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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, 2005                                                 
|          
|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





o þ


o þ


þ o


S-K 10-K 10-K. þ


12b-2


|                         |  |                    |  |                       
|------------------------ |  | ------------------ |  | ----------------------
|Large accelerated filero |  | Accelerated filero |  | Non-accelerated filerþ

12b-2 o þ






DOCUMENTS INCORPORATED BY REFERENCE












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TABLE OF CONTENTS


|              |  |                                                                                                                            |    |      |    | 
|------------- |  | -------------------------------------------------------------------------------------------------------------------------- | -- | ---- | -- | 
|              |  |                                                                                                                            |    | Page |   
|              |  |                                                                                                                            |    |      |   
|PART I       
|Item 1.       |  | Business                                                                                                                   |    |      | 2  | 
|Item 1A.      |  | Risk Factors                                                                                                               |    |      | 21 | 
|Item 1B.      |  | Unresolved Staff Comments                                                                                                  |    |      | 29 | 
|Item 2.       |  | Properties                                                                                                                 |    |      | 29 | 
|Item 3.       |  | Legal Proceedings                                                                                                          |    |      | 30 | 
|Item 4.       |  | Submission of Matters to a Vote of Security
    Holders                                                                    |    |      | 30 | 
|             
|PART II      
|Item 5.       |  | Market for the Registrants Common
    Stock and Related Stockholder Matters and Issuer Purchases of
    Equity Securities |    |      | 30 | 
|Item 6.       |  | Selected Financial Data                                                                                                    |    |      | 32 | 
|Item 7.       |  | Managements Discussion and Analysis
    of Financial Condition and Results of Operations                                  |    |      | 33 | 
|Item 7A.      |  | Quantitative and Qualitative Disclosure
    About Market Risk                                                              |    |      | 41 | 
|Item 8.       |  | Financial Statements and Supplementary
    Data                                                                            |    |      | 42 | 
|Item 9.       |  | Changes in and Disagreements with
    Accountants on Accounting and Financial Disclosure                                   |    |      | 67 | 
|Item 9A.      |  | Controls and Procedures                                                                                                    |    |      | 67 | 
|Item 9B.      |  | Other Information                                                                                                          |    |      | 67 | 
|             
|PART III     
|Item 10.      |  | Directors and Executive Officers of the
    Registrant                                                                     |    |      | 68 | 
|Item 11.      |  | Executive Compensation                                                                                                     |    |      | 68 | 
|Item 12.      |  | Security Ownership of Certain Beneficial
    Owners and Management and Related Stockholder Matters                         |    |      | 68 | 
|Item 13.      |  | Certain Relationships and Related
    Transactions                                                                         |    |      | 68 | 
|Item 14.      |  | Principal Accountant Fees and Services                                                                                     |    |      | 68 | 
|             
|PART IV      
|Item 15.      |  | Exhibits and Financial Statements
    Schedules                                                                            |    |      | 69 | 
|             
|SIGNATURES    |  |                                                                                                                            | 72 |     
|EXHIBIT INDEX |  |                                                                                                                            | 73 |     
|EXHIBIT 3.9  
|EXHIBIT 10.25
|EXHIBIT 10.26
|EXHIBIT 23.1 
|EXHIBIT 31.1 
|EXHIBIT 31.2 
|EXHIBIT 32.1 



1



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10-K





PART I







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

Overview








|                                                    |  |                                       
|--------------------------------------------------- |  | --------------------------------------
|Platform/Indication                                 |  | Stage of Development                  
|                                                    |  |                                       
|AERx/Type 1 and Type 2 Diabetes                     |  | In Phase 3                            
|Intraject/Migraine                                  |  | Ready for Pivotal Bioequivalence Study
|AERx/HCQ/Asthma                                     |  | In Phase 2                            
|AERx/Respiratory (Undisclosed)                      |  | In Phase 1                            
|AERx/Liposomal Ciprofloxacin (Bioterrorism)         |  | Preclinical                           
|Pulmonary Liposomal Ciprofloxacin (Cystic Fibrosis) |  | Preclinical                           
|AERx/Smoking Cessation                              |  | Preclinical                           
|AERx/Liposomal Treprostinil                         |  | Preclinical                           

2



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AERx Diabetes Management System










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





3



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| |                                         
| | ----------------------------------------
| | Development and Commercialization Status



12-week


1-year










4



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Intraject Triptan


easy-to




ease-of




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





| |                                         
| | ----------------------------------------
| | Development and Commercialization Status

ease-of






5



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AERx Hydrochloroquine








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





| |                                         
| | ----------------------------------------
| | Development and Commercialization Status





6



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Liposomal Ciprofloxacin








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







| |                                         
| | ----------------------------------------
| | Development and Commercialization Status





AERx Smoking Cessation






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



7



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| |                                         
| | ----------------------------------------
| | Development and Commercialization Status





AERx Treprostinil








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





| |                                         
| | ----------------------------------------
| | Development and Commercialization Status





Potential Product Applications




8



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Drug Delivery Technology Background




Pulmonary Delivery Background






9



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The Aradigm Solution for Pulmonary Delivery




| |     
| | ----
| | AERx





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





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





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





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



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The Aradigm Solution for Needle-Free Subcutaneous Delivery




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





Ease-of










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



Our Strategy






| |                                                                 
| | ----------------------------------------------------------------
| | Identify Suitable Drug Delivery Candidates for our
    Platforms







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



11



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





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

in-vitro/in-vivo


Research and Development Strategy




Sales and Marketing Strategy






Manufacturing/ Commercialization Strategy


best-in


12



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non-AERx




best-in




Intellectual Property and Other Proprietary Rights










13



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Competition






14



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Government Regulation










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| |   |                            
| | - | ---------------------------
| |  | controlled drug substances;
|
| |  | safe working conditions;   
|
| |  | manufacturing practices;   
|
| |  | environmental protection;  

16



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| |   |                                                           
| | - | ----------------------------------------------------------
| |  | 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                
|Robert E. Ratner, M.D.  |  | MedStar Research Institute                                        |  | Endocrinology                

Employees




17



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Corporate History and Website Information


10-K, 10-Q, 8-K 1-800-SEC-0330.


Directors and Executive Officers




|                          |  |     |    |  |          |                                                          
|------------------------- |  | --- | -- |  | -------- | ---------------------------------------------------------
|Name                      |  | Age |    |  | Position
|                          |  |     |    |  |         
|V. Bryan Lawlis, Ph.D.    |  |     | 54 |  |          | President, Chief Executive Officer and Director          
|Thomas C. Chesterman      |  |     | 46 |  |          | Senior Vice President and Chief Financial Officer        
|Steven J. Farr, Ph.D.     |  |     | 47 |  |          | Senior Vice President, Chief Scientific Officer          
|Bobba Venkatadri          |  |     | 62 |  |          | Senior Vice President, Operations                        
|Babatunde A. Otulana, M.D |  |     | 49 |  |          | Vice President, Clinical & Regulatory Affairs            
|John J. Turanin           |  |     | 48 |  |          | Vice President, Program Management and Corporate Planning
|Virgil D. Thompson(2)     |  |     | 66 |  |          | Director and Chairman of the Board                       
|Frank H. Barker(1)(3)     |  |     | 75 |  |          | Director                                                 
|Igor Gonda(2)             |  |     | 58 |  |          | Director                                                 
|Stephen O. Jaeger(1)(2)   |  |     | 61 |  |          | Director                                                 
|John Nehra(3)(4)          |  |     | 57 |  |          | Director                                                 
|Wayne I. Roe(1)(4)        |  |     | 55 |  |          | Director                                                 
|Richard P. Thompson(3)(4) |  |     | 54 |  |          | Director                                                 






|    |                                                                             
|--- | ----------------------------------------------------------------------------
|(1) | Member of the Audit Committee.                                              
|   
|(2) | Member of the Compensation Committee.                                       
|   
|(3) | Member of the Nominating and Corporate Governance Committee.                
|   
|(4) | Not standing for reelection at the May 2006 Annual
    Shareholders Meeting

V. Bryan Lawlis, Ph.D.


18



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Thomas C. Chesterman


Stephen J. Farr, Ph.D.,


Bobba Venkatadri


Babatunde A. Otulana, M.D. ,


John J. Turanin


Virgil D. Thompson


19



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Frank H. Barker


Igor Gonda, Ph.D.


Stephen O. Jaeger


John M. Nehra


Wayne I. Roe


Richard P. Thompson


20



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Item 1A. 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 will need additional capital and our ability to find
additional funding is uncertain.






| |   |                                                                                                                 
| | - | ----------------------------------------------------------------------------------------------------------------
| |  | progress in researching and developing our technology, our drug
    delivery systems and potential applications;
|
| |  | 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.                                                     





21



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We have a history of losses and anticipate future losses.






| |   |                                                                        
| | - | -----------------------------------------------------------------------
| |  | expand our research and development efforts;                           
|
| |  | expand our preclinical and clinical testing activities;                
|
| |  | pursue additional applications for our existing delivery
    platforms;
|
| |  | expand our manufacturing efforts; and                                  
|
| |  | plan and build our commercial production capabilities.                 



We may not be able to develop our products successfully.








| |   |                                                                                                                  
| | - | -----------------------------------------------------------------------------------------------------------------
| |  | 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.                                    



22



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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 iDMS.      



We have limited manufacturing experience.




23



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| |   |                                                                                                                                                   
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------
| |  | 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.




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






24



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25



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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.                                                                   





26



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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.




27



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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.






| |   |                                       
| | - | --------------------------------------
| |  | investor perception of us;            
|
| |  | analyst recommendations;              
|
| |  | fluctuations in our operating results;

28



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| |   |                                                                                                                          
| | - | -------------------------------------------------------------------------------------------------------------------------
| |  | 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.                                                                                     



We have implemented certain anti-takeover provisions.









