##### Table of Contents



UNITED STATES SECURITIES AND EXCHANGE COMMISSION
 Washington, DC 20549
 Form 10-Q
  þ
    
    QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
 For the quarterly period ended June 30, 2006
 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
    
    (I.R.S. Employerincorporation or organization)
    
    Identification No.)
 3929 Point Eden Way
Hayward, CA 94545  (Address of principal executive offices including zip code)
 (510) 265-9000  (Registrants telephone number, including area code)
 þ o
  o o þ
 o þ
  (Class)
    
    (Outstanding at July 31, 2006)Common
    
    14,765,502




---



##### 



ARADIGM CORPORATION
TABLE OF CONTENTS
 PagePART I. FINANCIAL INFORMATION
    
    3Item 1. Financial Statements:
    
    3Condensed Balance Sheets at June 30, 2006 and December 31, 2005 (unaudited)
    
    3Condensed Statements of Operations for the three months ended June 30, 2006 and 2005 (unaudited)
    
    4Condensed Statements of Operations for the six months ended June 30, 2006 and 2005 (unaudited)
    
    5Condensed Statements of Cash Flows for the six months ended June 30, 2006 and 2005 (unaudited)
    
    6Notes to Condensed Financial Statements (unaudited)
    
    7Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
    
    15Item 3. Quantitative and Qualitative Disclosure About Market Risk
    
    23Item 4. Controls and Procedures
    
    24PART II. OTHER INFORMATION
    
    24Item 1. Legal Proceedings
    
    24Item 1A. Risk Factors
    
    24Item 4. Submission of Matters to a Vote of Security Holders
    
    25Item 6. Exhibits
    
    26SIGNATURES
    
    27EXHIBIT 10.27EXHIBIT 31.1EXHIBIT 31.2EXHIBIT 32.1
  2




---



##### Table of Contents



PART I. FINANCIAL INFORMATION
 
 Item 1. CONDENSED FINANCIAL STATEMENTS
 ARADIGM CORPORATION
 
 CONDENSED BALANCE SHEETS
 (In thousands, except share data)
 (Unaudited)
 June 30,
    
    
    December 31,2006
    
    
    2005(Note 1)ASSETSCurrent assets:Cash and cash equivalents
    
    $
    8,407
    
    
    $
    27,694Short-term investments
    
    
    507
    
    
    
    Receivables
    
    
    552
    
    
    
    400Current portion of notes receivable from officers and employees
    
    
    20
    
    
    
    62Prepaid expenses and other current assets
    
    
    662
    
    
    
    874Total current assets
    
    
    10,148
    
    
    
    29,030Property and equipment, net
    
    
    6,294
    
    
    
    9,875Non-current portion of notes receivable from officers and employees
    
    
    151
    
    
    
    129Other assets
    
    
    456
    
    
    
    463Total assets
    
    $
    17,049
    
    
    $
    39,947LIABILITIES, REDEEMABLE CONVERTIBLE PREFERRED STOCK AND
SHAREHOLDERS EQUITY (DEFICIT)Current liabilities:Accounts payable
    
    $
    672
    
    
    $
    3,034Accrued clinical and cost of other studies
    
    
    523
    
    
    
    398Accrued compensation
    
    
    3,021
    
    
    
    3,814Deferred revenue
    
    
    217
    
    
    
    222Other accrued liabilities
    
    
    573
    
    
    
    475Total current liabilities
    
    
    5,006
    
    
    
    7,943Non-current portion of deferred rent
    
    
    824
    
    
    
    714Commitments and contingenciesRedeemable convertible preferred stock, no par value; 5,000,000 shares
authorized; issued and outstanding shares: 1,544,626 at June 30, 2006
and December 31, 2005; liquidation preference of $41,866 at June 30,
2006 and December 31, 2005
    
    
    23,669
    
    
    
    23,669Shareholders equity (deficit):Common stock, no par value; 100,000,000 shares authorized; issued and
outstanding shares: 14,765,502 at June 30, 2006 and 14,562,809 at
December 31, 2005
    
    
    283,107
    
    
    
    282,004Accumulated other comprehensive income (loss)
    
    
    (2
    )
    
    
    5Accumulated deficit
    
    
    (295,555
    )
    
    
    (274,838
    )Total shareholders equity (deficit)
    
    
    (12,450
    )
    
    
    7,171Total liabilities, redeemable convertible preferred
stock and shareholders equity (deficit)
    
