##### Table of Contents









UNITED STATES SECURITIES AND EXCHANGE COMMISSION


Washington D.C. 20549





Form 10-K


|           |  |                                                                                             
|---------- |  | --------------------------------------------------------------------------------------------
|(Mark One) |  |                                                                                             
|þ          |  | ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
    OF THE SECURITIES EXCHANGE ACT OF 1934    
|          
|           |  | For the fiscal year ended December 31, 2004                                                 
|          
|or        
|          
|o          |  | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
    OF THE SECURITIES EXCHANGE ACT OF 1934
|          
|           |  | For the transition period
    from           to          .                                  

Commission File Number: 0-28402





Aradigm Corporation


(Exact Name of Registrant as Specified in Its Charter)


|                                                                   |  |                                         
|------------------------------------------------------------------ |  | ----------------------------------------
|California                                                         |  | 94-3133088                              
|(State or Other Jurisdiction of
    Incorporation or Organization) |  | (I.R.S. Employer
    Identification No.)

3929 Point Eden Way, Hayward, CA 94545


(Address of Principal Executive Offices)


Registrants telephone number, including area code:


(510) 265-9000


Securities registered pursuant to Section 12(b) of the
Act:


None


Securities registered pursuant to Section 12(g) of the
Act:


Common Stock, no par value





þ o


o þ


o þ






DOCUMENTS INCORPORATED BY REFERENCE








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TABLE OF CONTENTS


|             |  |                                                                                                    |    |      |    | 
|------------ |  | -------------------------------------------------------------------------------------------------- | -- | ---- | -- | 
|             |  |                                                                                                    |    | Page |   
|             |  |                                                                                                    |    |      |   
|PART I      
|Item 1.      |  | Business                                                                                           |    |      | 1  | 
|Item 2.      |  | Properties                                                                                         |    |      | 18 | 
|Item 3.      |  | Legal Proceedings                                                                                  |    |      | 18 | 
|Item 4.      |  | Submission of Matters to a Vote of Security
    Holders                                            |    |      | 18 | 
|            
|PART II     
|Item 5.      |  | Market for the Registrants Common
    Stock and Related Stockholder Matters                       |    |      | 19 | 
|Item 6.      |  | Selected Financial Data                                                                            |    |      | 21 | 
|Item 7.      |  | Managements Discussion and Analysis
    of Financial Condition and Results of Operations          |    |      | 22 | 
|Item 7.      |  | Risk Factors                                                                                       |    |      | 29 | 
|Item 7A.     |  | Quantitative and Qualitative Disclosure
    About Market Risk                                      |    |      | 38 | 
|Item 8.      |  | Financial Statements and Supplementary
    Data                                                    |    |      | 39 | 
|Item 9.      |  | Changes in and Disagreements with
    Accountants on Accounting and Financial Disclosure           |    |      | 63 | 
|Item 9A.     |  | Controls and Procedures                                                                            |    |      | 63 | 
|Item 9B.     |  | Other Information                                                                                  |    |      | 63 | 
|            
|PART III    
|Item 10.     |  | Directors and Executive Officers of the
    Registrant                                             |    |      | 64 | 
|Item 11.     |  | Executive Compensation                                                                             |    |      | 64 | 
|Item 12.     |  | Security Ownership of Certain Beneficial
    Owners and Management and Related Stockholder Matters |    |      | 64 | 
|Item 13.     |  | Certain Relationships and Related
    Transactions                                                 |    |      | 64 | 
|Item 14.     |  | Principal Accountant Fees and Services                                                             |    |      | 64 | 
|            
|PART IV     
|Item 15.     |  | Exhibits, Financial Statements Schedules,
    and Reports on Form 8-K                              |    |      | 65 | 
|SIGNATURES   |  |                                                                                                    | 68 |     
|EXHIBIT 23.1
|EXHIBIT 31.1
|EXHIBIT 31.2
|EXHIBIT 32.1





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PART I







|        |         
|------- | --------
|Item 1. | Business

Overview










| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                             
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | Entering into a restructuring of the license agreement for the
    AERx insulin Diabetes Management System between Aradigm and Novo
    Nordisk. The restructuring allows for the sale of assets from
    Aradigm to Novo Nordisk and shifts responsibility to Novo
    Nordisk for further development and commercialization of the
    product. We continue to be entitled to royalties on future sales
    of the commercialized product.
|
| |  | Verifying the final design of our Intraject needle-free system,
    demonstrating that the system met commercially acceptable
    parameters and that previous issues encountered prior to the
    technologys acquisition have been addressed.                                                                                                                                                                                            
|
| |  | Receiving positive clinical results from a pilot pharmacokinetic
    study (measurement of drug level in the blood) of the Intraject
    system administering sumatriptan as a potential treatment for
    migraines, showing bioequivalence to the currently marketed
    injectable product.                                                                                                                                              
|
| |  | Executing a development and licensing agreement with Defense
    R&D Canada for the development of liposomal ciprofloxacin
    for the treatment of respiratory infections including biological
    terrorism-related inhalation anthrax.                                                                                                                                                                                                   



| |                                     
| | ------------------------------------
| | Needle-Free Drug Delivery Background



1



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| |                   
| | ------------------
| | Pulmonary Delivery







| |                      
| | ---------------------
| | Subcutaneous Delivery



The Aradigm Solution for Pulmonary Delivery




| |     
| | ----
| | AERx



2



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| |                         
| | ------------------------
| | Ease of Drug Formulation





| |                                      
| | -------------------------------------
| | Efficient, Precise Aerosol Generation





| |                                     
| | ------------------------------------
| | Automated Breath-Controlled Delivery



The Aradigm Solution for Needle-Free Subcutaneous Delivery




| |          
| | ---------
| | Intraject









3



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| |   |                                  
| | - | ---------------------------------
| |  | Pre-filled and ready to use;     
|
| |  | Lightweight and pocket-sized; and
|
| |  | Easy to operate.                 





| |         
| | --------
| | Strategy





| |                                               
| | ----------------------------------------------
| | Establish Broad Applicability of our Platforms







| |                                                                
| | ---------------------------------------------------------------
| | Expand Existing and Develop New Collaborative
    Relationships





| |                                        
| | ---------------------------------------
| | Enhance Our Strong Proprietary Position



4



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| |                                  
| | ---------------------------------
| | Maintain Technological Leadership



Aradigm Product Applications






AERx insulin Diabetes Management System






| |           
| | ----------
| | The Market



5



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| |            
| | -----------
| | The Product







| |                     
| | --------------------
| | Clinical Development



6



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| |              
| | -------------
| | Collaboration







| |   |                                                                                                                                                                                                                                                                                                               
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | an amended and restated license agreement amending the
    Development and License Agreement previously in place with Novo
    Nordisk, expanding Novo Nordisks development and
    manufacturing rights to the AERx iDMS program and providing for
    royalties to us on future AERx iDMS net sales and    
|
| |  | a three-year agreement under which Novo Nordisk Delivery
    Technologies will perform contract manufacturing for us of AERx
    iDMS-identical devices and dosage forms filled with compounds
    provided by us in support of preclinical and initial clinical
    development by us of other AERx products.



Intraject/Sumatriptan Needle-Free Subcutaneous Delivery
System




7



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| |           
| | ----------
| | The Market





| |            
| | -----------
| | The Product







| |                     
| | --------------------
| | Clinical Development







8



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| |                                         
| | ----------------------------------------
| | Manufacturing/Commercialization Strategy



Additional Potential Applications  AERx and
Intraject






|                        |  |                    
|----------------------- |  | -------------------
|Cardiovascular disease  |  | Endocrine disorder 
|Oncology                |  | Infections         
|Neurological disease    |  | Respiratory disease
|Inflammatory conditions |  |                    





|                        |  |                       
|----------------------- |  | ----------------------
|Neurological disease    |  | Endocrine disorder    
|Oncology                |  | Infections            
|Inflammatory conditions |  | Immunological disorder

9



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Sales and Marketing






Manufacturing












Intellectual Property and Other Proprietary Rights






10



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Competition




11



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Government Regulation








12



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13



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| |   |                                                           
| | - | ----------------------------------------------------------
| |  | controlled drug substances;                               
|
| |  | safe working conditions;                                  
|
| |  | manufacturing practices;                                  
|
| |  | environmental protection;                                 
|
| |  | fire hazard control; and                                  
|
| |  | disposal of hazardous or potentially hazardous substances.





Scientific Advisory Board




|                        |  |                                                               |                            |  |                               |  |                     | 
|----------------------- |  | ------------------------------------------------------------- | -------------------------- |  | ----------------------------- |  | ------------------- | 
|Name                    |  | Affiliation                                                   |                            |  | Area of Expertise             | 
|                        |  |                                                               |                            |  |                               | 
|Peter R. Byron, Ph.D.   |  | Medical College of Virginia, Virginia Commonwealth University |                            |  | Aerosol Science/Pharmaceutics | 
|Peter S. Creticos, M.D. |  | The Johns Hopkins University School of Medicine               |                            |  | Allergy/Immunology/Asthma     | 
|Igor Gonda, Ph.D.       |  |                                                               | Acrux Limited              |  |                               |  | Drug Delivery       | 
|Craig M. Pratt, M.D.    |  |                                                               | Baylor College of Medicine |  |                               |  | Clinical Cardiology | 
|Robert E. Ratner, M.D.  |  |                                                               | MedStar Research Institute |  |                               |  | Endocrinology       | 

Employees




14



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Corporate History and Website Information




Directors and Executive Officers




|                          |  |     |    |  |          |                                                          
|------------------------- |  | --- | -- |  | -------- | ---------------------------------------------------------
|Name                      |  | Age |    |  | Position
|                          |  |     |    |  |         
|V. Bryan Lawlis, Ph.D.    |  |     | 53 |  |          | President, Chief Executive Officer and Director          
|Thomas C. Chesterman      |  |     | 45 |  |          | Senior Vice President and Chief Financial Officer        
|Klaus D. Kohl, Ph.D       |  |     | 54 |  |          | Senior Vice President, Quality and Technical Director    
|Steven J. Farr, Ph.D.     |  |     | 46 |  |          | Senior Vice President, Chief Scientific Officer          
|Bobba Venkatadri          |  |     | 61 |  |          | Senior Vice President, Operations                        
|Babatunde A. Otulana, M.D |  |     | 48 |  |          | Vice President, Clinical & Regulatory Affairs            
|John J. Turanin           |  |     | 47 |  |          | Vice President, Program Management and Corporate Planning
|Norma L. Milligin         |  |     | 66 |  |          | Vice President, Human Resources                          
|Virgil D. Thompson(2)     |  |     | 65 |  |          | Director and Chairman of the Board                       
|Frank H. Barker(1)(3)     |  |     | 74 |  |          | Director                                                 
|Stan M. Benson(2)(3)      |  |     | 54 |  |          | Director                                                 
|Igor Gonda(2)             |  |     | 57 |  |          | Director                                                 
|Stephen O. Jaeger(1)      |  |     | 60 |  |          | Director                                                 
|John Nehra(3)             |  |     | 56 |  |          | Director                                                 
|Wayne I. Roe(1)           |  |     | 54 |  |          | Director                                                 
|Richard P. Thompson       |  |     | 53 |  |          | Director                                                 






|    |                                                             
|--- | ------------------------------------------------------------
|(1) | Member of the Audit Committee.                              
|   
|(2) | Member of the Compensation Committee.                       
|   
|(3) | Member of the Nominating and Corporate Governance Committee.

V. Bryan Lawlis, Ph.D.


15



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Thomas C. Chesterman


Klaus D. Kohl, Ph.D.


Stephen J. Farr, Ph.D.,


Bobba Venkatadri


Babatunde A. Otulana, M.D.,


John J. Turanin


16



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Norma L. Milligin


Virgil D. Thompson


Frank H. Barker


Stan M. Benson


Igor Gonda, Ph.D.


Stephen O. Jaeger


17



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John M. Nehra


Wayne I. Roe


Richard P. Thompson







|        |           
|------- | ----------
|Item 2. | Properties








|        |                  
|------- | -----------------
|Item 3. | Legal Proceedings








|        |                                                    
|------- | ---------------------------------------------------
|Item 4. | Submission of Matters to a Vote of Security Holders



18



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PART II







|        |                                                                             
|------- | ----------------------------------------------------------------------------
|Item 5. | Market for the Registrants Common Stock and Related
    Stockholder Matters

Market Information




|     |                                           |      |   |      |     |  |   |      | 
|---- | ----------------------------------------- | ---- | - | ---- | --- |  | - | ---- | 
|     |                                           | High |   |      | Low | 
|     |                                           |      |   |      |     | 
|2003 |                                           |      |   |      |     |  |   |     
|     | First Quarter                             |      | $ | 1.85 |     |  | $ | 0.66 | 
|     | Second Quarter                            |      |   | 3.51 |     |  |   | 0.84 | 
|     | Third Quarter                             |      |   | 2.25 |     |  |   | 1.07 | 
|     | Fourth Quarter                            |      |   | 2.65 |     |  |   | 1.67 | 
|2004 |                                           |      |   |      |     |  |   |     
|     | First Quarter                             |      | $ | 2.74 |     |  | $ | 1.81 | 
|     | Second Quarter                            |      |   | 2.27 |     |  |   | 0.84 | 
|     | Third Quarter                             |      |   | 1.28 |     |  |   | 0.66 | 
|     | Fourth Quarter                            |      |   | 2.00 |     |  |   | 1.18 | 
|2005 |                                           |      |   |      |     |  |   |     
|     | First Quarter (through February 28, 2005) |      | $ | 1.73 |     |  |   | 1.15 | 



Dividend Policy




Sales of Unregistered Securities




19



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|                                                               |  |                    |           |  |                           |   |                              |                          |  |  |           | 
|-------------------------------------------------------------- |  | ------------------ | --------- |  | ------------------------- | - | ---------------------------- | ------------------------ |  |  | --------- | 
|                                                               |  | Common stock to    |           |  |                           |   | Common stock available for   |                         
|                                                               |  | be issued upon     |           |  |                           |   | future issuance under equity |                         
|                                                               |  | exercise of        |           |  |                           |   | compensation plans           |                         
|                                                               |  | outstanding        |           |  | Weighted-average exercise |   |                              | (excluding securities    | 
|                                                               |  | options and rights |           |  | price of outstanding      |   |                              | reflected in column (a)) | 
|Plan Category                                                  |  | (1)                |           |  | options and rights        |   |                              | (1)                      | 
|                                                               |  |                    |           |  |                           |   |                              |                          | 
|                                                               |  | (a)                |           |  | (b)                       |   |                              | (c)                      | 
|Equity compensation plans approved by Aradigm stockholders     |  |                    | 9,415,848 |  |                           | $ | 4.44                         |                          |  |  | 3,879,960 | 
|Equity compensation plans not approved by Aradigm stockholders |  |                    | 0         |  |                           |   | 0                            |                          |  |  | 0         | 
|                                                               |  |                    |           |  |                           |   |                              |                          | 
|Totals:                                                        |  |                    | 9,415,848 |  |                           | $ | 4.44                         |                          |  |  | 3,879,960 | 






|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
|--- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(1) | Includes 13,189,884 and 105,924 shares reserved for future
    issuance under the Companys 1996 Equity Incentive Plan
    (the 1996 EIP), and the 1996 Non-Employee
    Directors Plan, respectively. We also have
    730,455 shares authorized for the Employee Stock Purchase
    Plan. The 1996 EIP contains an evergreen provision whereby the
    aggregate number of shares reserved for issuance is increased
    annually by a number of shares equal to 6% of the issued and
    outstanding common stock as determined on the date of the annual
    meeting of shareholders beginning with the 2001 meeting (or some
    lesser number of shares as determined by the board of
    directors). Under the 1996 EIP, the aggregate increase in the
    number of shares to be reserved by operation of the evergreen
    provision will not exceed 10,000,000.