Item 1B. Unresolved Staff Comments









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



29



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








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






PART II







|        |                                                                                                                           
|------- | --------------------------------------------------------------------------------------------------------------------------
|Item 5. | Market for the Registrants Common Stock and Related
    Stockholder Matters and Issuer Purchases of Equity
    Securities

Market Information




|     |                                       |      |   |       |     |  |   |      | 
|---- | ------------------------------------- | ---- | - | ----- | --- |  | - | ---- | 
|     |                                       | High |   |       | Low | 
|     |                                       |      |   |       |     | 
|2004 |                                       |      |   |       |     |  |   |     
|     | First Quarter                         |      | $ | 13.70 |     |  | $ | 9.05 | 
|     | Second Quarter                        |      |   | 11.35 |     |  |   | 4.20 | 
|     | Third Quarter                         |      |   | 6.40  |     |  |   | 3.30 | 
|     | Fourth Quarter                        |      |   | 10.00 |     |  |   | 5.90 | 
|2005 |                                       |      |   |       |     |  |   |     
|     | First Quarter                         |      | $ | 8.65  |     |  | $ | 5.60 | 
|     | Second Quarter                        |      |   | 5.90  |     |  |   | 5.00 | 
|     | Third Quarter                         |      |   | 6.05  |     |  |   | 4.95 | 
|     | Fourth Quarter                        |      |   | 5.25  |     |  |   | 3.45 | 
|2006 |                                       |      |   |       |     |  |   |     
|     | First Quarter (through Feb. 28, 2006) |      | $ | 5.04  |     |  |   | 3.50 | 



Dividend Policy




30



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Equity Compensation Plan Information




|                                                           |  |                     |           |  |                     |                 |              |                      |  |  |         | 
|---------------------------------------------------------- |  | ------------------- | --------- |  | ------------------- | --------------- | ------------ | -------------------- |  |  | ------- | 
|                                                           |  |                     |           |  |                     | Common Stock    |             
|                                                           |  |                     |           |  |                     | Available for   |             
|                                                           |  |                     |           |  |                     | Future Issuance |             
|                                                           |  | Common Stock to     |           |  |                     |                 | Under Equity |                     
|                                                           |  | be Issued Upon      |           |  | Weighted-Average    |                 |              | Compensation         | 
|                                                           |  | Exercise of         |           |  | Exercise Price of   |                 |              | Plans (Excluding     | 
|                                                           |  | Outstanding Options |           |  | Outstanding Options |                 |              | Securities Reflected | 
|                                                           |  | and Rights(1)       |           |  | and Rights          |                 |              | in Column (a))(1)    | 
|Plan Category                                              |  | (a)                 |           |  | (b)                 |                 |              | (c)                  | 
|                                                           |  |                     |           |  |                     |                 |              |                      | 
|Equity compensation plans approved by Aradigm stockholders |  |                     | 1,729,709 |  |                     | $               | 19.47        |                      |  |  | 919,386 | 






|    |                                                                                                                                                                                              
|--- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(1) | Issued pursuant to the Companys 1996 Equity Incentive
    Plan, the 1996 Non-Employee Directors Plan, and the 2005
    Equity Incentive Plan. (See Note 6 of the Financial
    Statements.)

31



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

10-K.


|                                                                  |                                                                         |                          |          |        |      |   |          |        |   |   |          |        |   |      |          |        |   |   |          |        |  
|----------------------------------------------------------------- | ----------------------------------------------------------------------- | ------------------------ | -------- | ------ | ---- | - | -------- | ------ | - | - | -------- | ------ | - | ---- | -------- | ------ | - | - | -------- | ------ | -
|                                                                  |                                                                         | Years Ended December 31, |         
|                                                                  |                                                                         |                          |         
|                                                                  |                                                                         | 2005(1)                  |          |        | 2004 |   |          | 2003   |   |   | 2002     |        |   | 2001 |         
|                                                                  |                                                                         |                          |          |        |      |   |          |        |   |   |          |        |   |      |         
|Statements of Operations Data:                                    |                                                                         |                          |          |        |      |   |          |        |   |   |          |        |   |      |          |        |   |   |          |       
|Contract and license revenues                                     |                                                                         | $                        | 10,507   |        |      | $ | 28,045   |        |   | $ | 33,857   |        |   | $    | 28,967   |        |   | $ | 28,916   |       
|Operating expenses:                                               |                                                                         |                          |          |        |      |   |          |        |   |   |          |        |   |      |          |        |   |   |          |       
|                                                                  | Research and Development                                                |                          |          | 30,174 |      |   |          | 46,477 |   |   |          | 49,636 |   |      |          | 54,680 |   |   |          | 58,836 |  
|                                                                  | General and Administrative                                              |                          |          | 10,895 |      |   |          | 11,934 |   |   |          | 10,391 |   |      |          | 10,394 |   |   |          | 9,355  |  
|                                                                  |                                                                         |                          |          |        |      |   |          |        |   |   |          |        |   |      |         
|                                                                  | Total Operating Expenses                                                |                          |          | 41,069 |      |   |          | 58,411 |   |   |          | 60,027 |   |      |          | 65,074 |   |   |          | 68,191 |  
|                                                                  |                                                                         |                          |          |        |      |   |          |        |   |   |          |        |   |      |         
|Loss from operations                                              |                                                                         |                          | (30,562  | )      |      |   | (30,366  | )      |   |   | (26,170  | )      |   |      | (36,107  | )      |   |   | (39,275  | )     
|Interest income                                                   |                                                                         |                          | 1,317    |        |      |   | 194      |        |   |   | 338      |        |   |      | 818      |        |   |   | 1,324    |       
|Other income(2)                                                   |                                                                         |                          |         |        |      |   |         |        |   |   |         |        |   |      |         |        |   |   | 6,675    |       
|Other income (expenses)                                           |                                                                         |                          | 30       |        |      |   | (17      | )      |   |   | (138     | )      |   |      | (642     | )      |   |   | (1,081   | )     
|                                                                  |                                                                         |                          |          |        |      |   |          |        |   |   |          |        |   |      |         
|Net loss                                                          |                                                                         |                          | (29,215  | )      |      |   | (30,189  | )      |   |   | (25,970  | )      |   |      | (35,931  | )      |   |   | (32,357  | )     
|Deemed dividend(3)                                                |                                                                         |                          |         |        |      |   |         |        |   |   |         |        |   |      |         |        |   |   | (10,722  | )     
|                                                                  |                                                                         |                          |          |        |      |   |          |        |   |   |          |        |   |      |         
|Net loss applicable to common shareholders                        |                                                                         | $                        | (29,215  | )      |      | $ | (30,189  | )      |   | $ | (25,970  | )      |   | $    | (35,931  | )      |   | $ | (43,079  | )     
|                                                                  |                                                                         |                          |          |        |      |   |          |        |   |   |          |        |   |      |         
|                                                                  | Basic and diluted loss per share applicable to common
    shareholders: |                          | $        | (2.01  | )    |   | $        | (2.37  | ) |   | $        | (2.59  | ) |      | $        | (5.94  | ) |   | $        | (9.89  | )
|                                                                  |                                                                         |                          |          |        |      |   |          |        |   |   |          |        |   |      |         
|                                                                  | Shares used in computing basic and diluted net loss per share           |                          |          | 14,513 |      |   |          | 12,741 |   |   |          | 10,039 |   |      |          | 6,052  |   |   |          | 4,358  |  
|                                                                  |                                                                         |                          |          |        |      |   |          |        |   |   |          |        |   |      |         
|Balance Sheet Data:                                               |                                                                         |                          |          |        |      |   |          |        |   |   |          |        |   |      |          |        |   |   |          |       
|Cash, cash equivalents and short term investments                 |                                                                         | $                        | 27,694   |        |      | $ | 16,763   |        |   | $ | 29,770   |        |   | $    | 31,443   |        |   | $ | 71,164   |       
|Working capital                                                   |                                                                         | $                        | 21,087   |        |      | $ | 4,122    |        |   | $ | 19,708   |        |   | $    | 16,039   |        |   | $ | 48,308   |       
|Total assets                                                      |                                                                         | $                        | 39,497   |        |      | $ | 79,741   |        |   | $ | 95,218   |        |   | $    | 97,129   |        |   | $ | 132,100  |       
|Noncurrent portion of notes payable and capital lease obligations |                                                                         | $                        |         |        |      | $ |         |        |   | $ |         |        |   | $    | 497      |        |   | $ | 2,427    |       
|Redeemable convertible preferred stock                            |                                                                         | $                        | 23,669   |        |      | $ | 23,669   |        |   | $ | 23,669   |        |   | $    | 30,665   |        |   | $ | 30,735   |       
|Accumulated deficit                                               |                                                                         | $                        | (274,838 | )      |      | $ | (245,623 | )      |   | $ | (215,436 | )      |   | $    | (189,443 | )      |   | $ | (153,535 | )     
|Total shareholders equity                                        |                                                                         | $                        | 7,171    |        |      | $ | 35,753   |        |   | $ | 52,970   |        |   | $    | 41,410   |        |   | $ | 71,149   |       






|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|--- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(1) | On January 26, 2005, we completed the restructuring of our
    AERx iDMS program, pursuant to the Restructuring Agreement
    entered into with Novo Nordisk and NNDT. In accordance with the
    restructuring transaction, the Company received
    $51.1 million in cash and applied $4.0 million of
    deposits from Novo Nordisk in consideration for
    $54.3 million of property and equipment at net book value,
    $515,000 of inventory and $317,000 for prepaid and other assets.
    As a result of the restructuring transaction, our contract
    revenue from our development agreement with Novo Nordisk ceased
    in 2005. Of the amount recorded in deferred revenue at
    December 31, 2004, we recorded $11.3 million in the
    first quarter of 2005, consisting of: project development
    revenue of $2.1 million, deferred milestone revenue of
    $5.2 million, and $4.0 million as partial payment for
    the sale of the insulin development program assets in

