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UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, DC 20549
  Form 10-Q
  (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, 2004Oro
    
    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
    
    (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
 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
    
    63,962,335(Class)
    
    (Outstanding at
October 31, 2004)




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ARADIGM CORPORATION
INDEX

|                                                                                              |  |          |    | 
|--------------------------------------------------------------------------------------------- |  | -------- | -- | 
|                                                                                              |  | Page
No.
|PART I. FINANCIAL INFORMATION                                                                 |  |          | 2  | 
|ITEM 1. Condensed Financial Statements (unaudited)                                            |  |          | 2  | 
|Condensed Balance Sheets                                                                      |  |          |    | 
|At
September 30, 2004 and December 31, 2003                                                   |  |          | 2  | 
|Condensed Statements of Operations                                                            |  |          |    | 
|Three
months ended September 30, 2004 and 2003                                                |  |          | 3  | 
|Nine
months ended September 30, 2004 and 2003                                                 |  |          | 4  | 
|Statements of Cash Flows                                                                      |  |          |    | 
|Nine
months ended September 30, 2004 and 2003                                                 |  |          | 5  | 
|Notes to Unaudited Condensed Financial Statements                                             |  |          | 6  | 
|ITEM 2. Managements Discussion and Analysis of Financial
Condition and Results of Operations |  |          | 8  | 
|ITEM 3. Quantitative and Qualitative Disclosure About Market Risk                             |  |          | 12 | 
|ITEM 4. Controls and Procedures                                                               |  |          | 13 | 
|PART
II. OTHER INFORMATION                                                                    |  |          | 13 | 
|ITEM 5. Other Information                                                                     |  |          | 13 | 
|ITEM 6. Exhibits                                                                              |  |          | 13 | 
|Signatures                                                                                    |  |          | 14 | 
|Index to Exhibits                                                                             |  |          | 15 | 
|EXHIBIT 10.29                                                                                
|EXHIBIT 31.1                                                                                 
|EXHIBIT 31.2                                                                                 
|EXHIBIT 32.1                                                                                 



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PART I. FINANCIAL INFORMATION 
 Item 1.Condensed Financial Statements ARADIGM CORPORATION 
 CONDENSED BALANCE SHEETS
 September 30,
    
    December 31,2004
    
    2003(Unaudited)
    
    (Note 1)(In thousands, except shares data)ASSETSCurrent assets:Cash and cash equivalents
    
    $
    6,657
    
    
    $
    18,327Short-term investments
    
    
    6,449
    
    
    
    11,443Receivables
    
    
    72
    
    
    
    140Current portion of notes receivable from officers and
employees
    
    
    77
    
    
    
    104Prepaid expenses and other current assets
    
    
    2,142
    
    
    
    1,910Total current assets
    
    
    15,397
    
    
    
    31,924Property and equipment, net
    
    
    60,387
    
    
    
    62,612Noncurrent portion of notes receivable from officers and employees
    
    
    259
    
    
    
    294Other assets
    
    
    447
    
    
    
    388Total assets
    
    $
    76,490
    
    
    $
    95,218LIABILITIES, REDEEMABLE CONVERTIBLE PREFERRED STOCK AND SHAREHOLDERS EQUITYCurrent liabilities:Accounts payable
    
    $
    1,334
    
    
    $
    885Accrued clinical and cost of other studies
    
    
    363
    
    
    
    149Accrued compensation
    
    
    4,573
    
    
    
    2,021Deferred revenue
    
    
    8,818
    
    
    
    7,891Current portion of capital lease obligations
    
    
    
    
    
    
    427Other accrued liabilities
    
    
    1,299
    
    
    
    843Total current liabilities
    
    
    16,387
    
    
    
    12,216Noncurrent portion of deferred revenue
    
    
    4,271
    
    
    
    5,040Noncurrent portion of deferred rent
    
    
    1,749
    
    
    
    1,323Commitments and contingenciesRedeemable convertible preferred stock, no par value; 5,000,000 shares
authorized; issued and outstanding shares: 1,544,626 at September 30, 2004
and at December 31, 2003; liquidation preference of $37,380 at September 30,
2004 and at December 31, 2003
    
    
    23,669
    
    
    
    23,669Shareholders equity:Common stock, no par value; 150,000,000 and 100,000,000 shares authorized at
September 30, 2004 and December 31, 2003, respectively; issued and
outstanding shares: 63,564,493 at September 30, 2004 and 62,751,196 at
December 31, 2003
    
