##### Table of Contents



UNITED STATES SECURITIES AND EXCHANGE COMMISSION
 Washington, DC 20549
 Form 10-Q
  þ
    
    QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
 For the quarterly period ended March 31, 2006
 Or
 TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
 For the transition period from            to .
 Commission File Number 0-28402
 Aradigm Corporation
 (Exact name of registrant as specified in its charter)
 California
    
    94-3133088(State or other jurisdiction of
    
    (I.R.S. Employerincorporation or organization)
    
    Identification No.)
 3929 Point Eden Way
Hayward, CA 94545  (Address of principal executive offices including zip code)  (510) 265-9000  (Registrants telephone number, including area code)
 þ o
 o o þ
 o þ
  (Class)
Common
    
    (Outstanding at April 30, 2006)
14,787,440




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##### 



ARADIGM CORPORATION
INDEX
 PART I. FINANCIAL INFORMATION
    
    
    3Item 1. Financial Statements:
    
    
    3Condensed Balance Sheets at March 31, 2006 and December 31, 2005 (unaudited)
    
    
    3Condensed Statements of Operations for the three months ended March 31, 2006 and 2005 (unaudited)
    
    
    4Condensed Statements of Cash Flows for the three months ended March 31, 2006 and 2005 (unaudited)
    
    
    5Notes to Condensed Financial Statements (unaudited)
    
    
    6Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
    
    
    13Item 3. Quantitative and Qualitative Disclosure About Market Risk
    
    
    22Item 4. Controls and Procedures
    
    
    22PART II. OTHER INFORMATION
    
    
    22Item 1A. Risk Factors
    
    
    22Item 6. Exhibits
    
    
    22SIGNATURES
    
    
    23EXHIBIT 31.1EXHIBIT 31.2EXHIBIT 32.1
  2




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##### Table of Contents



PART I. FINANCIAL INFORMATION
 
 Item 1. CONDENSED FINANCIAL STATEMENTS
 ARADIGM CORPORATION
 
 CONDENSED BALANCE SHEETS
 (In thousands, except share data)
 (Unaudited)
 March
31,
    
    
    December 31,2006
    
    
    2005(Note 1)ASSETSCurrent assets:Cash and cash equivalents
    
    $
    14,979
    
    
    $
    27,694Short-term investments
    
    
    512
    
    
    
    Receivables
    
    
    829
    
    
    
    400Current portion of notes receivable from officers and employees
    
    
    52
    
    
    
    62Prepaid expenses and other current assets
    
    
    1,406
    
    
    
    874Total current assets
    
    
    17,778
    
    
    
    29,030Property and equipment, net
    
    
    10,186
    
    
    
    9,875Noncurrent portion of notes receivable from officers and employees
    
    
    126
    
    
    
    129Other assets
    
    
    462
    
    
    
    463Total assets
    
    $
    28,552
    
    
    $
    39,947LIABILITIES, REDEEMABLE CONVERTIBLE PREFERRED STOCK
AND SHAREHOLDERS EQUITY (DEFICIT)Current liabilities:Accounts payable
    
    $
    1,339
    
    
    $
    3,034Accrued clinical and cost of other studies
    
    
    404
    
    
    
    398Accrued compensation
    
    
    1,983
    
    
    
    3,814Deferred revenue
    
    
    299
    
    
    
    222Other accrued liabilities
    
    
    486
    
    
    
    475Total current liabilities
    
    
    4,511
    
    
    
    7,943Noncurrent portion of deferred rent
    
    
    769
    
    
    
    714Commitments and contingenciesRedeemable convertible preferred stock, no par value; 5,000,000
shares authorized; issued and outstanding shares: 1,544,626 at
March 31, 2006 and December 31, 2005; liquidation preference of
$41,866 at March 31, 2006 and December 31, 2005
    
    
    23,669
    
    
    
    23,669Shareholders equity (deficit):Common stock, no par value; 100,000,000 shares authorized; issued
and outstanding shares: 14,787,440 at March 31, 2006 and
14,562,809 at December 31, 2005
    