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|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|--- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|    | accordance with the restructuring agreement. We recorded no
    material gain or loss was recorded as a result of sales of
    assets.                                                                                                                                                                                                                                                                                                                                                        
|   
|(2) | Other income consists of the gain related to forgiveness of
    outstanding notes and interest 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.
|   
|(3) | This represents the beneficial conversion feature, measured as
    the difference between the fair market value of Aradigms
    common stock and the discounted conversion price. We reported
    the value of the beneficial conversion feature on the Statements
    of Operations for the year ended December 31, 2001 as a
    deemed dividend and included the value in the calculation of net
    loss applicable to the common shareholders.                                          






|        |                                                                                          
|------- | -----------------------------------------------------------------------------------------
|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


scale-up








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| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | 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 in lieu of a
    percentage interest in the gross profits from the
    commercialization of AERx iDMS;                                                                                                            
|
| |  | a three-year agreement under which NNDT agreed to perform
    contract manufacturing for us of AERx iDMS-identical devices and
    dosage forms filled with compounds we provide in support of our
    preclinical and initial clinical development of other AERx
    products; and                                                                                                                                                                                                                                      
|
| |  | an amendment of the stock purchase agreement in place with Novo
    Nordisk, Inc. prior to the closing of the restructuring
    transaction, deleting the provisions whereby we can require Novo
    Nordisk to purchase certain amounts of common stock, imposing
    certain restrictions on the ability of Novo Nordisk to sell
    shares of our 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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| |                    
| | -------------------
| | Reverse Stock Split

1-for-5


Critical Accounting Policies and Estimates






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



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| |                                
| | -------------------------------
| | Impairment of Long-Lived Assets



Results of Operations




| |                                             
| | --------------------------------------------
| | Years Ended December 31, 2005, 2004 and 2003

Contract Revenues.




Research and Development Expenses.




|                                   |                                        |                          |   |      |      |  |   |      |  |  |   |      | 
|---------------------------------- | -------------------------------------- | ------------------------ | - | ---- | ---- |  | - | ---- |  |  | - | ---- | 
|                                   |                                        | Years Ended December 31, |  
|                                   |                                        |                          |  
|                                   |                                        | 2005                     |   |      | 2004 |  |   | 2003 | 
|                                   |                                        |                          |   |      |      |  |   |      | 
|Research and Development Expenses: |                                        |                          |   |      |      |  |   |      |  |  |   |     
|                                   | Collaborative                          |                          | $ | 6.0  |      |  | $ | 28.2 |  |  | $ | 33.5 | 
|                                   | Self-Initiated                         |                          |   | 24.2 |      |  |   | 18.3 |  |  |   | 16.1 | 
|                                   |                                        |                          |   |      |      |  |   |      | 
|                                   | Total research and development expense |                          | $ | 30.2 |      |  | $ | 46.5 |  |  | $ | 49.6 | 
|                                   |                                        |                          |   |      |      |  |   |      | 

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General and Administrative Expenses.


Interest Income.


Other Income (Expense):


Liquidity and Capital Resources






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scale-up


scale-up




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         |  | $                     | 2,113  |           |        | $ | 2,113 |           |       | $ |          |  |  | $       |      |  |  | $ |       | 
|Unconditional capital purchase obligations |  |                       | 1,015  |           |        |   | 1,015 |           |       |   |          |  |  |         |      |  |  |   |       | 
|Operating lease obligations(a)             |  |                       | 22,811 |           |        |   | 1,660 |           |       |   | 4,677     |  |  |         | 4,541 |  |  |   | 11,933 | 
|                                           |  |                       |        |           |        |   |       |           |       |   |           |  |  |         |      
|Total contractual commitments              |  | $                     | 25,939 |           |        | $ | 4,788 |           |       | $ | 4,677     |  |  | $       | 4,541 |  |  | $ | 11,933 | 
|                                           |  |                       |        |           |        |   |       |           |       |   |           |  |  |         |      






|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|--- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(a) | We have future commitments under one building lease. The lease
    is for a building containing office, laboratory and
    manufacturing facilities, and expires in 2016. A portion of
    operating lease obligation is offset by a sublease to NNDT of
    $10,000 per month for 24 months that commenced in
    January 2005 and expires in December 2006. We were committed to
    a second lease for a warehouse that expired December 31,
    2005 and is not included above. Additionally, we entered into a
    new copier lease agreement in July 2005 for $5,030 per
    month for 60 months.

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Recent Accounting Pronouncements


Accounting for Stock Issued to
Employees,










Practical Accommodation to the Application of Grant Date.


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Transition Election and Accounting for Tax Effects. Share-Based Payment,







|         |                                                              
|-------- | -------------------------------------------------------------
|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,                                                                          |       
|                                                                                                                                                                                                             |                                                                                                                                          |                                                                                       |       
|                                                                                                                                                                                                             |                                                                                                                                          | 2005                                                                                  |        |          | 2004   | 
|                                                                                                                                                                                                             |                                                                                                                                          |                                                                                       |        |          |        | 
|                                                                                                                                                                                                             |                                                                                                                                          | (In thousands,                                                                        |       
|                                                                                                                                                                                                             |                                                                                                                                          | except share data)                                                                    |       
|ASSETS                                                                                                                                                                                                      
|Current assets:                                                                                                                                                                                              |                                                                                                                                          |                                                                                       |        |          |        |  |        |         
|                                                                                                                                                                                                             | Cash and cash equivalents                                                                                                                |                                                                                       | $      | 27,694   |        |  | $      | 14,308   |       
|                                                                                                                                                                                                             | Short-term investments                                                                                                                   |                                                                                       |        |         |        |  |        | 2,455    |       
|                                                                                                                                                                                                             | Receivables                                                                                                                              |                                                                                       |        | 400      |        |  |        | 99       |       
|                                                                                                                                                                                                             | Current portion of notes receivable from officers and employees                                                                          |                                                                                       |        | 62       |        |  |        | 67       |       
|                                                                                                                                                                                                             | Prepaid and other current assets                                                                                                         |                                                                                       |        | 874      |        |  |        | 1,602    |       
|                                                                                                                                                                                                             |                                                                                                                                          |                                                                                       |        |          |        | 
|                                                                                                                                                                                                             |                                                                                                                                          | Total current assets                                                                  |        |          | 29,030 |  |        |          | 18,531 | 
|Property and equipment, net                                                                                                                                                                                  |                                                                                                                                          |                                                                                       | 9,875  |          |        |  | 60,555 |         
|Noncurrent portion of notes receivable from officers and
    employees                                                                                                                                       |                                                                                                                                          |                                                                                       | 129    |          |        |  | 216    |         
|Other assets                                                                                                                                                                                                 |                                                                                                                                          |                                                                                       | 463    |          |        |  | 439    |         
|                                                                                                                                                                                                             |                                                                                                                                          |                                                                                       |        |          |        | 
|                                                                                                                                                                                                             |                                                                                                                                          | Total assets                                                                          |        | $        | 39,497 |  |        | $        | 79,741 | 
|                                                                                                                                                                                                             |                                                                                                                                          |                                                                                       |        |          |        | 
|                                                                                                                                                                                                            
|LIABILITIES, REDEEMABLE CONVERTIBLE PREFERRED
    STOCK AND SHAREHOLDERS EQUITY                                                                                                                            
|Current liabilities:                                                                                                                                                                                         |                                                                                                                                          |                                                                                       |        |          |        |  |        |         
|                                                                                                                                                                                                             | Accounts payable                                                                                                                         |                                                                                       | $      | 3,034    |        |  | $      | 2,469    |       
|                                                                                                                                                                                                             | Accrued clinical and cost of other studies                                                                                               |                                                                                       |        | 398      |        |  |        | 293      |       
|                                                                                                                                                                                                             | Accrued compensation                                                                                                                     |                                                                                       |        | 3,814    |        |  |        | 2,984    |       
|                                                                                                                                                                                                             | Deferred revenue                                                                                                                         |                                                                                       |        | 222      |        |  |        | 7,525    |       
|                                                                                                                                                                                                             | Other accrued liabilities                                                                                                                |                                                                                       |        | 475      |        |  |        | 1,138    |       
|                                                                                                                                                                                                             |                                                                                                                                          |                                                                                       |        |          |        | 
|                                                                                                                                                                                                             |                                                                                                                                          | Total current liabilities                                                             |        |          | 7,943  |  |        |          | 14,409 | 
|Noncurrent portion of deferred revenue                                                                                                                                                                       |                                                                                                                                          |                                                                                       |       |          |        |  | 3,966  |         
|Noncurrent portion of deferred rent                                                                                                                                                                          |                                                                                                                                          |                                                                                       | 714    |          |        |  | 1,943  |         
|Commitments and contingencies                                                                                                                                                                                |                                                                                                                                          |                                                                                       |        |          |        |  |        |         
|Redeemable convertible preferred stock, no par value;
    5,000,000 shares authorized; issued and outstanding shares:
    1,544,626 in 2005 and 2004; liquidation preference of $41,866 in
    2005 and 2004 |                                                                                                                                          |                                                                                       | 23,669 |          |        |  | 23,669 |         
|Shareholders equity:                                                                                                                                                                                        |                                                                                                                                          |                                                                                       |        |          |        |  |        |         
|                                                                                                                                                                                                             | Common stock, no par value, 100,000,000 shares authorized;
    issued and outstanding shares: 14,562,809 in 2005; 14,459,145 in
    2004 |                                                                                       |        | 282,004  |        |  |        | 281,387  |       
|                                                                                                                                                                                                             | Accumulated other comprehensive income (loss)                                                                                            |                                                                                       |        | 5        |        |  |        | (10      | )     
|                                                                                                                                                                                                             | Accumulated deficit                                                                                                                      |                                                                                       |        | (274,838 | )      |  |        | (245,623 | )     
|                                                                                                                                                                                                             |                                                                                                                                          |                                                                                       |        |          |        | 
|                                                                                                                                                                                                             |                                                                                                                                          | Total shareholders equity                                                            |        |          | 7,171  |  |        |          | 35,754 | 
|                                                                                                                                                                                                             |                                                                                                                                          |                                                                                       |        |          |        | 
|                                                                                                                                                                                                             |                                                                                                                                          | Total liabilities,redeemable convertible preferred stock and
    shareholders equity |        | $        | 39,497 |  |        | $        | 79,741 | 
|                                                                                                                                                                                                             |                                                                                                                                          |                                                                                       |        |          |        | 