    
    269,270
    
    
    
    268,406Accumulated deficit
    
    
    (238,856
    )
    
    
    (215,436
    )Total shareholders equity
    
    
    30,414
    
    
    
    52,970Total liabilities,
redeemable
convertible
preferred stock and
shareholders
equity
    
    $
    76,490
    
    
    $
    95,218
 See accompanying notes. 2




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ARADIGM CORPORATION 
 CONDENSED STATEMENTS OF OPERATIONS
 Three Months EndedSeptember 30,2004
    
    2003(Unaudited)(In thousands, except per share data)Contract revenues (Including amounts from related parties:2004  $5,918; 2003  $9,840)
    
    $
    6,352
    
    
    $
    9,843Operating expenses:Research and development
    
    
    11,407
    
    
    
    11,988General and administrative
    
    
    3,217
    
    
    
    2,428Total operating expenses
    
    
    14,624
    
    
    
    14,416Loss from operations
    
    
    (8,272
    )
    
    
    (4,573
    )Interest income
    
    
    45
    
    
    
    68Interest expense
    
    
    (3
    )
    
    
    (27
    )Net loss
    
    $
    (8,230
    )
    
    $
    (4,532
    )Basic and diluted net loss per share
    
    $
    (0.13
    )
    
    $
    (0.08
    )Shares used in computing basic and diluted net loss per share
    
    
    63,564
    
    
    
    54,263
 See accompanying notes. 3




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ARADIGM CORPORATION CONDENSED STATEMENTS OF OPERATIONS
 Nine Months EndedSeptember 30,2004
    
    2003(Unaudited)(In thousands, except per share data)Contract revenues (Including amounts from related parties:2004  $19,534; 2003  $26,664)
    
    $
    20,073
    
    
    $
    26,911Operating expenses:Research and development
    
    
    34,706
    
    
    
    38,988General and administrative
    
    
    8,920
    
    
    
    7,941Total operating expenses
    
    
    43,626
    
    
    
    46,929Loss from operations
    
    
    (23,553
    )
    
    
    (20,018
    )Interest income
    
    
    160
    
    
    
    262Interest expense
    
    
    (18
    )
    
    
    (122
    )Net loss
    
    $
    (23,411
    )
    
    $
    (19,878
    )Basic and diluted net loss per share:Net loss per share
    
    $
    (0.37
    )
    
    $
    (0.42
    )Shares used in computing basic and diluted net loss per share
    
    
    63,350
    
    
    
    47,088
 See accompanying notes. 4




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ARADIGM CORPORATION 
 STATEMENTS OF CASH FLOWS
 Nine Months EndedSeptember 30,2004
    
    2003(Unaudited)(In thousands)Cash flows from operating activities:Net loss
    
    $
    (23,411
    )
    
    $
    (19,878
    )Adjustments to reconcile net loss to cash used in operating activities:Depreciation and amortization
    
    
    3,240
    
    
    
    4,646Loss on disposal of fixed assets
    
    
    257
    
    
    
    Issuance of warrants and common stock for services
    
    
    78
    
    
    
    14Changes in operating assets and liabilities:Receivables
    
    
    68
    
    
    
    (8,677
    )Prepaid expenses and other current assets
    
    
    (232
    )
    
    
    (244
    )Other assets
    
    
    (59
    )
    
    
    16Accounts payable
    
    
    449
    
    
    
    (805
    )Accrued compensation
    
    
    2,552
    
    
    
    1,680Other accrued liabilities
    
    
    670
    
    
    
    264Deferred rent
    
    
    426
    
    
    
    161Deferred revenue
    
    
    158
    
    
    
    (3,788
    )Net cash used in operating activities
    
    
    (15,804
    )
    
    
    (26,611
    )Cash flows from investing activities:Capital expenditures
    
    
    (1,272
    )
    
    
    (5,298
    )Sale (purchase) of available-for-sale investments
    
    
    (6,376
    )
    
    
    1,417Proceeds from maturities of available-for-sale investments
    
    
    11,361
    
    
    
    4,597Net cash provided by investing activities
    
    
    3,713
    
    
    
    716Cash flows from financing activities:Proceeds from issuance of common stock, net
    
    
    481
    
    
    
    16,557Proceeds from exercise of options and warrants for common stock
    
    
    305
    
    
    
