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UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, DC 20549




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Form 10-Q


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(Mark One)

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

Or

|  |  |                                                                                         
|- |  | ----------------------------------------------------------------------------------------
|o |  | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
|  |  | For the transition period from                      to                     .            

Commission File Number 0-28402

Aradigm Corporation

(Exact name of registrant as specified in its charter)


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

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

Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes x 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 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 |  | 54,295,481                    
|(Class)                    |  | (Outstanding at July 31, 2003)





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TABLE OF CONTENTS



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



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ARADIGM CORPORATION
INDEX

|                              |  |                                                                                       |                                                    |                                         |                                                       |   |          |  | 
|----------------------------- |  | ------------------------------------------------------------------------------------- | -------------------------------------------------- | --------------------------------------- | ----------------------------------------------------- | - | -------- |  | 
|                              |  |                                                                                       |                                                    |                                         |                                                       |   | Page No.
|                              |  |                                                                                       |                                                    |                                         |                                                       |   |         
|PART I. FINANCIAL INFORMATION
|ITEM 1.                       |  | Financial
Statements                                                                  |                                                    |                                         |                                                       |  
|                              |  | Balance Sheets                                                                        |                                                    |                                         |                                                      
|                              |  |                                                                                       | At June 30, 2003 and December 31, 2002 (unaudited) | 2                                       |                                                      
|                              |  |                                                                                       |                                                    | Statements of Operations                |                                                       |  
|                              |  |                                                                                       |                                                    |                                         | Three Months Ended June 30, 2003 and 2002 (unaudited) | 3 |         
|                              |  |                                                                                       |                                                    |                                         | Six months ended June 30, 2003 and 2002 (unaudited)   | 4 |         
|                              |  |                                                                                       |                                                    | Statements of Cash Flows                |                                                       |  
|                              |  |                                                                                       |                                                    |                                         | Six months ended June 30, 2003 and 2002 (unaudited)   | 5 |         
|                              |  |                                                                                       |                                                    | Notes to Unaudited 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                             | 13                                                 |                                        
|ITEM 4.                       |  | Controls and Procedures                                                               | 13                                                 |                                        
|PART II. OTHER INFORMATION   
|ITEM 1.                       |  | Legal Proceedings                                                                     | 14                                                 |                                        
|ITEM 4.                       |  | Submission of Matters to a Vote of Security Holders                                   | 14                                                 |                                        
|ITEM 6.                       |  | Exhibits and Reports on Form 8-K                                                      | 15                                                 |                                        
|Signature                     |  |                                                                                       |                                                    | 16                                      |                                                      
|Index to Exhibits             |  |                                                                                       |                                                    | 17                                      |                                                      

1



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PART I. FINANCIAL INFORMATION




