## 

# UNITED STATES
SECURITIES AND EXCHANGE COMMISSIONWashington, DC 20549

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# Form 10-Q

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(Mark One)

||X| |  | QUARTERLY REPORT PURSUANT
      TO SECTION 13 OR 15(d)
      OF THE SECURITIES EXCHANGE ACT OF 1934
      For the quarterly period ended June 30, 2004
|--- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------

# 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(State or other jurisdiction of 
      incorporation or organization) | 94-3133088(I.R.S. Employer 
      Identification No.)
|------------------------------------------------------------------------------- | -----------------------------------------------------



3929
  Point Eden Way
  Hayward, CA 94545(Address of principal executive offices including zip code)(510) 265-9000(Registrants telephone number, including area code)


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

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

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

|Common Stock, no par value
      (Class) | 63,564,493 (Outstanding at July 31, 2004)
|---------------------------------------- | -----------------------------------------

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| |  | 
| |  | 

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# ARADIGM CORPORATION
                                                       INDEX



|                               |  |                                                                                             | PageNo.
|------------------------------ |  | ------------------------------------------------------------------------------------------- | -------
|                               |  |                                                                                             |        
|PART I.  FINANCIAL INFORMATION
|                              
|ITEM 1.                        |  | Condensed Financial Statements (unaudited)                                                  |        
|                               |  | Condensed Balance Sheets                                                                    |        
|                               |  | At June 30, 2004 and December 31,
      2003 (unaudited)                                    | 2      
|                               |  | Condensed Statements of Operations                                                          |        
|                               |  | Three months ended June 30,
      2004 and 2003 (unaudited)                                 | 3      
|                               |  | Six months ended June 30,
      2004 and 2003 (unaudited)                                   | 4      
|                               |  | Statements of Cash Flows                                                                    |        
|                               |  | Six months ended June 30,
      2004 and 2003 (unaudited)                                   | 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                                                                     | 12     
|                              
|PART II.  OTHER INFORMATION   
|                              
|                               |  |                                                                                             |        
|ITEM 4.                        |  | Submission of Matters to a Vote of Security
      Holders                                   | 13     
|ITEM 5.                        |  | Other Information                                                                           | 13     
|ITEM 6.                        |  | Exhibits and Reports on Form 8-K                                                            | 14     
|Signatures                     | 
|Index to Exhibits              | 
|Exhibits                       | 



| | 1 | 
| | - | 

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# PART I.
    FINANCIAL INFORMATION