20



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|        |                        
|------- | -----------------------
|Item 6. | Selected Financial Data



|                                                                           |                            |                          |          |        |      |   |          |        |  |   |          |        |  |      |          |        |  |   |          |        | 
|-------------------------------------------------------------------------- | -------------------------- | ------------------------ | -------- | ------ | ---- | - | -------- | ------ |  | - | -------- | ------ |  | ---- | -------- | ------ |  | - | -------- | ------ | 
|                                                                           |                            | Years Ended December 31, |         
|                                                                           |                            |                          |         
|                                                                           |                            | 2004                     |          |        | 2003 |   |          | 2002   |  |   | 2001     |        |  | 2000 |         
|                                                                           |                            |                          |          |        |      |   |          |        |  |   |          |        |  |      |         
|Statements of Operations Data:                                             |                            |                          |          |        |      |   |          |        |  |   |          |        |  |      |          |        |  |   |          |       
|Contract and license revenues                                              |                            | $                        | 28,045   |        |      | $ | 33,857   |        |  | $ | 28,967   |        |  | $    | 28,916   |        |  | $ | 20,303   |       
|Operating expenses:                                                        |                            |                          |          |        |      |   |          |        |  |   |          |        |  |      |          |        |  |   |          |       
|                                                                           | Research and Development   |                          |          | 46,477 |      |   |          | 49,636 |  |   |          | 54,680 |  |      |          | 58,836 |  |   |          | 48,176 | 
|                                                                           | General and Administrative |                          |          | 11,934 |      |   |          | 10,391 |  |   |          | 10,394 |  |      |          | 9,355  |  |   |          | 9,271  | 
|                                                                           |                            |                          |          |        |      |   |          |        |  |   |          |        |  |      |         
|                                                                           | Total Operating Expenses   |                          |          | 58,411 |      |   |          | 60,027 |  |   |          | 65,074 |  |      |          | 68,191 |  |   |          | 57,447 | 
|                                                                           |                            |                          |          |        |      |   |          |        |  |   |          |        |  |      |         
|Loss from operations                                                       |                            |                          | (30,366  | )      |      |   | (26,170  | )      |  |   | (36,107  | )      |  |      | (39,275  | )      |  |   | (37,144  | )     
|Interest income                                                            |                            |                          | 194      |        |      |   | 338      |        |  |   | 818      |        |  |      | 1,324    |        |  |   | 3,110    |       
|Other income(2)                                                            |                            |                          |         |        |      |   |         |        |  |   |         |        |  |      | 6,675    |        |  |   |         |       
|Interest expense                                                           |                            |                          | (17      | )      |      |   | (138     | )      |  |   | (642     | )      |  |      | (1,081   | )      |  |   | (1,528   | )     
|                                                                           |                            |                          |          |        |      |   |          |        |  |   |          |        |  |      |         
|Net loss                                                                   |                            |                          | (30,189  | )      |      |   | (25,970  | )      |  |   | (35,931  | )      |  |      | (32,357  | )      |  |   | (35,562  | )     
|Deemed dividend                                                            |                            |                          |         |        |      |   |         |        |  |   |         |        |  |      | (10,722  | )      |  |   |         |       
|                                                                           |                            |                          |          |        |      |   |          |        |  |   |          |        |  |      |         
|Net loss applicable to common shareholders                                 |                            | $                        | (30,189  | )      |      | $ | (25,970  | )      |  | $ | (35,931  | )      |  | $    | (43,079  | )      |  | $ | (35,562  | )     
|                                                                           |                            |                          |          |        |      |   |          |        |  |   |          |        |  |      |         
|Basic and diluted loss per share applicable to common
    shareholders(1): |                            | $                        | (0.47    | )      |      | $ | (0.52    | )      |  | $ | (1.19    | )      |  | $    | (1.98    | )      |  | $ | (2.07    | )     
|                                                                           |                            |                          |          |        |      |   |          |        |  |   |          |        |  |      |         
|                                                                           |                            |                          | 63,705   |        |      |   | 50,196   |        |  |   | 30,261   |        |  |      | 21,792   |        |  |   | 17,196   |       
|                                                                           |                            |                          |          |        |      |   |          |        |  |   |          |        |  |      |         
|Balance Sheet Data:                                                        |                            |                          |          |        |      |   |          |        |  |   |          |        |  |      |          |        |  |   |          |       
|Cash, cash equivalents and short term investments                          |                            | $                        | 16,763   |        |      | $ | 29,770   |        |  | $ | 31,443   |        |  | $    | 71,164   |        |  | $ | 44,381   |       
|Working capital                                                            |                            |                          | 4,122    |        |      |   | 19,708   |        |  |   | 16,039   |        |  |      | 48,308   |        |  |   | 19,862   |       
|Total assets                                                               |                            |                          | 79,741   |        |      |   | 95,218   |        |  |   | 97,129   |        |  |      | 132,100  |        |  |   | 71,371   |       
|Noncurrent portion of notes payable and capital lease obligations          |                            |                          |         |        |      |   |         |        |  |   | 497      |        |  |      | 2,427    |        |  |   | 6,230    |       
|Redeemable convertible preferred stock                                     |                            |                          | 23,669   |        |      |   | 23,669   |        |  |   | 30,665   |        |  |      | 30,735   |        |  |   |         |       
|Accumulated deficit                                                        |                            |                          | (245,623 | )      |      |   | (215,436 | )      |  |   | (189,443 | )      |  |      | (153,535 | )      |  |   | (110,441 | )     
|Total shareholders equity                                                 |                            | $                        | 35,754   |        |      | $ | 52,970   |        |  | $ | 41,410   |        |  | $    | 71,149   |        |  | $ | 37,785   |       






|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|--- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(1) | See Note 1 of Notes to Financial Statements for an
    explanation of shares used in computing basic and diluted net
    loss per share.                                                                                                                                                                                                                                                                                                                                                       
|   
|(2) | Other income consists of the gain related to forgiveness of
    outstanding notes and interests by Genentech, previously
    classified as an extraordinary item. In 2002, the Company early
    adopted Statement of Financial Accounting Standard
    (SFAS) 145, Rescission of FASB Statements
    No. 4, 44 and 64, Amendment of FASB 13 and Technical
    Corrections, which requires the reclassification of this
    type of extraordinary item as a component of operating results.

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|        |                                                                                          
|------- | -----------------------------------------------------------------------------------------
|Item 7. | Managements Discussion and Analysis of Financial
    Condition and Results of Operations

The discussion below contains forward-looking statements that
are based on the beliefs of management, as well as assumptions
made by, and information currently available to, management. Our
future results, performance or achievements could differ
materially from those expressed in, or implied by, any such
forward-looking statements as a result of certain factors,
including, but not limited to, those discussed in this section
as well as in the section entitled Risk Factors and
elsewhere in this report. This discussion should be read in
conjunction with the financial statements and notes to the
financial statements contained in this report.


Overview












| |   |                                                                                                                                                                                                
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | provide needed working capital to accelerate the pursuit of
    opportunities for our AERx and Intraject systems;                                                                              
|
| |  | relieve us of the financial burden of raising an estimated
    $100 million in capital that would be required to provide
    manufacturing capability for the AERx iDMS product
    launch; and
|
| |  | also allow us to retain a financial interest in the AERx iDMS
    program through future royalty payments                                                                                      



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Intraject/Sumatriptan Needle-Free Subcutaneous Delivery
System








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Critical Accounting Policies and Estimates






| |                    
| | -------------------
| | Revenue Recognition





| |                  
| | -----------------
| | Long-Lived Assets





| |                 
| | ----------------
| | Use of Estimates



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Results of Operations




| |                                             
| | --------------------------------------------
| | Years Ended December 31, 2004, 2003 and 2002

Contract Revenues.




Research and Development Expenses.




|                   |  |      |      |  |      |   |      |      |  |   |      | 
|------------------ |  | ---- | ---- |  | ---- | - | ---- | ---- |  | - | ---- | 
|                   |  | 2004 |      |  | 2003 |   |      | 2002 | 
|                   |  |      |      |  |      |   |      |      | 
|Collaborative      |  | $    | 28.2 |  |      | $ | 33.5 |      |  | $ | 33.4 | 
|Self Initiated     |  |      | 18.3 |  |      |   | 16.1 |      |  |   | 21.3 | 
|                   |  |      |      |  |      |   |      |      | 
|Total R&D Spending |  | $    | 46.5 |  |      | $ | 49.6 |      |  | $ | 54.7 | 









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General and Administrative Expenses.


Interest Income.


Interest Expense.


Liquidity and Capital Resources








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Off-Balance Sheet Financings and Liabilities




Contractual Obligations




|                                   |  |                       |        |           |        |   |       |           |       |   |           |  |  |         |        |  |  |  |        | 
|---------------------------------- |  | --------------------- | ------ | --------- | ------ | - | ----- | --------- | ----- | - | --------- |  |  | ------- | ------ |  |  |  | ------ | 
|                                   |  | Payment Due by Period |       
|                                   |  |                       |       
|                                   |  |                       |        | Less than |        |   |       |           | After |  
|Contractual Obligations            |  | Total                 |        |           | 1 Year |   |       | 1-3 Years |       |   | 3-5 Years |  |  | 5 Years |       
|                                   |  |                       |        |           |        |   |       |           |       |   |           |  |  |         |       
|Unconditional Purchase Obligations |  |                       | 1,856  |           |        |   | 1,856 |           |       |   |          |  |  |         |       |  |  |  |       | 
|Operating Lease Obligations        |  |                       | 53,389 |           |        |   | 5,131 |           |       |   | 9,366     |  |  |         | 10,225 |  |  |  | 28,667 | 
|                                   |  |                       |        |           |        |   |       |           |       |   |           |  |  |         |       
|Total Contractual Commitments      |  | $                     | 55,245 |           |        | $ | 6,987 |           |       | $ | 9,366     |  |  | $       | 10,225 |  |  |  | 28,667 | 
|                                   |  |                       |        |           |        |   |       |           |       |   |           |  |  |         |       

Recent Accounting Pronouncements






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RISK FACTORS


Except for historical information contained herein, the
discussion in this Report on Form 10-K contains
forward-looking statements, including, without limitation,
statements regarding timing and results of clinical trials, the
establishment of corporate partnering arrangements, the
anticipated commercial introduction of our products and the
timing of our cash requirements. These forward-looking
statements involve certain risks and uncertainties that could
cause actual results to differ materially from those in such
forward-looking statements. Potential risks and uncertainties
include, without limitation, those mentioned in this report and
in particular the factors described below.


We are an early-stage company.




We have a history of losses and anticipate future losses.






| |   |                                                        
| | - | -------------------------------------------------------
| |  | expand our research and development efforts;           
|
| |  | expand our preclinical and clinical testing activities;
|
| |  | expand our manufacturing efforts; and                  
|
| |  | plan and build our commercial production capabilities. 



We may not be able to develop our products successfully.






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| |   |                                                                                                                  
| | - | -----------------------------------------------------------------------------------------------------------------
| |  | are safe and effective;                                                                                          
|
| |  | will not be subject to physical or chemical instability over
    time and under differing storage conditions; and
|
| |  | do not suffer from other problems that would affect commercial
    viability.                                    



We may not be able to commercialize products successfully.






| |   |                 
| | - | ----------------
| |  | safety;         
|
| |  | efficacy        
|
| |  | ease of use; and
|
| |  | price.          



We depend on collaborative partners and need additional
collaborative partners.










| |   |                                                                                                            
| | - | -----------------------------------------------------------------------------------------------------------
| |  | development and commercialization of the AERx diabetes
    management products; and                        
|
| |  | management and operation of the manufacturing facility for the
    AERx insulin Diabetes Management System.







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We have limited manufacturing experience.








| |   |                                                                                                                                                   
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------
| |  | the design requirements of our pulmonary and subcutaneous
    systems will make it feasible for us to develop it beyond the
    current prototype;
|
| |  | manufacturing and quality control problems will not arise as we
    attempt to scale-up; or                                                       
|
| |  | any scale-up can be achieved in a timely manner or at a
    commercially reasonable cost.                                                         







We rely on a small number of vendors and contract
manufacturers to supply us with specialized equipment, tools and
components.