Item 1.Financial Statements




ARADIGM CORPORATION
BALANCE SHEETS

|                                                                                                                                                                                                                                                                     |                                                                 |                           |        |        |                                    |   |              |        |        |  | 
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- | --------------------------------------------------------------- | ------------------------- | ------ | ------ | ---------------------------------- | - | ------------ | ------ | ------ |  | 
|                                                                                                                                                                                                                                                                     |                                                                 |                           |        |        | June 30,                           |   | December 31,
|                                                                                                                                                                                                                                                                     |                                                                 |                           |        |        | 2003                               |   | 2002        
|                                                                                                                                                                                                                                                                     |                                                                 |                           |        |        |                                    |   |             
|                                                                                                                                                                                                                                                                     |                                                                 |                           |        |        | (Unaudited)                        |   | (Note 1)    
|                                                                                                                                                                                                                                                                     |                                                                 |                           |        |        | (In thousands, except shares data)
|ASSETS                                                                                                                                                                                                                                                              
|Current assets:                                                                                                                                                                                                                                                      |                                                                 |                           |        |        |                                    |   |              |       
|                                                                                                                                                                                                                                                                     | Cash and cash equivalents                                       |                           | $      | 24,392 |                                    |   | $            | 22,800 |       
|                                                                                                                                                                                                                                                                     | Short-term investments                                          |                           |        | 3,837  |                                    |   |              | 7,090  |       
|                                                                                                                                                                                                                                                                     | Receivables                                                     |                           |        | 167    |                                    |   |              | 282    |       
|                                                                                                                                                                                                                                                                     | Current portion of notes receivable from officers and employees |                           |        | 138    |                                    |   |              | 136    |       
|                                                                                                                                                                                                                                                                     | Prepaid expenses and other current assets                       |                           |        | 1,376  |                                    |   |              | 1,457  |       
|                                                                                                                                                                                                                                                                     |                                                                 |                           |        |        |                                    |   |              |       
|                                                                                                                                                                                                                                                                     |                                                                 | Total current assets      |        |        | 29,910                             |   |              |        | 31,765 | 
|Property and equipment, net                                                                                                                                                                                                                                          |                                                                 |                           | 64,207 |        |                                    |   | 63,233       |       
|Noncurrent portion of notes receivable from officers and employees                                                                                                                                                                                                   |                                                                 |                           | 332    |        |                                    |   | 169          |       
|Long-term investments                                                                                                                                                                                                                                                |                                                                 |                           |       |        |                                    |   | 1,553        |       
|Other assets                                                                                                                                                                                                                                                         |                                                                 |                           | 399    |        |                                    |   | 409          |       
|                                                                                                                                                                                                                                                                     |                                                                 |                           |        |        |                                    |   |              |       
|Total
assets                                                                                                                                                                                                                                                         |                                                                 | $                         | 94,848 |        |                                    | $ | 97,129       |       
|                                                                                                                                                                                                                                                                     |                                                                 |                           |        |        |                                    |   |              |       
|LIABILITIES, REDEEMABLE CONVERTIBLE PREFERRED                                                                                                                                                                                                                       
|STOCK AND SHAREHOLDERS EQUITY                                                                                                                                                                                                                                      
|Current liabilities:                                                                                                                                                                                                                                                 |                                                                 |                           |        |        |                                    |   |              |       
|                                                                                                                                                                                                                                                                     | Accounts payable                                                |                           | $      | 1,010  |                                    |   | $            | 1,951  |       
|                                                                                                                                                                                                                                                                     | Accrued clinical and cost of other studies                      |                           |        | 207    |                                    |   |              | 291    |       
|                                                                                                                                                                                                                                                                     | Accrued compensation                                            |                           |        | 3,368  |                                    |   |              | 2,195  |       
|                                                                                                                                                                                                                                                                     | Deferred revenue                                                |                           |        | 8,909  |                                    |   |              | 10,682 |       
|                                                                                                                                                                                                                                                                     | Current portion of capital lease obligations                    |                           |        | 992    |                                    |   |              | 1,753  |       
|                                                                                                                                                                                                                                                                     | Other accrued liabilities                                       |                           |        | 648    |                                    |   |              | 407    |       
|                                                                                                                                                                                                                                                                     |                                                                 |                           |        |        |                                    |   |              |       
|                                                                                                                                                                                                                                                                     |                                                                 | Total current liabilities |        |        | 15,134                             |   |              |        | 17,279 | 
|Noncurrent portion of deferred revenue                                                                                                                                                                                                                               |                                                                 |                           | 5,142  |        |                                    |   | 6,170        |       
|Noncurrent portion of capital lease obligations                                                                                                                                                                                                                      |                                                                 |                           | 73     |        |                                    |   | 497          |       
|Noncurrent portion of deferred rent                                                                                                                                                                                                                                  |                                                                 |                           | 1,216  |        |                                    |   | 1,108        |       
|Commitments and contingencies                                                                                                                                                                                                                                        |                                                                 |                           |        |        |                                    |   |              |       
|Redeemable convertible preferred stock, no par value; 5,000,000 shares
authorized; issued and outstanding shares: 1,794,626 at June 30, 2003 and
2,001,236 at December 31, 2002; liquidation preference of $43,430 at June 30,
2003 and $48,430 at December 31, 2002 |                                                                 |                           | 27,499 |        |                                    |   | 30,665       |       
|Shareholders equity:                                                                                                                                                                                                                                                |                                                                 |                           |        |        |                                    |   |              |       