# Item 1.Condensed Financial Statements

# ARADIGM CORPORATION
                                             CONDENSED BALANCE SHEETS



|                                                                                                                                                                                                                                                                     | June 30,2004                                                          |                            | December 31,2003                                                                        
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- | --------------------------------------------------------------------- | -------------------------- | ----------------------------------------------------------------------------------------
|                                                                                                                                                                                                                                                                     |                                                                       |                            |                                                                                         
|                                                                                                                                                                                                                                                                     | (Unaudited)                                                           |                            | (Note 1)                                                                                
|                                                                                                                                                                                                                                                                     | (In thousands,
      except shares data)                             
|ASSETS                                                                                                                                                                                                                                                              
|Current assets:                                                                                                                                                                                                                                                      |                                                                       |                            |                                                                                         
|                                                                                                                                                                                                                                                                     | Cash and cash equivalents                                             | $                          | 10,591                                                                                  
|                                                                                                                                                                                                                                                                     | Short-term investments                                                |                            | 8,332                                                                                   
|                                                                                                                                                                                                                                                                     | Receivables                                                           |                            | 135                                                                                     
|                                                                                                                                                                                                                                                                     | Current portion of notes receivable from officers
      and employees |                            | 61                                                                                      
|                                                                                                                                                                                                                                                                     | Prepaid expenses and other current assets                             |                            | 1,739                                                                                   
|                                                                                                                                                                                                                                                                     |                                                                       |                            |                                                                                         
|                                                                                                                                                                                                                                                                     |                                                                       | Total current assets       |                                                                                         
|Property and equipment, net                                                                                                                                                                                                                                          |                                                                       | 60,628                     |                                                                                         
|Noncurrent portion of notes receivable from
      officers and employees                                                                                                                                                                                             |                                                                       | 249                        |                                                                                         
|Other assets                                                                                                                                                                                                                                                         |                                                                       | 454                        |                                                                                         
|                                                                                                                                                                                                                                                                     |                                                                       |                            |                                                                                         
|                                                                                                                                                                                                                                                                     |                                                                       | Total assets               | $                                                                                       
|                                                                                                                                                                                                                                                                     |                                                                       |                            |                                                                                         
|LIABILITIES, REDEEMABLE CONVERTIBLE PREFERRED
      STOCK AND SHAREHOLDERS EQUITY                                                                                                                                                                                  
|Current liabilities:                                                                                                                                                                                                                                                 |                                                                       |                            |                                                                                         
|                                                                                                                                                                                                                                                                     | Accounts payable                                                      | $                          | 1,005                                                                                   
|                                                                                                                                                                                                                                                                     | Accrued clinical and cost of other studies                            |                            | 216                                                                                     
|                                                                                                                                                                                                                                                                     | Accrued compensation                                                  |                            | 3,588                                                                                   
|                                                                                                                                                                                                                                                                     | Deferred revenue                                                      |                            | 8,104                                                                                   
|                                                                                                                                                                                                                                                                     | Current portion of capital lease obligations                          |                            |                                                                                        
|                                                                                                                                                                                                                                                                     | Other accrued liabilities                                             |                            | 745                                                                                     
|                                                                                                                                                                                                                                                                     |                                                                       |                            |                                                                                         
|                                                                                                                                                                                                                                                                     |                                                                       | Total current liabilities  |                                                                                         
|Noncurrent portion of deferred revenue                                                                                                                                                                                                                               |                                                                       | 4,576                      |                                                                                         
|Noncurrent portion of deferred rent                                                                                                                                                                                                                                  |                                                                       | 1,656                      |                                                                                         
|Commitments and contingencies                                                                                                                                                                                                                                        |                                                                       |                            |                                                                                         
|Redeemable convertible preferred stock, no par
      value; 5,000,000 shares authorized; issued and outstanding shares: 1,544,626
      at June 30, 2004 and at December 31, 2003; liquidation preference
      of $37,380 at June 30, 2004 and at December 31, 2003 |                                                                       | 23,669                     |                                                                                         
|Shareholders equity:                                                                                                                                                                                                                                                |                                                                       |                            |                                                                                         
|Common stock, no par value; 150,000,000 and
      100,000,000 shares authorized at June 30, 2004 and December 31, 2003, respectively;
      issued and outstanding shares: 63,564,493 at June 30, 2004 and 62,751,196
      at December 31, 2003                     |                                                                       | 269,267                    |                                                                                         
|                                                                                                                                                                                                                                                                     |                                                                       |                            |                                                                                         
|Accumulated deficit                                                                                                                                                                                                                                                  |                                                                       | (230,637                   | )                                                                                       
|                                                                                                                                                                                                                                                                     |                                                                       |                            |                                                                                         
|                                                                                                                                                                                                                                                                     |                                                                       | Total shareholders equity |                                                                                         
|                                                                                                                                                                                                                                                                     |                                                                       |                            |                                                                                         
|                                                                                                                                                                                                                                                                     |                                                                       |                            | Total liabilities, redeemable convertible
      preferred stock and shareholders equity
|                                                                                                                                                                                                                                                                     |                                                                       |                            |                                                                                         

See accompanying notes.