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We will need additional capital and our ability to find
additional funding is uncertain.






| |   |                                                                                            
| | - | -------------------------------------------------------------------------------------------
| |  | progress in researching and developing our technology and drug
    delivery systems;       
|
| |  | our ability to establish and maintain favorable collaborative
    arrangements with others;
|
| |  | progress with preclinical studies and clinical trials;                                     
|
| |  | time and costs to obtain regulatory approvals;                                             
|
| |  | costs of development and the rate at which we expand our
    production technologies;      
|
| |  | costs of preparing, filing, prosecuting, maintaining and
    enforcing patent claims; and  
|
| |  | our need to acquire licenses or other rights to technology.                                







We depend upon proprietary technology and the status of
patents and proprietary technology is uncertain.




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We may not obtain regulatory approval for our products on a
timely basis, or at all.














| |   |                                                                                          
| | - | -----------------------------------------------------------------------------------------
| |  | warning letters;                                                                         
|
| |  | fines;                                                                                   
|
| |  | product recalls or seizures;                                                             
|
| |  | injunctions;                                                                             
|
| |  | refusals to permit products to be imported into or exported out
    of the United States;
|
| |  | withdrawals of previously approved marketing
    applications; and                       
|
| |  | criminal prosecutions.                                                                   



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The results of preclinical and clinical testing are
uncertain.












We are in a highly competitive market and our competitors may
develop alternative therapies.




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We depend on key personnel and must continue to attract and
retain key employees.




We may be exposed to product liability.






Third-party reimbursement for our products is uncertain.




We use hazardous materials.




Our stock price is likely to remain volatile.




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| |   |                                                                                                                          
| | - | -------------------------------------------------------------------------------------------------------------------------
| |  | investor perception of us;                                                                                               
|
| |  | analyst recommendations;                                                                                                 
|
| |  | fluctuations in our operating results;                                                                                   
|
| |  | market conditions relating to the drug delivery industry;                                                                
|
| |  | announcements of technological innovations or new commercial
    products by us or our competitors;                      
|
| |  | publicity regarding actual or potential developments relating to
    products under development by us or our competitors;
|
| |  | failure to establish new collaborative relationships;                                                                    
|
| |  | developments or disputes concerning patent or proprietary rights;                                                        
|
| |  | delays in the development or approval of our product candidates;                                                         
|
| |  | regulatory developments in both the United States and foreign
    countries;                                             
|
| |  | public concern as to the safety of drug delivery technologies;                                                           
|
| |  | period-to-period fluctuations in financial results;                                                                      
|
| |  | future sales of substantial amounts of common stock by
    shareholders; or                                              
|
| |  | economic and other external factors.                                                                                     



Nasdaq National Market.




We have implemented certain anti-takeover provisions.






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|         |                                                              
|-------- | -------------------------------------------------------------
|Item 7A. | Quantitative and Qualitative Disclosure About Market
    Risk

Market Risk Disclosure






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|        |                                            
|------- | -------------------------------------------
|Item 8. | Financial Statements and Supplementary Data

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM












| |                          
| | -------------------------
| | /s/ Ernst & Young
    LLP









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ARADIGM CORPORATION


BALANCE SHEETS


|                                                                                                                                                                                                             |                                                                                                                                          |                                                                                        |        |          |        |  |        |          |        | 
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------ | ---------------------------------------------------------------------------------------------------------------------------------------- | -------------------------------------------------------------------------------------- | ------ | -------- | ------ |  | ------ | -------- | ------ | 
|                                                                                                                                                                                                             |                                                                                                                                          | December 31,                                                                           |       
|                                                                                                                                                                                                             |                                                                                                                                          |                                                                                        |       
|                                                                                                                                                                                                             |                                                                                                                                          | 2004                                                                                   |        |          | 2003   | 
|                                                                                                                                                                                                             |                                                                                                                                          |                                                                                        |        |          |        | 
|                                                                                                                                                                                                             |                                                                                                                                          | (In thousands, except                                                                  |       
|                                                                                                                                                                                                             |                                                                                                                                          | shares data)                                                                           |       
|ASSETS                                                                                                                                                                                                      
|Current assets:                                                                                                                                                                                              |                                                                                                                                          |                                                                                        |        |          |        |  |        |         
|                                                                                                                                                                                                             | Cash and cash equivalents                                                                                                                |                                                                                        | $      | 14,308   |        |  | $      | 18,327   |       
|                                                                                                                                                                                                             | Short-term investments                                                                                                                   |                                                                                        |        | 2,455    |        |  |        | 11,443   |       
|                                                                                                                                                                                                             | Receivables                                                                                                                              |                                                                                        |        | 99       |        |  |        | 140      |       
|                                                                                                                                                                                                             | Current portion of notes receivable from officers and employees                                                                          |                                                                                        |        | 67       |        |  |        | 104      |       
|                                                                                                                                                                                                             | Prepaid and other current assets                                                                                                         |                                                                                        |        | 1,602    |        |  |        | 1,910    |       
|                                                                                                                                                                                                             |                                                                                                                                          |                                                                                        |        |          |        | 
|                                                                                                                                                                                                             |                                                                                                                                          | Total current assets                                                                   |        |          | 18,531 |  |        |          | 31,924 | 
|Property and equipment, net                                                                                                                                                                                  |                                                                                                                                          |                                                                                        | 60,555 |          |        |  | 62,612 |         
|Noncurrent portion of notes receivable from officers and
    employees                                                                                                                                       |                                                                                                                                          |                                                                                        | 216    |          |        |  | 294    |         
|Other assets                                                                                                                                                                                                 |                                                                                                                                          |                                                                                        | 439    |          |        |  | 388    |         
|                                                                                                                                                                                                             |                                                                                                                                          |                                                                                        |        |          |        | 
|                                                                                                                                                                                                             |                                                                                                                                          | Total assets                                                                           |        | $        | 79,741 |  |        | $        | 95,218 | 
|                                                                                                                                                                                                             |                                                                                                                                          |                                                                                        |        |          |        | 
|                                                                                                                                                                                                            
|LIABILITIES, REDEEMABLE CONVERTIBLE PREFERRED STOCK AND
    SHAREHOLDERS EQUITY                                                                                                                            
|Current liabilities:                                                                                                                                                                                         |                                                                                                                                          |                                                                                        |        |          |        |  |        |         
|                                                                                                                                                                                                             | Accounts payable                                                                                                                         |                                                                                        | $      | 2,469    |        |  | $      | 885      |       
|                                                                                                                                                                                                             | Accrued clinical and cost of other studies                                                                                               |                                                                                        |        | 293      |        |  |        | 149      |       
|                                                                                                                                                                                                             | Accrued compensation                                                                                                                     |                                                                                        |        | 2,984    |        |  |        | 2,021    |       
|                                                                                                                                                                                                             | Deferred revenue                                                                                                                         |                                                                                        |        | 7,525    |        |  |        | 7,891    |       
|                                                                                                                                                                                                             | Current portion of capital lease obligations                                                                                             |                                                                                        |        |         |        |  |        | 427      |       
|                                                                                                                                                                                                             | Other accrued liabilities                                                                                                                |                                                                                        |        | 1,138    |        |  |        | 843      |       
|                                                                                                                                                                                                             |                                                                                                                                          |                                                                                        |        |          |        | 
|                                                                                                                                                                                                             |                                                                                                                                          | Total current liabilities                                                              |        |          | 14,409 |  |        |          | 12,216 | 
|Noncurrent portion of deferred revenue                                                                                                                                                                       |                                                                                                                                          |                                                                                        | 3,966  |          |        |  | 5,040  |         
|Noncurrent portion of deferred rent                                                                                                                                                                          |                                                                                                                                          |                                                                                        | 1,943  |          |        |  | 1,323  |         
|Commitments and contingencies                                                                                                                                                                                |                                                                                                                                          |                                                                                        |        |          |        |  |        |         
|Redeemable convertible preferred stock, no par value;
    5,000,000 shares authorized; issued and outstanding shares:
    1,544,626 in 2004 and 2003; liquidation preference of $37,380 in
    2004 and 2003 |                                                                                                                                          |                                                                                        | 23,669 |          |        |  | 23,669 |         
|Shareholders equity:                                                                                                                                                                                        |                                                                                                                                          |                                                                                        |        |          |        |  |        |         
|                                                                                                                                                                                                             | Common stock, no par value, 150,000,000 shares authorized;
    issued and outstanding shares: 72,295,730 in 2004; 62,751,196 in
    2003 |                                                                                        |        | 281,387  |        |  |        | 268,406  |       
|                                                                                                                                                                                                             | Accumulated other comprehensive loss                                                                                                     |                                                                                        |        | (10      | )      |  |        | (2       | )     
|                                                                                                                                                                                                             | Accumulated deficit                                                                                                                      |                                                                                        |        | (245,623 | )      |  |        | (215,434 | )     
|                                                                                                                                                                                                             |                                                                                                                                          |                                                                                        |        |          |        | 
|                                                                                                                                                                                                             |                                                                                                                                          | Total shareholders equity                                                             |        |          | 35,754 |  |        |          | 52,970 | 
|                                                                                                                                                                                                             |                                                                                                                                          |                                                                                        |        |          |        | 
|                                                                                                                                                                                                             |                                                                                                                                          | Total liabilities, redeemable convertible preferred stock and
    shareholders equity |        | $        | 79,741 |  |        | $        | 95,218 | 
|                                                                                                                                                                                                             |                                                                                                                                          |                                                                                        |        |          |        | 



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ARADIGM CORPORATION


STATEMENTS OF OPERATIONS


|                                                          |                            |                                       |         |        |        |   |         |        |        |   |         |        |        | 
|--------------------------------------------------------- | -------------------------- | ------------------------------------- | ------- | ------ | ------ | - | ------- | ------ | ------ | - | ------- | ------ | ------ | 
|                                                          |                            | Years Ended December 31,              |        
|                                                          |                            |                                       |        
|                                                          |                            | 2004                                  |         |        | 2003   |   |         | 2002   |       
|                                                          |                            |                                       |         |        |        |   |         |        |       
|                                                          |                            | (In thousands, except per share data) |        
|Contract and license revenues:                            |                            |                                       |         |        |        |   |         |        |        |   |         |       
|                                                          | Related parties            |                                       | $       | 26,999 |        |   | $       | 33,546 |        |   | $       | 26,864 |       
|                                                          | Unrelated parties          |                                       |         | 1,046  |        |   |         | 311    |        |   |         | 2,103  |       
|                                                          |                            |                                       |         |        |        |   |         |        |       
|                                                          |                            | Total revenues                        |         |        | 28,045 |   |         |        | 33,857 |   |         |        | 28,967 | 
|                                                          |                            |                                       |         |        |        |   |         |        |       
|                                                          | Research and development   |                                       |         | 46,477 |        |   |         | 49,636 |        |   |         | 54,680 |       
|                                                          | General and administrative |                                       |         | 11,934 |        |   |         | 10,391 |        |   |         | 10,394 |       
|                                                          |                            |                                       |         |        |        |   |         |        |       
|                                                          |                            | Total expenses                        |         |        | 58,411 |   |         |        | 60,027 |   |         |        | 65,074 | 
|                                                          |                            |                                       |         |        |        |   |         |        |       
|Loss from operations                                      |                            |                                       | (30,366 | )      |        |   | (26,170 | )      |        |   | (36,107 | )     
|Interest income                                           |                            |                                       | 194     |        |        |   | 338     |        |        |   | 818     |       
|Interest expense                                          |                            |                                       | (17     | )      |        |   | (138    | )      |        |   | (642    | )     
|                                                          |                            |                                       |         |        |        |   |         |        |       
|Net loss                                                  |                            | $                                     | (30,189 | )      |        | $ | (25,970 | )      |        | $ | (35,931 | )     
|                                                          |                            |                                       |         |        |        |   |         |        |       
|Basic and diluted loss per share:                         |                            |                                       |         |        |        |   |         |        |        |   |         |       
|Net loss                                                  |                            | $                                     | (0.47   | )      |        | $ | (0.52   | )      |        | $ | (1.19   | )     
|                                                          |                            |                                       |         |        |        |   |         |        |       
|Shares used in computing basic and diluted loss per share |                            |                                       | 63,705  |        |        |   | 50,196  |        |        |   | 30,261  |       
|                                                          |                            |                                       |         |        |        |   |         |        |       