    $
    17,049
    
    
    $
    39,497
  3




---



##### Table of Contents



ARADIGM CORPORATION
 
 CONDENSED STATEMENTS OF OPERATIONS
 (In thousands, except per share data)
 (Unaudited)
 Three Months EndedJune 30,2006
    
    
    2005Contract and
milestone revenues (including amounts from related parties: 2006 - $18; 2005 - $267)
    
    $
    1,807
    
    
    $
    1,212Operating expenses:Research and development
    
    
    6,357
    
    
    
    7,317General and administrative
    
    
    2,685
    
    
    
    2,713Restructuring and asset impairment
    
    
    5,370
    
    
    
    Total operating expenses
    
    
    14,412
    
    
    
    10,030Loss from operations
    
    
    (12,605
    )
    
    
    (8,818
    )Interest income
    
    
    135
    
    
    
    350Interest expense and other income (expense )
    
    
    37
    
    
    
    (8
    )Net loss
    
    $
    (12,433
    )
    
    $
    (8,476
    )Basic and diluted net loss per common share
    
    $
    (0.85
    )
    
    $
    (0.58
    )Shares used in computing basic and diluted net loss per common share
    
    
    14,656
    
    
    
    14,512
  4




---



##### Table of Contents



ARADIGM CORPORATION
 
 CONDENSED STATEMENTS OF OPERATIONS
 (In thousands, except per share data)
 (Unaudited)
 Six Months EndedJune 30,2006
    
    
    2005Contract and
milestone revenues (including amounts from related parties: 2006 - $50; 2005 - $7,711)
    
    $
    2,880
    
    
    $
    8,926Operating expenses:Research and development
    
    
    13,098
    
    
    
    14,387General and administrative
    
    
    5,537
    
    
    
    5,948Restructuring and asset impairment
    
    
    5,370
    
    
    
    Total operating expenses
    
    
    24,005
    
    
    
    20,335Loss from operations
    
    
    (21,125
    )
    
    
    (11,409
    )Interest income
    
    
    380
    
    
    
    638Interest expense and other income (expense)
    
    
    27
    
    
    
    (45
    )Net loss
    
    $
    (20,717
    )
    
    $
    (10,816
    )Basic and diluted net loss per common share
    
    $
    (1.42
    )
    
    $
    (0.75
    )Shares used in computing basic and diluted net loss per common share
    
    
    14,614
    
    
    
    14,486
  5




---



##### Table of Contents



ARADIGM CORPORATION
 
 CONDENSED STATEMENTS OF CASH FLOWS
 (In thousands)
 (Unaudited)
 Six Months EndedJune 30,2006
    
    
    2005Cash flows from operating activities:Net loss
    
    $
    (20,717
    )
    
    $
    (10,816
    )Adjustments to reconcile net loss to cash used in operating activities:Non-cash asset impairment on property and equipment
    
    
    4,000
    
    
    
    Depreciation and amortization
    
    
    549
    
    
    
    743Stock-based compensation expense related to employee stock options
and employee stock purchases
    
    
    854
    
    
    
    Loss on retirement and sale of property and equipment
    
    
    6
    
    
    
    25Cost of warrants and stock options for services
    
    
    
    
    
    
    93Amortization of deferred compensation
    
    
    
    
    
    
    7Changes in operating assets and liabilities:Receivables
    
    
    (152
    )
    
    
    (650
    )Prepaid and other current assets
    
    
    212
    
    
    
    444Other assets
    
    
    7
    
    
    
    (118
    )Accounts payable
    
    
    (2,362
    )
    
    
    (248
    )Accrued compensation
    
    
    (793
    )
    
    
    147Other accrued liabilities
    
    
    223
    
    
    
    (889
    )Deferred rent
    
    
    110
    
    
    
    (1,337
    )Deferred revenue
    
    
    (5
    )
    
    
    (7,472
    )Net cash used in operating activities
    
    
    (18,068
    )
    
    
    (20,071
    )Cash flows from investing activities:Capital expenditures
    
    
    (974
    )
    
    
    (2,490
    )Proceeds from the sale of property and equipment
    
    
    
    
    
    
    50,291Purchases of available-for-sale investments
    
    
    (514
    )
    
    
    (5,530
    )Increase in restricted cash
    
    
    
    
    
    
    Proceeds from maturities and sales of available-for-sale
investments
    
    
    