| | 2 | 
| | - | 

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# ARADIGM CORPORATION
                                        CONDENSED STATEMENTS OF OPERATIONS



|                                                                                                         | Three Months
      EndedJune 30,                
|-------------------------------------------------------------------------------------------------------- | ------------------------------------------------
|                                                                                                         |                                                 
|                                                                                                         | 2004                                            
|                                                                                                         |                                                 
|                                                                                                         | (Unaudited)(In thousands, except per share data)
|Contract revenues (Including amounts from related
      parties:
          2004  $7,006; 2003  $9,255) | $                                               
|                                                                                                         |                                                 
|Operating expenses:                                                                                      |                                                 
|                                                                                                         | Research and development                        
|                                                                                                         | General and administrative                      
|                                                                                                         |                                                 
|                                                                                                         |                                                 
|                                                                                                         |                                                 
|Loss from operations                                                                                     |                                                 
|                                                                                                         |                                                 
|Interest income                                                                                          |                                                 
|Interest expense                                                                                         |                                                 
|                                                                                                         |                                                 
|Net loss                                                                                                 | $                                               
|                                                                                                         |                                                 
|Basic and diluted net loss per share                                                                     | $                                               
|                                                                                                         |                                                 
|Shares used in computing basic and diluted net
      loss per share                                      |                                                 
|                                                                                                         |                                                 

See accompanying notes.



| | 3 | 
| | - | 

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# ARADIGM CORPORATION
                                        CONDENSED STATEMENTS OF OPERATIONS



|                                                                                                         | Six Months
      EndedJune 30,                  
|-------------------------------------------------------------------------------------------------------- | ------------------------------------------------
|                                                                                                         |                                                 
|                                                                                                         | 2004                                            
|                                                                                                         |                                                 
|                                                                                                         | (Unaudited)(In thousands, except per share data)
|Contract revenues (Including amounts from related
      parties:
         2004  $13,616; 2003  $16,824 | $                                               
|                                                                                                         |                                                 
|Operating expenses:                                                                                      |                                                 
|                                                                                                         | Research and development                        
|                                                                                                         | General and administrative                      
|                                                                                                         |                                                 
|                                                                                                         |                                                 
|                                                                                                         |                                                 
|Loss from operations                                                                                     |                                                 
|                                                                                                         |                                                 
|Interest income                                                                                          |                                                 
|Interest expense                                                                                         |                                                 
|                                                                                                         |                                                 
|Net loss                                                                                                 | $                                               
|                                                                                                         |                                                 
|Basic and diluted net loss per share:                                                                    |                                                 
|Net loss per share                                                                                       | $                                               
|                                                                                                         |                                                 
|Shares used in computing basic and diluted net
      loss per share                                      |                                                 
|                                                                                                         |                                                 

See accompanying notes.



| | 4 | 
| | - | 

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# ARADIGM CORPORATION
                                             STATEMENTS OF CASH FLOWS