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ARADIGM CORPORATION


STATEMENTS OF REDEEMABLE CONVERTIBLE PREFERRED STOCK AND


SHAREHOLDERS EQUITY


|                                                                                                         |  |                       |           |   |              |   |        |                                    |  |             |               |  |  |              |         |  |               |   |     |         |  |   |        |   |  |   |          |   |  |   |         |  
|-------------------------------------------------------------------------------------------------------- |  | --------------------- | --------- | - | ------------ | - | ------ | ---------------------------------- |  | ----------- | ------------- |  |  | ------------ | ------- |  | ------------- | - | --- | ------- |  | - | ------ | - |  | - | -------- | - |  | - | ------- | -
|                                                                                                         |  | Redeemable            |           |   |              |   |        |                                    |  |             |               |  |  |              |        
|                                                                                                         |  | Convertible Preferred |           |   |              |   |        |                                    |  |             |               |  | 
|                                                                                                         |  | Stock                 |           |   | Common Stock |   |        |                                    |  | Accumulated |               |  |  |              | Total   | 
|                                                                                                         |  |                       |           |   |              |   |        | Deferred                           |  |             | Comprehensive |  |  | Accumulated  |         |  | Shareholders |  
|                                                                                                         |  | Shares                |           |   | Amount       |   |        | Shares                             |  |             | Amount        |  |  | Compensation |         |  | Gain/Loss     |   |     | Deficit |  |   | Equity |  
|                                                                                                         |  |                       |           |   |              |   |        |                                    |  |             |               |  |  |              |         |  |               |   |     |         |  |   |        |  
|                                                                                                         |  |                       |           |   |              |   |        | (In thousands, except shares data) |  |             |               |  | 
|Balances at December 31, 2001                                                                            |  |                       | 2,001,236 |   |              | $ | 30,735 |                                    |  |             | 29,536,383    |  |  | $            | 224,738 |  |               | $ | (54 | )       |  | $ | (2     | ) |  | $ | (153,533 | ) |  | $ | 71,149  |  
|Issuance of common stock for cash, net of issuance costs of $79                                          |  |                       |          |   |              |   |       |                                    |  |             | 1,182,034     |  |  |              | 4,921   |  |               |   |    |         |  |   |       |   |  |   |         |   |  |   | 4,921   |  
|Issuance of common stock under the employee stock purchase plan                                          |  |                       |          |   |              |   |       |                                    |  |             | 431,695       |  |  |              | 1,157   |  |               |   |    |         |  |   |       |   |  |   |         |   |  |   | 1,157   |  
|Issuance of common stock upon exercise of stock options                                                  |  |                       |          |   |              |   |       |                                    |  |             | 7,500         |  |  |              | 26      |  |               |   |    |         |  |   |       |   |  |   |         |   |  |   | 26      |  
|Issuance of options to purchase common stock for services                                                |  |                       |          |   |              |   |       |                                    |  |             |              |  |  |              | 11      |  |               |   |    |         |  |   |       |   |  |   |         |   |  |   | 11      |  
|Issuance costs related to prior years sale of convertible
    preferred stock                           |  |                       |          |   |              |   | (70    | )                                  |  |             |              |  |  |              |        |  |               |   |    |         |  |   |       |   |  |   |         |   |  |   |        |  
|Amortization of deferred compensation                                                                    |  |                       |          |   |              |   |       |                                    |  |             |              |  |  |              |        |  |               |   | 54  |         |  |   |       |   |  |   |         |   |  |   | 54      |  
|Comprehensive loss:                                                                                      |  |                       |           |   |              |   |        |                                    |  |             |               |  |  |              |         |  |               |   |     |         |  |   |        |   |  |   |          |   |  |   |         |  
|Net loss                                                                                                 |  |                       |          |   |              |   |       |                                    |  |             |              |  |  |              |        |  |               |   |    |         |  |   |       |   |  |   | (35,931  | ) |  |   | (35,931 | )
|Net change in unrealized loss on available-for sale-investments:                                         |  |                       |          |   |              |   |       |                                    |  |             |              |  |  |              |        |  |               |   |    |         |  |   | 23     |   |  |   |         |   |  |   | 23      |  
|                                                                                                         |  |                       |           |   |              |   |        |                                    |  |             |               |  |  |              |         |  |               |   |     |         |  |   |        |  
|Total comprehensive loss                                                                                 |  |                       |           |   |              |   |        |                                    |  |             |               |  |  |              |         |  |               |   |     |         |  |   |        |   |  |   |          |   |  |   | (35,908 | )
|                                                                                                         |  |                       |           |   |              |   |        |                                    |  |             |               |  |  |              |         |  |               |   |     |         |  |   |        |  
|Balances at December 31, 2002                                                                            |  |                       | 2,001,236 |   |              |   | 30,665 |                                    |  |             | 31,157,612    |  |  |              | 230,853 |  |               |   |    |         |  |   | 21     |   |  |   | (189,464 | ) |  |   | 41,410  |  
|Issuance of common stock for cash, net of issuance costs of
    7,353 including warrants valued at 5,657 |  |                       |          |   |              |   |       |                                    |  |             | 26,772,941    |  |  |              | 27,312  |  |               |   |    |         |  |   |       |   |  |   |         |   |  |   | 27,312  |  
|Issuance of common stock through conversion of Series A
    preferred stock                              |  |                       | (456,610  | ) |              |   | (6,996 | )                                  |  |             | 1,826,440     |  |  |              | 6,996   |  |               |   |    |         |  |   |       |   |  |   |         |   |  |   | 6,996   |  
|Issuance of common stock under the employee stock purchase plan                                          |  |                       |          |   |              |   |       |                                    |  |             | 553,028       |  |  |              | 596     |  |               |   |    |         |  |   |       |   |  |   |         |   |  |   | 596     |  
|Issuance of common stock upon exercise of stock options                                                  |  |                       |          |   |              |   |       |                                    |  |             | 27,125        |  |  |              | 11      |  |               |   |    |         |  |   |       |   |  |   |         |   |  |   | 11      |  
|Issuance of common stock upon exercise of warrants                                                       |  |                       |           |   |              |   |        |                                    |  |             | 2,414,050     |  |  |              | 2,522   |  |               |   |     |         |  |   |        |   |  |   |          |   |  |   | 2,522   |  
|Issuance of options and warrants to purchase common stock for
    services                               |  |                       |          |   |              |   |       |                                    |  |             |              |  |  |              | 116     |  |               |   |    |         |  |   |       |   |  |   |         |   |  |   | 116     |  
|Comprehensive loss:                                                                                      |  |                       |           |   |              |   |        |                                    |  |             |               |  |  |              |         |  |               |   |     |         |  |   |        |   |  |   |          |   |  |   |         |  
|Net loss                                                                                                 |  |                       |          |   |              |   |       |                                    |  |             |              |  |  |              |        |  |               |   |    |         |  |   |       |   |  |   | (25,970  | ) |  |   | (25,970 | )

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|                                                                                                       |  |                       |           |  |              |   |        |                                    |  |             |               |  |  |              |         |  |               |   |   |         |  |   |        |   |  |   |          |   |  |   |         |  
|------------------------------------------------------------------------------------------------------ |  | --------------------- | --------- |  | ------------ | - | ------ | ---------------------------------- |  | ----------- | ------------- |  |  | ------------ | ------- |  | ------------- | - | - | ------- |  | - | ------ | - |  | - | -------- | - |  | - | ------- | -
|                                                                                                       |  | Redeemable            |           |  |              |   |        |                                    |  |             |               |  |  |              |        
|                                                                                                       |  | Convertible Preferred |           |  |              |   |        |                                    |  |             |               |  | 
|                                                                                                       |  | Stock                 |           |  | Common Stock |   |        |                                    |  | Accumulated |               |  |  |              | Total   | 
|                                                                                                       |  |                       |           |  |              |   |        | Deferred                           |  |             | Comprehensive |  |  | Accumulated  |         |  | Shareholders |  
|                                                                                                       |  | Shares                |           |  | Amount       |   |        | Shares                             |  |             | Amount        |  |  | Compensation |         |  | Gain/Loss     |   |   | Deficit |  |   | Equity |  
|                                                                                                       |  |                       |           |  |              |   |        |                                    |  |             |               |  |  |              |         |  |               |   |   |         |  |   |        |  
|                                                                                                       |  |                       |           |  |              |   |        | (In thousands, except shares data) |  |             |               |  | 
|Net change in unrealized loss on available-for sale-investments:                                       |  |                       |          |  |              |   |       |                                    |  |             |              |  |  |              |        |  |               |   |  |         |  |   | (23    | ) |  |   |         |   |  |   | (23     | )
|                                                                                                       |  |                       |           |  |              |   |        |                                    |  |             |               |  |  |              |         |  |               |   |   |         |  |   |        |  
|Total comprehensive loss                                                                               |  |                       |           |  |              |   |        |                                    |  |             |               |  |  |              |         |  |               |   |   |         |  |   |        |   |  |   |          |   |  |   | (25,993 | )
|                                                                                                       |  |                       |           |  |              |   |        |                                    |  |             |               |  |  |              |         |  |               |   |   |         |  |   |        |  
|Balances at December 31, 2003                                                                          |  |                       | 1,544,626 |  |              |   | 23,669 |                                    |  |             | 62,751,196    |  |  |              | 268,406 |  |               |   | 0 |         |  |   | (2     | ) |  |   | (215,434 | ) |  |   | 52,970  |  
|Issuance of common stock for cash, net of issuance costs of 817
    including warrants valued at 2,278 |  |                       |          |  |              |   |       |                                    |  |             | 8,333,395     |  |  |              | 11,683  |  |               |   |  |         |  |   |       |   |  |   |         |   |  |   | 11,683  |  
|Issuance of common stock under the employee stock purchase plan                                        |  |                       |          |  |              |   |       |                                    |  |             | 839,731       |  |  |              | 911     |  |               |   |  |         |  |   |       |   |  |   |         |   |  |   | 911     |  
|Issuance of common stock upon exercise of stock options                                                |  |                       |          |  |              |   |       |                                    |  |             | 406           |  |  |              | 1       |  |               |   |  |         |  |   |       |   |  |   |         |   |  |   | 1       |  
|Issuance of common stock upon exercise of warrants                                                     |  |                       |          |  |              |   |       |                                    |  |             | 371,002       |  |  |              | 304     |  |               |   |  |         |  |   |       |   |  |   |         |   |  |   | 304     |  
|Issuance of options and warrants to purchase common stock for
    services                             |  |                       |          |  |              |   |       |                                    |  |             |              |  |  |              | 82      |  |               |   |  |         |  |   |       |   |  |   |         |   |  |   | 82      |  
|Comprehensive loss:                                                                                    |  |                       |           |  |              |   |        |                                    |  |             |               |  |  |              |         |  |               |   |   |         |  |   |        |   |  |   |          |   |  |   |         |  
|Net loss                                                                                               |  |                       |          |  |              |   |       |                                    |  |             |              |  |  |              |        |  |               |   |  |         |  |   |       |   |  |   | (30,189  | ) |  |   | (30,189 | )
|Net change in unrealized loss on available-for-sale investments                                        |  |                       |          |  |              |   |       |                                    |  |             |              |  |  |              |        |  |               |   |  |         |  |   | (8     | ) |  |   |         |   |  |   | (8      | )
|                                                                                                       |  |                       |           |  |              |   |        |                                    |  |             |               |  |  |              |         |  |               |   |   |         |  |   |        |  
|Total comprehensive loss                                                                               |  |                       |           |  |              |   |        |                                    |  |             |               |  |  |              |         |  |               |   |   |         |  |   |        |   |  |   |          |   |  |   | (30,197 | )
|                                                                                                       |  |                       |           |  |              |   |        |                                    |  |             |               |  |  |              |         |  |               |   |   |         |  |   |        |  
|Balances at December 31, 2004                                                                          |  |                       | 1,544,626 |  |              | $ | 23,669 |                                    |  |             | 72,295,730    |  |  | $            | 281,387 |  |               | $ | 0 |         |  | $ | (10    | ) |  | $ | (245,623 | ) |  | $ | 35,754  |  
|                                                                                                       |  |                       |           |  |              |   |        |                                    |  |             |               |  |  |              |         |  |               |   |   |         |  |   |        |  



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ARADIGM CORPORATION


STATEMENTS OF CASH FLOWS


|                                                                                                      |                                                                            |                                  |         |       |        |   |         |       |        |   |         |       |        |  
|----------------------------------------------------------------------------------------------------- | -------------------------------------------------------------------------- | -------------------------------- | ------- | ----- | ------ | - | ------- | ----- | ------ | - | ------- | ----- | ------ | -
|                                                                                                      |                                                                            | Years Ended December 31,         |        
|                                                                                                      |                                                                            |                                  |        
|                                                                                                      |                                                                            | 2004                             |         |       | 2003   |   |         | 2002  |       
|                                                                                                      |                                                                            |                                  |         |       |        |   |         |       |       
|                                                                                                      |                                                                            | (In thousands)                   |        
|Cash flows from operating activities:                                                                 |                                                                            |                                  |         |       |        |   |         |       |        |   |         |      
|Net loss                                                                                              |                                                                            | $                                | (30,189 | )     |        | $ | (25,970 | )     |        | $ | (35,931 | )    
|Adjustments to reconcile net loss to net cash used in operating
    activities:                       |                                                                            |                                  |         |       |        |   |         |       |        |   |         |      
|                                                                                                      | Depreciation and amortization                                              |                                  |         | 3,813 |        |   |         | 5,983 |        |   |         | 5,749 |       
|                                                                                                      | Reserve for obsolete capital assets                                        |                                  |         | 544   |        |   |         |      |        |   |         | 114   |       
|                                                                                                      | Issuance of warrants and common stock for services                         |                                  |         | 82    |        |   |         | 116   |        |   |         | 11    |       
|                                                                                                      | Amortization of deferred compensation                                      |                                  |         |      |        |   |         |      |        |   |         | 54    |       
|                                                                                                      | Changes in operating assets and liabilities:                               |                                  |         |       |        |   |         |       |        |   |         |       |       
|                                                                                                      |                                                                            | Receivables                      |         |       | 41     |   |         |       | 142    |   |         |       | 1,067  |  
|                                                                                                      |                                                                            | Prepaid and other current assets |         |       | 308    |   |         |       | (454   | ) |         |       | (645   | )
|                                                                                                      |                                                                            | Other assets                     |         |       | (51    | ) |         |       | 21     |   |         |       | 121    |  
|                                                                                                      |                                                                            | Accounts payable                 |         |       | 1,584  |   |         |       | (1,066 | ) |         |       | (3,346 | )
|                                                                                                      |                                                                            | Accrued compensation             |         |       | 963    |   |         |       | (174   | ) |         |       | 434    |  
|                                                                                                      |                                                                            | Accrued liabilities              |         |       | 439    |   |         |       | 294    |   |         |       | (2,765 | )
|                                                                                                      |                                                                            | Deferred rent                    |         |       | 620    |   |         |       | 215    |   |         |       | 808    |  
|                                                                                                      |                                                                            | Deferred revenue                 |         |       | (1,440 | ) |         |       | (3,921 | ) |         |       | 3,410  |  
|                                                                                                      |                                                                            |                                  |         |       |        |   |         |       |       
|Net cash used in operating activities                                                                 |                                                                            |                                  | (23,286 | )     |        |   | (24,814 | )     |        |   | (30,919 | )    
|                                                                                                      |                                                                            |                                  |         |       |        |   |         |       |       
|Cash flows from investing activities:                                                                 |                                                                            |                                  |         |       |        |   |         |       |        |   |         |      
|Capital expenditures                                                                                  |                                                                            |                                  | (2,300  | )     |        |   | (5,362  | )     |        |   | (11,157 | )    
|Purchases of available-for-sale investments                                                           |                                                                            |                                  | (6,376  | )     |        |   | (9,962  | )     |        |   | (12,105 | )    
|Proceeds from sales and maturities of available-for-sale
    investments                              |                                                                            |                                  | 15,356  |       |        |   | 7,139   |       |        |   | 4,685   |      
|                                                                                                      |                                                                            |                                  |         |       |        |   |         |       |       
|Net cash provided by (used) in investing activities                                                   |                                                                            |                                  | 6,680   |       |        |   | (8,185  | )     |        |   | (18,577 | )    
|                                                                                                      |                                                                            |                                  |         |       |        |   |         |       |       
|Cash flows from financing activities:                                                                 |                                                                            |                                  |         |       |        |   |         |       |        |   |         |      
|Proceeds from issuance of common stock, net                                                           |                                                                            |                                  | 12,899  |       |        |   | 30,441  |       |        |   | 6,104   |      
|Cash used in issuance of redeemable convertible preferred stock,
    net                              |                                                                            |                                  |        |       |        |   |        |       |        |   | (70     | )    
|Proceeds from payments on (cash used in issuance of) notes
    receivable with officers and employees |                                                                            |                                  | 115     |       |        |   | (93     | )     |        |   |        |      
|Payments on capital lease obligations and equipment loans                                             |                                                                            |                                  | (427    | )     |        |   | (1,822  | )     |        |   | (3,703  | )    
|                                                                                                      |                                                                            |                                  |         |       |        |   |         |       |       
|Net cash provided by financing activities                                                             |                                                                            |                                  | 12,587  |       |        |   | 28,526  |       |        |   | 2,331   |      
|                                                                                                      |                                                                            |                                  |         |       |        |   |         |       |       
|Net decrease in cash and cash equivalents                                                             |                                                                            |                                  | (4,019  | )     |        |   | (4,473  | )     |        |   | (47,165 | )    
|Cash and cash equivalents at beginning of year                                                        |                                                                            |                                  | 18,327  |       |        |   | 22,800  |       |        |   | 69,965  |      
|                                                                                                      |                                                                            |                                  |         |       |        |   |         |       |       
|Cash and cash equivalents at end of year                                                              |                                                                            | $                                | 14,308  |       |        | $ | 18,327  |       |        | $ | 22,800  |      
|Supplemental disclosure of cash flow information:                                                     |                                                                            |                                  |         |       |        |   |         |       |        |   |         |      
|                                                                                                      | Cash paid for interest                                                     |                                  | $       | 16    |        |   | $       | 126   |        |   | $       | 499   |       
|                                                                                                      |                                                                            |                                  |         |       |        |   |         |       |       
|Non-cash investing and financing activities:                                                          |                                                                            |                                  |         |       |        |   |         |       |        |   |         |      
|                                                                                                      | Issuance of options and warrants to purchase common stock for
    services |                                  | $       | 82    |        |   | $       | 116   |        |   | $       | 11    |       
|Issuance of common stock through conversion of Series A
    preferred stock                           |                                                                            |                                  |        |       |        |   | 6,996   |       |        |   |        |      
|Issuance of warrants in conjunction with private placement of
    common stock                        |                                                                            | $                                | 2,278   |       |        | $ | 5,657   |       |        | $ |        |      



