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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 March 31, 2005
 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
    
    (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) 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. (Class)
    
    (Outstanding at April 30, 2005)Common
    
    72,589,902




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ARADIGM CORPORATION
INDEX PART I. FINANCIAL INFORMATIONITEM 1. Condensed Financial Statements
    
    
    3Condensed Balance Sheets at March 31, 2005 and December 31, 2004 (unaudited)
    
    
    3Condensed Statements of Operations for the three months ended March 31, 2005 and
2004 (unaudited)
    
    
    4Condensed Statements of Cash Flows for the three months ended March 31, 2005 and
2004 (unaudited)
    
    
    5Notes to Condensed Financial Statements (unaudited)
    
    
    6ITEM 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
    
    
    11ITEM 3. Quantitative and Qualitative Disclosure About Market Risk
    
    
    17ITEM 4. Controls and Procedures
    
    
    17PART II. OTHER INFORMATIONITEM 4. Submission of Matters to a Vote of Security Holders
    
    
    18ITEM 5. Other InformationITEM 6. Exhibits
    
    
    18SIGNATURES
    
    
    19INDEX TO EXHIBITSEXHIBIT 31.1EXHIBIT 31.2EXHIBIT 32.1
 2




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PART I. FINANCIAL INFORMATION 
 ITEM 1. Condensed Financial Statements ARADIGM CORPORATION 
 CONDENSED BALANCE SHEETS
 March 31,
    
    
    December 31,2005
    
    
    2004(Unaudited)
    
    
    (Note 1)(In thousands)ASSETSCurrent assets:Cash and cash equivalents
    
    $
    48,641
    
    
    $
    14,308Restricted cash
    
    
    200
    
    
    
    Short-term investments
    
    
    5,029
    
    
    
    2,455Receivables
    
    
    466
    
    
    
    99Current portion of notes receivable from officers and employees
    
    
    63
    
    
    
    67Prepaid expenses and other current assets
    
    
    635
    
    
    
    1,602Total current assets
    
    
    55,034
    
    
    
    18,531Property and equipment, net
    
    
    7,263
    
    
    
    60,555Noncurrent portion of notes receivable from officers and employees
    
    
    206
    
    
    
    216Other assets
    
    
    414
    
    
    
    439Total assets
    
    $
    62,917
    
    
    $
    79,741LIABILITIES, REDEEMABLE CONVERTIBLE PREFERRED STOCK
AND SHAREHOLDERS EQUITYCurrent liabilities:Accounts payable
    
    $
    1,966
    
    
    $
    2,469Accrued clinical and cost of other studies
    
    
    345
    
    
    
    293Accrued compensation
    
    
    1,969
    
    
    
    2,984Deferred revenue
    
    
    199
    
    
    
    7,525Other accrued liabilities
    
    
    711
    
    
    
    1,138Total current liabilities
    
    
    5,190
    
    
    
    14,409Noncurrent portion of deferred revenue
    
    
    
    
    
    
    3,966Noncurrent portion of deferred rent
    
    
    552
    
    
    
    1,943Commitments and contingenciesRedeemable convertible preferred stock, no par value; 5,000,000
shares authorized; issued and outstanding shares: 1,544,626 at
March 31, 2005 and December 31, 2004; liquidation preference of
$37,380 at March 31, 2005 and December 31, 2004
    
    
    23,669
    
    
    
    23,669Shareholders equity:Common stock, no par value; 150,000,000 shares authorized; issued
and outstanding shares: 72,297,980 at March 31, 2005 and
72,295,730 at December 31, 2004
    
    
    281,500
    
    
    
    281,387Accumulated other comprehensive loss
    
    
    (15
    )
    
    
    (10
    )Deferred compensation
    
    
    (16
    )
    
    
    Accumulated deficit
    
    
    (247,963
    )
    
    
    (245,623
    )Total shareholders equity
    
    
    33,506
    
    
    
    35,754Total liabilities, redeemable convertible preferred
stock and shareholders equity
    
    $
    62,917
    
    
    $
    79,741
 See accompanying notes. 3




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ARADIGM CORPORATION 
 CONDENSED STATEMENTS OF OPERATIONS
 Three Months EndedMarch 31,2005
    
    
    2004(Unaudited)(In thousands, except per share data)Contract revenues (Including amounts from related parties:2005 - $7,444; 2004 - $6,610)
    
    $
    7,714
    
    
    $
    6,643Operating expenses:Research and development
    
    
    7,070
    
    
    
    11,887General and administrative
    
    
    3,235
    
    
    
    2,536Total operating expenses
    
    
    10,305
    
    
    
    14,423Loss from operations
    
    
    (2,591
    )
    
    
    (7,780

    )Interest income
    
    
    288
    
    
    
    66Interest and other expense
    
    
    (37
    )
    
    
    (10
    )Net loss
    
    $
    (2,340
    )
    