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ARADIGM CORPORATION





STATEMENTS OF OPERATIONS


|                                                                         |                            |                                       |         |        |        |   |         |        |        |   |         |        |        | 
|------------------------------------------------------------------------ | -------------------------- | ------------------------------------- | ------- | ------ | ------ | - | ------- | ------ | ------ | - | ------- | ------ | ------ | 
|                                                                         |                            | Years Ended December 31,              |        
|                                                                         |                            |                                       |        
|                                                                         |                            | 2005                                  |         |        | 2004   |   |         | 2003   |       
|                                                                         |                            |                                       |         |        |        |   |         |        |       
|                                                                         |                            | (In thousands, except per share data) |        
|Contract and license revenues:                                           |                            |                                       |         |        |        |   |         |        |        |   |         |       
|                                                                         | Related parties            |                                       | $       | 8,013  |        |   | $       | 26,999 |        |   | $       | 33,546 |       
|                                                                         | Unrelated parties          |                                       |         | 2,494  |        |   |         | 1,046  |        |   |         | 311    |       
|                                                                         |                            |                                       |         |        |        |   |         |        |       
|                                                                         |                            | Total revenues                        |         |        | 10,507 |   |         |        | 28,045 |   |         |        | 33,857 | 
|                                                                         |                            |                                       |         |        |        |   |         |        |       
|                                                                         | Research and development   |                                       |         | 30,174 |        |   |         | 46,477 |        |   |         | 49,636 |       
|                                                                         | General and administrative |                                       |         | 10,895 |        |   |         | 11,934 |        |   |         | 10,391 |       
|                                                                         |                            |                                       |         |        |        |   |         |        |       
|                                                                         |                            | Total expenses                        |         |        | 41,069 |   |         |        | 58,411 |   |         |        | 60,027 | 
|                                                                         |                            |                                       |         |        |        |   |         |        |       
|Loss from operations                                                     |                            |                                       | (30,562 | )      |        |   | (30,366 | )      |        |   | (26,170 | )     
|Interest income                                                          |                            |                                       | 1,317   |        |        |   | 194     |        |        |   | 338     |       
|Other income (expense)                                                   |                            |                                       | 30      |        |        |   | (17     | )      |        |   | (138    | )     
|                                                                         |                            |                                       |         |        |        |   |         |        |       
|Net loss                                                                 |                            | $                                     | (29,215 | )      |        | $ | (30,189 | )      |        | $ | (25,970 | )     
|                                                                         |                            |                                       |         |        |        |   |         |        |       
|Basic and diluted net loss per common share                              |                            | $                                     | (2.01   | )      |        | $ | (2.37   | )      |        | $ | (2.59   | )     
|                                                                         |                            |                                       |         |        |        |   |         |        |       
|Shares used in computing basic and diluted net loss per common
    share |                            |                                       | 14,513  |        |        |   | 12,741  |        |        |   | 10,039  |       
|                                                                         |                            |                                       |         |        |        |   |         |        |       



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ARADIGM CORPORATION





STATEMENTS OF REDEEMABLE CONVERTIBLE PREFERRED STOCK


AND SHAREHOLDERS EQUITY


|                                                                                                           |  |                                   |           |   |              |   |        |          |  |                   |            |  |             |              |         |                |  |   |         |  |  |        |     |   |  |   |          |   |  |   |         |  
|---------------------------------------------------------------------------------------------------------- |  | --------------------------------- | --------- | - | ------------ | - | ------ | -------- |  | ----------------- | ---------- |  | ----------- | ------------ | ------- | -------------- |  | - | ------- |  |  | ------ | --- | - |  | - | -------- | - |  | - | ------- | -
|                                                                                                           |  | Redeemable Convertible            |           |   |              |   |        |          |  |                   |            |  |            
|                                                                                                           |  | Preferred Stock                   |           |   | Common Stock |   |        |          |  | Accumulated Other |            |  |             |              | Total   |               
|                                                                                                           |  |                                   |           |   |              |   |        | Deferred |  | Comprehensive     |            |  | Accumulated |              |         | Shareholders  | 
|                                                                                                           |  | Shares                            |           |   | Amount       |   |        | Shares   |  |                   | Amount     |  |             | Compensation |         | Income/ (Loss) |  |   | Deficit |  |  | Equity |    
|                                                                                                           |  |                                   |           |   |              |   |        |          |  |                   |            |  |             |              |         |                |  |   |         |  |  |        |    
|                                                                                                           |  | (In thousands, except share data) |          
|Balances at December 31, 2002                                                                              |  |                                   | 2,001,236 |   |              | $ | 30,665 |          |  |                   | 6,231,522  |  |             | $            | 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 |  |                                   |          |   |              |   |       |          |  |                   | 5,354,588  |  |             |              | 27,312  |                |  |   |        |  |  |        |    |   |  |   |         |   |  |   | 27,312  |  
|Issuance of common stock through conversion of Series A
    preferred stock                                |  |                                   | (456,610  | ) |              |   | (6,996 | )        |  |                   | 365,288    |  |             |              | 6,996   |                |  |   |        |  |  |        |    |   |  |   |         |   |  |   | 6,996   |  
|Issuance of common stock under the employee stock purchase plan                                            |  |                                   |          |   |              |   |       |          |  |                   | 110,606    |  |             |              | 596     |                |  |   |        |  |  |        |    |   |  |   |         |   |  |   | 596     |  
|Issuance of common stock upon exercise of stock options                                                    |  |                                   |          |   |              |   |       |          |  |                   | 5,425      |  |             |              | 11      |                |  |   |        |  |  |        |    |   |  |   |         |   |  |   | 11      |  
|Issuance of common stock upon exercise of warrants                                                         |  |                                   |          |   |              |   |       |          |  |                   | 482,810    |  |             |              | 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 | )
|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 |          |  |                   | 12,550,239 |  |             |              | 268,406 |                |  |   |        |  |  |        | (2  | ) |  |   | (215,434 | ) |  |   | 52,970  |  
|Issuance of common stock for cash, net of issuance costs of $817
    including warrants valued at $2,278   |  |                                   |          |   |              |   |       |          |  |                   | 1,666,679  |  |             |              | 11,683  |                |  |   |        |  |  |        |    |   |  |   |         |   |  |   | 11,683  |  
|Issuance of common stock under the employee stock purchase plan                                            |  |                                   |          |   |              |   |       |          |  |                   | 167,946    |  |             |              | 911     |                |  |   |        |  |  |        |    |   |  |   |         |   |  |   | 911     |  
|Issuance of common stock upon exercise of stock options                                                    |  |                                   |          |   |              |   |       |          |  |                   | 81         |  |             |              | 1       |                |  |   |        |  |  |        |    |   |  |   |         |   |  |   | 1       |  
|Issuance of common stock upon exercise of warrants                                                         |  |                                   |          |   |              |   |       |          |  |                   | 74,200     |  |             |              | 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 |          |  |                   | 14,459,145 |  |             |              | 281,387 |                |  |   |        |  |  |        | (10 | ) |  |   | (245,623 | ) |  |   | 35,754  |  