    Notes receivable from officers
    
    
    62
    
    
    
    (151
    )Payments on lease obligations and equipment loans
    
    
    (427
    )
    
    
    (1,605
    )Net cash provided by financing activities
    
    
    421
    
    
    
    14,801Net decrease in cash and cash equivalents
    
    
    (11,670
    )
    
    
    (11,094
    )Cash and cash equivalents at beginning of period
    
    
    18,327
    
    
    
    22,800Cash and cash equivalents at end of period
    
    $
    6,657
    
    
    $
    11,706Supplemental disclosure of cash flow information:Cash paid for interest
    
    $
    16
    
    
    $
    122Non-cash investing and financing activities:Issuance of common stock through conversion of Series A preferred stock
    
    $
    
    
    
    $
    6,995Issuance of warrants in conjunction with private placement of common stock
    
    $
    
    
    
    $
    2,469Issuance of warrants and options to purchase common stock for services
    
    $
    78
    
    
    $
    14
 See accompanying notes. 5




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ARADIGM CORPORATION 
  NOTES TO THE UNAUDITED CONDENSED FINANCIAL STATEMENTS
September 30, 2004
 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.
The Company does not anticipate receiving any revenue from the sale of products
in the upcoming year. 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. 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, 2003 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.
(APB) 25, Accounting for Stock Issued to Employees, and related
interpretations in accounting for its employee stock options. 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. This amount is
recorded as Deferred Stock Compensation in the Balance Sheet and amortized as
a charge over the vesting period of the applicable options or share rights. In
accordance with Statement of Financial Accounting Standards (SFAS) 123,
Accounting for Stock-Based Compensation, 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 (in thousands, except per share data). Three Months Ended
    
    Nine Months EndedSeptember 30,
    
    September 30,2004
    
    2003
    
    2004
    
    2003Net loss applicable to common
shareholders  as reported
    
    $
    (8,230
    )
    
    $
    (4,532
    )
    
    $
    (23,411
    )
    
    $
    (19,878
    )Less:Total stock-based
employee
compensation
expense determined
under fair value
based method for
all awards
    
    $
    (827
    )
    
    $
    (1,319
    )
    
    $
    (3,230
    )
    
    $
    (4,230
    )Pro forma net loss applicable to
common shareholders
    
    $
    (9,057
    )
    
    $
    (5,851
    )
    
    $
    (26,641
    )
    
    $
    (24,108
    )Basic and diluted net loss per
share applicable
to common shareholders As reported
    
    $
    (0.13
    )
    
    $
    (0.08
    )
    
    $
    (0.37
    )
    
    $
    (0.42
    )Pro forma
    
    $
    (0.14
    )
    
    $
    (0.11
    )
    
    $
    (0.42
    )
    
    $
    (0.51
    )
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The Company accounts for options and warrants issued to non-employees
under SFAS 123 and Emerging Issues Task Force (EITF) Issue No. 96-18,
Accounting for Equity Instruments that are Issued to Other than Employees for
Acquiring, or in Conjunction with Selling Goods or Services, using the
Black-Scholes option pricing model. The value of options and warrants are
periodically remeasured over their vesting terms. 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. Shareholders Equity In January and April 2004, holders of warrants to purchase 455,693 shares
of common stock elected to exercise the warrants, either with cash or by
operation of cashless exercise provisions contained in the warrants. The
Company issued an aggregate of 371,002 shares of common stock in connection
with the exercise of these warrants, 406 shares of common stock in connection
with the exercise of options, and 441,889 shares of common stock under the
Employee Stock Purchase Plan during the nine months ending September 30, 2004. In January 2004, the Company amended the operating lease for one of its
facilities. Effective January 1, 2004, the new agreement reduces the aggregate
annual lease payments by $1.1 million through 2006 and increases the aggregate
annual payments by $1.1 million from 2007 through 2010. In consideration for
the amended lease agreement, the Company replaced warrants to purchase 135,000
shares of common stock at prices ranging from $10.16 to $21.72 per share with
new warrants to purchase 135,000 shares of common stock at $1.71 per share.
The repricing resulted in additional expense of $88,000 that is being amortized
on a straight-line basis over the remaining life of the lease. 4. Related Party Novo Nordisk and its affiliate, Novo Nordisk Pharmaceuticals, Inc., are
considered related parties and at September 30, 2004 own approximately 11.3% of
the Companys total outstanding common stock (on an as-converted basis).
Contract revenue from Novo Nordisk represent 93.2% and 97.3% of total contract
revenue for the three months and the nine months ended September 30, 2004,
respectively. Contract revenue from Novo Nordisk was 99.9% and 99.1% of total
contract revenue for the three months and the nine months ended September 30,
2003, respectively. In September 2004, we announced an expansion and restructuring of our
original licensing agreement with Novo Nordisk for the AERx insulin program. As
part of this agreement, we will receive approximately $55 million dollars in
cash, based on the net book value of the assets being transferred to Novo
Nordisk Delivery Technologies, an affiliate of Novo Nordisk, which will be
adjusted for depreciation of the assets from June 30, 2004, the date of the
initial valuation for this purpose, up to the date of closing. As of September
30, 2004, the assets being transferred had a net book value of $54.4 million
dollars. The Closing is subject to the fulfillment of 7