    $
    (7,724
    )Basic and diluted net loss per common share
    
    $
    (0.03
    )
    
    $
    (0.12
    )Shares used in computing basic and diluted net loss per
common share
    
    
    72,297
    
    
    
    62,942
 See accompanying notes. 4




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ARADIGM CORPORATION 
 CONDENSED STATEMENTS OF CASH FLOWS
 Three months EndedMarch 31,2005
    
    
    2004(Unaudited)(In thousands)Cash flows from operating activities:Net loss
    
    $
    (2,340
    )
    
    $
    (7,724
    )Adjustments to reconcile net loss to cash used in operating activities:Depreciation and amortization
    
    
    436
    
    
    
    1,374Loss on retirement and sale of property and equipment
    
    
    25
    
    
    
    Cost of warrants and stock options for services
    
    
    92
    
    
    
    70Amortization of deferred compensation
    
    
    5
    
    
    
    Changes in operating assets and liabilities:Receivables
    
    
    (367
    )
    
    
    113Prepaid and other current assets
    
    
    967
    
    
    
    441Other assets
    
    
    25
    
    
    
    (73
    )Accounts payable
    
    
    (503
    )
    
    
    727Accrued compensation
    
    
    (1,015
    )
    
    
    828Other accrued liabilities
    
    
    (375
    )
    
    
    194Deferred rent
    
    
    (1,391
    )
    
    
    239Deferred revenue
    
    
    (7,273
    )
    
    
    (454
    )Net cash used in operating activities
    
    
    (11,714
    )
    
    
    (4,265
    )Cash flows from investing activities:Capital expenditures
    
    
    (1,479
    )
    
    
    (264
    )Proceeds from the sale of property and equipment
    
    
    50,291
    
    
    
    Purchases of available-for-sale investments
    
    
    (2,595
    )
    
    
    (2,518
    )Increase in restricted cash
    
    
    (200
    )
    
    
    Proceeds from maturities and sales of available-for-sale investments
    
    
    16
    
    
    
    6,922Net cash provided in investing activities
    
    
    46,033
    
    
    
    4,140Cash flows from financing activities:Proceeds from issuance of common stock, net
    
    
    
    
    
    
    305Notes receivable from officers and employees
    
    
    14
    
    
    
    13Payments on capital lease obligations and equipment loans
    
    
    
    
    
    
    (211
    )Net cash provided by financing activities
    
    
    14
    
    
    
    107Net increase (decrease) in cash and cash equivalents
    
    
    34,333
    
    
    
    (18
    )Cash and cash equivalents at beginning of period
    
    
    14,308
    
    
    
    18,327Cash and cash equivalents at end of period
    
    $
    48,641
    
    
    $
    18,309
 See accompanying notes. 5




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ARADIGM CORPORATION 
 NOTES TO THE UNAUDITED CONDENSED FINANCIAL STATEMENTS
 March 31, 2005
 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. The Company operates as a sole operating segment. Basis of Presentation The accompanying unaudited condensed financial statements have been prepared in accordance
with U.S. generally accepted accounting principles for interim financial information and with the
instructions to Form 10-Q and Article 10 of Regulation S-X. Certain information and footnote
disclosures normally included in financial statements prepared in accordance with U.S. generally
accepted accounting principles have been condensed or omitted pursuant to the Securities and
Exchange Commissions rules and regulations. In the opinion of management, the financial statements
reflect all adjustments, which are only of a normal recurring nature, necessary for a fair
presentation. The accompanying condensed 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
for the year ended December 31, 2004, as filed with the Securities and Exchange Commission. 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, 2004 has been derived from the audited financial statements
at that date, but does not include all of the information and footnotes required by U.S. 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). 6




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Three Months EndedMarch 31, 2005
    
    
    March 31, 2004Net loss  as reported
    
    $
    (2,340
    )
    
    $
    (7,724
    )Add:Amortization of deferred stock-based
employee compensation expense included in
reported net loss
    
    
    5
    
    
    
    Less:Total stock-based employee compensation expense
determined under fair value based method for all awards
    
    
    (738
    )
    
    
    (1,104
    )Pro forma net loss applicable to common shareholders
    
    $
    (3,073
    )
    
    $
    (8,828
    )Basic and diluted net loss per share applicable to common
shareholders As reported
    
    $
    (0.03
    )
    
    $
    (0.12
    )Pro forma
    
    $
    (0.04
    )
    
    $
    (0.14
    )
 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. 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. Cash Equivalents, Restricted Cash and Investments The following summarizes the fair value of the Companys cash equivalents and investments
(amounts in thousands): March 31, 2005
    
    
    December 31, 2004Cash equivalents:Money market fund
    
    $
    811
    
    
    $
    800Commercial paper
    
    
    45,845
    
    
    
    13,508U.S. Government Agencies
    
    
    1,985
    
    
    
