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UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, DC 20549




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Form 10-Q



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(Mark One)

þ
    
    QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934For the quarterly period ended September 30, 2003


Or

o
    
    TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934For 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 including zip code)

(510) 265-9000(Registrants telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past
90 days.     Yes  þ  No  o

Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange
Act).     Yes  o  No  þ

Indicate the number of shares outstanding of each of the issuers classes
of common stock, as of the latest practicable date.

Common Stock, no par value(Class)
    
    54,725,435(Outstanding at October 31, 2003)






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TABLE OF CONTENTS



|                              |                                                                                               |                                             |  |  |  |  |  | 
|----------------------------- | --------------------------------------------------------------------------------------------- | ------------------------------------------- |  |  |  |  |  | 
|PART I. FINANCIAL INFORMATION
|                              | Item 1. Financial Statements                                                                 
|                              |                                                                                               | BALANCE SHEETS                             
|                              |                                                                                               | STATEMENTS OF OPERATIONS                   
|                              |                                                                                               | STATEMENTS OF CASH FLOWS                   
|                              |                                                                                               | NOTES TO THE UNAUDITED FINANCIAL STATEMENTS
|                              | Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
|                              | Item 3. Quantitative and Qualitative Disclosures About Market Risk                           
|                              | Item 4. Controls and Procedures                                                              
|PART II. OTHER INFORMATION   
|                              | Item 6. Exhibits and Reports on Form 8-K                                                     
|SIGNATURES                   
|INDEX TO EXHIBITS            
|EXHIBIT 31.1                 
|EXHIBIT 31.2                 
|EXHIBIT 32.1                 



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ARADIGM CORPORATION
INDEX

PageNo.PART I. FINANCIAL INFORMATIONITEM 1.
    
    Financial StatementsBalance SheetsAt September 30, 2003 and December 31, 2002 (unaudited)
    
    2Statements of OperationsThree months ended September 30, 2003 and 2002 (unaudited)
    
    3Nine months ended September 30, 2003 and 2002 (unaudited)
    
    4Statements of Cash FlowsNine months ended September 30, 2003 and 2002 (unaudited)
    
    5Notes to Unaudited Financial Statements
    
    6ITEM 2.
    
    Managements Discussion and Analysis of Financial Condition
and Results of Operations
    
    8ITEM 3.
    
    Quantitative and Qualitative Disclosure About Market Risk
    
    13ITEM 4.
    
    Controls and Procedures
    
    14PART II. OTHER INFORMATIONITEM 6.
    
    Exhibits and Reports on Form 8-K
    
    14Signature
    
    15CertificationsExhibits


1



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PART I. FINANCIAL INFORMATION




Item 1.Financial Statements




ARADIGM CORPORATION
BALANCE SHEETS

September 30,
    
    December 31,2003
    
    2002(Unaudited)
    
    (Note 1)(In thousands, except shares data)ASSETSCurrent assets:Cash and cash equivalents
    
    $
    11,706
    
    
    $
    22,800Short-term investments
    
    
    2,612
    
    
    
    7,090Receivables
    
    
    8,959
    
    
    
    282Current portion of notes receivable from officers and employees
    
    
    139
    
    
    
    136Prepaid expenses and other current assets
    
    
    1,700
    
    
    
    1,457Total current assets
    
    
    25,116
    
    
    
    31,765Property and equipment, net
    
    
    63,885
    
    
    
    63,233Noncurrent portion of notes receivable from officers and employees
    
    
    317
    
    
    
    169Long-term investments
    
    
    0
    
    
    
    1,553Other assets
    
    
    394
    
    
    
    409Total assets
    
    $
    89,712
    
    
    $
    97,129LIABILITIES, REDEEMABLE CONVERTIBLE PREFERREDSTOCK AND SHAREHOLDERS EQUITYCurrent liabilities:Accounts payable
    
    $
    1,146
    
    
    $
    1,951Accrued clinical and cost of other studies
    
    
    214
    
    
    
    291Accrued compensation
    
    
    3,875
    
    
    
    2,195Deferred revenue
    
    
    8,281
    
    
    
    10,682Current portion of capital lease obligations
    
    
    645
    
    
    
    1,753Other accrued liabilities
    
    
    748
    
    
    
    407Total current liabilities
    
    
    14,909
    
    
    
    17,279Noncurrent portion of deferred revenue
    
    
    4,782
    
    
    
    6,170Noncurrent portion of capital lease obligations
    
    
    0
    
    
    
    497Noncurrent portion of deferred rent
    
    
    1,270
    
    
    