|                                                     | Six Months
      EndedJune 30,                                                  
|---------------------------------------------------- | --------------------------------------------------------------------------------
|                                                     |                                                                                 
|                                                     | 2004                                                                            
|                                                     |                                                                                 
|                                                     | (Unaudited)(In thousands)                                                       
|Cash flows from operating activities:                |                                                                                 
|                                                     | Net loss                                                                        
|                                                     | Adjustments to reconcile net loss to cash used
      in operating activities:   
|                                                     |                                                                                 
|                                                     |                                                                                 
|                                                     |                                                                                 
|                                                     |                                                                                 
|                                                     |                                                                                 
|                                                     |                                                                                 
|                                                     |                                                                                 
|                                                     |                                                                                 
|                                                     |                                                                                 
|                                                     |                                                                                 
|                                                     |                                                                                 
|                                                     |                                                                                 
|                                                     |                                                                                 
|Net cash used in operating activities                |                                                                                 
|                                                     |                                                                                 
|Cash flows from investing activities:                |                                                                                 
|                                                     | Capital expenditures                                                            
|                                                     | Sale (purchase) of available-for-sale investments                               
|                                                     | Proceeds from maturities of available-for-sale
      investments                
|                                                     |                                                                                 
|Net cash provided by investing activities            |                                                                                 
|                                                     |                                                                                 
|Cash flows from financing activities:                |                                                                                 
|                                                     | Proceeds from issuance of common stock, net                                     
|                                                     | Proceeds from exercise of options and warrants
      for common stock           
|                                                     | Notes receivable from officers                                                  
|                                                     | Payments on lease obligations and equipment
      loans                         
|                                                     |                                                                                 
|Net cash provided by financing activities            |                                                                                 
|                                                     |                                                                                 
|Net increase (decrease) in cash and cash equivalents |                                                                                 
|Cash and cash equivalents at beginning of period     |                                                                                 
|                                                     |                                                                                 
|Cash and cash equivalents at end of period           | $                                                                               
|                                                     |                                                                                 
|Supplemental disclosure of cash flow information:    |                                                                                 
|                                                     | Cash paid for interest                                                          
|                                                     |                                                                                 
|Non-cash investing and financing activities:         |                                                                                 
|                                                     | Issuance of common stock through conversion
      of Series A preferred stock   
|                                                     | Issuance of warrants in conjunction with private
      placement of common stock
|                                                     | Issuance of warrants and options to purchase
      common stock for services    
|                                                     |                                                                                 

See accompanying notes.



| | 5 | 
| | - | 

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# ARADIGM CORPORATION
                               NOTES TO THE UNAUDITED CONDENSED FINANCIAL STATEMENTS
                                                   June 30, 2004

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.

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 Ended | Six Months Ended
|-------------------------------------------------------------- | ------------------------------------------------------------------------------------------------------------- | ------------------ | ----------------
|                                                               |                                                                                                               | June 30,           | June 30,        
|                                                               |                                                                                                               | 2004               | 2003            
|Net loss applicable to common shareholders 
      as reported | $  (7,457                                                                                                     | )                  | $ (7,420        
|Less:                                                          |                                                                                                               |                    |                 
|                                                               | Total stock-based employee compensation expense
      determined under fair value based method for all awards | $  (1,299          | )               
|                                                               |                                                                                                               |                    |                 
|Pro forma net loss applicable to
      common shareholders     | $  (8,756                                                                                                     | )                  | $ (8,747        
|Basic and diluted net loss per share:                          |                                                                                                               |                    |                 
|                                                               | As reported                                                                                                   | $    (0.12         | )               
|                                                               | Pro forma                                                                                                     | $    (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 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.

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 six months ending June 30, 2004.

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. In consideration for the amended lease agreement, we 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 we will amortize on a
straight-line basis over the remaining life of the lease.

Novo
Nordisk and its affiliate, Novo Nordisk Pharmaceuticals, Inc., are considered related
parties and at June 30, 2004 own approximately 11.3% of the Companys total outstanding
common stock (on an as-converted basis).



| | 7 | 
| | - | 

---

# 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 and Form 10-Q 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 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 June 30,
2004, we had an accumulated deficit of $231 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.

We
expect to perform various studies evaluating our Intraject subcutaneous delivery platform
following the completion of clinical performance verification trials scheduled for later
this year. While Aradigm will be actively engaging partners for discussions on Intraject,
we believe that it is unlikely that a new commercial agreement for Intraject will be
signed until the clinical verification trial is completed and presented to potential
partners later this year. In some cases, a partnership may not be disclosed until a
long-term development agreement has been established.

Our
lead development program is developing pulmonary delivery systems to manage diabetes
using insulin 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



| | 8 | 
| | - | 

---

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 has decided to amend the current
  trial protocol. Novo Nordisk will make decisions concerning the structure and
  timing of additional clinical trials after these observations have been fully
  assessed.