    $
    48,641
    
    
    $
    14,308Restricted Cash:Certificate of Deposit
    
    $
    200
    
    
    $
    $
    200
    
    
    $
    Short-term investments:Corporate and Government notes
    
    $
    5,029
    
    
    $
    2,455$
    5,029
    
    
    $
    2,455
 Short-Term investments: 7




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March 31, 2005
    
    
    December 31, 2004Investments maturing in 90 days to less than
1 year:Corporate notes
    
    $
    1,525
    
    
    $
    1,016US government agencies
    
    
    1,066
    
    
    
    1,439Total maturing in less than 1 year
    
    $
    2,591
    
    
    $
    2,455Investments maturing in 1 to 2 years:Corporate notes
    
    $
    1,008
    
    
    
    US government agencies
    
    
    1,430
    
    
    
    Total maturing in 1 to 2 years
    
    
    2,438
    
    
    
    Total short term investments
    
    $
    5,029
    
    
    $
    2,455
 We consider all highly liquid investments purchased with an original maturity of three months
or less to be cash equivalents. We place our cash and cash equivalents in money market funds,
commercial paper, and corporate notes. Restricted cash consists of a corporate certificate of
deposit that collateralizes a standby letter of credit for approximately the same amount maturing
on September 23, 2005. As of March 31, 2005 and December 31, 2004, the difference between the fair
value and the amortized cost of available-for-sale securities was $15,000 loss and $10,000 loss,
respectively 4. Property and Equipment Property and equipment consist of the following (amounts in thousands): March 31, 2005
    
    
    December 31,2004Machinery and equipment
    
    $
    3,025
    
    
    $
    14,364Furniture and fixtures
    
    
    1,165
    
    
    
    1,917Lab equipment
    
    
    2,464
    
    
    
    4,086Computer equipment and software
    
    
    5,291
    
    
    
    6,256Leasehold improvements
    
    
    1,412
    
    
    
    12,225Fixed assets at cost
    
    
    13,357
    
    
    
    38,848Less accumulated depreciation
and amortization
    
    
    (11,133
    )
    
    
    (27,740
    )Net depreciable assets
    
    
    2,224
    
    
    
    11,108Construction in progress
    
    
    5,039
    
    
    
    49,447Property and equipment, net
    
    $
    7,263
    
    
    $
    60,555
 As of January 26, 2005, the Company completed the restructuring of its AERx iDMS program,
pursuant to the Restructuring Agreement entered into with Novo Nordisk, A/S and Novo Nordisk
Delivery Technologies, Inc., a newly created wholly owned subsidiary of Novo Nordisk, A/S (NNDT),
as of September 28, 2004. Under the terms of the Restructuring Agreement the Company sold certain
equipment and leasehold improvements utilized in the AERx iDMS program with net book value of $53.9
million to NNDT. 5. Commitments and Contingencies Subsequent to completion in January 2005 of the restructuring transaction with Novo Nordisk,
A/S, the Company has commitments under two leases rather than four. The first lease is for a
building containing office, laboratory and manufacturing facilities, and expires in 2016. A minor
portion of this lease expense is offset by a sublease to NNDT of $10,000 per month for 14 months
commencing January 2005. The second lease is for a warehouse and expires in December 2005. Our
contractual obligations and future minimum lease payments that are non-cancelable at March 8




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31, 2005
under the two lease agreements are disclosed in the following table. Unconditional purchase
obligations have increased in support of Intraject development and manufacturing activities. Payment Due by Period(amounts in thousands)Contractual obligations
    
    Total
    
    
    20051
    
    
    2006/2007
    
    
    2008/2009
    
    
    2010+Operating lease obligations
    
    $
    25,364
    
    
    $
    1,849
    
    
    $
    4,085
    
    
    $
    4,725
    
    
    $
    14,705Unconditional purchase obligations
    
    
    2,852
    
    
    
    2,852
    
    
    
    
    
    
    
    
    
    
    