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|                                                                                                                                                          |  |                            |                                                                                    |   |                                    |        |              |   |        |        | 
|--------------------------------------------------------------------------------------------------------------------------------------------------------- |  | -------------------------- | ---------------------------------------------------------------------------------- | - | ---------------------------------- | ------ | ------------ | - | ------ | ------ | 
|                                                                                                                                                          |  |                            |                                                                                    |   | June 30,                           |        | December 31,
|                                                                                                                                                          |  |                            |                                                                                    |   | 2003                               |        | 2002        
|                                                                                                                                                          |  |                            |                                                                                    |   |                                    |        |             
|                                                                                                                                                          |  |                            |                                                                                    |   | (Unaudited)                        |        | (Note 1)    
|                                                                                                                                                          |  |                            |                                                                                    |   | (In thousands, except shares data)
|Common stock, no par value; 100,000,000 shares authorized; issued and
outstanding shares: 53,295,481 at June 30, 2003 and 31,157,612 at December 31,
2002 |  |                            | 250,587                                                                            |   |                                    |        | 230,853      |  
|Accumulated deficit                                                                                                                                       |  |                            | (204,803                                                                           | ) |                                    |        | (189,443     | )
|                                                                                                                                                          |  |                            |                                                                                    |   |                                    |        |              |  
|                                                                                                                                                          |  | Total shareholders equity |                                                                                    |   | 45,784                             |        |              |   | 41,410 |       
|                                                                                                                                                          |  |                            |                                                                                    |   |                                    |        |              |  
|                                                                                                                                                          |  |                            | Total liabilities,
redeemable
convertible
preferred stock and
shareholders
equity |   | $                                  | 94,848 |              |   | $      | 97,129 | 
|                                                                                                                                                          |  |                            |                                                                                    |   |                                    |        |              |  

See accompanying notes.

2



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ARADIGM CORPORATION
STATEMENTS OF OPERATIONS

|                                                              |                            |                          |        |                                       |        |      |         |        |        | 
|------------------------------------------------------------- | -------------------------- | ------------------------ | ------ | ------------------------------------- | ------ | ---- | ------- | ------ | ------ | 
|                                                              |                            |                          |        | Three Months Ended                   
|                                                              |                            |                          |        | June 30,                             
|                                                              |                            |                          |        |                                      
|                                                              |                            |                          |        | 2003                                  |        | 2002
|                                                              |                            |                          |        |                                       |        |     
|                                                              |                            |                          |        | (Unaudited)                          
|                                                              |                            |                          |        | (In thousands, except per share data)
|Contract revenues (Including amounts from related parties:    |                            |                          |        |                                       |        |      |         |       
|2003  $9,255; 2002  $6,558)                                 |                            | $                        | 9,378  |                                       |        | $    | 7,295   |       
|                                                              |                            |                          |        |                                       |        |      |         |       
|Operating expenses:                                           |                            |                          |        |                                       |        |      |         |       
|                                                              | Research and development   |                          |        | 14,001                                |        |      |         | 14,588 |       
|                                                              | General and administrative |                          |        | 2,844                                 |        |      |         | 2,809  |       
|                                                              |                            |                          |        |                                       |        |      |         |       
|                                                              |                            | Total operating expenses |        |                                       | 16,845 |      |         |        | 17,397 | 
|                                                              |                            |                          |        |                                       |        |      |         |       
|Loss from operations                                          |                            |                          | (7,467 | )                                     |        |      | (10,102 | )     
|Interest income                                               |                            |                          | 86     |                                       |        |      | 210     |       
|Interest expense and other                                    |                            |                          | (39    | )                                     |        |      | (84     | )     
|                                                              |                            |                          |        |                                       |        |      |         |       
|Net loss                                                      |                            | $                        | (7,420 | )                                     |        | $    | (9,976  | )     
|                                                              |                            |                          |        |                                       |        |      |         |       
|Basic and diluted net loss per share                          |                            | $                        | (0.15  | )                                     |        | $    | (0.34   | )     
|                                                              |                            |                          |        |                                       |        |      |         |       
|Shares used in computing basic and diluted net loss per share |                            |                          | 51,144 |                                       |        |      | 29,723  |       
|                                                              |                            |                          |        |                                       |        |      |         |       

See accompanying notes.