    1,108Commitments and contingenciesRedeemable convertible preferred stock, no par value;
5,000,000 shares authorized; issued and outstanding
shares: 1,544,626 at September 30, 2003 and 2,001,236
at December 31, 2002; liquidation preference of $37,380
at September 30, 2003 and $48,430 at December 31, 2002
    
    
    23,669
    
    
    
    30,665Shareholders equity:Common stock, no par value; 100,000,000 shares authorized;
issued and outstanding shares: 54,295,481 at September 30,
2003 and 31,157,612 at December 31, 2002
    
    
    254,420
    
    
    
    230,853Accumulated deficit
    
    
    (209,338
    )
    
    
    (189,443
    )Total shareholders equity
    
    
    45,082
    
    
    
    41,410Total liabilities, redeemable convertible preferred
stock and shareholders equity
    
    $
    89,712
    
    
    $
    97,129


See accompanying notes.

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ARADIGM CORPORATION
STATEMENTS OF OPERATIONS

Three Months EndedSeptember 30,2003
    
    2002(Unaudited)(In thousands, except per share data)Contract
revenues (Including amounts from related parties:
2003  $9,840; 2002  $5,525)
    
    $
    9,843
    
    
    $
    5,951Operating expenses:Research and development
    
    
    11,988
    
    
    
    13,660General and administrative
    
    
    2,428
    
    
    
    2,636Total operating expenses
    
    
    14,416
    
    
    
    16,296Loss from operations
    
    
    (4,573
    )
    
    
    (10,345
    )Interest income
    
    
    68
    
    
    
    164Interest expense and other
    
    
    (27
    )
    
    
    (100
    )Net loss
    
    $
    (4,532
    )
    
    $
    (10,281
    )Basic and diluted net loss per share
    
    $
    (0.08
    )
    
    $
    (0.34
    )Shares used in computing basic and diluted net loss per share
    
    
    54,263
    
    
    
    30,597


See accompanying notes.

3



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ARADIGM CORPORATION
STATEMENTS OF OPERATIONS

Nine Months EndedSeptember 30,2003
    
    2002(Unaudited)(In thousands, except per share data)Contract
revenues (Including amounts from related parties:
2003  $26,664; 2002 $19,682
    
    $
    26,911
    
    
    $
    21,364Operating expenses:Research and development
    
    
    38,988
    
    
    
    42,561General and administrative
    
    
    7,941
    
    
    
    7,903Total operating expenses
    
    
    46,929
    
    
    
    50,464Loss from operations
    
    
    (20,018
    )
    
    
    (29,100
    )Interest income
    
    
    262
    
    
    
    664Interest expense and other
    
    
    (122
    )
    
    
    (349
    )Net loss
    
    
    (19,878
    )
    
    
    (28,785
    )Basic and diluted net loss per share:Net loss per share
    
    $
    (0.42
    )
    
    $
    (0.96
    )Shares used in computing basic and diluted net loss per share
    
    
    47,088
    
    
    
    29,958


See accompanying notes.

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ARADIGM CORPORATION
STATEMENTS OF CASH FLOWS

Nine Months EndedSeptember 30,2003
    
    2002(Unaudited)(In thousands)Cash flows from operating activities:Net loss
    
    $
    (19,878
    )
    
    $
    (28,785
    )Adjustments to reconcile net loss to cash used in operating activities:Depreciation and amortization
    
    
    4,646
    
    
    
    4,289Issuance of warrants and common stock for services
    
    
    14
    
    
    
    6Amortization of deferred compensation
    
    
    
    
    
    
    54Changes in operating assets and liabilities:Receivables
    
    
    (8,677
    )
    
    
    1,344Other current assets
    
    
    (244
    )
    
    
    (1,263
    )Other assets
    
    
    16
    
    
    
    54Accounts payable
    
    
    (805
    )
    
    
    (3,765
    )Accrued compensation
    
    
    1,680
    
    
    
    3,388Other accrued liabilities
    
    
    264
    
    
    
    (2,063
    )Deferred rent
    
    
    161
    
    
    
    Deferred revenue
    
    
    (3,788
    )
    
    
    (3,914
    )Net cash used in operating activities
    
    
    (26,611
    )
    
    
    (30,655
    )Cash flows from investing activities:Capital expenditures
    
    
    (5,298
    )
    
    
    (8,644
    )Sale of available-for-sale investments
    
    
    1,417
    
    
    
    (9,786
    )Proceeds from maturities of available-for-sale investments
    
    
    4,597
    
    
    
    4,784Net cash provided by (used) in investing activities
    
    
    716
    
    
    
