of products requiring such licenses is not possible. OUR STOCK PRICE IS VOLATILE. The market prices for securities of emerging companies, including ours, have historically been highly volatile. Future announcements concerning our competitors or us may have a significant impact on the market price of our callable common stock. Such announcements might include: - financial results; 15 - the results of clinical testing or other developments with our competitors' products; - regulatory developments; - technological innovations; - new commercial products; - changes to government regulations; - regulatory decisions on commercialization of products; - developments concerning proprietary rights; - litigation or public concern as to safety of our products; or - our failure to achieve securities analysts' expectations concerning our earnings per share. ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK We invest our excess cash and short term investments in U.S. government and corporate debt securities with high quality credit ratings and maturities of less than two years. These investments are not held for trading or other speculative purposes. Changes in interest rates affect the investment income we earn on our investments and, therefore, impact our cash flows and results of operations. We are not exposed to risks for changes in foreign currency exchange rates, commodity prices, or any other market rates. PART II - OTHER INFORMATION ITEM 2. CHANGE IN SECURITIES AND USE OF PROCEEDS Use of Proceeds from Registered Securities On December 22, 1997, we and Dura completed an initial public offering of 6,325,000 units. Each unit consisted of one share of our callable common stock and one warrant to purchase one-fourth of one share of Dura common stock, pursuant to a registration statement on Form S-1/S-3 (No. 333-37673/37673-01). The registration statement was declared effective on December 16, 1997. The net proceeds from the offering were invested in cash, cash equivalents and short-term investments. As of June 30, 2000, we have used $129.5 million of our cash, cash equivalents and short-term investments, all of which has been paid to Dura for our operating activities and we have $33.2 million of working capital. ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) Exhibits EXHIBIT NO. DESCRIPTION (1) 3.1 Amended and Restated Certificate of Incorporation 16 (1) 3.2 Amended and Restated Bylaws 27 Financial Data Schedule (1) Incorporated by reference to the Company's Registration Statement on Forms S-1/S-3 (No. 333-37673/37673-01) filed on October 10, 1997, as amended. (b) Reports on Form 8-K None 17 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. SPIROS DEVELOPMENT CORPORATION II, INC. Date: August 11, 2000 /s/ Erle T. Mast --------------------- ------------------- (Erle T. Mast) Vice President, and Chief Financial Officer (Principal Financial Officer) 18

SPIROS DEVELOPMENT CORP II INC 10-Q