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ARADIGM CORPORATION


NOTES TO FINANCIAL STATEMENTS




|   |                                           
|-- | ------------------------------------------
|1. | Summary of Significant Accounting Policies



| |                                       
| | --------------------------------------
| | Organization and Basis of Presentation





| |                 
| | ----------------
| | Use of Estimates





| |                          
| | -------------------------
| | Cash and Cash Equivalents



Investments






| |                 
| | ----------------
| | Notes Receivable



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ARADIGM CORPORATION


NOTES TO FINANCIAL STATEMENTS  (Continued)




| |                              
| | -----------------------------
| | Depreciation and Amortization





|                                |  |  |                | 
|------------------------------- |  |  | -------------- | 
|Machinery and equipment         |  |  | 5 to 7 years   | 
|Furniture and fixtures          |  |  | 5 to 7 years   | 
|Lab equipment                   |  |  | 5 to 7 years   | 
|Computer equipment and software |  |  | 3 to 5 years   | 
|Leasehold improvements          |  |  | 5 to 17  years | 



| |                  
| | -----------------
| | Long-Lived Assets





| |                    
| | -------------------
| | Revenue Recognition





| |                         
| | ------------------------
| | Research and Development



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ARADIGM CORPORATION


NOTES TO FINANCIAL STATEMENTS  (Continued)




| |            
| | -----------
| | Advertising





| |                         
| | ------------------------
| | Stock Based Compensation



|                                                                             |                                                                                                             |                          |         |        |      |   |         |        |   |   |         |        |  
|---------------------------------------------------------------------------- | ----------------------------------------------------------------------------------------------------------- | ------------------------ | ------- | ------ | ---- | - | ------- | ------ | - | - | ------- | ------ | -
|                                                                             |                                                                                                             | Years Ended December 31, |        
|                                                                             |                                                                                                             |                          |        
|                                                                             |                                                                                                             | 2004                     |         |        | 2003 |   |         | 2002   |  
|                                                                             |                                                                                                             |                          |         |        |      |   |         |        |  
|Net loss applicable to common shareholders  as
    reported                 |                                                                                                             | $                        | (30,189 | )      |      | $ | (25,970 | )      |   | $ | (35,931 | )     
|Add:                                                                         |                                                                                                             |                          |         |        |      |   |         |        |   |   |         |       
|                                                                             | Stock-based employee compensation expense included in reported
    net income                               |                          |         |       |      |   |         |       |   |   |         | 54     |  
|Less:                                                                        |                                                                                                             |                          |         |        |      |   |         |        |   |   |         |       
|                                                                             | Total stock-based employee compensation expense determined under
    fair value based method for all awards |                          |         | (4,585 | )    |   |         | (5,400 | ) |   |         | (7,455 | )
|                                                                             |                                                                                                             |                          |         |        |      |   |         |        |  
|Pro forma net loss applicable to common shareholders                         |                                                                                                             | $                        | (34,774 | )      |      | $ | (31,370 | )      |   | $ | (43,332 | )     
|                                                                             |                                                                                                             |                          |         |        |      |   |         |        |  
|Basic and diluted net loss per share applicable to common
    shareholders  |                                                                                                             |                          |         |        |      |   |         |        |   |   |         |       
|                                                                             | As reported                                                                                                 |                          | $       | (0.47  | )    |   | $       | (0.52  | ) |   | $       | (1.19  | )
|                                                                             | Pro forma                                                                                                   |                          | $       | (0.55  | )    |   | $       | (0.62  | ) |   | $       | (1.43  | )





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ARADIGM CORPORATION


NOTES TO FINANCIAL STATEMENTS  (Continued)






| |             
| | ------------
| | Income Taxes





| |                   
| | ------------------
| | Net Loss Per Share





| |                           
| | --------------------------
| | Significant Concentrations







| |                            
| | ---------------------------
| | Comprehensive Income (Loss)



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ARADIGM CORPORATION


NOTES TO FINANCIAL STATEMENTS  (Continued)




| |                                 
| | --------------------------------
| | Recent Accounting Pronouncements







| |                  
| | -----------------
| | Reclassifications





|   |                      
|-- | ---------------------
|2. | Financial Instruments



| |                                 
| | --------------------------------
| | Cash Equivalents and Investments



|                        |                                |              |        |        |      |   |        |        | 
|----------------------- | ------------------------------ | ------------ | ------ | ------ | ---- | - | ------ | ------ | 
|                        |                                | December 31, |       
|                        |                                |              |       
|                        |                                | 2004         |        |        | 2003 |  
|                        |                                |              |        |        |      |  
|Cash equivalents:       |                                |              |        |        |      |   |        |       
|                        | Money market fund              |              | $      | 800    |      |   | $      | 604    | 
|                        | Commercial paper               |              |        | 13,508 |      |   |        | 17,723 | 
|                        |                                |              |        |        |      |  
|                        |                                | $            | 14,308 |        |      | $ | 18,327 |       
|                        |                                |              |        |        |      |  
|Short-term investments: |                                |              |        |        |      |   |        |       
|                        | Commercial paper               |              | $      |       |      |   |        | 5,522  | 
|                        | Corporate and Government notes |              |        | 2,455  |      |   | $      | 5,921  | 
|                        |                                |              |        |        |      |  
|                        |                                | $            | 2,455  |        |      | $ | 11,443 |       
|                        |                                |              |        |        |      |  

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ARADIGM CORPORATION


NOTES TO FINANCIAL STATEMENTS  (Continued)


|                                                     |                                    |              |   |       |      |  |   |        | 
|---------------------------------------------------- | ---------------------------------- | ------------ | - | ----- | ---- |  | - | ------ | 
|                                                     |                                    | December 31, |  
|                                                     |                                    |              |  
|                                                     |                                    | 2004         |   |       | 2003 | 
|                                                     |                                    |              |   |       |      | 
|Short-Term investments:                              |                                    |              |   |       |      |  |   |       
|Investments maturing in 90 days to less than 1 year: |                                    |              |   |       |      |  |   |       
|                                                     | Commercial paper                   |              | $ |      |      |  | $ | 5,522  | 
|                                                     | Corporate notes                    |              |   | 1,016 |      |  |   | 1,017  | 
|                                                     | Foreign debt securities            |              |   |      |      |  |   | 337    | 
|                                                     | US government agencies             |              |   | 1,439 |      |  |   | 2,080  | 
|                                                     |                                    |              |   |       |      | 
|                                                     | Total maturing in less than 1 year |              | $ | 2,455 |      |  | $ | 8,956  | 
|                                                     |                                    |              |   |       |      | 
|Investments maturing in 1 to 2 years:                |                                    |              |   |       |      |  |   |       
|                                                     | Corporate notes                    |              | $ |      |      |  |   | 1,507  | 
|                                                     | US government agencies             |              |   |      |      |  |   | 980    | 
|                                                     |                                    |              |   |       |      | 
|                                                     | Total maturing in 1 to 2 years     |              |   |      |      |  |   | 2,487  | 
|                                                     |                                    |              |   |       |      | 
|                                                     | Total short term investments       |              | $ | 2,455 |      |  | $ | 11,443 | 
|                                                     |                                    |              |   |       |      | 





|   |                       
|-- | ----------------------
|3. | Property and Equipment



|                                               |  |              |         |   |      |   |         |  
|---------------------------------------------- |  | ------------ | ------- | - | ---- | - | ------- | -
|                                               |  | December 31, |        
|                                               |  |              |        
|                                               |  | 2004         |         |   | 2003 |  
|                                               |  |              |         |   |      |  
|Machinery and equipment                        |  | $            | 14,364  |   |      | $ | 18,336  |  
|Furniture and fixtures                         |  |              | 1,917   |   |      |   | 1,903   |  
|Lab equipment                                  |  |              | 4,086   |   |      |   | 4,050   |  
|Computer equipment and software                |  |              | 6,256   |   |      |   | 6,068   |  
|Leasehold improvements                         |  |              | 12,225  |   |      |   | 12,176  |  
|                                               |  |              |         |   |      |  
|Fixed Assets at Cost                           |  |              | 38,848  |   |      |   | 42,533  |  
|Less accumulated depreciation and amortization |  |              | (27,740 | ) |      |   | (23,927 | )
|                                               |  |              |         |   |      |  
|Net Depreciable Assets                         |  |              | 11,108  |   |      |   | 18,606  |  
|Construction in progress                       |  |              | 49,447  |   |      |   | 44,006  |  
|                                               |  |              |         |   |      |  
|Property and equipment, net                    |  | $            | 60,555  |   |      | $ | 62,612  |  
|                                               |  |              |         |   |      |  



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ARADIGM CORPORATION


NOTES TO FINANCIAL STATEMENTS  (Continued)




|   |                                      
|-- | -------------------------------------
|4. | Leases, Commitments and Contingencies



|                          |                              |           |        |        | 
|------------------------- | ---------------------------- | --------- | ------ | ------ | 
|                          |                              | Operating |       
|                          |                              | Leases    |       
|                          |                              |           |       
|Years ending December 31: |                              |           |        |       
|2005                      |                              | $         | 5,131  |       
|2006                      |                              |           | 4,434  |       
|2007                      |                              |           | 4,932  |       
|2008                      |                              |           | 5,091  |       
|2009                      |                              |           | 5,134  |       
|2010 and thereafter       |                              |           | 28,667 |       
|                          |                              |           |       
|                          | Total minimum lease payments |           | $      | 53,389 | 
|                          |                              |           |       











| |                
| | ---------------
| | Indemnification





| |              
| | -------------
| | Legal Matters





|   |                                                                     
|-- | --------------------------------------------------------------------
|5. | Redeemable Convertible Preferred Stock and Common Stock
    Warrants



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ARADIGM CORPORATION


NOTES TO FINANCIAL STATEMENTS  (Continued)
















| |                                                  
| | -------------------------------------------------
| | Summary of Preferred Stock and Warrant Accounting



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ARADIGM CORPORATION


NOTES TO FINANCIAL STATEMENTS  (Continued)






|   |                     
|-- | --------------------
|6. | Shareholders Equity











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ARADIGM CORPORATION


NOTES TO FINANCIAL STATEMENTS  (Continued)




| |                
| | ---------------
| | Reserved Shares





| |                            
| | ---------------------------
| | Other Common Stock Warrants











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ARADIGM CORPORATION


NOTES TO FINANCIAL STATEMENTS  (Continued)




| |                                                                     
| | --------------------------------------------------------------------
| | 1996 Equity Incentive Plan and 1996 Non-Employee
    Directors Plan