3



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ARADIGM CORPORATION
STATEMENTS OF OPERATIONS

|                                                              |                            |                          |         |                                       |        |      |         |        |        | 
|------------------------------------------------------------- | -------------------------- | ------------------------ | ------- | ------------------------------------- | ------ | ---- | ------- | ------ | ------ | 
|                                                              |                            |                          |         | Six Months Ended                     
|                                                              |                            |                          |         | June 30,                             
|                                                              |                            |                          |         |                                      
|                                                              |                            |                          |         | 2003                                  |        | 2002
|                                                              |                            |                          |         |                                       |        |     
|                                                              |                            |                          |         | (Unaudited)                          
|                                                              |                            |                          |         | (In thousands, except per share data)
|Contract revenues (Including amounts from related parties:    |                            |                          |         |                                       |        |      |         |       
|2003  $16,824; 2002 $14,157                                 |                            | $                        | 17,068  |                                       |        | $    | 15,413  |       
|                                                              |                            |                          |         |                                       |        |      |         |       
|Operating expenses:                                           |                            |                          |         |                                       |        |      |         |       
|                                                              | Research and development   |                          |         | 27,000                                |        |      |         | 28,901 |       
|                                                              | General and administrative |                          |         | 5,513                                 |        |      |         | 5,267  |       
|                                                              |                            |                          |         |                                       |        |      |         |       
|                                                              |                            | Total operating expenses |         |                                       | 32,513 |      |         |        | 34,168 | 
|                                                              |                            |                          |         |                                       |        |      |         |       
|Loss from operations                                          |                            |                          | (15,445 | )                                     |        |      | (18,755 | )     
|Interest income                                               |                            |                          | 194     |                                       |        |      | 501     |       
|Interest expense and other                                    |                            |                          | (95     | )                                     |        |      | (250    | )     
|                                                              |                            |                          |         |                                       |        |      |         |       
|Net loss                                                      |                            |                          | (15,346 | )                                     |        |      | (18,504 | )     
|                                                              |                            |                          |         |                                       |        |      |         |       
|Basic and diluted net loss per share:                         |                            |                          |         |                                       |        |      |         |       
|Net loss per share                                            |                            | $                        | (0.35   | )                                     |        | $    | (0.62   | )     
|                                                              |                            |                          |         |                                       |        |      |         |       
|Shares used in computing basic and diluted net loss per share |                            |                          | 43,440  |                                       |        |      | 29,634  |       
|                                                              |                            |                          |         |                                       |        |      |         |       

See accompanying notes.