    
    282,724
    
    
    
    282,004Accumulated other comprehensive income
    
    
    2
    
    
    
    5Accumulated deficit
    
    
    (283,123
    )
    
    
    (274,838
    )Total shareholders equity(deficit)
    
    
    (397
    )
    
    
    7,171Total liabilities, redeemable convertible preferred
stock and shareholders equity(deficit)
    
    $
    28,552
    
    
    $
    39,497
  3




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ARADIGM CORPORATION
 
 CONDENSED STATEMENTS OF OPERATIONS
 (In thousands, except per share data)
 (Unaudited)
 Three Months EndedMarch 31,2006
    
    
    2005Contract revenues (Including amounts from related parties:2006 - $33; 2005 - $7,444)
    
    $
    1,073
    
    
    $
    7,714Operating expenses:Research and development
    
    
    6,740
    
    
    
    7,070General and administrative
    
    
    2,853
    
    
    
    3,235Total operating expenses
    
    
    9,593
    
    
    
    10,305Loss from operations
    
    
    (8,520
    )
    
    
    (2,591
    )Interest income
    
    
    245
    
    
    
    288Interest and other expense
    
    
    (10
    )
    
    
    (37
    )Net loss
    
    $
    (8,285
    )
    
    $
    (2,340
    )Basic and diluted net loss per common share
    
    $
    (0.57
    )
    
    $
    (0.16
    )Shares used in computing basic and diluted net loss per common
share
    
    
    14,563
    
    
    
    14,459
  4




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ARADIGM CORPORATION
 
 CONDENSED STATEMENTS OF CASH FLOWS
 (In thousands)
 (Unaudited)
 Three Months EndedMarch 31,2006
    
    
    2005Cash flows from operating activities:Net loss
    
    $
    (8,285
    )
    
    $
    (2,340
    )Adjustments to reconcile net loss to cash used in operating activities:Depreciation and amortization
    
    
    283
    
    
    
    436Stock-based compensation expense related to employee stock options
and employee stock purchases
    
    
    470
    
    
    
    Loss on retirement and sale of property and equipment
    
    
    6
    
    
    
    25Cost of warrants and stock options for services
    
    
    1
    
    
    
    92Amortization of deferred compensation
    
    
    
    
    
    
    5Changes in operating assets and liabilities:Receivables
    
    
    (429
    )
    
    
    (367
    )Prepaid and other current assets
    
    
    (532
    )
    
    
    967Other assets
    
    
    1
    
    
    
    25Accounts payable
    
    
    (1,695
    )
    
    
    (503
    )Accrued compensation
    
    
    (1,831
    )
    
    
    (1,015
    )Other accrued liabilities
    
    
    17
    
    
    
    (375
    )Deferred rent
    
    
    55
    
    
    
    (1,391
    )Deferred revenue
    
    
    77
    
    
    
    (7,273
    )Net cash used in operating activities
    
    
    (11,862
    )
    
    
    (11,714
    )Cash flows from investing activities:Capital expenditures
    
    
    (600
    )
    
    
    (1,479
    )Proceeds from the sale of property and equipment
    
    
    
    
    
    
    50,291Purchases of available-for-sale investments
    
    
    (515
    )
    
    
    (2,595
    )Increase in restricted cash
    
    
    
    
    
    
    (200
    )Proceeds from maturities and sales of available-for-sale investments
    
    
    
    
    
    
    16Net cash provided by (used in) investing activities
    
    
    (1,115
    )
    
    
    46,033Cash flows from financing activities:Proceeds from issuance of common stock, net
    
    
    249
    
    
    
    Payments received on notes receivable from officers and employees
    
    
    13
    
    
    
    14Net cash provided by financing activities
    
    
    262
    
    
    
    14Net increase (decrease) in cash and cash equivalents
    
    
    (12,715
    )
    