    
    
    
    538Net cash provided by (used in) investing activities
    
    
    (1,488
    )
    
    
    42,809Cash flows from financing activities:Proceeds from issuance of common stock, net
    
    
    249
    
    
    
    254Proceeds from exercise of options and warrants for common stock
    
    
    
    
    
    
    42Payments received on notes receivable from officers and employees
    
    
    20
    
    
    
    30Net cash provided by financing activities
    
    
    269
    
    
    
    326Net increase (decrease) in cash and cash equivalents
    
    
    (19,287
    )
    
    
    23,064Cash and cash equivalents at beginning of period
    
    
    27,694
    
    
    
    14,308Cash and cash equivalents at end of period
    
    $
    8,407
    
    
    $
    37,372
  6




---



##### Table of Contents



ARADIGM CORPORATION
 
 NOTES TO THE UNAUDITED CONDENSED FINANCIAL STATEMENTS
 June 30, 2006
 1. Organization and Basis of Presentation
 Organization
  Basis of Presentation
   2. Summary of Significant Accounting Policies
 Use of Estimates
  Revenue Recognition
  7




---



##### Table of Contents



Impairment or Disposal of Long-Lived Assets
 Accounting for the Impairment or Disposal of
Long-Lived Assets
 3. Stock-Based Compensation
 Accounting
for Stock-based Compensation Accounting for
Stock-Based Compensation  Transition and Disclosure
  8




---



##### Table of Contents



Employee Stock Plans
  2005 Equity Incentive Plan
      9




---



##### Table of Contents



1996 Non-Employee Directors Plan
  Employee Stock Purchase Plan
   Pro Forma Information for Period Prior to Adoption of SFAS No.123R
  Three Months
    
    
    Six MonthsEnded
    
    
    EndedJune 30,
    
    
    June 30,2005
    
    
    2005Net loss, as reported
    
    $
    (8,476
    )
    
    $
    (10,816
    )Add: Stock-based employee compensation expense
included in reported net loss
    
    
    2
    
    
    
    7Less: Total stock-based employee compensation
expense determined under fair value method
    
    
    (867
    )
    
    
    (1,605
    )Pro forma net loss
    
    $
    (9,284
    )
    
    $
    (12,414
    )Basic and diluted net loss per share, as reported:
    
    $
    (0.60
    )
    
    $
    (0.75
    )Basic and diluted pro forma loss per share
    
    $
    (0.65
    )
    
    $
    (0.85
    )
  10




---



##### Table of Contents



Valuation Assumptions
   Three Months Ended June 30,
    
    Six Months Ended June 30,2006
    
    2005
    
    2006
    
    2005Employee Stock OptionsDividend yield
    
    
    0.0
    %
    
    
    0.0
    %
    
    
    0.0
    %
    
    
    0.0
    %Volatility factor
    
    
    85.8
    %
    
    
    98.0
    %
    
    
    85.8
    %
    
    
    97.9
    %Risk-free interest rate
    
    
    5.1
    %
    
    
    3.8
    %
    
    
    4.9
    %
    
    
    3.7
    %Expected life (years)
    
    
    4.2
    
    
    
    4.0
    
    
    
    4.2
    
    
    
    4.0Weighted-average fair value
of options granted during
the periods
    
    $
    1.11
    
    
    $
    3.73
    
    
    $
    1.64
    
    
    $
    4.21Employee Stock Purchase PlanDividend yield
    
    
    0.0
    %
    
    
    0.0
    %
    
    
    0.0
    %
    
    
    0.0
    %Volatility factor
    
    
    85.7
    %
    
    
    87.3
    %
    
    
    85.7
    %
    
    
    87.3
    %Risk-free interest rate
    
    
    4.8
    %
    
    
    3.5
    %
    
    
    4.8
    %
    
    
    3.5
    %Expected life (years)
    
    
    0.7
    
    
    
    1.2
    
    
    
    0.7
    
    
    
    1.2Weighted-average fair value
of employee stock purchases
during the periods
    
    $
    1.33
    
    
    $
    2.67
    
    
    $
    1.33
    
    
    $
    2.67
 Adoption of SFAS No.123R
  Three Months
    
    
    Six MonthsEnded
    
    
    EndedJune 30,2006
    
    
    June 30,2006Costs and expenses:Research and development
    
    $
    207
    
    
    $
    469General and administrative
    
    
    177
    
    
    