    (13,646
    )Cash flows from financing activities:Proceeds from issuance of common stock, net
    
    
    16,557
    
    
    
    6,161Cost from issuance of redeemable convertible preferred stock
    
    
    0
    
    
    
    (70
    )Notes receivable from officers
    
    
    (151
    )
    
    
    (40
    )Payments on lease obligations and equipment loans
    
    
    (1,605
    )
    
    
    (2,699
    )Net cash provided by financing activities
    
    
    14,801
    
    
    
    3,352Net (decrease) in cash and cash equivalents
    
    
    (11,094
    )
    
    
    (40,949
    )Cash and cash equivalents at beginning of period
    
    
    22,800
    
    
    
    69,965Cash and cash equivalents at end of period
    
    $
    11,706
    
    
    $
    29,016Supplemental disclosure of cash flow information:Cash paid for interest
    
    $
    122
    
    
    $
    392Non-cash investing and financing activities:Issuance of common stock through conversion of Series A preferred stock
    
    $
    6,995
    
    
    $
    0Issuance of warrants in conjunction with private placement of common stock
    
    $
    2,469
    
    
    $
    0Issuance of warrants and options to purchase common stock for services
    
    $
    14
    
    
    $
    6


See accompanying notes.

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ARADIGM CORPORATION
NOTES TO THE UNAUDITED FINANCIAL STATEMENTS
September 30, 2003

1. Organization and Basis of Presentation

Organization

Aradigm Corporation (the Company) is a California corporation engaged in
the development and commercialization of non-invasive drug delivery systems.
Principal activities to date have included obtaining financing, recruiting
management and technical personnel, securing operating facilities, conducting
research and development, and expanding commercial production capabilities.
The Company does not anticipate receiving any revenue from the sale of products
in the upcoming year. These factors indicate that the Companys ability to
continue its research, development and commercialization activities is
dependent upon the ability of management to obtain additional financing as
required.

Basis of Presentation

The accompanying unaudited financial statements have been prepared in
accordance with generally accepted accounting principles for interim financial
information and with the instructions to Form 10-Q and Article 10 of Regulation
S-X. In the opinion of management, the financial statements reflect all
adjustments, which are of a normal recurring nature, necessary for a fair
presentation. The accompanying financial statements should be read in
conjunction with the financial statements and notes thereto included with the
Companys Annual Report on Form 10-K. The results of the Companys operations
for the interim periods presented are not necessarily indicative of operating
results for the full fiscal year or any future interim period.

The Balance Sheet at December 31, 2002 has been derived from the audited
financial statements at that date, but does not include all of the information
and footnotes required by generally accepted accounting principles for complete
financial statements.

2. Summary of Significant Accounting Policies

Stock Based Compensation

The Company has elected to follow Accounting Principles Board Opinion No.
25 Accounting for Stock Issued to Employees and related interpretations in
accounting for its employee stock options, including Financial Accounting
Standard Board Interpretation 44 Accounting for Certain Transactions Involving
Stock Compensation. Compensation expense is based on the difference, if any,
between the fair value of the Companys common stock and the exercise price of
the option or share right on the measurement date, which is typically the date
of grant. In accordance with Statement of Financial Accounting Standards (SFAS)
123 Accounting for Stock-Based Compensation (SFAS 123) as amended by SFAS
148 Accounting for Stock-Based Compensation  Transition and Disclosure, the
Company has provided below, the pro forma disclosures of the effect on net loss
and loss per share as if SFAS 123 had been applied in measuring compensation
expense for all periods presented.





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Three Months Ended
    
    Nine Months EndedSeptember 30,
    
    September 30,2003
    
    2002
    
    2003
    
    2002Net loss applicable to common shareholders  as reported
    
    $
    (4,532
    )
    
    $
    (10,281
    )
    
    $
    (19,878
    )
    
    $
    (28,785
    )Add:Stock-based employee
compensation expense
included in reported net
loss
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    54Less:Total stock-based employee
compensation expense
determined under fair value
based method for all awards
    
    $
    (1,319
    )
    
    $
    (1,754
    )
    
    $
    (4,230
    )
    
    $
    (5,705
    )Pro forma net loss applicable to common shareholders
    
    $
    (5,851
    )
    
    $
    (12,035
    )
    
    $
    (24,108
    )
    
    $
    (34,436
    )Basic and diluted net loss per share applicable
to common
shareholders As reported
    
    $
    (0.08
    )
    
    $
    (0.34
    )
    
    $
    (0.42
    )
    
    $
    (0.96
    )Pro forma
    
    $
    (0.11
    )
    
    $
    (0.39
    )
    
    $
    (0.51
    )
    
    $
    (1.15
    )


The Company accounts for options and warrants issued to non-employees
under SFAS 123 and Emerging Issues Task Force Issue No. 96-18.