The
collaborative agreement with Novo Nordisk provides for reimbursement of research and
development expenses as well as additional payments to us as we achieve certain
significant milestones. We also expect to receive royalties from this development partner
based on revenues from product sales and to receive revenue from the manufacturing of
unit dose packets and hand-held devices. We recognize revenues under the terms of our
collaborative agreement as the research and development expenses are incurred, to the
extent they are reimbursable. For the six months ended June 30, 2004, this partner-funded
program has contributed approximately 99.2% of our total contract revenues. At June 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 a related party.

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.

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



| | 9 | 
| | - | 

---

and accompanying notes to the
financial statements. These estimates include useful lives for property and equipment and
related depreciation calculations, estimated amortization period for payments received
from product development and license agreements as they relate to the revenue recognition
of deferred revenue and assumptions for valuing options and warrants. Actual results
could differ from these estimates.

# Three Months Ended
June 30, 2004 and 2003

Contract
  and License Revenues:Contract revenues for the three months ended June
  30, 2004 decreased to $7.1 million from $9.4 million for the same period in
  2003. Revenue from Novo Nordisk was $7.0 million for the three months ended
  June 30, 2004 and $9.3 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 trend down over the coming quarters due to the expected level
  of activity in support of the ongoing Phase 3 clinical program.

Research
  and Development Expenses:Research and development expenses for the three
  months ended June 30, 2004 decreased to $11.4 million from $14.0 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.

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, and initiate commercial manufacturing of the AERx
systems. The increase in research and development expenditures cannot be predicted
accurately as it depends in part upon the future success of, and funding levels supported
by, our existing development collaborations, as well as obtaining new collaborative
agreements.

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.

General
  and Administrative Expenses:General and administrative expenses for the
  three months ended June 30, 2004 increased by 11.4% to $3.2 million from $2.8
  million for the same period in 2003 due to an increase in cost associated with
  increased marketing and legal expenses, which were slightly offset by lower
  depreciation.

Interest
  Income: Interest income for the three months ended June 30, 2004 decreased
  to $49,000 from $86,000 for the same period in 2003. The decrease is due to
  lower average investment portfolio balances and lower yields.

Interest
  Expense:Interest expense for the three months ended June 30, 2004 decreased
  to $5,000 from $39,000 for the same period in 2003. The decrease is primarily
  due to the pay off 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 June 30, 2004 increased by 0.5%
  to $7.5 million from $7.4 million for the same period in 2003, reflecting lower
  Novo Nordisk contract revenues and primarily offset by reduced associated development
  expense.

# Six Months Ended June
30, 2004 and 2003

Contract
  Revenues:Contract revenues for the six months ended June 30, 2004 decreased
  by 19.6% to $13.7 million from $17.1 million for the same period in 2003. Revenue
  from Novo Nordisk was $13.6 million for the six months ended June 30, 2004 and
  $16.8 million for the same period in 2003. The decrease in revenue is related
  to lower budgeted Novo Nordisk activities for clinical supply and product



| | 10 | 
| | -- | 

---

development activities for the
ongoing phase 3 clinical program and by lower revenue from other funded programs. Costs
associated with collaborative agreements are included in research and development
expenses. The Company expects that the revenue from Novo Nordisk may trend down over the
coming quarter(s) due to the expected level of activity in support of the ongoing phase 3
clinical program.

Research
  and Development Expenses: Research and development expenses for the six
  months ended June 30, 2004 decreased to $23.3 million from $27.0 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
  six months ended June 30, 2004 increased by 3.5% to $5.7 million from $5.5 million
  for the same period in 2003. The increase is primarily due to higher marketing,
  insurance, legal and consulting costs.

Interest
  Income: Interest income for the six months ended June 30, 2004 decreased
  to $115,000 from $194,000 for the same period in 2003. The decrease is due to
  lower invested balances.

Interest
  Expense: Interest expense for the six months ended June 30, 2004 decreased
  to $15,000 from $95,000 for the same period in 2003. The decrease is primarily
  due to the pay off of the outstanding capital lease and equipment loan balances
  under various equipment and lease lines of credit.