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|                                                                                            |  |                                   |           |  |              |   |        |          |  |                   |               |   |  |              |         |  |                |   |     |         |  |   |        |  |  |   |          |   |  |   |         |  
|------------------------------------------------------------------------------------------- |  | --------------------------------- | --------- |  | ------------ | - | ------ | -------- |  | ----------------- | ------------- | - |  | ------------ | ------- |  | -------------- | - | --- | ------- |  | - | ------ |  |  | - | -------- | - |  | - | ------- | -
|                                                                                            |  | Redeemable Convertible            |           |  |              |   |        |          |  |                   |               |   | 
|                                                                                            |  | Preferred Stock                   |           |  | Common Stock |   |        |          |  | Accumulated Other |               |   |  |              | Total   | 
|                                                                                            |  |                                   |           |  |              |   |        | Deferred |  |                   | Comprehensive |   |  | Accumulated  |         |  | Shareholders  |  
|                                                                                            |  | Shares                            |           |  | Amount       |   |        | Shares   |  |                   | Amount        |   |  | Compensation |         |  | Income/ (Loss) |   |     | Deficit |  |   | Equity | 
|                                                                                            |  |                                   |           |  |              |   |        |          |  |                   |               |   |  |              |         |  |                |   |     |         |  |   |        | 
|                                                                                            |  | (In thousands, except share data) |          
|Issuance of common stock under the employee stock purchase plan                             |  |                                   |          |  |              |   |       |          |  |                   | 93,662        |   |  |              | 458     |  |                |   |    |         |  |   |       |  |  |   |         |   |  |   | 458     |  
|Issuance of common stock upon exercise of stock options                                     |  |                                   |          |  |              |   |       |          |  |                   | 10,077        |   |  |              | 42      |  |                |   |    |         |  |   |        |  |  |   |         |   |  |   | 42      |  
|Adjustment to common stock shares for rounding of partial shares
    from the reverse split |  |                                   |          |  |              |   |       |          |  |                   | (75           | ) |  |              |        |  |                |   |    |         |  |   |       |  |  |   |         |   |  |   |        |  
|Warrant revaluation                                                                         |  |                                   |           |  |              |   |        |          |  |                   |               |   |  |              | 90      |  |                |   |     |         |  |   |       |  |  |   |         |   |  |   | 90      |  
|Issuance of options for services                                                            |  |                                   |          |  |              |   |       |          |  |                   |              |   |  |              | 27      |  |                |   | (21 | )       |  |   |       |  |  |   |         |   |  |   | 6       |  
|Amortization of deferred compensation                                                       |  |                                   |          |  |              |   |       |          |  |                   |              |   |  |              |        |  |                |   | 21  |         |  |   |       |  |  |   |         |   |  |   | 21      |  
|Comprehensive loss:                                                                         |  |                                   |          |  |              |   |       |          |  |                   |              |   |  |              |        |  |                |   |    |         |  |   |       |  |  |   |         |   |  |   |        |  
|Net loss                                                                                    |  |                                   |           |  |              |   |        |          |  |                   |               |   |  |              |         |  |                |   |     |         |  |   |        |  |  |   | (29,215  | ) |  |   | (29,215 | )
|Net change in unrealized loss on available-for-sale investments                             |  |                                   |          |  |              |   |       |          |  |                   |              |   |  |              |        |  |                |   |    |         |  |   | 15     |  |  |   |         |   |  |   | 15      |  
|                                                                                            |  |                                   |           |  |              |   |        |          |  |                   |               |   |  |              |         |  |                |   |     |         |  |   |        | 
|Total comprehensive loss                                                                    |  |                                   |          |  |              |   |       |          |  |                   |              |   |  |              |        |  |                |   |    |         |  |   |       |  |  |   |         |   |  |   | (29,200 | )
|                                                                                            |  |                                   |           |  |              |   |        |          |  |                   |               |   |  |              |         |  |                |   |     |         |  |   |        | 
|Balances at December 31, 2005                                                               |  |                                   | 1,544,626 |  |              | $ | 23,669 |          |  |                   | 14,562,809    |   |  | $            | 282,004 |  |                | $ |    |         |  | $ | 5      |  |  | $ | (274,838 | ) |  | $ | 7,171   |  
|                                                                                            |  |                                   |           |  |              |   |        |          |  |                   |               |   |  |              |         |  |                |   |     |         |  |   |        | 



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ARADIGM CORPORATION





STATEMENTS OF CASH FLOWS


|                                                                                                              |                                                        |                                                                            |         |       |        |   |         |       |        |   |         |       |        |  
|------------------------------------------------------------------------------------------------------------- | ------------------------------------------------------ | -------------------------------------------------------------------------- | ------- | ----- | ------ | - | ------- | ----- | ------ | - | ------- | ----- | ------ | -
|                                                                                                              |                                                        | Years Ended December 31,                                                   |        
|                                                                                                              |                                                        |                                                                            |        
|                                                                                                              |                                                        | 2005                                                                       |         |       | 2004   |   |         | 2003  |       
|                                                                                                              |                                                        |                                                                            |         |       |        |   |         |       |       
|                                                                                                              |                                                        | (In thousands)                                                             |        
|Cash flows from operating activities:                                                                         |                                                        |                                                                            |         |       |        |   |         |       |        |   |         |      
|Net loss                                                                                                      |                                                        | $                                                                          | (29,215 | )     |        | $ | (30,189 | )     |        | $ | (25,970 | )    
|Adjustments to reconcile net loss to net cash used in operating
    activities:                               |                                                        |                                                                            |         |       |        |   |         |       |        |   |         |      
|                                                                                                              | Amortization and accretion of investments              |                                                                            |         | 50    |        |   |         | 166   |        |   |         | 83    |       
|                                                                                                              | Depreciation and amortization                          |                                                                            |         | 1,412 |        |   |         | 3,813 |        |   |         | 5,983 |       
|                                                                                                              | Loss on impairment and sale of property and equipment  |                                                                            |         | 268   |        |   |         | 544   |        |   |         |      |       
|                                                                                                              | Cost of warrants and common stock options for services |                                                                            |         | 117   |        |   |         | 82    |        |   |         | 116   |       
|                                                                                                              | Changes in operating assets and liabilities:           |                                                                            |         |       |        |   |         |       |        |   |         |       |       
|                                                                                                              |                                                        | Receivables                                                                |         |       | (301   | ) |         |       | 41     |   |         |       | 142    |  
|                                                                                                              |                                                        | Prepaid and other current assets                                           |         |       | 728    |   |         |       | 308    |   |         |       | (454   | )
|                                                                                                              |                                                        | Other assets                                                               |         |       | (24    | ) |         |       | (51    | ) |         |       | 21     |  
|                                                                                                              |                                                        | Accounts payable                                                           |         |       | 565    |   |         |       | 1,584  |   |         |       | (1,066 | )
|                                                                                                              |                                                        | Accrued compensation                                                       |         |       | 830    |   |         |       | 963    |   |         |       | (174   | )
|                                                                                                              |                                                        | Accrued liabilities                                                        |         |       | (558   | ) |         |       | 439    |   |         |       | 294    |  
|                                                                                                              |                                                        | Deferred rent                                                              |         |       | (1,229 | ) |         |       | 620    |   |         |       | 215    |  
|                                                                                                              |                                                        | Deferred revenue                                                           |         |       | (7,250 | ) |         |       | (1,440 | ) |         |       | (3,921 | )
|                                                                                                              |                                                        |                                                                            |         |       |        |   |         |       |       
|Net cash used in operating activities                                                                         |                                                        |                                                                            | (34,607 | )     |        |   | (23,120 | )     |        |   | (24,731 | )    
|                                                                                                              |                                                        |                                                                            |         |       |        |   |         |       |       
|Cash flows from investing activities:                                                                         |                                                        |                                                                            |         |       |        |   |         |       |        |   |         |      
|Capital expenditures                                                                                          |                                                        |                                                                            | (5,311  | )     |        |   | (2,300  | )     |        |   | (5,362  | )    
|Proceeds from sale of property and equipment to Novo Nordisk
    Delivery Technologies, Inc., a related party |                                                        |                                                                            | 50,292  |       |        |   |        |       |        |   |        |      
|Purchases of available-for-sale investments                                                                   |                                                        |                                                                            | (5,330  | )     |        |   | (6,376  | )     |        |   | (9,962  | )    
|Proceeds from sales and maturities of available-for-sale
    investments                                      |                                                        |                                                                            | 7,750   |       |        |   | 15,190  |       |        |   | 7,056   |      
|                                                                                                              |                                                        |                                                                            |         |       |        |   |         |       |       
|Net cash provided by (used) in investing activities                                                           |                                                        |                                                                            | 47,401  |       |        |   | 6,514   |       |        |   | (8,268  | )    
|                                                                                                              |                                                        |                                                                            |         |       |        |   |         |       |       
|Cash flows from financing activities:                                                                         |                                                        |                                                                            |         |       |        |   |         |       |        |   |         |      
|Proceeds from issuance of common stock, net                                                                   |                                                        |                                                                            | 500     |       |        |   | 12,899  |       |        |   | 30,441  |      
|Forgiveness of (cash used in issuance of) notes receivable with
    officers and employees                    |                                                        |                                                                            | 92      |       |        |   | 115     |       |        |   | (93     | )    
|Payments on capital lease obligations and equipment loans                                                     |                                                        |                                                                            |        |       |        |   | (427    | )     |        |   | (1,822  | )    
|                                                                                                              |                                                        |                                                                            |         |       |        |   |         |       |       
|Net cash provided by financing activities                                                                     |                                                        |                                                                            | 592     |       |        |   | 12,587  |       |        |   | 28,526  |      
|                                                                                                              |                                                        |                                                                            |         |       |        |   |         |       |       
|Net increase (decrease) in cash and cash equivalents                                                          |                                                        |                                                                            | 13,386  |       |        |   | (4,019  | )     |        |   | (4,473  | )    
|Cash and cash equivalents at beginning of year                                                                |                                                        |                                                                            | 14,308  |       |        |   | 18,327  |       |        |   | 22,800  |      
|                                                                                                              |                                                        |                                                                            |         |       |        |   |         |       |       
|Cash and cash equivalents at end of year                                                                      |                                                        | $                                                                          | 27,694  |       |        | $ | 14,308  |       |        | $ | 18,327  |      
|                                                                                                              |                                                        |                                                                            |         |       |        |   |         |       |       
|Supplemental disclosure of cash flow information:                                                             |                                                        |                                                                            |         |       |        |   |         |       |        |   |         |      
|                                                                                                              |                                                        | Cash paid for interest                                                     |         | $     | 6      |   |         | $     | 16     |   |         | $     | 126    |  
|Non-cash investing and financing activities:                                                                  |                                                        |                                                                            |         |       |        |   |         |       |        |   |         |      
|                                                                                                              |                                                        | Issuance of options and warrants to purchase common stock for
    services |         | $     | 117    |   |         | $     | 82     |   |         | $     | 116    |  
|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