    
    34,333Cash and cash equivalents at beginning of period
    
    
    27,694
    
    
    
    14,308Cash and cash equivalents at end of period
    
    $
    14,979
    
    
    $
    48,641
  5




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ARADIGM CORPORATION
 
 NOTES TO THE UNAUDITED CONDENSED FINANCIAL STATEMENTS
 March 31, 2006
 1. Organization and Basis of Presentation
 Organization
   Basis of Presentation
   Use of Estimates
  2. Stock-Based Compensation
 Accounting
for Stock-based Compensation
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Accounting for Stock-Based Compensation 
Transition and Disclosure
  Employee Stock Plans
  2005 Equity Incentive Plan
   7




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1996 Non-Employee Directors Plan
  Employee Stock Purchase Plan
   8




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Pro Forma Information for Period Prior to Adoption of FAS 123R
  Three MonthsEndedMarch 31,2005Net loss, as reported
    
    $
    (2,340
    )Add: Stock-based employee compensation expense included in reported net loss,
    
    
    5Deduct: Total stock-based employee compensation expense determined under
fair value method
    
    
    (738
    )Proforma net loss
    
    $
    (3,073
    )Basic and diluted net loss per common share:As reported
    
    $
    (0.16
    )Pro forma
    
    $
    (0.21
    )
  Valuation Assumptions
   Three Months Ended March 31,2006
    
    2005Employee Stock OptionsDividend yield
    
    
    0.0
    %
    
    
    0.0
    %Volatility factor
    
    
    85.9
    %
    
    
    97.9
    %Risk-free interest rate
    
    
    4.8
    %
    
    
    3.7
    %Expected life (years)
    
    
    4.2
    
    
    
    4.0Weighted-average fair value of options granted during the periods
    
    $
    2.47
    
    
    $
    4.28Employee Stock Purchase PlanDividend yield
    
    
    0.0
    %
    
    
    0.0
    %Volatility factor
    
    
    87.1
    %
    
    
    110.0
    %Risk-free interest rate
    
    
    3.6
    %
    
    
    1.6
    %Expected life (years)
    
    
    1.2
    
    
    
    2.0Weighted-average fair value of employee stock purchases during
the periods
    
    $
    2.62
    
    
    $
    3.99
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Impact of the Adoption of FAS 123R
  Three MonthsEndedMarch 31,2006Costs and expenses:Research and development
    
    $
    263General and administrative
    
    
    207Total stock-based compensation expense
    
    $
    470Impact on basic and diluted net loss per share
    
    $
    (0.03
    )
    WeightedWeighted
    
    
    Average
    
    
    AggregateNumber
    
    
    Average
    
    
    Remaining
    
    
    Intrinsicof
    
    
    Exercise
    
    
    Contractual
    
    
    Value (inShares
    
    
    Price
    
    
    Life
    
    
    000s)Options outstanding at December 31, 2005
    
    
    1,729,709
    
    
    $
    19.47
    
    
    
    7.10
    
    
    
    Options granted
    
    
    444,000
    
    
    $
    3.77
    
    
    
    9.93
    
    
    
    Options exercised
    
    
    (645
    )
    
    $
    2.83
    
    
    
    
    
    
    
    Options cancelled
    
    
    (7,314
    )
    
    $
    17.90
    
    
    
    
    
    
    
    Options outstanding at March 31, 2006
    
    
    2,165,750
    
    
    $
    16.26
    
    
    
    7.45
    
    
    
    Options exercisable at March 31, 2006
    
    
    1,208,732
    
    
    $
    24.64
    
    
    
    6.17
    
    
    
    
 10




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3. Summary of Significant Accounting Policies
 Revenue Recognition
  Impairment of Long-Lived Assets
  Computation of Net Loss Per Share
   Three Months Ended March 31,2006
    
    
    2005Options to purchase common stock
    
    
    35
    
    
    
    30,660Preferred convertible shares
    
    
    1,235,701
    
    
    