    Total contractual commitments
    
    $
    28,216
    
    
    $
    4,701
    
    
    $
    4,085
    
    
    $
    4,725
    
    
    $
    14,705
   1
    
    For nine months ending December 31, 2005. 6. Shareholders Equity In January 2005, the Company completed the restructuring of its AERx iDMS program, pursuant to
the Restructuring Agreement entered into with Novo Nordisk, A/S and NNDT, as of September 28, 2004.
As part of the restructuring transaction, the stock purchase agreement in place between the
Company and Novo Nordisk, A/S prior to the closing of the restructuring transaction was amended to
delete the provisions whereby the Company can require Novo Nordisk, A/S to purchase certain amounts
of common stock, to impose certain restrictions on the ability of Novo Nordisk, A/S to sell shares
of the Companys common stock previously purchased by Novo Nordisk, A/S, and to provide Novo
Nordisk, A/S with certain registration and information rights with respect to these shares. 7. Related Party Novo Nordisk, A/S and its affiliates, Novo Nordisk Pharmaceuticals, Inc. and NNDT, are
considered related parties, and at March 31, 2005 own approximately 10.9% of the Companys total
outstanding common stock (10.0% on an as-converted basis). As of January 26, 2005, the Company completed the restructuring of its AERx iDMS program,
pursuant to the Restructuring Agreement entered into with Novo Nordisk, A/S and NNDT as of
September 28, 2004. At the closing of the restructuring transaction, the Company received $50.3
million in cash, applied $4.0 million of deposits from Novo Nordisk, A/S and recorded $731,000 as
payment for inventory, prepaid, and other assets from NNDT in consideration for $54.5 million of
fixed assets at net book value, $515,000 of inventory and $317,000 for prepaid and other assets. As a result of this transaction the Company was no longer obligated to continue work related
to the non-refundable milestone payment from Novo Nordisk, A/S related to the commercialization of
AERx and recognized the remaining balance of the deferred revenue associated with the milestone of
$5.2 million as revenue in the first quarter of 2005. Additionally, Aradigm was released from its
contractual obligation relating to future operating leases payments for the two buildings assigned
to NNDT and accordingly reversed to current period rent expense the deferred rent expense related
to the two buildings of $1.4 million. At December 31, 2004 the Companys future lease commitments
totaled $53.4 million. After the closing of the restructuring transaction with Novo Nordisk, A/S,
the Companys future lease commitments totaled $25.4 million at March 31, 2005. As a result of the restructuring transaction, our contract revenue from the Companys
development agreement with Novo Nordisk, A/S ceased in January 2005. The Company recorded project
development revenue from Novo
Nordisk, A/S for the first 26 days of 2005 of approximately
$2.1 million and $160,000 from NNDT related
to transition and support agreements entered into in connection with the restructuring transaction
through the three months ended March 31, 2005. In the remainder of 2005 we expect to record
revenue of approximately $640,000 from NNDT related to transition and support agreements entered
into in connection with the restructuring transaction. In addition, NNDT hired 126 Aradigm employees, including 119 research and development
employees, at the closing of the restructuring transaction. 8. Recent Accounting Pronouncements 9




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In December 2004, the Financial Accounting Standards Board, or FASB, issued Statement of
Financial Accounting Standards 123R (SFAS 123R), Share-Based Payment, effective beginning after
June 15, 2005. FAS 123R supersedes APB Opinion No. 25, Accounting for Stock Issued to Employees,
and will require companies to recognize compensation expense, using a fair-value based method, for
costs related to share-based payments including stock options and stock issued under our employee
stock purchase plans. On April 14, 2005, the Securities and Exchange Commission issued a rule to
allow companies to adopt the standard at the beginning of their next fiscal year that begins after
June 15, 2005. We will be required to implement SFAS 123R beginning January 1, 2006. We are
currently evaluating how we will adopt the standard and will be evaluating option valuation
methodologies and assumptions in light of SFAS 123R, and therefore cannot estimate the impact of
our adoption at this time. These methodologies and assumptions may be different than those
currently employed by us in applying SFAS 123 as outlined in our Stock-based Compensation section
above. We expect that our adoption of SFAS 123R will have a material adverse impact on our results
of operations. In March 2005, the SEC staff issued guidance on SFAS 123(R). Staff Accounting Bulletin No. 107
(SAB 107) was issued to assist preparers by simplifying some of the implementation challenges of
SFAS 123(R) while enhancing the information that investors receive. SAB 107 creates a framework
that is premised on two overarching themes: (a) considerable judgment will be required by preparers
to successfully implement SFAS 123(R), specifically when valuing employee stock options; and (b)
reasonable individuals, acting in good faith, may conclude differently on the fair value of
employee stock options. Key topics covered by SAB 107 include: (a) valuation models  SAB 107
reinforces the flexibility allowed by SFAS 123(R) to choose an option-pricing model that meets the
standards fair value measurement objective; (b) expected volatility  SAB 107 provides guidance on
when it would be appropriate to rely exclusively on either historical or implied volatility in
estimating expected volatility; and (c) expected term  the new guidance includes examples and some
simplified approaches to determining the expected term under certain circumstances. The Company
will apply the principles of SAB 107 in conjunction with its adoption of SFAS 123(R). 10