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ARADIGM CORPORATION


NOTES TO FINANCIAL STATEMENTS  (Continued)






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





| |                       
| | ----------------------
| | Property and Equipment





|                                |  |  |               | 
|------------------------------- |  |  | ------------- | 
|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 | 



| |                                
| | -------------------------------
| | Impairment of Long-Lived Assets





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



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ARADIGM CORPORATION


NOTES TO FINANCIAL STATEMENTS  (Continued)






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





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





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



|                                             |                                                                                                             |                          |         |        |      |   |         |        |   |   |         |        |  
|-------------------------------------------- | ----------------------------------------------------------------------------------------------------------- | ------------------------ | ------- | ------ | ---- | - | ------- | ------ | - | - | ------- | ------ | -
|                                             |                                                                                                             | Years Ended December 31, |        
|                                             |                                                                                                             |                          |        
|                                             |                                                                                                             | 2005                     |         |        | 2004 |   |         | 2003   |  
|                                             |                                                                                                             |                          |         |        |      |   |         |        |  
|Net loss  as reported                       |                                                                                                             | $                        | (29,215 | )      |      | $ | (30,189 | )      |   | $ | (25,970 | )     
|Add:                                         |                                                                                                             |                          |         |        |      |   |         |        |   |   |         |       
|                                             | Stock-based employee compensation expense included in reported
    net loss                                 |                          |         | 21     |      |   |         |       |   |   |         |       |  
|Less:                                        |                                                                                                             |                          |         |        |      |   |         |        |   |   |         |       
|                                             | Total stock-based employee compensation expense determined under
    fair value based method for all awards |                          |         | (3,066 | )    |   |         | (4,585 | ) |   |         | (5,400 | )
|                                             |                                                                                                             |                          |         |        |      |   |         |        |  
|Pro forma net loss                           |                                                                                                             | $                        | (32,260 | )      |      | $ | (34,774 | )      |   | $ | (31,370 | )     
|                                             |                                                                                                             |                          |         |        |      |   |         |        |  
|Basic and diluted net loss per common share: |                                                                                                             |                          |         |        |      |   |         |        |   |   |         |       
|                                             | As reported                                                                                                 |                          | $       | (2.01  | )    |   | $       | (2.37  | ) |   | $       | (2.59  | )
|                                             | Pro forma                                                                                                   |                          | $       | (2.22  | )    |   | $       | (2.73  | ) |   | $       | (3.12  | )



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ARADIGM CORPORATION


NOTES TO FINANCIAL STATEMENTS  (Continued)








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





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





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





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ARADIGM CORPORATION


NOTES TO FINANCIAL STATEMENTS  (Continued)






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





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

Accounting for Stock Issued to
Employees,








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ARADIGM CORPORATION


NOTES TO FINANCIAL STATEMENTS  (Continued)






Practical Accommodation to the Application of Grant Date.


Transition Election and Accounting for Tax Effects. Share-Based Payment,




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



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ARADIGM CORPORATION


NOTES TO FINANCIAL STATEMENTS  (Continued)




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



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



|                        |                                |              |        |        |      |   |        |        | 
|----------------------- | ------------------------------ | ------------ | ------ | ------ | ---- | - | ------ | ------ | 
|                        |                                | December 31, |       
|                        |                                |              |       
|                        |                                | 2005         |        |        | 2004 |  
|                        |                                |              |        |        |      |  
|Cash equivalents:       |                                |              |        |        |      |   |        |       
|                        | Money market fund              |              | $      | 1,321  |      |   | $      | 800    | 
|                        | Commercial paper               |              |        | 26,373 |      |   |        | 13,508 | 
|                        |                                |              |        |        |      |  
|                        |                                | $            | 27,694 |        |      | $ | 14,308 |       
|                        |                                |              |        |        |      |  
|Short-term investments: |                                |              |        |        |      |   |        |       
|                        | Commercial paper               |              | $      |       |      |   |        |       | 
|                        | Corporate and Government notes |              |        |       |      |   | $      | 2,455  | 
|                        |                                |              |        |        |      |  
|                        |                                | $            |       |        |      | $ | 2,455  |       
|                        |                                |              |        |        |      |  







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



|                                               |                        |              |         |       |      |   |         |        | 
|---------------------------------------------- | ---------------------- | ------------ | ------- | ----- | ---- | - | ------- | ------ | 
|                                               |                        | December 31, |        
|                                               |                        |              |        
|                                               |                        | 2005         |         |       | 2004 |  
|                                               |                        |              |         |       |      |  
|Machinery and equipment                        |                        | $            | 4,505   |       |      | $ | 14,364  |       
|Furniture and fixtures                         |                        |              | 1,150   |       |      |   | 1,917   |       
|Lab equipment                                  |                        |              | 2,539   |       |      |   | 4,086   |       
|Computer equipment and software                |                        |              | 3,790   |       |      |   | 6,256   |       
|Leasehold improvements                         |                        |              | 1,564   |       |      |   | 12,225  |       
|                                               |                        |              |         |       |      |  
|Property and Equipment at cost                 |                        |              | 13,548  |       |      |   | 38,848  |       
|Less accumulated depreciation and amortization |                        |              | (10,201 | )     |      |   | (27,740 | )     
|                                               |                        |              |         |       |      |  
|                                               | Net depreciable assets |              |         | 3,347 |      |   |         | 11,108 | 
|Construction in progress                       |                        |              | 6,528   |       |      |   | 49,447  |       
|                                               |                        |              |         |       |      |  
|Property and equipment, net                    |                        | $            | 9,875   |       |      | $ | 60,555  |       
|                                               |                        |              |         |       |      |  





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ARADIGM CORPORATION


NOTES TO FINANCIAL STATEMENTS  (Continued)






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



|                             |  |           |        | 
|---------------------------- |  | --------- | ------ | 
|                             |  | Operating |       
|                             |  | Leases    |       
|                             |  |           |       
|Year ending December 31:     |  |           |        | 
|2006                         |  | $         | 1,660  | 
|2007                         |  |           | 2,306  | 
|2008                         |  |           | 2,371  | 
|2009                         |  |           | 2,318  | 
|2010                         |  |           | 2,223  | 
|2011 and thereafter          |  |           | 11,933 | 
|                             |  |           |       
|Total minimum lease payments |  | $         | 22,811 | 
|                             |  |           |       









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



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ARADIGM CORPORATION


NOTES TO FINANCIAL STATEMENTS  (Continued)




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





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















| |                                      
| | -------------------------------------
| | Summary of Preferred Stock Accounting

S-X


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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)




| |                    
| | -------------------
| | Reverse Stock Split

1-for-5




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





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











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ARADIGM CORPORATION


NOTES TO FINANCIAL STATEMENTS  (Continued)






| |                                                                                                 
| | ------------------------------------------------------------------------------------------------
| | 1996 Equity Incentive Plan, 2005 Equity Incentive Plan and
    1996 Non-Employee Directors Plan









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ARADIGM CORPORATION


NOTES TO FINANCIAL STATEMENTS  (Continued)








|                                         |                    |                     |          |          |           |  |           |           |   |  |                 |                 |  |   |       |       | 
|---------------------------------------- | ------------------ | ------------------- | -------- | -------- | --------- |  | --------- | --------- | - |  | --------------- | --------------- |  | - | ----- | ----- | 
|                                         |                    | Options Outstanding |         
|                                         |                    |                     |         
|                                         |                    | Shares              |          |          |           |  | Weighted  |          
|                                         |                    | Available           |          |          |           |  | Average   |          
|                                         |                    | for Grant           |          |          | Number of |  |           | Price     |   |  | Exercise        |                
|                                         |                    | of Options          |          |          | Shares    |  |           | Per Share |   |  | Price           |                
|                                         |                    |                     |          |          |           |  |           |           |   |  |                 |                
|Balance at December 31, 2002             |                    |                     | 117,619  |          |           |  | 1,175,752 |           |   |  | $1.65  $120.65 |                 |  | $ | 40.25 |      
|                                         | Options authorized |                     |          | 608,524  |           |  |           |          |   |  |                 |                |  |   |       |      | 
|                                         | Options granted    |                     |          | (362,550 | )         |  |           | 362,550   |   |  |                 | $4.55  $ 10.80 |  |   | $     | 6.45  | 
|                                         | Options exercised  |                     |          |          |           |  |           | (5,426    | ) |  |                 | $1.65  $  4.75 |  |   | $     | 2.10  | 
|                                         | Options cancelled  |                     |          | 236,111  |           |  |           | (236,111  | ) |  |                 | $4.75  $116.90 |  |   | $     | 39.15 | 
|                                         |                    |                     |          |          |           |  |           |           |   |  |                 |                
|Balance at December 31, 2003             |                    |                     | 599,704  |          |           |  | 1,296,765 |           |   |  | $1.85  $120.65 |                 |  | $ | 31.15 |      
|                                         | Options authorized |                     |          | 762,774  |           |  |           |          |   |  |                 |                |  |   |       |      | 
|                                         | Options granted    |                     |          | (697,760 | )         |  |           | 697,760   |   |  |                 | $3.80  $ 12.00 |  |   | $     | 7.75  | 
|                                         | Options exercised  |                     |          |          |           |  |           | (81       | ) |  |                 | $4.75  $  7.10 |  |   | $     | 6.20  | 
|                                         | Options cancelled  |                     |          | 111,274  |           |  |           | (111,274  | ) |  |                 | $1.85  $117.85 |  |   | $     | 31.60 | 
|                                         |                    |                     |          |          |           |  |           |           |   |  |                 |                
|Balance at December 31, 2004             |                    |                     | 775,992  |          |           |  | 1,883,170 |           |   |  | $2.15  $120.65 |                 |  | $ | 22.20 |      
|Options authorized                       |                    |                     |         |          |           |  |          |           |   |  |                |                 |  |   |      |      
|Options granted                          |                    |                     | (325,460 | )        |           |  | 325,460   |           |   |  | $4.30  $  7.95 |                 |  | $ | 5.97  |      
|Options exercised                        |                    |                     |          |          |           |  | (10,077   | )         |   |  | $2.17  $  4.75 |                 |  | $ | 4.39  |      
|Adjustment for rounding of reverse split |                    |                     |          |          |           |  | 10        |           |   |  |                 |                 |  |   |       |      
|Options cancelled                        |                    |                     | 468,854  |          |           |  | (468,854  | )         |   |  | $2.83  $120.63 |                 |  | $ | 21.84 |      
|                                         |                    |                     |          |          |           |  |           |           |   |  |                 |                
|Balance at December 31, 2005             |                    |                     | 919,386  |          |           |  | 1,729,709 |           |   |  | $2.83  $120.63 |                 |  | $ | 19.47 |      
|                                         |                    |                     |          |          |           |  |           |           |   |  |                 |                