    385Total stock-based compensation expense
    
    $
    384
    
    
    $
    854Impact on basic and diluted net loss per share
    
    $
    0.03
    
    
    $
    0.06
   11




---



##### Table of Contents



Stock Option Activity
  WeightedWeighted
    
    Average
    
    AggregateNumber
    
    Average
    
    Remaining
    
    Intrinsicof
    
    Exercise
    
    Contractual
    
    Value (inShares
    
    Price
    
    Life
    
    000s)Options outstanding at January 1, 2006
    
    
    1,730
    
    
    $
    19.47
    
    
    
    7.10
    
    
    
    Options granted
    
    
    1,145
    
    
    $
    2.50
    
    
    
    
    
    
    
    Options exercised
    
    
    (645
    )
    
    $
    2.83
    
    
    
    
    
    
    
    Options cancelled
    
    
    (300
    )
    
    $
    7.84
    
    
    
    
    
    
    
    Options outstanding at June 30, 2006
    
    
    2,573
    
    
    $
    13.28
    
    
    
    7.83
    
    
    $
    33Options exercisable at June 30, 2006
    
    
    1,229
    
    
    $
    24.02
    
    
    
    6.06
    
    
    
    
   Options OutstandingWeighted-
    
    
    
    
    
    Options ExercisableAverageRemaining
    
    Weighted-
    
    
    
    
    
    Weighted-Number
    
    Contractual
    
    Average
    
    Number
    
    AverageRange
of
    
    Outstanding
    
    Life
    
    Exercise
    
    Exercisable
    
    ExerciseExercise
Price
    
    (in thousands)
    
    (in years)
    
    Price
    
    (in thousands)
    
    Price$    1.29-$    1.29
    
    
    300
    
    
    
    9.99
    
    
    $
    1.29
    
    
    
    0
    
    
    $
    0.00$    1.52-$    1.70
    
    
    316
    
    
    
    9.94
    
    
    $
    1.69
    
    
    
    0
    
    
    $
    0.00$    3.14-$    3.14
    
    
    84
    
    
    
    9.78
    
    
    $
    3.14
    
    
    
    4
    
    
    $
    3.14$    3.63-$    3.77
    
    
    338
    
    
    
    9.68
    
    
    $
    3.77
    
    
    
    1
    
    
    $
    3.63$    3.80-$    5.30
    
    
    299
    
    
    
    7.50
    
    
    $
    5.02
    
    
    
    232
    
    
    $
    5.01$    5.35-$    5.95
    
    
    296
    
    
    
    8.48
    
    
    $
    5.89
    
    
    
    129
    
    
    $
    5.88$    6.25-$  12.00
    
    
    301
    
    
    
    7.55
    
    
    $
    10.45
    
    
    
    226
    
    
    $
    10.13$  13.00-$  24.10
    
    
    341
    
    
    
    5.64
    
    
    $
    20.67
    
    
    
    339
    
    
    $
    20.72$  25.55-$107.81
    
    
    258
    
    
    
    3.23
    
    
    $
    53.27
    
    
    
    258
    
    
    $
    53.27$112.50-$120.63
    
    
    40
    
    
    
    3.65
    
    
    $
    113.96
    
    
    
    40
    
    
    $
    113.962,573
    
    
    
    
    
    
    
    
    
    
    
    1,229
  12




---



##### Table of Contents



4. Net Loss Per Share
  Three Months Ended
    
    Six Months EndedJune 30,
    
    June 30,2006
    
    2005
    
    2006
    
    2005Options to purchase common stock
    
    
    
    
    
    
    4,552
    
    
    
    4,328
    
    
    
    11,287Preferred convertible shares
    
    
    1,235,701
    
    
    
    1,235,701
    
    
    
    1,235,701
    
    
    
    1,235,701Unearned restricted stock
    
    
    139,500
    
    
    
    
    
    
    
    109,690
    
    
    
    Warrants to purchase common shares
    
    
    
    
    
    
    120,809
    
    
    
    
    
    
    
    120,8091,375,201
    
    
    
    1,361,062
    
    
    
    1,349,719
    
    
    
    1,367,797
 5. Comprehensive Loss
  Three Months Ended
    
    
    Six Months EndedJune 30,
    
    
    June 30,2006
    
    
    2005
    
    
    2006
    
    
    2005(In thousands)Net loss
    
    $
    (12,433
    )
    