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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. 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 update these forward-looking statements in light of events or circumstances occurring
after the date hereof or to reflect the occurrence of unanticipated events. Overview Aradigm Corporation is a leading developer of innovative needle-free drug delivery systems
that enable patients to self-administer liquid drugs that would otherwise be given by injection.
Our hand-held AERx technology is designed for the rapid and reproducible delivery of a wide range
of pharmaceutical drugs and biotech compounds through the lung. Our pen-sized, needle-free
Intraject system is designed to comfortably and rapidly deliver drugs to the subcutaneous layer of
the skin, where they can gain access to the bloodstream. We believe that our non-invasive AERx and
Intraject systems, which have been shown in clinical studies to achieve performance equivalent to
injection, will be welcome alternatives to needle-based drug delivery. In addition, our systems may
improve therapeutic efficacy in cases where other existing drug delivery methods, such as pills,
transdermal patches or inhalers, are too slow or imprecise. Since our inception in 1991, we have been engaged in the development of needle-free drug
delivery systems. As of March 31, 2005 we had an accumulated deficit of $248.0 million. We 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 2005. The sources of working capital
have been equity financings, equipment lease financings, contract and license revenues, interest
earned on investments and funds received from the sale of assets to NNDT. AERx Our AERx technology platform is being developed to enable pulmonary delivery of a wide range
of pharmaceuticals in liquid formulations for local or systemic effect. Our proprietary AERx
technologies focus principally on delivering liquid medications through small-particle aerosol
generation and controlling patient-inhalation technique for efficient and reproducible delivery of
the aerosol drug to the deep lung. We have developed these proprietary technologies through an
integrated approach that combines expertise in physics, electrical engineering, mechanical
engineering, laser engineering and pharmaceutical sciences. AERx insulin Diabetes Management System The AERx iDMS permits patients with diabetes to non-invasively self-administer insulin. We
believe that when patients are provided a non-invasive delivery alternative to injection, they will
be more likely to self-administer 11




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insulin as often as needed to keep tight control of their blood-glucose levels. This product is
being developed by Novo Nordisk, A/S, a leader in the field of diabetes care. From the inception
of our collaboration in June 1998 through March 31, 2005, we have received from Novo Nordisk, A/S
approximately $137.1 million in product development payments, approximately $13.0 million in
milestone payments and $35.0 million from the purchase of our common stock by Novo Nordisk, A/S and
its affiliates. As of January 26, 2005, we completed the restructuring of our AERx iDMS program, pursuant to
the Restructuring Agreement entered into with Novo Nordisk, A/S and NNDT. Under the terms of the
Restructuring Agreement we sold certain equipment, leasehold improvements and other tangible assets
currently utilized in the AERx iDMS program to NNDT, for a cash payment of approximately $55.0
million, netting proceeds of $51.0 million after refund of cost advances from Novo Nordisk, A/S of
approximately $4.0 million. Our expenses related to this transaction for legal and other advisory
services were approximately $1.1 million. In connection with the restructuring transaction, we
entered into various related agreements with Novo Nordisk, A/S and NNDT, effective January 26,
2005, including the following:  
    an amended and restated license agreement amending the Development and
License Agreement previously in place with Novo Nordisk, A/S,
expanding Novo Nordisks development and manufacturing rights to the
AERx iDMS program and providing for royalties to us on future AERx
iDMS net sales;
    a three-year agreement under which NNDT will perform contract
manufacturing for us of AERx iDMS-identical devices and dosage forms
filled with compounds provided by us in support of preclinical and
initial clinical development by us of other AERx products;
    we will receive royalties of approximately 6% on net sales of AERx iDMS products, AERx
products containing insulin analogs, and, in certain circumstances, non-AERx products by Novo
Nordisk and its sublicensees. In addition, NNDT hired 126 Aradigm employees, including 119 research and development
employees, as of the closing of the restructuring transaction. We continue to provide support and
consulting services for the AERx iDMS program. As of March 31, 2005 Novo Nordisk, A/S beneficially owned 7,868,369 shares of our common
stock, representing approximately 10.9% of our total common stock (10.0% on an as converted basis).
In connection with the restructuring transaction, we entered into an amendment of the common stock
purchase agreement in place with an affiliate of Novo Nordisk, A/S deleting the provisions whereby
we can require the Novo Nordisk affiliate to purchase certain amounts of common stock and imposing
certain restrictions on the ability of the Novo Nordisk affiliate to sell shares of our common
stock that it holds. Other AERx Applications We continue to work on other early-stage AERx programs, including liposomal ciprofloxacin
under the recently announced agreement with Canadas Department of Defence, Hydroxycholoroquine (or
HCQ) for the treatment of asthma and an undisclosed drug that targets a common respiratory disease. Intraject Intraject, a pen-sized, pre-filled, single-use system, is designed to enable patients and
healthcare workers to deliver precise, measured doses of drug to the subcutaneous layer of the skin
without the use of needles. This system has two main parts: the glass drug capsule with a fill
volume of 0.5 ml and a compact nitrogen gas power source called the actuator. Intraject uses the
actuator to create a fine, high-velocity liquid stream that penetrates the skin to pass into the
subcutaneous layer. Key features of the Intraject platform include:  
    Pre-filled, fixed dose and ready to use;
    Lightweight and pocket-sized; and
    Easy to operate. 12