Computation of Net Loss Per Share

Basic net loss per share has been computed using the weighted average
number of shares of common stock outstanding less the weighted average number
of shares subject to repurchase during the period. No diluted loss per share
information has been presented in the accompanying statements of operations
since potential common shares from stock options, warrants and redeemable
convertible preferred stocks are antidilutive.

3. Asset Acquisition

On May 12, 2003, the Company completed the purchase of certain assets from
the Weston Medical Group (Weston), a UK public company currently in
bankruptcy. Westons business involved the design, development, manufacture and
exploitation of drug delivery technologies, including a proprietary needle-free
injection technology known as Intraject. The Company acquired test and
production equipment, intellectual property and other assets associated with
Westons drug delivery technologies for an initial cash consideration of
approximately $2.0 million and subsequent transfer costs of approximately $0.9
million. The initial purchase price and subsequent transfer costs are
included in property and equipment on the balance sheet at
September 30, 2003.

4. Shareholders Equity

Pursuant to a Securities Purchase Agreement entered into as of February
10, 2003, the Company issued in a private placement 18,992,391 shares of common
stock at $0.79 per share and warrants to purchase 4,273,272 shares of common
stock at $1.07 per share to certain investors for an aggregate purchase price
of approximately $15.0 million. The warrants are exercisable at the election of
the warrant holders for a four-year term. The Company valued the warrants using
the Black-Scholes option pricing model using the following assumptions:
estimated volatility of 62%, risk-free interest rate of 4.4%, no dividend
yield, and an expected life of 4 years, and recorded approximately $1.4 million
as issuance costs related to the private placement. In addition, in connection
with this private placement, the Company issued warrants (repriced warrants)
to purchase an aggregate of 4,016,024 shares of its common stock at $1.12 per
share to certain of the investors in the private placement in exchange for the
cancellation of an equal number of warrants to
purchase shares of the common stock at $6.97 per share, held by the same
investors. The Company valued





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the repriced warrants using the Black-Scholes
option pricing model using the following assumptions: estimated volatility of
62%, risk-free interest rate of 4.4%, no dividend yield, and an expected life
of 3.8 years, and recorded an additional $1.1 million as issuance costs related
to the private placement.

In June 2003 the Company received net proceeds of approximately $2.3
million and issued an aggregate of 2,171,964 shares of common stock in
connection with the exercise of warrants by three investors.

In March, June and July 2003, holders of an aggregate of 456,610 shares of
redeemable convertible preferred stock (preferred stock) elected to convert
shares of preferred stock to common stock under the terms of a preferred stock
purchase agreement entered into as of December 14, 2001. Each share of
preferred stock, together with accrued and unpaid dividends, is convertible at
the option of the holder, into four shares of common stock. The Company issued
1,826,440 shares of common stock in connection with the conversion.

5. Related Party

Novo Nordisk and its affiliate, Novo Nordisk Pharmaceuticals, Inc., are
considered related parties, and in addition to being the Companys primary
revenue source and at September 30, 2003 own approximately 13.0% of the
Companys total outstanding common stock (on an as-converted basis).

6. Subsequent Event

On
November, 10 2003, the Company closed a private placement in
which it sold 7,502,774 shares of common stock at a price of $1.80 per
share and warrants to purchase 1,875,690 shares of common stock at $2.50 per
share for an aggregate consideration of approximately
$13.5 million.




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 the Companys most recent Form 10-K
andForm 10-Qfiled with the Securities and Exchange Commission.

The 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 publicly release the results of any revision to these forward-looking
statements which may be made to reflect events or circumstances occurring after
the date hereof or to reflect the occurrence of unanticipated events.

Overview

Since our inception in 1991, we have been engaged in the development of
innovative drug delivery systems. Beginning with our AERx pulmonary delivery
system and more recently with the Intraject subcutaneous delivery technology
acquired in May 2003 from Weston, we are building a solid platform in
needle-free drug delivery. As of September 30, 2003, we had an accumulated
deficit of $209.3 million. We





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have not been profitable since inception and
expect to incur additional operating losses over the next several years as
research and development efforts, preclinical and clinical testing activities
and manufacturing scale-up efforts expand and as we plan and build our
late-stage clinical and early commercial production capabilities. To date, we
have not had any material product sales and do not anticipate receiving any
revenue from the sale of products in the upcoming year. Our sources of working
capital have been equity financings, equipment lease financings, contract
revenues and interest earned on investments.