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closing conditions, including approval by our shareholders, regulatory
approvals, the agreement by a substantial number of our employees to transfer
their employment and services to Novo Nordisk Delivery Technologies and the
receipt of third-party consents to assignment. 
 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 that 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 Medical, we are building a solid platform in
needle-free drug delivery. As of September 30, 2004, we had an accumulated
deficit of approximately $239 million. We have never 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. Our lead development program is developing pulmonary delivery systems to
manage diabetes using insulin 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. In April 2004, Novo Nordisk and
we announced results from a planned interim analysis of the initial Phase 3
trial. Although the results showed that the trial met its primary safety and
efficacy endpoints, the analysis showed delayed post-meal plasma glucose
suppression in Type 1 diabetics using the AERx system. Because of the
unexpected nature of these observations, Novo Nordisk decided to amend the
current trial protocol. Novo Nordisk will make decisions concerning the
structure and timing of additional clinical trials. In September 2004, we announced an expansion and restructuring of our
original licensing agreement with Novo Nordisk for the AERx insulin program. As
part of this agreement, we will receive approximately $55 million dollars in
cash, based on the net book value of the assets being transferred to Novo
Nordisk Delivery Technologies, an affiliate of Novo Nordisk, which will be
adjusted for depreciation of the assets from June 30, 8




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2004, the date of the initial valuation for this purpose, up to the date
of closing. As of September 30, 2004, the assets being transferred had a net
book value of $54.4 million dollars. The Closing is subject to the fulfillment
of closing conditions, including approval by our shareholders, regulatory
approvals, the agreement by a substantial number of our employees to transfer
their employment and services to Novo Nordisk Delivery Technologies and the
receipt of third-party consents to assignment. Following the close of the
transaction, Novo Nordisk will be responsible for all future clinical and
commercial manufacturing and development of the program. We expect to receive
future royalties on the commercialized product which will amount to
approximately 75% of the original royalty stream. As we will no longer
participate in the development program, we will not be entitled to future
milestone as such payments were tied to development and regulatory timelines.
Going forward we will work with Novo Nordisk as a contract organization in
manufacturing AERx devices and dosage forms for use in our other programs. This
transaction is subject to approval by Aradigm shareholders at a special meeting
to be scheduled. We expect the transaction to close by the end of the year. We have filed a preliminary proxy statement with the SEC relating to the
special meeting of our shareholders related to the proposed transactions with
Novo Nordisk. At the special meeting our shareholders will also be asked to
approve an amendment to our Amended and Restated Articles of Incorporation to
effect a reverse stock split pursuant to which any whole number of outstanding
shares between and including two and seven (such number to be selected by our
Board) would be combined into one share of our common stock. The existing collaborative agreement with Novo Nordisk provides for
reimbursement of research and development expenses as well as additional
payments to Aradigm as we achieve certain significant milestones. 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, 2004, this partner-funded program has
contributed approximately 97.3% of our total contract revenues. At September
30, 2004, Novo Nordisk and its affiliate, Novo Nordisk Pharmaceuticals, Inc.,
own approximately 11.3% of our total outstanding common stock (on an
as-converted basis) and are considered related parties. Recently, we completed a clinical performance verification trial of our
Intraject subcutaneous delivery system. Based on the positive results from this
trial that showed that the system met performance and reliability endpoints, we
will be presenting this configuration to potential partners and investigating
self-funded opportunities in the near future. With respect to new development partners and new applications for our
delivery systems, 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. 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 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. 9