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ARADIGM CORPORATION
STATEMENTS OF CASH FLOWS

|                                                     |                                                                         |                                                    |         |                  |        |      |         |         |        |  
|---------------------------------------------------- | ----------------------------------------------------------------------- | -------------------------------------------------- | ------- | ---------------- | ------ | ---- | ------- | ------- | ------ | -
|                                                     |                                                                         |                                                    |         | Six Months Ended
|                                                     |                                                                         |                                                    |         | June 30,        
|                                                     |                                                                         |                                                    |         |                 
|                                                     |                                                                         |                                                    |         | 2003             |        | 2002
|                                                     |                                                                         |                                                    |         |                  |        |     
|                                                     |                                                                         |                                                    |         | (Unaudited)     
|                                                     |                                                                         |                                                    |         | (In thousands)  
|Cash flows from operating activities:                |                                                                         |                                                    |         |                  |        |      |         |        
|                                                     | Net loss                                                                |                                                    | $       | (15,346          | )      |      | $       | (18,504 | )     
|                                                     | Adjustments to reconcile net loss to cash used in operating activities: |                                                    |         |                  |        |      |         |         |       
|                                                     |                                                                         | Depreciation and amortization                      |         |                  | 3,177  |      |         |         | 2,954  |  
|                                                     |                                                                         | Issuance of warrants and common stock for services |         |                  | 10     |      |         |         | 2      |  
|                                                     |                                                                         | Amortization of deferred compensation              |         |                  |       |      |         |         | 54     |  
|                                                     |                                                                         | Changes in operating assets and liabilities:       |         |                  |        |      |         |         |        |  
|                                                     |                                                                         | Receivables                                        |         |                  | 115    |      |         |         | 1,023  |  
|                                                     |                                                                         | Other current assets                               |         |                  | 81     |      |         |         | (822   | )
|                                                     |                                                                         | Other assets                                       |         |                  | 10     |      |         |         | 24     |  
|                                                     |                                                                         | Accounts payable                                   |         |                  | (941   | )    |         |         | (3,280 | )
|                                                     |                                                                         | Accrued compensation                               |         |                  | 1,173  |      |         |         | 1,714  |  
|                                                     |                                                                         | Other accrued liabilities                          |         |                  | 157    |      |         |         | (2,308 | )
|                                                     |                                                                         | Deferred rent                                      |         |                  | 108    |      |         |         | 150    |  
|                                                     |                                                                         | Deferred revenue                                   |         |                  | (2,801 | )    |         |         | (5,267 | )
|                                                     |                                                                         |                                                    |         |                  |        |      |         |         |        |  
|Net cash used in operating activities                |                                                                         |                                                    | (14,257 | )                |        |      | (24,260 | )      
|                                                     |                                                                         |                                                    |         |                  |        |      |         |         |        |  
|Cash flows from investing activities:                |                                                                         |                                                    |         |                  |        |      |         |        
|                                                     | Capital expenditures                                                    |                                                    |         | (2,488           | )      |      |         | (6,627  | )     
|                                                     | Purchase of available-for-sale investments                              |                                                    |         | (1,663           | )      |      |         | (7,410  | )     
|                                                     | Proceeds from maturities of available-for-sale investments              |                                                    |         | 4,792            |        |      |         | 4,762   |       
|                                                     |                                                                         |                                                    |         |                  |        |      |         |         |        |  
|Net cash provided by (used) in investing activities  |                                                                         |                                                    | 641     |                  |        |      | (9,275  | )      
|                                                     |                                                                         |                                                    |         |                  |        |      |         |         |        |  
|Cash flows from financing activities:                |                                                                         |                                                    |         |                  |        |      |         |        
|                                                     | Proceeds from issuance of common stock, net                             |                                                    |         | 16,560           |        |      |         | 722     |       
|                                                     | Cost from issuance of redeemable convertible preferred stock            |                                                    |         |                 |        |      |         | (70     | )     
|                                                     | Notes receivable from officers                                          |                                                    |         | (165             | )      |      |         | (53     | )     
|                                                     | Payments on lease obligations and equipment loans                       |                                                    |         | (1,185           | )      |      |         | (2,006  | )     
|                                                     |                                                                         |                                                    |         |                  |        |      |         |         |        |  
|Net cash provided by (used in) financing activities  |                                                                         |                                                    | 15,208  |                  |        |      | (1,407  | )      
|                                                     |                                                                         |                                                    |         |                  |        |      |         |         |        |  
|Net increase (decrease) in cash and cash equivalents |                                                                         |                                                    | 1,592   |                  |        |      | (34,942 | )      
|Cash and cash equivalents at beginning of period     |                                                                         |                                                    | 22,800  |                  |        |      | 69,965  |        





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|                                                  |                                                                            |   |        |                  |  |      |        |     |  | 
|------------------------------------------------- | -------------------------------------------------------------------------- | - | ------ | ---------------- |  | ---- | ------ | --- |  | 
|                                                  |                                                                            |   |        | Six Months Ended
|                                                  |                                                                            |   |        | June 30,        
|                                                  |                                                                            |   |        |                 
|                                                  |                                                                            |   |        | 2003             |  | 2002
|                                                  |                                                                            |   |        |                  |  |     
|                                                  |                                                                            |   |        | (Unaudited)     
|                                                  |                                                                            |   |        | (In thousands)  
|Cash and cash equivalents at end of period        |                                                                            | $ | 24,392 |                  |  | $    | 35,023 |    
|                                                  |                                                                            |   |        |                  |  |      |        |     |  | 
|Supplemental disclosure of cash flow information: |                                                                            |   |        |                  |  |      |        |    
|                                                  | Cash paid for interest                                                     |   | $      | 95               |  |      | $      | 292 | 
|                                                  |                                                                            |   |        |                  |  |      |        |     |  | 
|Non-cash investing and financing activities:      |                                                                            |   |        |                  |  |      |        |    
|                                                  | Issuance of common stock through conversion of Series A preferred stock    |   | $      | 3,165            |  |      | $      |    | 
|                                                  | Issuance of warrants in conjunction with private placement of common stock |   | $      | 2,469            |  |      | $      |    | 
|                                                  | Issuance of warrants and options to purchase common stock for services     |   | $      | 10               |  |      | $      | 2   | 
|                                                  |                                                                            |   |        |                  |  |      |        |     |  | 

See accompanying notes.