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We are continuing to develop this system to allow for the subcutaneous, needle-free delivery
of a wide range of pharmaceuticals and biopharmaceuticals. In clinical trials, patients have
clearly preferred Intraject as compared to the standard needle and syringe. We are implementing a Contract Manufacturing Organization (CMO) strategy for manufacture of
the Intraject system. This approach will use best-in-class suppliers, whose expertise will allow
us to minimize risk and investment compared to assuming these manufacturing responsibilities
ourselves. We have secured supplier agreements with each of these manufacturers and are now in a
position to execute on this strategy with production of lots for pivotal bioequivalence studies in
2005 for our first drug, sumatriptan. Intraject Sumatriptan Our most advanced Intraject application is for the delivery of sumatriptan, which is being
developed as a needle-free alternative for migraine sufferers. In our clinical studies to date,
patients have indicated a clear preference for the Intraject system over the currently available
needle-based therapy, and we believe that this application could offer significant benefits over
currently marketed products. We believe that the easy-to-use, patient friendly approach will assist
patients in managing their migraines. In November 2004, we announced clinical results from a pilot
pharmacokinetic study demonstrating that Intraject sumatriptan was bioequivalent to the currently
injectable product. We plan to manufacture registration batches to be used as a basis for
regulatory approval later this year. We intend to develop this program with the goal of securing a
commercial partner during 2005. There can be no assurance that this development program will be
successful. Other Intraject Applications Over the last several months, based on the success of our work with sumatriptan, business
development activities have increased substantially; we expect to be able to initiate other
early-stage development programs for Intraject in 2005. Critical Accounting Policies and Estimates We consider certain accounting policies related to revenue recognition, impairment of
long-lived assets 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 provisions of the Securities and Exchange Commission issued Staff
Accounting Bulletin No. 104, Revenue Recognition (SAB 104). Under the agreements, revenue is
recognized 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. 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 in accordance with SFAS 144,
Accounting for the Impairment or Disposal of Long-Lived Assets. 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. 13




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Use of Estimates The preparation of financial statements in conformity with U.S. 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, warrants
and the beneficial conversion feature of preferred stock. Actual results could differ from these
estimates. Results of Operations Three Months Ended March 31, 2005 and 2004 Contract Revenues.Contract revenues for the three months ended March 31, 2005 were $7.7
million, compared to $6.6 million for the three months ended March 31, 2004. Contract revenues are
divided into two components: development contract revenues and milestone revenues. Contract Revenues: Three months ended March 31, 2005 and 2004 (in thousands)
    
    2005
    
    
    2004
    
    
    ChangeDevelopment revenues
    
    $
    2,528
    
    
    $
    6,283
    
    
    $
    (3,755
    )Milestone revenues
    
    
    5,186
    
    
    
    360
    
    
    
    4,826Total contract revenues
    
    $
    7,714
    
    
    $
    6,643
    
    
    $
    1,071
 Of the $7.7 million in total contract revenues for the three months ended March 31, 2005, $5.2
million represents the remaining balance from a milestone payment made by Novo Nordisk, A/S prior
to the close of the restructuring transaction. As a result of the closing of the restructuring
transaction, the remaining associated deferred revenue was recognized as all of our obligations
under the prior agreement were released. In addition, $2.1 million was recognized for work related
to the AERx insulin program that we performed during the month of January 2005. The balance of the
revenue was from other funded development programs and $160,000 from NNDT related to transition and
support services performed in accordance with the restructuring agreement. Revenues for the three
months ended March 31, 2004 include $6.2 million related to the AERx insulin program and $360,000
in deferred milestone revenue amortization. In the remainder of 2005 we expect to record revenue
of approximately $640,000 from NNDT related to transition and support agreements entered into in
connection with the restructuring transaction. While we expect some revenues from collaborations
with other partners, we cannot reliably predict expected revenues for the remaining quarters of
2005, but they are likely to be significantly lower than in 2004. Costs associated with
contract-research revenue are included in research and development expenses. Research and Development Expenses.Research and development expenses for the three months
ended March 31, 2005 were $7.1 million, compared to $11.9 million for the three months ended March
31, 2004. Research and development expenses as a percentage of total operating expenses were 69% in
the first quarter of 2005 and 83% in the first quarter of 2004. The decrease in research and
development expenses is due to the closing of the restructuring transaction with Novo Nordisk, A/S,
in connection with which approximately 119 research and development employees transferred to NNDT
and the reversal of a deferred rent credit related to the building leases transferred to NNDT,
offset by an increase in self initiated studies, primarily for Intraject. Spending for collaborative and self-initiatedresearch and development projects was as
    
    Three months ended March 31,
    
    Increasefollows (in thousands of dollars):
    
    2005
    
    
    2004
    
    
    (Decrease)Collaborative
    
    $
    2,047
    
    
    $
    7,406
    
    
    $
    (5,359
    )Self initiated
    
    
    5,023
    
    
    