55



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ARADIGM CORPORATION


NOTES TO FINANCIAL STATEMENTS  (Continued)




|                             |                    |                      |           |            |           |  |           |                 |   |                  |                |             |  |   |      |      | 
|---------------------------- | ------------------ | -------------------- | --------- | ---------- | --------- |  | --------- | --------------- | - | ---------------- | -------------- | ----------- |  | - | ---- | ---- | 
|                             |                    | Options Outstanding  |          
|                             |                    |                      |          
|                             |                    | Shares Available for |           |            | Number of |  |           |                 |   | Weighted Average |               
|                             |                    | Grant of Options     |           |            | Shares    |  |           | Price Per Share |   |                  | Exercise Price |            
|                             |                    |                      |           |            |           |  |           |                 |   |                  |                |            
|Balance at December 31, 2001 |                    |                      | 496,010   |            |           |  | 4,217,448 |                 |   | $                | 0.33$24.13    |             |  | $ | 9.94 |     
|                             | Options authorized |                      |           | 1,783,393  |           |  |           |                |   |                  |                |            |  |   |      |     | 
|                             | Options granted    |                      |           | (2,149,280 | )         |  |           | 2,149,280       |   |                  | $              | 1.42$4.82  |  |   | $    | 4.20 | 
|                             | Options exercised  |                      |           |           |           |  |           | (7,500          | ) |                  | $              | 3.44        |  |   | $    | 3.44 | 
|                             | Options cancelled  |                      |           | 457,970    |           |  |           | (480,470        | ) |                  | $              | 1.42$23.00 |  |   | $    | 7.81 | 
|                             |                    |                      |           |            |           |  |           |                 |   |                  |                |            
|Balance at December 31, 2002 |                    |                      | 588,093   |            |           |  | 5,878,758 |                 |   | $                | 0.33$24.13    |             |  | $ | 8.05 |     
|                             | Options authorized |                      |           | 3,042,618  |           |  |           |                |   |                  |                |            |  |   |      |     | 
|                             | Options granted    |                      |           | (1,812,750 | )         |  |           | 1,812,750       |   |                  | $              | 0.91$2.16  |  |   | $    | 1.29 | 
|                             | Options exercised  |                      |           |           |           |  |           | (27,125         | ) |                  | $              | 0.33$0.95  |  |   | $    | 0.42 | 
|                             | Options cancelled  |                      |           | 1,180,557  |           |  |           | (1,180,557      | ) |                  | $              | 0.95$23.38 |  |   | $    | 7.83 | 
|                             |                    |                      |           |            |           |  |           |                 |   |                  |                |            
|Balance at December 31, 2003 |                    |                      | 2,998,518 |            |           |  | 6,483,826 |                 |   | $                | 0.37$24.13    |             |  | $ | 6.23 |     
|                             | Options authorized |                      |           | 3,813,870  |           |  |           |                |   |                  |                |            |  |   |      |     | 
|                             | Options granted    |                      |           | (3,488,800 | )         |  |           | 3,488,800       |   |                  | $              | 0.76$2.40  |  |   | $    | 1.55 | 
|                             | Options exercised  |                      |           |           |           |  |           | (406            | ) |                  | $              | 0.95$1.42  |  |   | $    | 1.24 | 
|                             | Options cancelled  |                      |           | 556,372    |           |  |           | (556,372        | ) |                  | $              | 0.37$23.57 |  |   | $    | 6.32 | 
|                             |                    |                      |           |            |           |  |           |                 |   |                  |                |            
|Balance at December 31, 2004 |                    |                      | 3,879,960 |            |           |  | 9,415,848 |                 |   | $                | 0.43$24.13    |             |  | $ | 4.44 |     
|                             |                    |                      |           |            |           |  |           |                 |   |                  |                |            

|                     |  |                     |           |          |                     |   |             |                 |  |  |        |          |  |       |                  |  |            |   |       |  |  |  |     | 
|-------------------- |  | ------------------- | --------- | -------- | ------------------- | - | ----------- | --------------- |  |  | ------ | -------- |  | ----- | ---------------- |  | ---------- | - | ----- |  |  |  | --- | 
|                     |  | Options Outstanding |           |          | Options Exercisable |  
|                     |  |                     |           |          |                     |  
|                     |  |                     |           | Weighted |                     |   |            
|                     |  |                     |           | Weighted |                     |   | Average     |                 |  |  |        | Weighted |  |       | Weighted Average | 
|                     |  |                     |           | Average  |                     |   | Remaining   |                 |  |  |        | Average  |  |       | Remaining        | 
|                     |  |                     |           | Exercise |                     |   | Contractual |                 |  |  |        | Exercise |  |       | Contractual Life | 
|Exercise Price Range |  | Number              |           |          | Price               |   |             | Life (in years) |  |  | Number |          |  | Price |                  |  | (in years) |  
|                     |  |                     |           |          |                     |   |             |                 |  |  |        |          |  |       |                  |  |            |  
|$0.43  $0.57        |  |                     | 11,499    |          |                     | $ | 0.50        |                 |  |  | 0.9    |          |  |       | 11,499           |  |            | $ | .50   |  |  |  | 0.9 | 
|$0.76  $1.10        |  |                     | 2,553,600 |          |                     | $ | 1.01        |                 |  |  | 9.0    |          |  |       | 528,142          |  |            | $ | .98   |  |  |  | 8.4 | 
|$1.15  $1.72        |  |                     | 839,456   |          |                     | $ | 1.27        |                 |  |  | 9.2    |          |  |       | 200,984          |  |            | $ | 1.36  |  |  |  | 8.4 | 
|$1.80  $2.60        |  |                     | 1,856,300 |          |                     | $ | 2.30        |                 |  |  | 8.9    |          |  |       | 264,668          |  |            | $ | 2.19  |  |  |  | 8.2 | 
|$3.34  $4.88        |  |                     | 2,027,810 |          |                     | $ | 4.22        |                 |  |  | 7.1    |          |  |       | 1,528,458        |  |            | $ | 4.20  |  |  |  | 7.1 | 
|$5.11  $7.52        |  |                     | 700,197   |          |                     | $ | 6.12        |                 |  |  | 5.7    |          |  |       | 662,146          |  |            | $ | 6.13  |  |  |  | 5.6 | 
|$8.25  $12.25       |  |                     | 683,943   |          |                     | $ | 10.76       |                 |  |  | 3.5    |          |  |       | 691,056          |  |            | $ | 10.76 |  |  |  | 3.5 | 
|$12.44  $17.63      |  |                     | 421,988   |          |                     | $ | 15.54       |                 |  |  | 5.0    |          |  |       | 424,925          |  |            | $ | 15.52 |  |  |  | 5.0 | 
|$18.75  $24.13      |  |                     | 321,055   |          |                     | $ | 22.24       |                 |  |  | 5.4    |          |  |       | 321,056          |  |            | $ | 22.24 |  |  |  | 5.4 | 
|                     |  |                     |           |          |                     |   |             |                 |  |  |        |          |  |       |                  |  |            |  
|                     |  |                     | 9,415,848 |          |                     | $ | 4.44        |                 |  |  | 7.6    |          |  |       | 4,632,934        |  |            | $ | 7.13  |  |  |  | 6.3 | 
|                     |  |                     |           |          |                     |   |             |                 |  |  |        |          |  |       |                  |  |            |  



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ARADIGM CORPORATION


NOTES TO FINANCIAL STATEMENTS  (Continued)




| |                             
| | ----------------------------
| | Employee Stock Purchase Plan



Stock Based Compensation




|   |                       
|-- | ----------------------
|7. | Employee Benefit Plans





|   |                         
|-- | ------------------------
|8. | Collaborative Agreements



| |                  
| | -----------------
| | Novo Nordisk A/ S







57



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ARADIGM CORPORATION


NOTES TO FINANCIAL STATEMENTS  (Continued)










|                                             |  |              |        |   |      |   |        |      |  |   |        |  
|-------------------------------------------- |  | ------------ | ------ | - | ---- | - | ------ | ---- |  | - | ------ | -
|                                             |  | December 31, |       
|                                             |  |              |       
|                                             |  | 2004         |        |   | 2003 |   |        | 2002 | 
|                                             |  |              |        |   |      |   |        |      | 
|Deferred revenue  beginning balance         |  | $            | 12,931 |   |      | $ | 16,852 |      |  | $ | 13,442 |  
|Partner payments:                            |  |              |        |   |      |   |        |      |  |   |        |  
|Novo Nordisk A/ S                            |  |              | 25,373 |   |      |   | 29,625 |      |  |   | 30,794 |  
|Other partner-funded programs                |  |              | 1,232  |   |      |   | 311    |      |  |   | 1,583  |  
|                                             |  |              |        |   |      |   |        |      | 
|Total partner payments                       |  |              | 26,605 |   |      |   | 29,936 |      |  |   | 32,377 |  
|                                             |  |              |        |   |      |   |        |      | 
|Contract revenue recognized:                 |  |              |        |   |      |   |        |      |  |   |        |  
|Novo Nordisk A/ S                            |  |              | 26,999 |   |      |   | 33,546 |      |  |   | 26,864 |  
|Other partner-funded programs                |  |              | 1,046  |   |      |   | 311    |      |  |   | 2,103  |  
|                                             |  |              |        |   |      |   |        |      | 
|Total contract revenue recognized            |  |              | 28,045 |   |      |   | 33,857 |      |  |   | 28,967 |  
|                                             |  |              |        |   |      |   |        |      | 
|Deferred revenue  ending balance            |  |              | 11,491 |   |      |   | 12,931 |      |  |   | 16,852 |  
|Less: Noncurrent portion of deferred revenue |  |              | (3,966 | ) |      |   | (5,040 | )    |  |   | (6,170 | )
|                                             |  |              |        |   |      |   |        |      | 
|Current portion of deferred revenue          |  | $            | 7,525  |   |      | $ | 7,891  |      |  | $ | 10,682 |  
|                                             |  |              |        |   |      |   |        |      | 





|   |                           
|-- | --------------------------
|9. | Related Party Transactions





| |                                  
| | ---------------------------------
| | Development and License Agreement



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ARADIGM CORPORATION


NOTES TO FINANCIAL STATEMENTS  (Continued)








| |                               
| | ------------------------------
| | Securities Purchase Agreements







|    |             
|--- | ------------
|10. | Income Taxes





|                                     |  |              |          |   |      |   |         |  
|------------------------------------ |  | ------------ | -------- | - | ---- | - | ------- | -
|                                     |  | December 31, |         
|                                     |  |              |         
|                                     |  | 2004         |          |   | 2003 |  
|                                     |  |              |          |   |      |  
|Net operating loss carryforward      |  | $            | 73,900   |   |      | $ | 58,900  |  
|Deferred revenue                     |  |              | 4,600    |   |      |   | 5,200   |  
|Research and development credits     |  |              | 14,400   |   |      |   | 11,900  |  
|Capitalized research and development |  |              | 7,100    |   |      |   | 11,400  |  
|Other                                |  |              | 1,800    |   |      |   | 1,200   |  
|                                     |  |              |          |   |      |  
|Total deferred tax assets            |  |              | 101,800  |   |      |   | 88,600  |  
|Valuation allowance                  |  |              | (101,800 | ) |      |   | (88,600 | )
|                                     |  |              |          |   |      |  
|Net deferred tax assets              |  | $            |         |   |      | $ |        |  
|                                     |  |              |          |   |      |  



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ARADIGM CORPORATION


NOTES TO FINANCIAL STATEMENTS  (Continued)








|    |                 
|--- | ----------------
|11. | Subsequent Event





| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | an amended and restated license agreement amending the
    Development and License Agreement previously in place with Novo
    Nordisk, expanding Novo Nordisks development and
    manufacturing rights to the AERx iDMS program and providing for
    royalties to the Company on future AERx iDMS net sales in lieu
    of a percentage interest in the gross profits from the
    commercialization of AERx iDMS;                                                                                                                                       
|
| |  | a three-year agreement under which Novo Nordisk Delivery
    Technologies will perform contract manufacturing for the Company
    of AERx iDMS-identical devices and dosage forms filled with
    compounds provided by the Company in support of preclinical and
    initial clinical development by the Company of other AERx
    products; and                                                                                                                                                                                                            
|
| |  | an amendment of the stock purchase agreement in place between
    the Company and Novo Nordisk prior to the closing of the
    restructuring transaction, deleting the provisions whereby the
    Company can require Novo Nordisk to purchase certain amounts of
    common stock, imposing certain restrictions on the ability of
    Novo Nordisk to sell shares of the Companys common stock
    previously purchased by Novo Nordisk, and providing Novo Nordisk
    with certain registration and information rights with respect to
    these shares.