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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 stock options and warrants. Actual results could differ
from these estimates. Three Months Ended September 30, 2004 and 2003 Contract and License Revenues:Contract revenues for the three months
ended September 30, 2004 decreased to $6.4 million from $9.8 million for the
same period in 2003. Revenue from Novo Nordisk was $5.9 million for the three
months ended September 30, 2004 and $9.8 million for the same period in 2003.
Clinical supply and product development activities for the ongoing Phase 3
clinical program with Novo Nordisk were higher for the same period in 2003 and
are decreasing as the program matures. Costs associated with collaborative
agreements are included in research and development expenses. The Company
expects that the revenue from Novo Nordisk may increase in the fourth quarter
of 2004 over the third quarter. Research and Development Expenses:Research and development expenses for
the three months ended September 30, 2004 decreased to $11.4 million from $12.0
million for the same period in 2003. The decrease in research and development
expenses is due to the decrease in Novo Nordisk program activities and
continued cost saving efforts off-set by increased spending on Intraject and
other self-funded projects. 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, increase development expense to support Intraject
subcutaneous delivery technology. 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. General and Administrative Expenses:General and administrative expenses
for the three months ended September 30, 2004 increased by 33.3% to $3.2
million from $2.4 million for the same period in 2003 due primarily to cost
associated with the restructuring agreement with Novo Nordisk in 2004. Interest Income:Interest income for the three months ended September 30,
2004 decreased to $45,000 from $68,000 for the same period in 2003. The
decrease is due to lower average investment portfolio balances. Interest Expense:Interest expense for the three months ended September
30, 2004 decreased to $3,000 from $27,000 for the same period in 2003. The
decrease is primarily due to the repayment of the 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, 2004 increased
by 82% to $8.2 million from $4.5 million for the same period in 2003,
reflecting lower Novo Nordisk contract revenues and increased general and
administrative costs. Nine Months Ended September 30, 2004 and 2003 Contract Revenues:Contract revenues for the nine months ended September
30, 2004 decreased by 25.4% to $20.1 million from $26.9 million for the same
period in 2003. Revenue from Novo Nordisk was $19.5 million for the nine months
ended September 30, 2004 and $26.7 million for the same period in 2003. The
decrease in 10




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revenue is related to lower budgeted Novo Nordisk activities for clinical
supply and product development activities for the ongoing phase 3 clinical
program. The Company expects
that the revenue from Novo Nordisk may increase in the fourth quarter of 2004
over the third quarter. Research and Development Expenses:Research and development expenses for
the nine months ended September 30, 2004 decreased to $34.7 million from $39.0
million for the same period in 2003. The decrease in research and development
expenses is due to the decrease in Novo Nordisk program activities and
continued cost saving efforts. General and Administrative Expenses:General and administrative expenses
for the nine months ended September 30, 2004 increased by 12.7% to $8.9 million
from $7.9 million for the same period in 2003. The increase is primarily due to
costs related the restructuring agreement with Novo Nordisk in 2004. Interest Income:Interest income for the nine months ended September 30,
2004 decreased to $160,000 from $262,000 for the same period in 2003. The
decrease is due to lower invested balances. Interest Expense:Interest expense for the nine months ended September 30,
2004 decreased to $18,000 from $122,000 for the same period in 2003. The
decrease is primarily due to the repayment of the 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, 2004 increased
to $23.4 million from $19.9 million for the same period in 2003, reflecting
lower Novo Nordisk contract revenues and primarily offset by reduced associated
development expense. 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, 2004, we had cash, cash equivalents and short-term investments of
approximately $13.1 million. In January and April 2004, the Company received net proceeds of
approximately $786,000 and issued an aggregate of 813,297 shares of Common
Stock in connection with the exercise of options and warrants, and the sale of
common stock under the Employee Stock Purchase Plan. On September 28, 2004, the Company entered into a Restructuring Agreement
with Novo Nordisk A/S and Novo Nordisk Delivery Technologies, Inc. The
Restructuring Agreement, subject to certain conditions, provides for the
restructuring of the license agreement between the Company and Novo Nordisk to
enlarge the license rights of Novo Nordisk to include the right to develop and
manufacture the AERx insulin Diabetes Management System (iDMS) and other AERx
products for use in managing blood glucose levels and, in connection therewith,
the sale of certain equipment, leasehold improvements and other tangible assets
currently utilized by the Company in the AERx iDMS program to Novo Nordisk
Delivery Technologies, for an estimated cash payment of $55 million, based on
the net book value of the assets being transferred to Novo Nordisk Delivery
Technologies, which will be adjusted for depreciation of the assets from June
30, 2004, the date of the initial valuation for this purpose, up to the date of
closing. As of September 30, 2004, the assets being transferred had a net
book value of $54.4 million dollars. This transaction is subject to approval by
Aradigm shareholders at a special meeting to be scheduled. We expect the
transaction to close by the end of the year. Net cash used in operating activities for the nine months ended September
30, 2004 decreased to $15.8 million from $26.6 million for the same period in
2003. As the net loss for the two periods was similar, the significant decline
in net cash used in operating activities was primarily the result of the timing
of cash payments and receipts for accounts receivable, accounts payable, and
deferred revenue. Accounts receivable was higher in the third quarter of 2003
due to a bank transaction delay for funds from Novo for the iDMS research
advance payment. The accounts payable balance at the end of the third quarter
of 2004 was lower than in 2003 due to lower research and development
activities. The amortization of deferred revenue decreased in 2004 relative to
2003 due to resource allocation to projects other then AERx. Investing activities for the nine months ended September 30, 2004 provided
cash of $3.7 million, compared to $0.7 million for the same period in 2003.
Higher capital expenditures in 2003 related to the acquisition of certain
assets and the intellectual property of related Intraject subcutaneous delivery
technology from Weston Medical Group. 11