We have performed initial feasibility work on a number of compounds with
the AERx system and have been compensated for expenses incurred while
performing this work in several cases pursuant to feasibility study agreements
with third parties. Once feasibility is demonstrated with respect to a
potential product, we seek to enter into development contracts with
pharmaceutical corporate partners. We currently have an agreement pursuant to
which we are developing pulmonary delivery systems with Novo Nordisk A/S, to
manage diabetes using insulin and other blood glucose regulating compounds, and
with GlaxoSmithKline plc, to manage acute and breakthrough pain using opioid
analgesics.

We expect to perform various studies evaluating our Intraject subcutaneous
delivery platform for both existing and future partnerships. The Intraject
technology is currently being evaluated for application with several worldwide
pharmaceutical corporations as well as with several other smaller-sized
biotechnology companies for various compounds. In some cases, a partnership may
not be disclosed until a long-term development agreement has been established.

Our lead development program is developing pulmonary delivery systems to
manage diabetes using insulin and other blood glucose regulating compounds with
our partner Novo Nordisk. Since Novo Nordisk and we successfully initiated
Phase 3 clinical trials in September 2002, we have been focused on supporting
our partner in the existing and planned additional Phase 3 clinical trials that
will be needed for their regulatory submission and commercial scale-up
activities. Current activities in this area focus on the elimination of a
blemish discovered on a certain percentage of AERx strips. Through extensive
quality testing we have determined that the blemish is strictly cosmetic and
has no impact on the functionality of the product nor does it cause the product
to fail sterility testing. The source of the appearance of the blemish must
now be resolved before initiation of additional clinical studies. Novo Nordisk
has announced that they do not expect to initiate these additional studies
until the end of 2004. During this investigation, Aradigm and Novo Nordisk
will also be undertaking steps to improve the design of the AERx device to
facilitate our commercial manufacturing program.

The collaborative agreement with Novo Nordisk provides for reimbursement
of research and development expenses as well as additional payments to us as we
achieve certain significant milestones. We also expect to receive royalties
from this development partner based on revenues from product sales and to
receive revenue from the manufacturing of unit dose packets and hand-held
devices. We recognize revenues under the terms of our collaborative agreement
as the research and development expenses are incurred, to the extent they are
reimbursable. For the nine months ended September 30, 2003, this partner-funded
program has contributed approximately 99.0% of our total contract revenues. At
September 30, 2003, Novo Nordisk and its affiliate Novo Nordisk
Pharmaceuticals, Inc. own approximately 13.0% of our total outstanding common
stock (on an as-converted basis) and are considered a related party.

Our next program has been conducted to date with our partner
GlaxoSmithKline pursuant to our development agreement, as amended, which covers
the use of the AERx Pain Management System for the delivery of narcotic
analgesics. During December 2000, GlaxoSmithKline and Aradigm amended the
product development and commercialization agreement whereby we assumed full
control and responsibility for conducting and financing the remainder of all
development activities. Under the amendment, unless GlaxoSmithKline or we have
terminated the agreement, GlaxoSmithKline can restore its rights to participate
in the development and commercialization of the product under the amended
agreement upon payment of a restoration fee to us. GlaxoSmithKline has been in
a position to exercise its restoration election since delivery of Phase 2b
trial results, which were made available to them during the second quarter of
2002. Since they have not done so and it appears unlikely that they will do so
in the future, we
are currently in discussions with several alternate partners for this product.
There can be no assurance that





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we will successfully enter into an alternative
partnership agreement for this product if GlaxoSmithKline does not elect to
restore its rights.

In addition to the diabetes, morphine and fentanyl programs, we have
additional partner funded programs in development, including two gene therapy
programs. In general, it is our policy not to disclose the partner and/or the
drug until a long-term development agreement has been established; both parties
agree to highlight a clinical advancement in the program or under special
circumstances in which both parties agree to disclosure. In 2002, we announced
successful clinical results from one partnered trial with interferon alpha when
an abstract was accepted at a leading scientific session, in which the partner
was not disclosed. In addition, a gene therapy collaboration with geneRx+ was
disclosed in which we hold certain potentially beneficial licensing rights.

Critical Accounting Policies

We consider certain accounting policies related to revenue recognition and
the use of estimates to be critical accounting policies that require the use of
significant judgments and estimates relating to matters that are inherently
uncertain and may result in materially different results under different
assumptions and conditions.