    1,235,701Warrants to purchase common shares
    
    
    
    
    
    
    383,4671,235,736
    
    
    
    1,649,828
 11




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4. Comprehensive Loss
  5. Cash, Cash Equivalents and Investments
  March 31, 2006
    
    
    December 31, 2005Cash and Cash equivalents:Money market fund
    
    $
    1,352
    
    
    $
    1,321Commercial paper
    
    
    13,627
    
    
    
    26,373$
    14,979
    
    
    $
    27,694Short-term investments:Corporate and Government notes
    
    $
    512
    
    
    $
    
   6. Shareholders Equity
 Reverse Stock Split
  7. Related Party
  12




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8. Subsequent Events
  
 Item 2. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
 The discussion below contains forward-looking statements that are based on the beliefs of
management, as well as assumptions made by, and information currently available to, management. Our
future results, performance or achievements could differ materially from those expressed in, or
implied by, any such forward-looking statements as a result of certain factors, including, but not
limited to, those discussed in this section as well as in the section entitled Risk Factors and
elsewhere in our most recent Annual Report on Form 10-K filed with the Securities and Exchange
Commission.
 Our business is subject to significant risks including, but not limited to, the success of
research and development efforts, dependence on corporate partners for marketing, distribution and
other resources, obtaining and enforcing patents important to the business, clearing the lengthy
and expensive regulatory process and possible competition from other products. Even if the products
appear promising at various stages of development, they may not reach the market or may not be
commercially successful for a number of reasons. Such reasons include, but are not limited to, the
possibilities that the potential products may be found to be ineffective during clinical trials,
fail to receive necessary regulatory approvals, are difficult to manufacture on a large scale, are
uneconomical to market, are precluded from commercialization by proprietary rights of third parties
or may not gain acceptance from health care professionals and patients. Readers are cautioned not
to place undue reliance on the forward-looking statements contained herein. We undertake no
obligation to update these forward-looking statements in light of events or circumstances occurring
after the date hereof or to reflect the occurrence of unanticipated events.
 13




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Overview
   AERx
  AERx Diabetes Management System
   AERx Hydrochloroquine
  14




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##### Table of Contents



Liposomal Ciprofloxacin
   AERx Smoking Cessation
  AERx Treprostinil
  Intraject
  15




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##### Table of Contents




    
    Pre-filled, fixed dose and ready to use;
    
    Lightweight and pocket-sized; and
    
    Easy to operate.
   Intraject Triptan
   Potential Product Applications
   16




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Critical Accounting Policies and Estimates
  Revenue Recognition
  Long-Lived Assets
  Stock-Based Compensation Expense
    17




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Results of Operations
  Three Months Ended March 31,2006
    
    2005
    
    Change in Dollars
    
    Change in PercentRevenueContract revenue
    
    $
    976
    
    
    $
    2,528
    
    
    $
    (1,552
    )
    
    
    (61
    %)Percentage of Total Revenue
    
    
    91
    %
    
    
    33
    %Milestone revenue
    
    
    97
    
    
    
    5,186
    
    
    
    (5,089
    )
    
    
    (98
    %)Percentage of Total Revenue
    
    
    9
    %
    
    
    67
    %Total Revenue
    
    $
    1,073
    
    
    $
    7,714
    
    
    $
    (6,641
    )
    
    
    (86
    %)
  Cost and Expenses
 Three Months Ended March 31,2006
    
    2005
    
    Change in Dollars
    
    Change in PercentResearch and Development ExpenseCollaborative
    
    $
    1,119
    
    
    $
    2,047
    
    
    $
    (928
    )
    
    
    (45
    )%Self-Funded
    
    
    5,621
    
    
    
    5,023
    
    
    
    598
    
    
    
    12
    %Total Research and Development Expense
    
    $
    6,740
    
    
    $
    7,070
    
    
    $
    (330
    )
    
    
    (5
    )%
 Research and Development:
  18




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Three Months Ended March 31,2006
    