    $
    (8,477
    )
    
    $
    (20,717
    )
    
    $
    (10,816
    )Other comprehensive loss:Net unrealized gain
(loss) on
available-for-sale
securities
    
    
    3
    
    
    
    (4
    )
    
    
    (7
    )
    
    
    1Comprehensive loss
    
    $
    (12,430
    )
    
    $
    (8,481
    )
    
    $
    (20,724
    )
    
    $
    (10,815
    )
 6. Cash, Cash Equivalents and Investments
  June
    
    
    December30, 2006
    
    
    31, 2005Cash and Cash equivalents:Money market fund
    
    $
    4,216
    
    
    $
    1,321Commercial paper
    
    
    4,191
    
    
    
    26,373$
    8,407
    
    
    $
    27,694Short-term investments:Corporate and Government notes
    
    $
    507
    
    
    $
    
  7. Reverse Stock Split
  13




---



##### Table of Contents



8. Restructuring and Asset Impairment
 Accounting for
Costs Associated with Exit or Disposal
   InitialRestructuring
    
    
    Non-cash
    
    
    
    
    
    
    Balance atType of Liability
    
    Charges
    
    
    Impairment
    
    
    Payments
    
    
    June 30, 2006(Unaudited)Quarter Ended June 30, 2006Severance and related benefits
    
    $
    1,300
    
    
    $
    
    
    
    $
    261
    
    
    $
    1,039Out-placement Services
    
    
    70
    
    
    
    
    
    
    
    17
    
    
    
    53Impairment on Intraject-related assets
    
    
    
    
    
    
    4,000
    
    
    
    
    
    
    
    $
    1,370
    
    
    $
    4,000
    
    
    $
    277
    
    
    $
    1,092
 9. Related Party
  ®
 ®
 10. Subsequent Event
  14




---



##### Table of Contents



Item 2. 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 our most recent Annual Report on Form 10-K filed with the Securities and Exchange
Commission.
 Our business is subject to significant risks including, but not limited to, the success of
research and development efforts, dependence on corporate partners for marketing, distribution and
other resources, obtaining and enforcing patents important to the business, clearing the lengthy
and expensive regulatory process and possible competition from other products. Even if the products
appear promising at various stages of development, they may not reach the market or may not be
commercially successful for a number of reasons. Such reasons include, but are not limited to, the
possibilities that the potential products may be found to be ineffective during clinical trials,
fail to receive necessary regulatory approvals, are difficult to manufacture on a large scale, are
uneconomical to market, are precluded from commercialization by proprietary rights of third parties
or may not gain acceptance from health care professionals and patients. Readers are cautioned not
to place undue reliance on the forward-looking statements contained herein. We
undertake no obligation to update these forward-looking statements in light of events or
circumstances occurring after the date hereof or to reflect the occurrence of unanticipated events.
 Overview
 ®
 15




---



##### Table of Contents



AERx ® Technology Platform
 ® ®
 AERx ® Diabetes Management System
 ® ® ® ®
 AERx ® Hydrochloroquine
 ® ®
 Liposomal Ciprofloxacin
   16




---



##### Table of Contents



AERx ® Smoking Cessation
 ® ®
 AERx ® Treprostinil
 ® ®
 Potential Product Applications
 ® ® ® ®
 Intraject
   17




---



##### Table of Contents



Critical Accounting Policies and Estimates
  Revenue Recognition
  Impairment or Disposal of Long-Lived Assets
  Stock-Based Compensation Expense
   18




---



##### Table of Contents



Results of Operations
 Three Months Ended June 30, 2006 and 2005
  Three Months Ended June 30,Change in
    
    
    Change in2006
    
    
    2005
    
    
    Dollars
    
    
    PercentRevenue:Contract revenue
    
    $
    1,710
    
    
    $
    1,212
    
    
    $
    498
    
    
    
    41
    %Percentage of Total Revenue
    
    
    95
    %
    
    
    100
    %Milestone revenue
    
    
    97
    
    
    
    
    
    
    
    97
    
    
    
    100
    %Percentage of Total Revenue
    
    
    5
    %
    
    
    
    %Total Revenue
    
    $
    1,807
    
    
    $
    1,212
    
    
    $
    595
    
    
    
    (49%
    )
 ® ® ® ® ® ® ® ®
 Cost and Expenses
 Three Months Ended June 30,Change in
    