Revenue Recognition

Contract revenues consist of revenue from collaboration agreements and
feasibility studies. We recognize revenue under the agreements as costs are
incurred. Deferred revenue represents the portion of all refundable and
nonrefundable research payments received that have not been earned. In
accordance with contract terms, milestone payments from collaborative research
agreements are considered reimbursements for costs incurred under the
agreements and, accordingly, are generally recognized as revenue either upon
the completion of the milestone effort when payments are contingent upon
completion of the effort or are based on actual efforts expended over the
remaining term of the agreements when payments precede the required efforts.
Costs of contract revenues are approximate to or are greater than such revenue
and are included in research and development expenses. Refundable development
and license fee payments are deferred until the specified performance criteria
are achieved. Refundable development and license fee payments are generally not
refundable once the specific performance criteria are achieved and accepted and
such payments are no longer refundable.

Impairment of Long-Lived Assets

We review for impairment whenever events or changes in circumstances
indicate that the carrying amount of property and equipment may not be
recoverable. Determination of recoverability is based on an estimate of
undiscounted future cash flows resulting from the use of the asset and its
eventual disposition. In the event that such cash flows are not expected to be
sufficient to recover the carrying amount of the assets, the assets are written
down to their estimated fair values and the loss is recognized on the
Statements of Operations.

Use of Estimates

The preparation of financial statements in conformity with generally
accepted accounting principles requires us to make estimates and assumptions
that affect the amounts reported in the financial statements and accompanying
notes to the financial statements. These estimates include useful lives for
property and equipment and related depreciation calculations, estimated
amortization period for payments received from product development and license
agreements as they relate to the revenue recognition of deferred revenue and
assumptions for valuing options and warrants. Actual results could differ from
these estimates.

Three Months Ended September 30, 2003 and 2002

Contract and License Revenues:Contract revenues for the three months
ended September 30, 2003 increased to $9.8 million from $6.0 million for the
same period in 2002. Revenue from Novo Nordisk was $9.8 million for the three
months ended September 30, 2003 and $5.5 million for the same period in 2002.
The increase in contract and license revenues is related to increased
reimbursement by Novo Nordisk for





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clinical supply and product development
activities for the ongoing Phase 3 clinical program as well as payment of
unreimbursed expenses from prior quarters; offset by lower revenues from other
funded programs. Costs associated with collaborative agreements are included
in research and development expenses. We expect that the revenue from Novo
Nordisk may trend down over the coming quarter(s) due to the expected level of
activity in support of the ongoing Phase 3 clinical program and the fact that
at September 30, 2003 payments for all unreimbursed expenses were received.

Research and Development Expenses:Research and development expenses for
the three months ended September 30, 2003 decreased to $12.0 million from $13.7
million for the same period in 2002. The decrease in research and development
expenses is primarily due to a reduction in self-funded development efforts and
cost reduction programs.

These expenses represent proprietary research expenses as well as costs
related to contract revenues and include salaries and benefits of scientific
and development personnel, laboratory supplies, consulting services and
expenses associated with the development of manufacturing processes. We expect
research and development spending to increase over the next few years as we
continue to expand our development activities to support current and potential
future collaborations and initiate commercial manufacturing of the AERx
systems. The increase in research and development expenditures cannot be
predicted accurately as it depends in part upon the future success of, and
funding levels supported by, our existing development collaborations, as well
as obtaining new collaborative agreements.

We have additional partner-funded programs, including two gene therapy
programs. Future research and development efforts for these partner-funded
programs are difficult to predict at this time due to their early stage of
development.

General and Administrative Expenses:General and administrative expenses
were $2.4 million for the three month period ended September 30, 2003 and $2.6
million for the same period in 2002. The decrease is primarily due to cost
reduction programs.

Interest Income:Interest income for the three months ended September 30,
2003 decreased to $68,000 from $164,000 for the same period in 2002. The
decrease is due to lower invested balances and lower interest rates.

Interest Expense and Other:Interest expense for the three months ended
September 30, 2003 decreased to $27,000 from $100,000 for the same period in
2002. The decrease is primarily due to lower outstanding capital lease and
equipment loan balances under various equipment and lease lines of credit.

Net Loss:Net loss for the three months ended September 30, 2003 of $4.5
million was lower compared to the $10.3 million loss for the same period in
2002, reflecting higher Novo Nordisk contract revenues and reduced expenses for
self-funded projects.