    4,481
    
    
    
    542Total R&D spending
    
    $
    7,070
    
    
    $
    11,887
    
    
    $
    (4,817
    )
 14




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These expenses represent proprietary research expenses as well as the costs related to
contract research revenue and include salaries and benefits of scientific and development
personnel, laboratory supplies, consulting services and the expenses associated with the
development of manufacturing processes. Our future research and development efforts will be focused on the development and
commercialization of Intraject and AERx applications, both through self-initiated activities and
collaborations with other parties, However, future research and development expenditures cannot be
predicted reliably as we depend in part upon continued success and funding levels supported by our
existing development collaborations, as well as entering into new collaborative agreements. As a
result of the restructuring transaction with Novo Nordisk, A/S, we expect our 2005 research and
development expenses to decrease by at least 50% from their level in 2004. General and Administrative Expenses.General and administrative expenses in the three months
ended March 31, 2005 were $3.2 million, compared to $2.5 million for in the three months ended
March 31, 2004. This increase of $700,000 was due primarily from legal and consulting costs
associated with the restructuring transaction with Novo Nordisk, A/S. For the year ended December
31, 2005 we expect general and administrative expense to decrease from 2004 levels by approximately
5% to 10% due to reduced activities resulting from the restructuring transaction with Novo Nordisk,
A/S. Interest Income.Interest income for the three months ended March 31, 2005 was $288,000,
compared to $66,000 for the three months ended March 31, 2004. This increase of $222,000 was
primarily due to higher cash and investment balances, and to a lesser extent, changes in interest
rates earned on invested cash balances. For the year ended December 31, 2005 we expect interest
income to increase significantly over 2004 due to our receipt of net proceeds of approximately
$11.7 million from the December 2004 closing of a private placement of our common stock and net
proceeds of approximately $51.0 million from the January 2005 closing of our restructuring
transaction with Novo Nordisk, A/S. Interest and Other Expense.Interest and other expense was $37,000, compared to $10,000 for
the three months ended March 31, 2004. We incurred no interest expense in the first quarter of
2005, as all payment obligations under capital leases have been satisfied in full. The increase is
due primarily to other expenses for foreign exchange loss, $12,000, loss on retirement of fixed
assets, $11,000, and net loss on the sale of equipment to NNDT, $14,000. Liquidity and Capital Resources Since inception, we have financed our operations primarily through private placements and
public offerings of our capital stock, proceeds from equipment lease financings, contract research
funding and interest earned on investments. The proceeds from the sale of assets to Novo Nordisk,
A/S in connection with the restructuring transaction will be used for operations and capital
investments. As of March 31, 2005, we had cash, cash equivalents, restricted cash and short-term
investments of approximately $53.9 million. Net cash used in operating activities for the three months ended March 31, 2005 was $11.7
million, compared to $4.3 million used for the three months ended March 31, 2004. The change is
primarily due to the restructuring transaction terminating the advanced funding for work to be
performed in the subsequent quarter. Novo Nordisk, A/S advanced $6.2 million in March 2004. In
addition, we paid out final vacation and other employee liabilities for those employees who
transitioned to NNDT and we paid vendor accounts related to AERx iDMS activities. We anticipate the
cash used in operation for the year to approximate $25 million. Net cash provided by investing activities in the three months ended March 31, 2005 was $46.0
million, compared to cash provided of $4.1 million for the three months ended March 31, 2004. This
increase is comprised of $50.3 million in net proceeds from NNDT in connection with the
restructuring agreement, offset by our purchase of $1.5 million of fixed assets relating to our
Intraject platform and purchases of $2.6 million in securities classified as short-term
investments. In the first quarter of 2005, $200,000 was committed to restricted cash. See
Contractual Obligations below. Net cash provided by financing activities for the three months ended March 31, 2005 was
$14,000, compared to $107,000 for the three months ended March 31, 2004. For the three months
ended March 31, 2004, the proceeds 15




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from issuance of common stock of $305,000 were offset by
payments on capital lease obligations of $211,000. For the three months ended March 31, 2005, we
received no proceeds from issuance of common stock and the capital lease obligations were paid in
full in 2004. The development of our technology and proposed products has and will continue to require a
commitment of substantial funds to conduct the costly and time-consuming research, preclinical and
clinical testing activities necessary to develop and refine such technology and proposed products
and to bring any such products to market. Our future capital requirements will depend on many
factors, including continued progress and the results of the research and development of our
technology and drug delivery systems, our 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 of our production technologies, the cost 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 2005 and beyond. We
particularly focus on capital spending requirements to ensure that capital outlays are not expended
sooner than necessary. We expect our total capital outlays for 2005 to be approximately $11
million. The majority of these outlays will be associated with completing the commercial scale-up
of the Intraject production processes, including process, qualification, and registration batch
production for sumatriptan. At March 31, 2005, we are contractually committed to approximately $2.5
million of the anticipated 2005 capital outlays. Capital outlays beyond 2005 will depend on our
ability to raise additional capital and future partner funding arrangements. We believe that our
existing cash balances at March 31, 2005 funding commitments from corporate development partners,
proceeds from the restructuring transaction with Novo Nordisk, A/S and interest earned on our
investments should be sufficient to meet our needs for at least the next 12 months. If we make good progress in our development programs, 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 additional equity securities
are issued to raise capital. 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. Off-Balance Sheet Financings and Liabilities Other than contractual obligations incurred in the normal course of business, we do not have
any off-balance sheet financing arrangements or liabilities, guarantee contracts, retained or
contingent interests in transferred assets or any obligation arising out of a material variable
interest in an unconsolidated entity. We do not have any majority-owned subsidiaries. 16