    
    Change in2006
    
    
    2005
    
    
    Dollars
    
    
    PercentResearch and Development Expense:Collaborative
    
    $
    1,653
    
    
    $
    1,183
    
    
    $
    470
    
    
    
    40
    %Self-Funded
    
    
    4,704
    
    
    
    6,134
    
    
    
    (1,430
    )
    
    
    (23
    )%Total Research and Development Expense
    
    $
    6,357
    
    
    $
    7,317
    
    
    $
    (960
    )
    
    
    (15
    )%
 Research and Development
  19




---



##### Table of Contents



Three Months Ended June 30,Change in
    
    Change in2006
    
    2005
    
    Dollars
    
    PercentGeneral and Administrative Expenses
    
    $
    2,685
    
    
    $
    2,713
    
    
    $
    (28
    )
    
    
    (1
    )%
 General and Administrative
  Three Months Ended June 30,Change in
    
    Change in2006
    
    2005
    
    Dollars
    
    PercentRestructuring and Asset Impairment Expenses
    
    $
    5,370
    
    
    $
    
    
    
    $
    5,370
    
    
    
    100
    %
 Restructuring and Asset Impairment
 Three Months Ended June 30,Change in
    
    
    Change in2006
    
    
    2005
    
    
    Dollars
    
    
    PercentInterest Income, Interest and Other Expense:Interest Income
    
    $
    135
    
    
    $
    350
    
    
    $
    (215
    )
    
    
    (61
    )%Interest and Other income (expense)
    
    
    37
    
    
    
    (8
    )
    
    
    45
    
    
    
    563
    %Total Interest Income, Interest and Other Expense
    
    $
    172
    
    
    $
    341
    
    
    $
    (170
    )
    
    
    (49
    )%
  20




---



##### Table of Contents



Six Months Ended June 30, 2006 and 2005
  Six Months Ended June 30,Change in
    
    
    Change in2006
    
    
    2005
    
    
    Dollars
    
    
    PercentRevenue:Contract revenue
    
    $
    2,686
    
    
    $
    3,740
    
    
    $
    (1,054
    )
    
    
    (28
    %)Percentage of Total Revenue
    
    
    93
    %
    
    
    42
    %Milestone revenue
    
    
    194
    
    
    
    5,186
    
    
    
    (4,992
    )
    
    
    (96
    %)Percentage of Total Revenue
    
    
    7
    %
    
    
    58
    %Total Revenue
    
    $
    2,880
    
    
    $
    8,926
    
    
    $
    (6,046
    )
    
    
    (68
    %)
 ® ® ® ® ® ®
 Cost and Expenses
 Six Months Ended June 30,Change in
    
    
    Change in2006
    
    
    2005
    
    
    Dollars
    
    
    PercentResearch and Development Expense:Collaborative
    
    $
    2,882
    
    
    $
    3,231
    
    
    $
    (349
    )
    
    
    (11
    )%Self-Funded
    
    
    10,216
    
    
    
    11,156
    
    
    
    (940
    )
    
    
    (8
    )%Total Research and Development Expense
    
    $
    13,098
    
    
    $
    14,387
    
    
    $
    (1,289
    )
    
    
    (9
    )%
 Research and Development:
  Six Months Ended June 30,Change in
    
    Change in2006
    
    2005
    
    Dollars
    
    PercentGeneral and Administrative Expenses
    
    $
    5,537
    
    
    $
    5,948
    
    
    $
    (411
    )
    
    
    (7
    )%
 General and Administrative
 21




---



##### Table of Contents



Six Months Ended June 30,Change in
    
    Change in2006
    
    2005
    
    Dollars
    
    PercentRestructuring and Asset Impairment Expenses
    
    $
    5,370
    
    
    $
    
    
    
    $
    5,370
    
    
    
    100
    %
 Restructuring and Asset Impairment
 Six Months Ended June 30,Change in
    
    
    Change in2006
    
    
    2005
    
    
    Dollars
    
    
    PercentInterest Income, Interest and Other Expense:Interest Income
    
    $
    380
    
    
    $
    638
    
    
    $
    (258
    )
    
    
    (40
    )%Interest and Other Income (Expense)
    
    
    27
    
    
    
    (45
    )
    
    
    72
    
    
    
    160
    %Total Interest Income, Interest and Other Expense
    
    $
    407
    
    
    $
    593
    
    
    $
    186
    
    
    