Nine Months Ended September 30, 2003 and 2002

Contract Revenues:Contract revenues for the nine months ended September
30, 2003 increased to $26.9 million from $21.4 million for the same period in
2002. Revenue from Novo Nordisk was $26.7 million for the nine months ended
September 30, 2003 and $19.7 million for the same period in 2002. The increase
in revenue is related to increased reimbursement by Novo Nordisk for clinical
supply and product development activities for the ongoing Phase 3 clinical
program as well as payment of unreimbursed expenses from prior quarters; offset
by lower revenue from other funded programs.

Research and Development Expenses:Research and development expenses for
the nine months ended September 30, 2003 decreased to $39.0 million from $42.6
million for the same period in 2002. The decrease in research and development
expenses is primarily due to a reduction in self-funded development efforts and
cost reduction programs.





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General and Administrative Expenses:General and administrative expenses
remained unchanged at $7.9 million for the nine months ended September 30, 2003
and for the same period in 2002.

Interest Income:Interest income for the nine months ended September 30,
2003 decreased to $262,000 from $664,000 for the same period in 2002. The
decrease is due to lower invested balances and lower interest rates.

Interest Expense and Other:Interest expense for the nine months ended
September 30, 2003 decreased to $122,000 from $349,000 for the same period in
2002. The decrease is primarily due to lower outstanding capital lease and
equipment loan balances under various equipment and lease lines of credit.

Net Loss:Net loss for the nine months ended September 30, 2003 decreased
to $19.9 million from $28.8 million for the same period in 2002 reflecting our
focus on the Novo Nordisk funded project and cost reduction efforts in other
areas.

Liquidity and Capital Resources

We have financed our operations since inception primarily through private
placements and public offerings of capital stock, proceeds from equipment lease
financing, contract revenues and interest earned on investments. As of
September 30, 2003, we had cash, cash equivalents and investments of
approximately $14.3 million. The receivable balance of $8.9 million at
September 30, 2003, was paid on October 2, 2003.

In March 2003, we raised approximately $15.0 million through the sale of
18,992,391 shares of common stock at a price of $0.79 per share and warrants to
purchase 4,273,272 shares of common stock at $1.07 per share to certain
investors in a private placement.

In June 2003, we received net proceeds of approximately $2.3 million and
issued an aggregate of 2,171,964 shares of Common Stock in connection with the
exercise of warrants by three investors.

Net cash used in operating activities for the nine months ended September
30, 2003 decreased to $26.6 million from $30.7 million for the same period in
2002. Net cash used was lower in 2003 due to the substantially lower operating
loss and lower cash usage for accounts payable and other accrued liabilities;
offset by decrease in cash provided from accounts receivable and other assets.

Investing activities for the nine months ended September 30, 2003 provided
cash of $716,000 in contrast to the use of cash of $13.6 million for the same
period in 2002. Lower net cash used in investing activities is primarily due to
lower capital expenditures offset by a net increase of
$6.0 million from matured investments and from sales of
short-term securities. The capital expenditures for the
nine months ended September 30, 2003 were $5.3 million compared to $8.6 million
for the same period in 2002. Higher capital expenditures in 2002 related to the
acquisition of manufacturing production equipment for commercial production.
The majority of the capital expenditures in 2003 relate to the acquisition of
the Intraject property and equipment.

On May 12, 2003, we completed the purchase of certain assets from Weston,
a UK public company currently in bankruptcy. Westons business involved the
design, development, manufacture and exploitation of drug delivery
technologies, including a proprietary needle-free injection technology known as
Intraject. We acquired test and production equipment, intellectual property
and other assets associated with Westons drug delivery technologies for an
initial cash consideration of $2.0 million. The initial purchase price and
subsequent transfer costs totaling $2.9 million have been funded out of our
working capital. We will continue the development of Westons technologies and
drug delivery systems at our existing US facilities. We will continue
development of Intraject by re-allocating existing resources and we are not
anticipating more than a small increase in our current cash burn rate.

Net cash provided by financing activities for the nine months ended
September 30, 2003 was $14.8 million compared to net cash provided of $3.4
million for the same period in 2002. The increase in cash





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provided is the result of the completion of the private placement in March 2003
and lower payments on lease obligations and equipment loans.

The development of our technology and proposed products, including the
Intraject development program, will require a commitment of substantial funds
to conduct the costly and time-consuming research, preclinical studies and
clinical trial activities necessary to develop and refine the technology and
proposed products and bring such products to market. Our future capital
requirements will depend on many factors, including continued progress and
results from research and development for the technology and drug delivery
systems, the ability to establish and maintain favorable collaborative
arrangements with others, progress with preclinical studies and clinical trials
and the results thereof, the time and costs involved in obtaining regulatory
approvals, the cost of development and the rate of scale-up for the required
production technologies, the costs involved in preparing, filing, prosecuting,
maintaining and enforcing patent claims and the need to acquire licenses or
other rights to new technology.