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ARADIGM CORPORATION


NOTES TO FINANCIAL STATEMENTS  (Continued)










|                             |  |           |        | 
|---------------------------- |  | --------- | ------ | 
|                             |  | Operating |       
|                             |  | Leases    |       
|                             |  |           |       
|Years ending December 31:    |  |           |        | 
|2005                         |  | $         | 2,645  | 
|2006                         |  |           | 1,764  | 
|2007                         |  |           | 2,321  | 
|2008                         |  |           | 2,388  | 
|2009                         |  |           | 2,337  | 
|2010 and thereafter          |  |           | 14,705 | 
|                             |  |           |       
|Total minimum lease payments |  | $         | 26,160 | 
|                             |  |           |       

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ARADIGM CORPORATION


NOTES TO FINANCIAL STATEMENTS  (Continued)




|    |                                            
|--- | -------------------------------------------
|12. | Quarterly Results of Operations (Unaudited)



|                                                                        |                                                                                                 |                |        |        |          |   |        |               |        |   |              |        |        |   |        |        |        | 
|----------------------------------------------------------------------- | ----------------------------------------------------------------------------------------------- | -------------- | ------ | ------ | -------- | - | ------ | ------------- | ------ | - | ------------ | ------ | ------ | - | ------ | ------ | ------ | 
|                                                                        |                                                                                                 | March 31,      |        |        | June 30, |   |        | September 30, |        |   | December 31, |       
|                                                                        |                                                                                                 | 2004           |        |        | 2004     |   |        | 2004          |        |   | 2004         |       
|                                                                        |                                                                                                 |                |        |        |          |   |        |               |        |   |              |       
|Contract and license revenues                                           |                                                                                                 | $              | 6,643  |        |          | $ | 7,078  |               |        | $ | 6,352        |        |        | $ | 7,972  |       
|                                                                        |                                                                                                 |                |        |        |          |   |        |               |        |   |              |       
|Operating expenses:                                                     |                                                                                                 |                |        |        |          |   |        |               |        |   |              |        |        |   |        |       
|                                                                        | Research and development                                                                        |                |        | 11,887 |          |   |        | 11,412        |        |   |              | 11,407 |        |   |        | 11,771 |       
|                                                                        | General and administrative                                                                      |                |        | 2,536  |          |   |        | 3,167         |        |   |              | 3,217  |        |   |        | 3,014  |       
|                                                                        |                                                                                                 |                |        |        |          |   |        |               |        |   |              |       
|                                                                        |                                                                                                 | Total expenses |        |        | 14,423   |   |        |               | 14,579 |   |              |        | 14,624 |   |        |        | 14,785 | 
|                                                                        |                                                                                                 |                |        |        |          |   |        |               |        |   |              |       
|Loss from operations                                                    |                                                                                                 |                | (7,780 | )      |          |   | (7,501 | )             |        |   | (8,272       | )      |        |   | (6,813 | )     
|Interest income                                                         |                                                                                                 |                | 66     |        |          |   | 49     |               |        |   | 45           |        |        |   | 34     |       
|Other income and expense                                                |                                                                                                 |                | (10    | )      |          |   | (5     | )             |        |   | (3           | )      |        |   | 1      |       
|                                                                        |                                                                                                 |                |        |        |          |   |        |               |        |   |              |       
|Net loss                                                                |                                                                                                 |                | (7,724 | )      |          |   | (7,457 | )             |        |   | (8,230       | )      |        |   | (6,778 | )     
|                                                                        |                                                                                                 |                |        |        |          |   |        |               |        |   |              |       
|Basic and diluted loss per share applicable to common
    shareholders: |                                                                                                 |                |        |        |          |   |        |               |        |   |              |        |        |   |        |       
|                                                                        | Net loss                                                                                        |                | $      | (0.12  | )        |   | $      | (0.12         | )      |   | $            | (0.13  | )      |   | $      | (0.10  | )     
|                                                                        |                                                                                                 |                |        |        |          |   |        |               |        |   |              |       
|                                                                        | Shares used in computing basic and diluted loss per share
    applicable to common shareholders |                |        | 62,942 |          |   |        | 63,531        |        |   |              | 63,564 |        |   |        | 64,773 |       
|                                                                        |                                                                                                 |                |        |        |          |   |        |               |        |   |              |       

|                                                                        |                                                                                                 |           |        |        |          |   |        |               |   |   |              |        |   |   |        |        |  
|----------------------------------------------------------------------- | ----------------------------------------------------------------------------------------------- | --------- | ------ | ------ | -------- | - | ------ | ------------- | - | - | ------------ | ------ | - | - | ------ | ------ | -
|                                                                        |                                                                                                 | March 31, |        |        | June 30, |   |        | September 30, |   |   | December 31, |       
|                                                                        |                                                                                                 | 2003      |        |        | 2003     |   |        | 2003          |   |   | 2003         |       
|                                                                        |                                                                                                 |           |        |        |          |   |        |               |   |   |              |       
|Contract and license revenues                                           |                                                                                                 | $         | 7,690  |        |          | $ | 9,378  |               |   | $ | 9,843        |        |   | $ | 6,946  |       
|                                                                        |                                                                                                 |           |        |        |          |   |        |               |   |   |              |       
|Operating expenses:                                                     |                                                                                                 |           |        |        |          |   |        |               |   |   |              |        |   |   |        |       
|                                                                        | Research and development                                                                        |           |        | 12,999 |          |   |        | 14,001        |   |   |              | 11,988 |   |   |        | 10,648 |  
|                                                                        | General and administrative                                                                      |           |        | 2,669  |          |   |        | 2,844         |   |   |              | 2,428  |   |   |        | 2,450  |  
|                                                                        |                                                                                                 |           |        |        |          |   |        |               |   |   |              |       
|                                                                        | Total expenses                                                                                  |           |        | 15,668 |          |   |        | 16,845        |   |   |              | 14,416 |   |   |        | 13,098 |  
|                                                                        |                                                                                                 |           |        |        |          |   |        |               |   |   |              |       
|Loss from operations                                                    |                                                                                                 |           | (7,978 | )      |          |   | (7,467 | )             |   |   | (4,573       | )      |   |   | (6,152 | )     
|Interest income                                                         |                                                                                                 |           | 108    |        |          |   | 86     |               |   |   | 68           |        |   |   | 76     |       
|Interest expense                                                        |                                                                                                 |           | (56    | )      |          |   | (39    | )             |   |   | (27          | )      |   |   | (16    | )     
|                                                                        |                                                                                                 |           |        |        |          |   |        |               |   |   |              |       
|Net loss                                                                |                                                                                                 | $         | (7,926 | )      |          | $ | (7,420 | )             |   | $ | (4,532       | )      |   | $ | (6,092 | )     
|                                                                        |                                                                                                 |           |        |        |          |   |        |               |   |   |              |       
|Basic and diluted loss per share applicable to common
    shareholders: |                                                                                                 |           |        |        |          |   |        |               |   |   |              |        |   |   |        |       
|                                                                        | Net loss                                                                                        |           | $      | (0.22  | )        |   | $      | (0.15         | ) |   | $            | (0.08  | ) |   | $      | (0.10  | )
|                                                                        |                                                                                                 |           |        |        |          |   |        |               |   |   |              |       
|                                                                        | Shares used in computing basic and diluted loss per share
    applicable to common shareholders |           |        | 35,601 |          |   |        | 51,144        |   |   |              | 54,263 |   |   |        | 59,421 |  
|                                                                        |                                                                                                 |           |        |        |          |   |        |               |   |   |              |       

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|        |                                                                                         
|------- | ----------------------------------------------------------------------------------------
|Item 9. | Changes in and Disagreements with Accountants on
    Accounting and Financial Disclosure








|         |                        
|-------- | -----------------------
|Item 9A. | Controls and Procedures

Evaluation of disclosure controls and procedures:




Changes in internal controls:







|         |                  
|-------- | -----------------
|Item 9B. | Other Information



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PART III







|         |                                                   
|-------- | --------------------------------------------------
|Item 10. | Directors and Executive Officers of the Registrant

Identification of Directors; Audit Committee Information;
Code of Ethics




Identification of Executive Officers




Section 16(a) Compliance









|         |                       
|-------- | ----------------------
|Item 11. | Executive Compensation








|         |                                                                                                   
|-------- | --------------------------------------------------------------------------------------------------
|Item 12. | Security Ownership of Certain Beneficial Owners and
    Management and Related Stockholder Matters








|         |                                               
|-------- | ----------------------------------------------
|Item 13. | Certain Relationships and Related Transactions








|         |                                       
|-------- | --------------------------------------
|Item 14. | Principal Accountant Fees and Services



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PART IV







|         |                                                                      
|-------- | ---------------------------------------------------------------------
|Item 15. | Exhibits, Financial Statements Schedules, and Reports on
    Form 8-K

(a)(1) Financial Statements.




|                                                                                                                                     |  |           |    | 
|------------------------------------------------------------------------------------------------------------------------------------ |  | --------- | -- | 
|                                                                                                                                     |  | Page in   |   
|                                                                                                                                     |  | Form 10-K |   
|                                                                                                                                     |  |           |   
|Report of Independent Registered Public Accounting Firm                                                                              |  |           | 39 | 
|Balance Sheets  December 31, 2004 and 2003                                                                                          |  |           | 40 | 
|Statements of Operations  Years ended
    December 31, 2004, 2003 and 2002                                                          |  |           | 41 | 
|Statements of Redeemable Convertible Preferred Stock and
    Shareholders Equity  Years ended
    December 31, 2004, 2003 and 2002 |  |           | 42 | 
|Statements of Cash Flows  Years ended
    December 31, 2004, 2003 and 2002                                                          |  |           | 44 | 
|Notes to Financial Statements                                                                                                        |  |           | 45 | 

(2) Financial Statement Schedules.




(3) Exhibits.


|            |    |             |  |                                                                                                                    
|----------- | -- | ----------- |  | -------------------------------------------------------------------------------------------------------------------
|Exhibit No. |    | Description
|            |    |            
|            | 3  | .1(1)       |  | Amended and Restated Articles of Incorporation of the Company.                                                     
|            | 3  | .2(4)       |  | Bylaws of the Company, as amended.                                                                                 
|            | 3  | .3(10)      |  | Certificate of Determination of Series A Junior
    Participating Preferred Stock.                                 
|            | 3  | .4(9)       |  | Certificate of Determination and Preferences of Series A
    Convertible Preferred Stock.                          
|            | 3  | .5(10)      |  | Certificate of Amendment of Amended and Restated Articles of
    Incorporation of the Company.                     
|            | 3  | .6(10)      |  | Certificate of Amendment of Certificate of Determination of
    Series A Junior Participating Preferred Stock.     
|            | 3  | .7(15)      |  | Certificate of Amendment of Amended and Restated Articles of
    Incorporation of the Company.                     
|            | 3  | .8(15)      |  | Certificate of Amendment of Certificate of Determination of
    Series A Junior Participating Preferred Stock.     
|            | 4  | .1          |  | Reference is made to Exhibits 3.1, 3.2, 3.3, 3.4, 3.5, 3.6,
    3.7 and 3.8.                                       
|            | 4  | .2(1)       |  | Specimen common stock certificate.                                                                                 
|            | 10 | .1(1)+      |  | Form of Indemnity Agreement between the Registrant and each of
    its directors and officers.                     
|            | 10 | .2(14)+     |  | Equity Incentive Plan, as amended.                                                                                 
|            | 10 | .3(1)+      |  | Form of the Companys Incentive Stock Option Agreement
    under the Equity Incentive Plan.                        
|            | 10 | .4(1)+      |  | Form of the Companys Non-statutory Stock Option Agreement
    under the Equity Incentive Plan.                    
|            | 10 | .5(1)+      |  | Form of the Companys Non-Employee Directors Stock
    Option Plan.                                               
|            | 10 | .6(1)+      |  | Form of the Companys Non-statutory Stock Option Agreement
    under the Non-Employee Directors Stock Option Plan.
|            | 10 | .7(14)+     |  | Employee Stock Purchase Plan, as amended.                                                                          
|            | 10 | .8(1)+      |  | Form of the Companys Employee Stock Purchase Plan Offering
    Document.                                          
|            | 10 | .9(1)       |  | Master Lease Agreement and Warrant, between the Company and
    Comdisco, Inc., dated June 9, 1995.                
|            | 10 | .10(2)*     |  | Product Development and Commercialization Agreement between the
    Company and SmithKline Beecham PLC.            

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|            |    |          |             |                                                                                                                                                                                                             
|----------- | -- | -------- | ----------- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit No. |    |          | Description
|            |    |          |            
|            | 10 | .11(3)   |             | Lease Agreement for the property located at 3911 Trust Way,
    Hayward, California, dated March 17, 1997, between the
    Company and Hayward Point Eden I Limited Partnership.                            
|            | 10 | .11a(3)  |             | First Amendment to Lease dated December 22, 1997, between
    the Company and Hayward Point Eden I Limited Partnership.                                                                                     
|            | 10 | .11b(3)  |             | Second Amendment to Lease, dated January 28, 1998, between
    the Company and Hayward Point Eden I Limited Partnership.                                                                                    
|            | 10 | .12(3)   |             | Lease Agreement for the property located in Phase V of the
    Britannia Point Eden Business Park in Hayward, California, dated
    January 28, 1998, between the Company and Britannia Point
    Eden, LLC.
|            | 10 | .13(5)   |             | Rights Agreement, dated as of August 31, 1998, between the
    Company and Bank Boston, N.A.                                                                                                                
|            | 10 | .13a(10) |             | Amendment to Rights Agreement, dated as of October 22,
    2001, by and between the Company and Fleet National Bank.                                                                                        
|            | 10 | .13b(10) |             | Amendment to Rights Agreement, dated as of December 6,
    2001, by and between the Company and EquiServe Trust Company.                                                                                    
|            | 10 | .14(6)   |             | Lease Agreement for the property located at 2704 West Winton
    Avenue, Hayward, California, dated September 11, 2000,
    between the Company and Winton Industrial Center, Inc.                          
|            | 10 | .14a(8)  |             | Amendment No. 1 to Standard Office/ Warehouse Lease, dated
    March 1, 2001, by and between the Company and Winton
    Industrial Center, Inc.                                                             
|            | 10 | .15(6)   |             | Lease Agreement for the property located at 3930 Point Eden Way,
    Hayward, California, dated July 1, 2000, between the
    Company and Hayward Point Eden I Limited Partnership.                         
|            | 10 | .16(7)*  |             | Amendment to GlaxoSmithKline agreement executed in December 2000.                                                                                                                                           
|            | 10 | .17(11)  |             | Securities Purchase Agreement, dated as of February 10,
    2003, by and among the Company and the purchasers named therein.                                                                                
|            | 10 | .18(11)  |             | Warrant Repricing Agreement, dated as of February 10, 2003,
    by and between the Company and the persons listed on
    Exhibit A thereto.                                                                 
|            | 10 | .19(12)  |             | Securities Purchase Agreement, dated as of November 7,
    2003, by and among the Company and the purchasers named therein.                                                                                 
|            | 10 | .20(13)  |             | Securities Purchase Agreement, dated as of November 14,
    2003, by and among the Company and the purchasers named therein.                                                                                
|            | 10 | .21(16)  |             | Restructuring Agreement, dated as of September 28, 2004, by
    and among the Company, Novo Nordisk A/S and Novo Nordisk
    Delivery Technologies, Inc.                                                    
|            | 10 | .22(17)  |             | Securities Purchase Agreement, dated as of December 17,
    2004, by and among the Company and the purchasers named therein.                                                                                
|            | 23 | .1       |             | Consent of Independent Registered Public Accounting Firm.                                                                                                                                                   
|            | 24 | .1       |             | Power of Attorney. Reference is made to the signature page.                                                                                                                                                 
|            | 31 | .1       |             | Section 302 Certification of the Chief Executive Officer.                                                                                                                                                   
|            | 31 | .2       |             | Section 302 Certification of the Chief Financial Officer.                                                                                                                                                   
|            | 32 | .1       |             | Section 906 Certification of the Chief Executive Officer
    and the Chief Financial Officer.                                                                                                               






| |   |                                                                                          
| | - | -----------------------------------------------------------------------------------------
| | * | The Company has sought confidential treatment for portions of
    the referenced exhibit.



| |   |                                                                          
| | - | -------------------------------------------------------------------------
| | + | Represents a management contract or compensatory plan or
    arrangement.



| |     |                                                                                              
| | --- | ---------------------------------------------------------------------------------------------
| | (1) | Incorporated by reference to the Companys Form S-1
    (No. 333-4236), as amended.          
|
| | (2) | Incorporated by reference to the Companys Form 8-K
    filed on November 7, 1997.           
|
| | (3) | Incorporated by reference to the Companys Form 10-K
    filed on March 24, 1998, as amended.
|
| | (4) | Incorporated by reference to the Companys Form 10-Q
    filed on August 14, 1998.           
|
| | (5) | Incorporated by reference to the Companys 8-K filed on
    September 2, 1998.               
|
| | (6) | Incorporated by reference to the Companys Form 10-Q
    filed on November 13, 2000.         