    2005
    
    Change in Dollars
    
    Change in PercentGeneral and Administrative Expenses
    
    $
    2,853
    
    
    $
    3,235
    
    
    $
    (382
    )
    
    
    (12
    )%
 General and Administrative
  Three Months Ended March 31,2006
    
    2005
    
    Change in Dollars
    
    Change in PercentInterest Income, Interest and Other Expense:Total Interest Income
    
    $
    245
    
    
    $
    288
    
    
    $
    (43
    )
    
    
    (15
    )%Total Interest and Other Expense
    
    $
    (10
    )
    
    $
    (37
    )
    
    $
    27
    
    
    
    (74
    )%
   19




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Financial Condition
  Three Months EndedMarch 31,2006
    
    2005Net cash provided by (used in) operating activities:Net income (loss)
    
    $
    (8,285
    )
    
    $
    (2,340
    )Depreciation and amortization
    
    
    283
    
    
    
    Stock-based compensation expense related to employee stock options
and employee stock purchases
    
    
    470
    
    
    
    Loss on impairment and sale of property and equipment
    
    
    6
    
    
    
    25Cost of warrants and common stock options for services
    
    
    1
    
    
    
    92Amortization of deferred compensation
    
    
    
    
    
    
    5Changes in operating assets and liabilities:
    
    
    (4,337
    )
    
    
    (9,932
    )Net cash used in operating activities
    
    $
    (11,862
    )
    
    $
    (11,714
    )Net cash used in investing activities:Capital expenditures
    
    
    (600
    )
    
    
    (1,479
    )Proceeds from sale of property and equipment
    
    
    
    
    
    
    50,291Purchases of available-for-sale investments
    
    
    (515
    )
    
    
    (2,595
    )Increase in restricted cash
    
    
    
    
    
    
    (200
    )Proceeds from sales and maturities of available-for-sale investments
    
    
    
    
    
    
    16Net cash used in investing activities
    
    $
    (1,115
    )
    
    $
    46,033Net cash provided by financing activities:
    
    $
    262
    
    
    $
    14Net decrease in cash and cash equivalents
    
    $
    (12,715
    )
    
    $
    34,333Cash and cash equivalents at beginning of period
    
    
    27,694
    
    
    
    14,308Cash and cash equivalents at end of period
    
    $
    14,979
    
    
    $
    48,641
  20




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Contractual Obligations
  Payment Due by Period(amounts in thousands)Contractual obligations
    
    Total
    
    
    2006
    (1)
    
    
    2007/2008
    
    
    
    2009/2010
    
    
    
    2011+Operating lease obligations
    
    $
    22,372
    
    
    $
    1,221
    
    
    $
    4,677
    
    
    $
    4,541
    
    
    $
    11,933Unconditional purchase obligations
    
    
    2,238
    
    
    
    2,238
    
    
    
    
    
    
    
    
    
    
    
    Total contractual commitments
    
    $
    24,610
    
    
    $
    3,459
    
    
    $
    4,677
    
    
    $
    4,541
    
    
    $
    11,933
 
 (1)
    
    For nine months ending December 31, 2006 Off-Balance Sheet Financings and Liabilities
  21




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Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
 Market Risk Disclosures
   
 Item 4. CONTROLS AND PROCEDURES
 Evaluation of Disclosure Controls and Procedures.
 Changes in internal control.
 Limitations on the effectiveness of controls.
 
 PART II. OTHER INFORMATION
 
 Item 1A. RISK FACTORS
 Risks Related to Our Company
 The liquidity of the markets on which our stock trades may adversely affect the price of our stock.
   
 Item 6. 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
pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
 22




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SIGNATURES
  ARADIGM CORPORATION(Registrant)/s/ V. BRYAN LAWLISV. Bryan LawlisPresident and Chief Executive Officer/s/ THOMAS C. CHESTERMANThomas C. ChestermanSenior Vice President and Chief Financial OfficerDated: May 15, 2006
 23




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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
pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
 24