    (31
    )%
  Liquidity and Capital Resources
   22




---



##### Table of Contents



Contractual Obligations
  Payment Due by Period(amounts in thousands)Total
    
    
    2006 (1)
    
    
    2007/2008
    
    
    2009/2010
    
    
    2011+Contractual obligations:Operating lease obligations
    
    $
    22,174
    
    
    $
    812
    
    
    $
    4,798
    
    
    $
    4,631
    
    
    $
    11,933Unconditional purchase obligations
    
    
    2,255
    
    
    
    2,255
    
    
    
    
    
    
    
    
    
    
    
    Total contractual commitments
    
    $
    24,429
    
    
    $
    3,067
    
    
    $
    4,798
    
    
    $
    4,631
    
    
    $
    11,933
 
 (1)
    
    For six months ending June 30, 2006 Off-Balance Sheet Financings and Liabilities
  
 Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
 Market Risk Disclosures
   23




---



##### Table of Contents



Item 4. CONTROLS AND PROCEDURES
 Evaluation of Disclosure Controls and Procedures.
 Changes in internal control.
 Limitations on the effectiveness of controls.
 
 PART II. OTHER INFORMATION
 
 Item 1. LEGAL PROCEEDINGS
  
 Item 1A. RISK FACTORS
  The Companys common stock currently trades on the Nasdaq Capital Market and may be subject to
delisting.
  ®
 We may not be able to effectively implement our restructuring activities, and our restructuring
activities may not result in the expected benefits, which would negatively impact our future
results of operations.
 24




---



##### Table of Contents



Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
  1.
    
    To elect directors nominees to hold office until the next Annual Meeting of Shareholders or
until their successors are elected:
 VotesNominee
    
    For
    
    WithheldFrank H. Barker
    
    
    11,850,567
    
    
    
    405,878Igor Gonda
    
    
    11,216,431
    
    
    
    1,040,014Stephen O. Jaeger
    
    
    11,714,067
    
    
    
    542,378V. Bryan Lawlis
    
    
    11,821,347
    
    
    
    435,098Virgil D. Thompson
    
    
    11,718,568
    
    
    
    537,877
 2.
    
    To approve the Companys 2005 Equity Incentive Plan, as amended and restated, to increase the
aggregate number of shares of common stock authorized for issuance under such plan by
2,000,000 shares
 VotesFor
    
    Against
    
    Abstain5,356,634
    
    
    
    1,510,034
    
    
    
    75,600
 3.
    
    To ratify the selection of Ernst and Young LLP as the Companys independent registered public
accounting firm for the fiscal year ending December 31, 2006
 VotesFor
    
    Against
    
    Abstain12,075,810
    
    
    
    148,515
    
    
    
    32,120
 25




---



##### Table of Contents



Item 6. EXHIBITS
 ExhibitNumber
    
    Description10.27*
    
    Second Amended and Restated License Agreement dated as of July 3, 2006 between
the Company and Novo Nordisk A/S31.1
    
    Certification by Chief Executive Officer pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002.31.2
    
    Certification by Chief Financial Officer pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002.32.1
    
    Certification by Chief Executive Officer and Chief Financial Officer pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002.
 
 *
    
    Confidential treatment has been requested with respect to portions of this exhibit 26




---



##### Table of Contents






SIGNATURES




| |                                       |  |  | 
| | ------------------------------------- |  |  | 
| | ARADIGM CORPORATION
(Registrant)      | 
| | /s/ Igor Gonda                        | 
| | Igor Gonda                            | 
| | President and Chief Executive Officer | 
|

| |                                                   |  |  | 
| | ------------------------------------------------- |  |  | 
| |                                                   | 
| | /s/ Thomas C. Chesterman                          | 
| | Thomas C. Chesterman                              | 
| | Senior Vice President and Chief Financial Officer | 
|



27



---



##### Table of Contents



INDEX TO EXHIBITS
 ExhibitNumber
    
    Description10.27*
    
    Second Amended and Restated License Agreement dated as of July 3, 2006 between
the Company and Novo Nordisk A/S31.1
    
    Certification by Chief Executive Officer pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002.31.2
    
    Certification by Chief Financial Officer pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002.32.1
    
    Certification by Chief Executive Officer and Chief Financial Officer pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002.
 
 *
    
    Confidential treatment has been requested with respect to portions of this exhibit 28