Net Loss:Net
  loss for the six months ended June 30, 2004 decreased to $15.2 million from
  $15.3 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 June 30, 2004, we had cash, cash
equivalents and short-term investments of approximately $18.9 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.

Net cash used
  in operating activities for the six months ended June 30, 2004 decreased to
  $10.4 million from $14.3 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 payable and deferred revenue. The accounts payable
  balance at the end of the second 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 the significantly higher deferred
  balance held at year-end 2003 that was recognized as revenue in the first six
  months of 2004.

Investing
activities for the six months ended June 30, 2004 provided cash of $2.2 million, compared
to $0.6 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.

Net
cash provided by financing activities for the six months ended June 30, 2004 was $0.4
million, compared to $15.2 million for the same period in 2003. Net cash provided in the
six months ended June 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



| | 11 | 
| | -- | 

---

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 $5.0 to $8.0 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. We believe that our existing cash
balances at June 30, 2004, funding commitments from corporate development partners and
interest earned on our investments should be sufficient to meet our needs for at least
the next 12 months. There can be no assurance that our funding commitments from corporate
development partners will not be amended or terminated, and if they are amended or
terminated, we will need to obtain additional sources of capital sooner than would
otherwise be the case.

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

# Item 3. Quantitative
  and Qualitative Disclosures About Market Risk

# Market Risk
Disclosures

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

As
of June 30, 2004, we had cash, cash equivalents and short-term investments of $18.9
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.

# 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.



| | 12 | 
| | -- | 

---

# Changes in Internal
Controls

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

# PART II.     OTHER
INFORMATION

# Item 4. Submission
  of Matters to a Vote of Security Holders

(a)
The Annual Meeting of Shareholders of Aradigm Corporation was held on May 20, 2004.

(b)
Frank H. Barker, Stan M. Benson, Igor Gonda, Stephen O. Jaeger, John M. Nehra, Wayne I.
Roe, Richard P. Thompson and Virgil D. Thompson, were elected to the Board of Directors
to hold office until the next Annual Meeting of Shareholders and until their successors
are elected and qualified.

(c)
The matters voted upon at the meeting and the voting of the shareholders with respect
thereto were as follows:



|                                                                                                                                                                                                         
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(1a) The
      election of Frank H. Barker as Director to hold office until the next 
      Annual Meeting of Shareholders and until his successor is elected and qualified:                             
|Withheld:                                                                                                                                                                                                
|                                                                                                                                                                                                         
|                                                                                                                                                                                                         
|                                                                                                                                                                                                         
|(1b) The
      election of Stan M. Benson as Director to hold office until the next 
      Annual Meeting of Shareholders and until his successor is elected and qualified:                              
|                                                                                                                                                                                                         
|                                                                                                                                                                                                         
|                                                                                                                                                                                                         
|(1c) The
      election of Igor Gonda as Director to hold office until the next 
      Annual Meeting of Shareholders and until his successor is elected and qualified:                                  
|                                                                                                                                                                                                         
|                                                                                                                                                                                                         
|                                                                                                                                                                                                         
|(1d) The
      election of Stephen O. Jaeger as Director to hold office until the next
      
      Annual Meeting of Shareholders and until his successor is elected and qualified:                     
|                                                                                                                                                                                                         
|                                                                                                                                                                                                         
|                                                                                                                                                                                                         
|(1e) The
      election of John M. Nehra as Director to hold office until the next 
      Annual Meeting of Shareholders and until his successor is elected and qualified:                               
|                                                                                                                                                                                                         
|                                                                                                                                                                                                         
|                                                                                                                                                                                                         
|(1f) The
      election of Wayne I. Roe as Director to hold office until the next 
      Annual Meeting of Shareholders and until his successor is elected and qualified:                                
|                                                                                                                                                                                                         
|                                                                                                                                                                                                         
|                                                                                                                                                                                                         
|(1g) The
      election of Richard P. Thompson as Director to hold office until the next
      