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ARADIGM CORPORATION


NOTES TO FINANCIAL STATEMENTS  (Continued)


|                     |  |                     |           |          |                     |   |             |                 |          |  |        |          |  |       |             |  |                 |   |       |  |  |  |     | 
|-------------------- |  | ------------------- | --------- | -------- | ------------------- | - | ----------- | --------------- | -------- |  | ------ | -------- |  | ----- | ----------- |  | --------------- | - | ----- |  |  |  | --- | 
|                     |  | Options Outstanding |           |          | Options Exercisable |  
|                     |  |                     |           |          |                     |  
|                     |  |                     |           | Weighted |                     |   |             |                 | Weighted | 
|                     |  |                     |           | Weighted |                     |   | Average     |                 |          |  |        | Weighted |  |       | Average     | 
|                     |  |                     |           | Average  |                     |   | Remaining   |                 |          |  |        | Average  |  |       | Remaining   | 
|                     |  |                     |           | Exercise |                     |   | Contractual |                 |          |  |        | Exercise |  |       | Contractual | 
|Exercise Price Range |  | Number              |           |          | Price               |   |             | Life (in years) |          |  | Number |          |  | Price |             |  | Life (in years) |  
|                     |  |                     |           |          |                     |   |             |                 |          |  |        |          |  |       |             |  |                 |  
|$ 2.83  $  5.30     |  |                     | 349,385   |          |                     | $ | 5.02        |                 |          |  | 8.0    |          |  |       | 197,911     |  |                 | $ | 4.98  |  |  |  | 7.8 | 
|$ 5.35  $  6.25     |  |                     | 350,700   |          |                     | $ | 5.89        |                 |          |  | 8.9    |          |  |       | 55,727      |  |                 | $ | 5.90  |  |  |  | 8.5 | 
|$ 6.50  $ 12.00     |  |                     | 364,370   |          |                     | $ | 10.48       |                 |          |  | 8.1    |          |  |       | 194,103     |  |                 | $ | 9.97  |  |  |  | 8.0 | 
|$13.00  $ 24.10     |  |                     | 349,410   |          |                     | $ | 20.66       |                 |          |  | 6.1    |          |  |       | 329,255     |  |                 | $ | 20.76 |  |  |  | 6.1 | 
|$25.55  $120.63     |  |                     | 315,844   |          |                     | $ | 59.56       |                 |          |  | 3.7    |          |  |       | 315,844     |  |                 | $ | 59.56 |  |  |  | 3.7 | 
|                     |  |                     |           |          |                     |   |             |                 |          |  |        |          |  |       |             |  |                 |  
|                     |  |                     | 1,729,709 |          |                     | $ | 19.47       |                 |          |  | 7.1    |          |  |       | 1,092,840   |  |                 | $ | 26.44 |  |  |  | 6.2 | 
|                     |  |                     |           |          |                     |   |             |                 |          |  |        |          |  |       |             |  |                 |  





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



Stock Based Compensation




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

30-days




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



| |             
| | ------------
| | Novo Nordisk



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ARADIGM CORPORATION


NOTES TO FINANCIAL STATEMENTS  (Continued)












| |   |                                                                                                                                                                                                                                                                                                                    
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | 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 and
|
| |  | a three-year agreement under which NNDT 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.        









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ARADIGM CORPORATION


NOTES TO FINANCIAL STATEMENTS  (Continued)


|                                                                                                                                                              |  |              |        |  |      |   |        |      |  |   |        |  
|------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ------------ | ------ |  | ---- | - | ------ | ---- |  | - | ------ | -
|                                                                                                                                                              |  | December 31, |       
|                                                                                                                                                              |  |              |       
|                                                                                                                                                              |  | 2005         |        |  | 2004 |   |        | 2003 | 
|                                                                                                                                                              |  |              |        |  |      |   |        |      | 
|Deferred revenue  beginning balance                                                                                                                          |  | $            | 11,491 |  |      | $ | 12,931 |      |  | $ | 16,852 |  
|Partner payments:                                                                                                                                             |  |              |        |  |      |   |        |      |  |   |        |  
|Novo Nordisk                                                                                                                                                  |  |              | 727    |  |      |   | 25,373 |      |  |   | 29,625 |  
|Other partner-funded programs                                                                                                                                 |  |              | 2,530  |  |      |   | 1,232  |      |  |   | 311    |  
|                                                                                                                                                              |  |              |        |  |      |   |        |      | 
|Total partner payments                                                                                                                                        |  |              | 3,257  |  |      |   | 26,605 |      |  |   | 29,936 |  
|                                                                                                                                                              |  |              |        |  |      |   |        |      | 
|Contract revenue recognized:                                                                                                                                  |  |              |        |  |      |   |        |      |  |   |        |  
|Novo Nordisk                                                                                                                                                  |  |              | 8,013  |  |      |   | 26,999 |      |  |   | 33,546 |  
|Other partner-funded programs                                                                                                                                 |  |              | 2,494  |  |      |   | 1,046  |      |  |   | 311    |  
|                                                                                                                                                              |  |              |        |  |      |   |        |      | 
|Total contract revenue recognized                                                                                                                             |  |              | 10,507 |  |      |   | 28,045 |      |  |   | 33,857 |  
|                                                                                                                                                              |  |              |        |  |      |   |        |      | 
|Deferred revenue at December 31, 2004 recognized on
    January 26, 2005 as payment for assets pursuant to the
    restructuring agreement with Novo Nordisk, |  |              | 4,019  |  |      |   |       |      |  |   |       |  
|                                                                                                                                                              |  |              |        |  |      |   |        |      | 
|Deferred revenue  ending balance                                                                                                                             |  |              | 222    |  |      |   | 11,491 |      |  |   | 12,931 |  
|Less: Noncurrent portion of deferred revenue                                                                                                                  |  |              |       |  |      |   | (3,966 | )    |  |   | (5,040 | )
|                                                                                                                                                              |  |              |        |  |      |   |        |      | 
|Current portion of deferred revenue                                                                                                                           |  | $            | 222    |  |      | $ | 7,525  |      |  | $ | 7,891  |  
|                                                                                                                                                              |  |              |        |  |      |   |        |      | 





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





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





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ARADIGM CORPORATION


NOTES TO FINANCIAL STATEMENTS  (Continued)






| |   |                                                                                                                                                                                                                                                                                                           
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | 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 NNDT agreed to 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.                     





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







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



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ARADIGM CORPORATION


NOTES TO FINANCIAL STATEMENTS  (Continued)




|                                     |  |              |          |   |      |   |          |  
|------------------------------------ |  | ------------ | -------- | - | ---- | - | -------- | -
|                                     |  | December 31, |         
|                                     |  |              |         
|                                     |  | 2005         |          |   | 2004 |  
|                                     |  |              |          |   |      |  
|Net operating loss carry forward     |  | $            | 91,800   |   |      | $ | 73,900   |  
|Deferred revenue                     |  |              | 100      |   |      |   | 4,600    |  
|Research and development credits     |  |              | 14,400   |   |      |   | 14,400   |  
|Capitalized research and development |  |              | 3,100    |   |      |   | 7,100    |  
|Other                                |  |              | 1,300    |   |      |   | 1,800    |  
|                                     |  |              |          |   |      |  
|Total deferred tax assets            |  |              | 110,700  |   |      |   | 101,800  |  
|Valuation allowance                  |  |              | (110,700 | ) |      |   | (101,800 | )
|                                     |  |              |          |   |      |  
|Net deferred tax assets              |  | $            |         |   |      | $ |         |  
|                                     |  |              |          |   |      |  