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Net cash provided by financing activities for the nine months ended
September 30, 2004 was $0.4 million, compared to $14.8 million for the same
period in 2003. Net cash provided in the nine months ended September 30, 2003
was higher as a result of the completion of a private placement financing in
March 2003. 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 2004 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 2004 will be from $2.0 to $3.0 million. In January
2004, we amended the operating lease for one of our facilities. Effective
January 1, 2004, the new agreement reduces the aggregate annual lease payments
by $1.1 million through 2006 and increases the aggregate annual payments by
$1.1 million from 2007 through 2010. Assuming completion of the pending
restructuring of our licensing agreement with Novo Nordisk Delivery
Technologies, we believe that our existing cash balances at September 30, 2004,
along with the $55 million from the transaction and interest earned on our
investments should be sufficient to meet our needs for at least the next 30
months. However, if the restructuring is not completed, we believe that our
existing cash balances at September 30, 2004 and existing and
potential future funding
from corporate development partners and financial institutions should be sufficient to meet our needs for at least the next 12
months. There can be no assurance that funding from corporate
development partners or financial institutions 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. 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 may 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, 2004, we had cash, cash equivalents and short-term
investments of $13.1 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. 12




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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 Rules 13a15(e) and 15d-15(e) 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 the Chief Executive
Officer and the 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 controls
over financial reporting. 
 PART II. OTHER INFORMATION 
 Item 5.Other Information On July 26, 2004, we received a letter from Nasdaq advising us that our
common stock had not met Nasdaqs minimum bid price requirement for 30
consecutive trading days and that, if we were unable to demonstrate compliance
with this requirement during the 180 calendar days ending January 24, 2005, our
common stock would be subject to delisting at that time. Subsequent to the
July 26, 2004 letter from Nasdaq, we sustained a closing bid price greater than
$1.00 per share for more than 10 consecutive trading days, beginning on
September 13, 2004 and we are therefore in compliance with Nasdaqs minimum bid
price requirement. 
 Item 6.Exhibits (a) Exhibits 10.29*
    
    
    Restructuring Agreement, dated as of September 28, 2004, among
Aradigm Corporation, Novo Nordisk A/S and Novo Nordisk Delivery
Technologies, Inc.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 pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
 * The Company has sought confidential treatment for portions of the referenced
exhibit. 13




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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/ V. BRYAN LAWLISV. Bryan LawlisPresident and Chief Executive Officer /s/ THOMAS C. CHESTERMANThomas C. ChestermanSenior Vice President and Chief Financial Officer Dated: November 15, 2004 14




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INDEX TO EXHIBITS ExhibitNumber
    
    Description10.29*
    
    Restructuring Agreement, dated as of September 28, 2004,
among Aradigm Corporation, Novo Nordisk A/S and Novo
Nordisk Delivery Technologies, Inc.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 pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.
 * The Company has sought confidential treatment for portions of the referenced exhibit. 15