We continue to review our planned operations through the end of 2003 and
beyond. We particularly focus on capital spending requirements to ensure that
capital outlays are not expended sooner than necessary. We expect our total
annual capital outlays for 2003 not to exceed $8.0 million. Other than in
connection with the acquisition of the Intraject related assets, since December
31, 2002, there have been no material changes in our contractual obligations or
commitments. We believe that our existing cash balances at September 30, 2003,
together with the $20.0 million unused common stock purchase commitment from
Novo Nordisk A/S, research and development funding commitments from corporate
development partners and interest earned on our investments should be
sufficient to meet our needs for at least the next 21 months. The sale of
additional common stock to Novo Nordisk A/S is subject to certain conditions
and there can be no assurance that our funding commitments from corporate
development partners will not be amended or terminated. If we cannot exercise
our option to sell additional shares of common stock to Novo Nordisk or if our
current funding commitments from corporate development partners are amended or
terminated, we will need to obtain additional sources of capital sooner than
would otherwise be the case.

If our development programs, including the Intraject development program,
continue to progress, we would expect our cash requirements for capital
spending and operations to increase in future periods. We will need to raise
additional capital to fund our capital spending and operations before we become
profitable. We may seek additional funding through collaborations, borrowing
arrangements or through public or private equity financings. There can be no
assurance that additional financing can be obtained on acceptable terms, or at
all. Dilution to shareholders may result if funds are raised by issuing
additional equity securities. If adequate funds are not available, we may be
required to delay, to reduce the scope of, or to eliminate one or more of our
research and development programs, or to obtain funds through arrangements with
collaborative partners or other sources that may require us to relinquish
rights to certain of our technologies or products that we would not otherwise
relinquish.




Item 3. Quantitative and Qualitative Disclosures About Market Risk

Market Risk Disclosures

In the normal course of business, our financial position is routinely
subject to a variety of risks, including market risk associated with interest
rate movement. We regularly assess these risks and have established policies
and business practices to protect against these and other exposures. As a
result, we do not anticipate material potential losses in these areas.

As of September 30, 2003, we had cash and cash equivalents and short-term
investments of $14.3 million consisting of cash and highly liquid short-term
investments. Our short-term investments will decline by an immaterial amount if
market interest rates increase, and therefore, our exposure to interest rate
changes has been immaterial. Declines of interest rates over time will,
however, reduce our interest income from our short-term investments. Our
outstanding capital lease obligations are all at fixed interest rates and,
therefore, have minimal exposure to changes in interest rates.





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Item 4.Controls and Procedures

Evaluation of Disclosure Controls and Procedures

Based on their evaluation of our disclosure controls and procedures (as
defined in the rules promulgated under the Securities Exchange Act of 1934),
our chief executive officer and our chief financial officer concluded that our
disclosure controls and procedures were effective as of the end of the period
covered by this report.

We believe that a controls system, no matter how well designed and
operated, cannot provide absolute assurance that the objectives of the controls
system are met, and no evaluation of controls can provide absolute assurance
that all control issues and instances of fraud, if any, within a company have
been detected. Our disclosure controls and procedures are designed to provide
reasonable assurance of achieving their objectives, and our chief executive
officer and our chief financial officer have concluded that these controls and
procedures are effective at the reasonable assurance level.

Changes in Internal Controls

There were no significant changes in our internal control over financial
reporting during the period covered by this report that have materially
affected, or are reasonably likely to materially affect, our internal control
over financial reporting.




PART II. OTHER INFORMATION




Item 6.Exhibits and Reports on Form 8-K

(a) Exhibits



| |  |  | 31.1 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
| |  |  | -------------------------------------------------------------------------

(b) Reports on Form 8-K

We filed a Current Report on Form 8-K dated July 23, 2003 to furnish (i) a
press release in which we announced our financial results for the second
quarter endedJune 30, 2003 and (ii) a transcript of our conference call held on
July 23, 2003.

We filed a Current Report on Form 8-K dated August 6, 2003 to furnish a
transcript of our conference call held on August 6, 2003.





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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.

ARADIGM CORPORATION
(Registrant)/s/ RICHARD P. THOMPSONRichard P. ThompsonChairman and Chief Executive Officer/s/ THOMAS C. CHESTERMANThomas C. ChestermanSenior Vice President and Chief Financial OfficerDated: November 11, 2003






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INDEX TO EXHIBITS

ExhibitNumber
    
    Description31.1
    
    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