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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, |       
|                              |                                                                          | 2005      |        |        | 2005     |   |        | 2005          |   |   | 2005         |       
|                              |                                                                          |           |        |        |          |   |        |               |   |   |              |       
|Contract and license revenues |                                                                          | $         | 7,714  |        |          | $ | 1,212  |               |   | $ | 719          |        |   | $ | 862     |       
|                              |                                                                          |           |        |        |          |   |        |               |   |   |              |       
|Operating expenses:           |                                                                          |           |        |        |          |   |        |               |   |   |              |        |   |   |         |       
|                              | Research and development                                                 |           |        | 7,070  |          |   |        | 7,317         |   |   |              | 6,471  |   |   |         | 9,316  |  
|                              | General and administrative                                               |           |        | 3,235  |          |   |        | 2,713         |   |   |              | 2,326  |   |   |         | 2,621  |  
|                              |                                                                          |           |        |        |          |   |        |               |   |   |              |       
|                              | Total expenses                                                           |           |        | 10,305 |          |   |        | 10,030        |   |   |              | 8,797  |   |   |         | 11,937 |  
|                              |                                                                          |           |        |        |          |   |        |               |   |   |              |       
|Loss from operations          |                                                                          |           | (2,591 | )      |          |   | (8,818 | )             |   |   | (8,078       | )      |   |   | (11,075 | )     
|Interest income               |                                                                          |           | 288    |        |          |   | 350    |               |   |   | 342          |        |   |   | 337     |       
|Other income and expense      |                                                                          |           | (37    | )      |          |   | (8     | )             |   |   | 8            |        |   |   | 67      |       
|                              |                                                                          |           |        |        |          |   |        |               |   |   |              |       
|Net loss                      |                                                                          |           | (2,340 | )      |          |   | (8,476 | )             |   |   | (7,728       | )      |   |   | (10,671 | )     
|                              |                                                                          |           |        |        |          |   |        |               |   |   |              |       
|                              | Basic and diluted net loss per common share                              |           | $      | (0.16  | )        |   | $      | (0.58         | ) |   | $            | (0.53  | ) |   | $       | (0.73  | )
|                              |                                                                          |           |        |        |          |   |        |               |   |   |              |       
|                              | Shares used in computing basic and diluted net loss per common
    share |           |        | 14,459 |          |   |        | 14,512        |   |   |              | 14,518 |   |   |         | 14,563 |  
|                              |                                                                          |           |        |        |          |   |        |               |   |   |              |       

|                              |                                                                          |           |        |        |          |   |        |               |   |   |              |        |   |   |        |        |  
|----------------------------- | ------------------------------------------------------------------------ | --------- | ------ | ------ | -------- | - | ------ | ------------- | - | - | ------------ | ------ | - | - | ------ | ------ | -
|                              |                                                                          | 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     |       
|Interest expense              |                                                                          |           | (10    | )      |          |   | (5     | )             |   |   | (3           | )      |   |   | 1      |       
|                              |                                                                          |           |        |        |          |   |        |               |   |   |              |       
|Net loss                      |                                                                          | $         | (7,724 | )      |          |   | (7,457 | )             |   |   | (8,230       | )      |   |   | (6,778 | )     
|                              |                                                                          |           |        |        |          |   |        |               |   |   |              |       
|                              | Basic and diluted net loss per common share                              |           | $      | (0.61  | )        |   | $      | (0.59         | ) |   | $            | (0.65  | ) |   | $      | (0.52  | )
|                              |                                                                          |           |        |        |          |   |        |               |   |   |              |       
|                              | Shares used in computing basic and diluted net loss per common
    share |           |        | 12,588 |          |   |        | 12,706        |   |   |              | 12,713 |   |   |        | 12,955 |  
|                              |                                                                          |           |        |        |          |   |        |               |   |   |              |       

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ARADIGM CORPORATION


NOTES TO FINANCIAL STATEMENTS  (Continued)







|        |                                                                                         
|------- | ----------------------------------------------------------------------------------------
|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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##### Table of Contents






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



68



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##### 






PART IV







|         |                                            
|-------- | -------------------------------------------
|Item 15. | Exhibits and Financial Statements Schedules

(a)(1) Financial Statements.









|                                                                                                                                     |  |           |    | 
|------------------------------------------------------------------------------------------------------------------------------------ |  | --------- | -- | 
|                                                                                                                                     |  | Page in   |   
|                                                                                                                                     |  | Form 10-K |   
|                                                                                                                                     |  |           |   
|Report of Independent Registered Public
    Accounting Firm                                                                          |  |           | 42 | 
|Balance Sheets 
    December 31, 2005 and 2004                                                                                      |  |           | 43 | 
|Statements of Operations  Years
    ended December 31, 2005, 2004 and 2003                                                          |  |           | 44 | 
|Statements of Redeemable Convertible
    Preferred Stock and Shareholders Equity  Years
    ended December 31, 2005, 2004 and 2003 |  |           | 45 | 
|Statements of Cash Flows  Years
    ended December 31, 2005, 2004 and 2003                                                          |  |           | 47 | 
|Notes to Financial Statements                                                                                                        |  |           | 48 | 



(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.     
|            | 3.9       |             |  | Certificate of Amendment of Amended and Restated Articles of
    Incorporation of the Company.                     
|            | 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(18)+ |             |  | Equity Incentive Plan.                                                                                             
|            | 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)+  |             |  | 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.                                          
|            | 10.10(2)* |             |  | Product Development and Commercialization Agreement between the
    Company and SmithKline Beecham PLC.            

69



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|            |            |             |  |                                                                                                                                                                                                             
|----------- | ---------- | ----------- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit No. |            | Description
|            |            |            
|            | 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.                                                                                    
|            | 10.16(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 18, 2004, by
    and among the Company, Novo Nordisk 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.                                                                                
|            | 10.23(19)+ |             |  | Form of Change of Control Agreement to be entered into between
    the Company and certain of the Companys senior officers.                                                                                
|            | 10.24(19)+ |             |  | Executive Officer Severance Benefit Plan.                                                                                                                                                                   
|            | 10.25+     |             |  | Form of the Companys Restricted Share Bonus Agreement
    under the Equity Incentive Plan                                                                                                                  
|            | 10.26#     |             |  | Amended and Restated License Agreement, dated as of
    January 26, 2005, by and between the Company and Novo
    Nordisk A/S                                                                               
|            | 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.                                                
|
| | # | The Commission has granted the Companys request for
    confidential treatment with respect to portions of this exhibit.



| |     |                                                                                                         
| | --- | --------------------------------------------------------------------------------------------------------
| | (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.                      
|
| | (7) | Incorporated by reference to the Companys
    Form 10-K filed
    for the year ended December 31, 2000.
|
| | (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.                     

70



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##### Table of Contents





|     |                                                                                                  
|---- | -------------------------------------------------------------------------------------------------
|(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.          
|    
|(18) | Incorporated by reference to the Companys definitive proxy
    statement filed on April 7, 2005.
|    
|(19) | Incorporated by reference to the Companys
    Form 8-K filed on
    October 13, 2005.           

(b) Index to Exhibits.




(c) Financial Statement Schedules.




71



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##### Table of Contents






SIGNATURES






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



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

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

attorneys-in 10-K, attorneys-in






|                                             |  |                                                                                     |  |                |  | 
|-------------------------------------------- |  | ----------------------------------------------------------------------------------- |  | -------------- |  | 
|Signature                                    |  | Title                                                                               |  | Date          
|                                             |  |                                                                                     |  |               
|                                            
|/s/ V. Bryan LawlisV. Bryan Lawlis           |  | President, Chief Executive Officer, and Director (Principal
    Executive Officer)  |  | March 30, 2006
|                                            
|/s/ Thomas C. ChestermanThomas C. Chesterman |  | Sr. VP and Chief Financial Officer (Principal Financial and
    Accounting Officer) |  | March 30, 2006
|                                            
|/s/ Virgil D. ThompsonVirgil D. Thompson     |  | Chairman of the Board and Director                                                  |  | March 30, 2006
|                                            
|/s/ Frank H. BarkerFrank H. Barker           |  | Director                                                                            |  | March 30, 2006
|                                            
|/s/ Igor GondaIgor Gonda                     |  | Director                                                                            |  | March 30, 2006
|                                            
|/s/ Stephen O. JaegerStephen O. Jaeger       |  | Director                                                                            |  | March 30, 2006
|                                            
|/s/ John M. NehraJohn M. Nehra               |  | Director                                                                            |  | March 30, 2006
|                                            
|/s/ Wayne L. RoeWayne L. Roe                 |  | Director                                                                            |  | March 30, 2006
|                                            
|/s/ Richard P. ThompsonRichard P. Thompson   |  | Director                                                                            |  | March 30, 2006

72



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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.                                                                                              
|            | 3.9        |             |  | Certificate of Amendment of Amended and Restated Articles of
    Incorporation of the Company.                                                                                                              
|            | 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(18)+  |             |  | Equity Incentive Plan.                                                                                                                                                                                      
|            | 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)+   |             |  | 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.                                                                                                                                   
|            | 10.10(2)*  |             |  | Product Development and Commercialization Agreement between the
    Company and SmithKline Beecham PLC.                                                                                                     
|            | 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.                                                                                    
|            | 10.16(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 18, 2004, by
    and among the Company, Novo Nordisk 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.                                                                                

73



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##### Table of Contents



|            |            |             |  |                                                                                                                              
|----------- | ---------- | ----------- |  | -----------------------------------------------------------------------------------------------------------------------------
|Exhibit No. |            | Description
|            |            |            
|            | 10.23(19)+ |             |  | Form of Change of Control Agreement to be entered into between
    the Company and certain of the Companys senior officers. 
|            | 10.24(19)+ |             |  | Executive Officer Severance Benefit Plan.                                                                                    
|            | 10.25+     |             |  | Form of the Companys Restricted Share Bonus Agreement
    under the Equity Incentive Plan                                   
|            | 10.26#     |             |  | Amended and Restated License Agreement, dated as of
    January 26, 2005, by and between the Company and Novo
    Nordisk A/S
|            | 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.                                                
|
| | # | The Commission has granted the Companys request for
    confidential treatment with respect to portions of this exhibit.



| |     |                                                                                                         
| | --- | --------------------------------------------------------------------------------------------------------
| | (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.                      
|
| | (7) | Incorporated by reference to the Companys
    Form 10-K filed
    for the year ended December 31, 2000.
|
| | (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.                 
|    
|(18) | Incorporated by reference to the Companys definitive proxy
    statement filed on April 7, 2005.       
|    
|(19) | Incorporated by reference to the Companys
    Form 8-K filed on
    October 13, 2005.                  

74