      Annual Meeting of Shareholders and until his successor is elected and qualified:                   
|                                                                                                                                                                                                         
|                                                                                                                                                                                                         
|                                                                                                                                                                                                         
|(1h) The
      election of Virgil D. Thompson as Director to hold office until the next
      
      Annual Meeting of Shareholders and until his successor is elected and qualified:                    
|                                                                                                                                                                                                         
|                                                                                                                                                                                                         
|                                                                                                                                                                                                         
|(2) Proposal
      to amend the Companys Amended and Restated Articles of 
      Incorporation to increase the authorized number of shares of common stock
      from 
      100,000,000 to 150,000,000:
|                                                                                                                                                                                                         
|                                                                                                                                                                                                         
|                                                                                                                                                                                                         
|(3) Ratification
      of the selection of Ernst & Young LLP as independent 
      auditors of the Company for the fiscal year ending December 31, 2004:                                                 
|                                                                                                                                                                                                         
|                                                                                                                                                                                                         
|                                                                                                                                                                                                         

# Item 5. Other
  Information

On
July 26, 2004 we received a letter from the Nasdaq informing us that we were not in
compliance with the Nasdaq minimum bid price requirement. Our common stock is currently
listed on the Nasdaq National Market and, since June 10, 2004, has had a closing bid
price of less than $1.00. Pursuant to the



| | 13 | 
| | -- | 

---

Nasdaqs minimum bid price
requirement, our common stock could be de-listed from the Nasdaq National Market as a
result of trading below $1.00 for 30 consecutive trading days and not trading above $1.00
for 10 consecutive days within the next 180 calendar days. We have until January 24, 2005
to regain compliance with this requirement. If we are unable to meet the Nasdaq
requirements to maintain listing on the Nasdaq National Market, our common stock could
trade on the Nasdaq Small Cap Market, the OTC Bulletin Board or in the pink sheets
maintained by the National Quotation Bureau, Inc. Such alternatives are generally
considered to be less efficient markets, and our stock price, as well as the liquidity of
our common stock, will be adversely impacted as a result.

# Item 6. Exhibits
  and Reports on Form 8-K

(a)
Exhibits

|3.7 |  | Certificate
of Amendment of Amended and Restated Articles of Incorporation of the Company.
|--- | - | ------------------------------------------------------------------------------------------

|3.8 |  | Certificate
of Amendment of Certificate of Determination of Series A Junior Participating
                  Preferred Stock of the Company.
|--- | - | -------------------------------------------------------------------------------------------------------------------------------------------

|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.
|---- | - | -------------------------------------------------------------------------------------------------------------------------------------------------

(b)
Reports on Form 8-K

| | We
filed a Current Report on Form 8-K dated May 10, 2004 to furnish a          press release
in which we announced our financial results for the first          quarter ended March
31, 2004.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | 14 | 
| | -- | 

---

# 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 LAWLIS                                    
|                       |                                                        
|                       | V. Bryan Lawlis                                        
|                       | President and Chief Executive Officer                  
|                       |                                                        
|                       | /s/ THOMAS C. CHESTERMAN                               
|                       |                                                        
|                       | Thomas C. Chesterman                                   
|                       | Senior Vice President and Chief Financial
      Officer
|                       |                                                        
|Dated: August 13, 2004 |                                                        



| | 15 | 
| | -- | 

---

# INDEX TO EXHIBITS



|ExhibitNumber |  | Description                                                                                                                                
|------------- |  | -------------------------------------------------------------------------------------------------------------------------------------------
|              |  |                                                                                                                                            
|3.7           |  | Certificate of Amendment of Amended and Restated
      Articles of Incorporation of the Company.                                           
|3.8           |  | Certificate of Amendment of Certificate of
      Determination of Series A Junior Participating Preferred Stock of the Company.            
|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.