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Contractual Obligations In order to begin construction at a third party manufacturing facility, we have established a
$180,000 standby letter of credit in favor of a contract manufacturer. The letter of credit is
secured by a $200,000 certificate of deposit that is classified as restricted cash. Subsequent to completion in January 2005 of the restructuring transaction with Novo Nordisk,
A/S, we have commitments under two remaining leases. The first lease is for a building containing
office, laboratory and manufacturing facilities, and expires in 2016. A minor portion of this
lease expense is offset by a sublease to NNDT of $10,000 per month for 14 months commencing January
2005. The second lease is for a warehouse and expires in December 2005. Our contractual
obligations and future minimum lease payments that are non-cancelable at March 31, 2005 under the
two lease agreements are disclosed in the following table. Unconditional purchase obligations have
increased in support of Intraject development and manufacturing activities. Payment Due by Period(amounts in thousands)Contractual obligations
    
    Total
    
    
    20051
    
    
    2006/2007
    
    
    2008/2009
    
    
    2010+Operating lease obligations
    
    $
    25,364
    
    
    $
    1,849
    
    
    $
    4,085
    
    
    $
    4,725
    
    
    $
    14,705Unconditional purchase obligations
    
    
    2,852
    
    
    
    2,852
    
    
    
    
    
    
    
    
    
    
    
    Total contractual commitments
    
    $
    28,216
    
    
    $
    4,701
    
    
    $
    4,085
    
    
    $
    4,725
    
    
    $
    14,705
   1
    
    For nine months ended December 31, 2005. 
 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 March 31, 2005, we had cash, cash equivalents and short-term investments of $53.7
million, consisting of cash, cash equivalents 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 have been immaterial. Declines of interest rates
over time will, however, reduce our interest income from our short-term investments 
 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 to ensure
that information required to be disclosed in this report was recorded, processed, summarized and
reported within the time periods specified in the Securities and Exchange Commissions rules and
forms. Changes in internal control.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. 17




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Limitations on the effectiveness of controls.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. 
 PART II. OTHER INFORMATION 
 Item 4. Submission of Matters to a Vote of Security Holders A Special Meeting of our shareholders was held on January 21, 2005. At the Special Meeting,
our shareholders approved (i) the sale of certain assets used in the development and manufacture of
the AERx iDMS, in connection with the restructuring of our license agreement with Novo Nordisk, A/S
(the Asset Sale Proposal), (ii) an amendment to our Amended and Restated Articles of
Incorporation to effect a stock combination pursuant to which any whole number of outstanding
shares between and including two and five would be combined into one share of our common stock and
to authorize our Board of Directors to select and file one such amendment (the Stock Combination
Proposal) and (iii) an amendment to our Amended and Restated Articles of Incorporation to reduce
the authorized number of shares of our capital stock from 155,000,000 to 105,000,000, subject to
the approval of the Stock Combination Proposal and the implementation of the stock combination (the
Reduction in Shares Authorized Proposal). The holders of our common stock and our Series A
preferred stock, voting together as a single class on an as-converted basis, voted as follows on
the three above-listed proposals:  
    Asset Sale Proposal: 43,719,736 votes for, 573,707 votes against, 143,988 abstentions,
20,361,822 broker non-votes;
    Stock Combination Proposal: 58,925,861 votes for, 5,431,901 votes against, 441,491
abstentions;
    Reduction in Shares Authorized Proposal: 59,756,153 votes for, 4,319,488 votes against,
723,612 abstentions. The following additional votes were taken with respect to the Asset Sale Proposal:  
    a vote of the holders of our outstanding Series A preferred stock: 1,338,015 votes for,
no votes against and no abstentions;
    a vote of the holders of our common stock and our Series A preferred stock present at
the meeting, in person or by proxy: 30,499,307 votes for, 573,707 votes against, 143,988
abstentions. 
 Item 6. 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 pursuant to Section 906 of
the Sarbanes-Oxley Act of 2002.
 18




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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 OfficerDated: May 13, 2005
 19




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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.