66



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##### Table of Contents





| |     |                                                                                                     
| | --- | ----------------------------------------------------------------------------------------------------
| | (7) | Incorporated by reference to the Companys Form 10-K
    filed for the year ended December 31, 2000.
|
| | (8) | Incorporated by reference to the Companys Form 10-Q
    filed on August 13, 2001.                  
|
| | (9) | Incorporated by reference to the Companys Form S-3
    (No. 333-76584).                            



|     |                                                                                                     
|---- | ----------------------------------------------------------------------------------------------------
|(10) | Incorporated by reference to the Companys Form 10-K
    filed for the year ended December 31, 2001.
|    
|(11) | Incorporated by reference to the Companys Form 10-Q
    filed on May 13, 2003.                     
|    
|(12) | Incorporated by reference to the Companys Form 8-K
    filed on November 12, 2003.                 
|    
|(13) | Incorporated by reference to the Companys Form 8-K
    filed on November 20, 2003.                 
|    
|(14) | Incorporated by reference to the Companys definitive proxy
    statement filed on April 2, 2004    
|    
|(15) | Incorporated by reference to the Companys Form 10-Q
    filed on August 13, 2004.                  
|    
|(16) | Incorporated by reference to the Companys Form 10-Q
    filed on November 15, 2004                 
|    
|(17) | Incorporated by reference to the Companys Form 8-K
    filed on December 23, 2004.                 

(c) Index to Exhibits.




(d) Financial Statement Schedules.




67



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##### Table of Contents






SIGNATURES






| |                    
| | -------------------
| | ARADIGM CORPORATION



| |     |                    
| | --- | -------------------
| | By: | /s/ V. Bryan Lawlis

| |                                      
| | -------------------------------------
| |                                      
| | V. Bryan Lawlis                      
| | President and Chief Executive Officer







|                                                     |  |                                                                                    |  |                |  | 
|---------------------------------------------------- |  | ---------------------------------------------------------------------------------- |  | -------------- |  | 
|Signature                                            |  | Title                                                                              |  | Date          
|                                                     |  |                                                                                    |  |               
|/s/ V. Bryan LawlisV.
    Bryan Lawlis               |  | President, Chief Executive Officer, and Director (Principal
    Executive Officer) |  | March 30, 2005
|                                                    
|/s/ Thomas C.
    ChestermanThomas
    C. Chesterman |  | Sr. VP and Chief Financial Officer(Principal Financial and
    Accounting Officer) |  | March 30, 2005
|                                                    
|/s/ Virgil D. ThompsonVirgil
    D. Thompson         |  | Chairman of the Board and Director                                                 |  | March 30, 2005
|                                                    
|/s/ Frank H. BarkerFrank
    H. Barker               |  | Director                                                                           |  | March 30, 2005
|                                                    
|/s/ Stan BensonStan
    Benson                       |  | Director                                                                           |  | March 30, 2005
|                                                    
|/s/ Igor GondaIgor
    Gonda                         |  | Director                                                                           |  | March 30, 2005
|                                                    
|/s/ Stephen O. JaegerStephen
    O. Jaeger           |  | Director                                                                           |  | March 30, 2005

68



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##### Table of Contents



|                                               |  |          |  |                |  | 
|---------------------------------------------- |  | -------- |  | -------------- |  | 
|Signature                                      |  | Title    |  | Date          
|                                               |  |          |  |               
|                                              
|/s/ John M. NehraJohn
    M. Nehra             |  | Director |  | March 30, 2005
|                                              
|/s/ Wayne L. RoeWayne
    L. Roe               |  | Director |  | March 30, 2005
|                                              
|/s/ Richard P. ThompsonRichard
    P. Thompson |  | Director |  | March 30, 2005

69



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##### Table of Contents






EXHIBIT INDEX


|            |    |             |  |                                                                                                                                                                                                             
|----------- | -- | ----------- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit No. |    | Description
|            |    |            
|            | 3  | .1(1)       |  | Amended and Restated Articles of Incorporation of the Company.                                                                                                                                              
|            | 3  | .2(4)       |  | Bylaws of the Company, as amended.                                                                                                                                                                          
|            | 3  | .3(10)      |  | Certificate of Determination of Series A Junior
    Participating Preferred Stock.                                                                                                                          
|            | 3  | .4(9)       |  | Certificate of Determination and Preferences of Series A
    Convertible Preferred Stock.                                                                                                                   
|            | 3  | .5(10)      |  | Certificate of Amendment of Amended and Restated Articles of
    Incorporation of the Company.                                                                                                              
|            | 3  | .6(10)      |  | Certificate of Amendment of Certificate of Determination of
    Series A Junior Participating Preferred Stock.                                                                                              
|            | 3  | .7(15)      |  | Certificate of Amendment of Amended and Restated Articles of
    Incorporation of the Company.                                                                                                              
|            | 3  | .8(15)      |  | Certificate of Amendment of Certificate of Determination of
    Series A Junior Participating Preferred Stock.                                                                                              
|            | 4  | .1          |  | Reference is made to Exhibits 3.1, 3.2, 3.3, 3.4, 3.5, 3.6,
    3.7 and 3.8.                                                                                                                                
|            | 4  | .2(1)       |  | Specimen common stock certificate.                                                                                                                                                                          
|            | 10 | .1(1)+      |  | Form of Indemnity Agreement between the Registrant and each of
    its directors and officers.                                                                                                              
|            | 10 | .2(14)+     |  | Equity Incentive Plan, as amended.                                                                                                                                                                          
|            | 10 | .3(1)+      |  | Form of the Companys Incentive Stock Option Agreement
    under the Equity Incentive Plan.                                                                                                                 
|            | 10 | .4(1)+      |  | Form of the Companys Non-statutory Stock Option Agreement
    under the Equity Incentive Plan.                                                                                                             
|            | 10 | .5(1)+      |  | Form of the Companys Non-Employee Directors Stock
    Option Plan.                                                                                                                                        
|            | 10 | .6(1)+      |  | Form of the Companys Non-statutory Stock Option Agreement
    under the Non-Employee Directors Stock Option Plan.                                                                                         
|            | 10 | .7(14)+     |  | Employee Stock Purchase Plan, as amended.                                                                                                                                                                   
|            | 10 | .8(1)+      |  | Form of the Companys Employee Stock Purchase Plan Offering
    Document.                                                                                                                                   
|            | 10 | .9(1)       |  | Master Lease Agreement and Warrant, between the Company and
    Comdisco, Inc., dated June 9, 1995.                                                                                                         
|            | 10 | .10(2)*     |  | Product Development and Commercialization Agreement between the
    Company and SmithKline Beecham PLC.                                                                                                     
|            | 10 | .11(3)      |  | Lease Agreement for the property located at 3911 Trust Way,
    Hayward, California, dated March 17, 1997, between the
    Company and Hayward Point Eden I Limited Partnership.                            
|            | 10 | .11a(3)     |  | First Amendment to Lease dated December 22, 1997, between
    the Company and Hayward Point Eden I Limited Partnership.                                                                                     
|            | 10 | .11b(3)     |  | Second Amendment to Lease, dated January 28, 1998, between
    the Company and Hayward Point Eden I Limited Partnership.                                                                                    
|            | 10 | .12(3)      |  | Lease Agreement for the property located in Phase V of the
    Britannia Point Eden Business Park in Hayward, California, dated
    January 28, 1998, between the Company and Britannia Point
    Eden, LLC.
|            | 10 | .13(5)      |  | Rights Agreement, dated as of August 31, 1998, between the
    Company and Bank Boston, N.A.                                                                                                                
|            | 10 | .13a(10)    |  | Amendment to Rights Agreement, dated as of October 22,
    2001, by and between the Company and Fleet National Bank.                                                                                        
|            | 10 | .13b(10)    |  | Amendment to Rights Agreement, dated as of December 6,
    2001, by and between the Company and EquiServe Trust Company.                                                                                    
|            | 10 | .14(6)      |  | Lease Agreement for the property located at 2704 West Winton
    Avenue, Hayward, California, dated September 11, 2000,
    between the Company and Winton Industrial Center, Inc.                          
|            | 10 | .14a(8)     |  | Amendment No. 1 to Standard Office/ Warehouse Lease, dated
    March 1, 2001, by and between the Company and Winton
    Industrial Center, Inc.                                                             
|            | 10 | .15(6)      |  | Lease Agreement for the property located at 3930 Point Eden Way,
    Hayward, California, dated July 1, 2000, between the
    Company and Hayward Point Eden I Limited Partnership.                         
|            | 10 | .16(7)*     |  | Amendment to GlaxoSmithKline agreement executed in December 2000.                                                                                                                                           



---



##### Table of Contents



|            |    |         |             |                                                                                                                                                          
|----------- | -- | ------- | ----------- | ---------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit No. |    |         | Description
|            |    |         |            
|            | 10 | .17(11) |             | Securities Purchase Agreement, dated as of February 10,
    2003, by and among the Company and the purchasers named therein.                             
|            | 10 | .18(11) |             | Warrant Repricing Agreement, dated as of February 10, 2003,
    by and between the Company and the persons listed on
    Exhibit A thereto.              
|            | 10 | .19(12) |             | Securities Purchase Agreement, dated as of November 7,
    2003, by and among the Company and the purchasers named therein.                              
|            | 10 | .20(13) |             | Securities Purchase Agreement, dated as of November 14,
    2003, by and among the Company and the purchasers named therein.                             
|            | 10 | .21(16) |             | Restructuring Agreement, dated as of September 18, 2004, by
    and among the Company, Novo Nordisk A/ S and Novo Nordisk
    Delivery Technologies, Inc.
|            | 10 | .22(17) |             | Securities Purchase Agreement, dated as of December 17,
    2004, by and among the Company and the purchasers named therein.                             
|            | 23 | .1      |             | Consent of Independent Registered Public Accounting Firm.                                                                                                
|            | 24 | .1      |             | Power of Attorney. Reference is made to the signature page.                                                                                              
|            | 31 | .1      |             | Section 302 Certification of the Chief Executive Officer.                                                                                                
|            | 31 | .2      |             | Section 302 Certification of the Chief Financial Officer.                                                                                                
|            | 32 | .1      |             | Section 906 Certification of the Chief Executive Officer
    and the Chief Financial Officer.                                                            






| |   |                                                                                          
| | - | -----------------------------------------------------------------------------------------
| | * | The Company has sought confidential treatment for portions of
    the referenced exhibit.



| |   |                                                                          
| | - | -------------------------------------------------------------------------
| | + | Represents a management contract or compensatory plan or
    arrangement.



| |     |                                                                                                     
| | --- | ----------------------------------------------------------------------------------------------------
| | (1) | Incorporated by reference to the Companys Form S-1
    (No. 333-4236), as amended.                 
|
| | (2) | Incorporated by reference to the Companys Form 8-K
    filed on November 7, 1997.                  
|
| | (3) | Incorporated by reference to the Companys Form 10-K
    filed on March 24, 1998, as amended.       
|
| | (4) | Incorporated by reference to the Companys Form 10-Q
    filed on August 14, 1998.                  
|
| | (5) | Incorporated by reference to the Companys 8-K filed on
    September 2, 1998.                      
|
| | (6) | Incorporated by reference to the Companys Form 10-Q
    filed on November 13, 2000.                
|
| | (7) | Incorporated by reference to the Companys Form 10-K
    filed for the year ended December 31, 2000.
|
| | (8) | Incorporated by reference to the Companys Form 10-Q
    filed on August 13, 2001.                  
|
| | (9) | Incorporated by reference to the Companys Form S-3
    (No. 333-76584).                            



|     |                                                                                                     
|---- | ----------------------------------------------------------------------------------------------------
|(10) | Incorporated by reference to the Companys Form 10-K
    filed for the year ended December 31, 2001.
|    
|(11) | Incorporated by reference to the Companys Form 10-Q
    filed on May 13, 2003.                     
|    
|(12) | Incorporated by reference to the Companys Form 8-K
    filed on November 12, 2003.                 
|    
|(13) | Incorporated by reference to the Companys Form 8-K
    filed on November 20, 2003.                 
|    
|(14) | Incorporated by reference to the Companys definitive proxy
    statement filed on April 2, 2004    
|    
|(15) | Incorporated by reference to the Companys Form 10-Q
    filed on August 13, 2004.                  
|    
|(16) | Incorporated by reference to the Companys Form 10-Q
    filed on November 15, 2004                 
|    
|(17) | Incorporated by reference to the Companys Form 8-K
    filed on December 23, 2004.