5



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



|1. |  | Organization and Basis of Presentation
|-- |  | --------------------------------------
|  
|   |  | Organization                          

Aradigm Corporation (the Company) is a California corporation engaged in
the development and commercialization of non-invasive drug delivery systems.
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, 2002 has been derived from the audited
financial statements at that date, but does not include all of the information
and footnotes required by generally accepted accounting principles for complete
financial statements.



|2. |  | Summary of Significant Accounting Policies
|-- |  | ------------------------------------------
|  
|   |  | Stock Based Compensation                  

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





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|                                                 |                                                                                                         |   |                    |        |                  |   |         |        |      |   |         |        |   |   |         |        |  
|------------------------------------------------ | ------------------------------------------------------------------------------------------------------- | - | ------------------ | ------ | ---------------- | - | ------- | ------ | ---- | - | ------- | ------ | - | - | ------- | ------ | -
|                                                 |                                                                                                         |   | Three Months Ended |        | Six Months Ended
|                                                 |                                                                                                         |   | June 30,           |        | June 30,        
|                                                 |                                                                                                         |   |                    |        |                 
|                                                 |                                                                                                         |   | 2003               |        | 2002             |   | 2003    |        | 2002
|                                                 |                                                                                                         |   |                    |        |                  |   |         |        |     
|Net loss applicable to                           |                                                                                                         | $ | (7,420             | )      |                  | $ | (9,976  | )      |      | $ | (15,346 | )      |   | $ | (18,504 | )     
|Add:                                             |                                                                                                         |   |                    |        |                  |   |         |        |      |   |         |        |   |   |         |       
|                                                 | Stock-based employee compensation
expense included in reported net loss                                 |   | $                  |       |                  |   | $       | 41     |      |   | $       |       |   |   | $       | 54     |  
|Less:                                            |                                                                                                         |   |                    |        |                  |   |         |        |      |   |         |        |   |   |         |       
|                                                 | Total stock-based employee compensation
expense determined under fair value based
method for all awards |   | $                  | (1,327 | )                |   | $       | (1,750 | )    |   | $       | (2,883 | ) |   | $       | (3,951 | )
|                                                 |                                                                                                         |   |                    |        |                  |   |         |        |      |   |         |        |   |   |         |       
|Pro forma net loss applicable to                 |                                                                                                         | $ | (8,747             | )      |                  | $ | (11,685 | )      |      | $ | (18,229 | )      |   | $ | (22,401 | )     
|Basic and diluted net loss per share
as reported |                                                                                                         | $ | (0.15              | )      |                  | $ | (0.34   | )      |      | $ | (0.35   | )      |   | $ | (0.62   | )     
|Pro forma                                        |                                                                                                         | $ | (0.17              | )      |                  | $ | (0.39   | )      |      | $ | (0.42   | )      |   | $ | (0.76   | )     

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



| |  | Reclassifications
| |  | -----------------

Certain reclassifications of prior year amounts have been made to conform
with current year presentation.



|3. |  | Asset Acquisition
|-- |  | -----------------

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



|4. |  | Shareholders Equity
|-- |  | --------------------

Pursuant to a Securities Purchase Agreement entered into as of February
10, 2003, the Company issued in a private placement 18,992,391 shares of common
stock at $0.79 per share and warrants to purchase 4,273,272 shares of common
stock at $1.07 per share to certain investors for an aggregate purchase price
of approximately $15.0 million. The warrants are exercisable at the election of
the warrant holders for a four-year term. The Company valued the warrants using
the Black-Scholes option pricing model using the





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following assumptions: estimated volatility of 62%, risk-free interest
rate of 4.4%, no dividend yield, and an expected life of 4 years, and recorded
approximately $1,366,964 as issuance costs related to the private placement. In
addition, in connection with this private placement, the Company issued
warrants (repriced warrants) to purchase an aggregate of 4,016,024 shares of
its common stock at $1.12 per share to certain of the investors in the private
placement in exchange for the cancellation of an equal number of warrants to
purchase shares of the common stock at $6.97 per share, held by the same
investors. The Company valued the repriced warrants using the Black-Scholes
option pricing model using the following assumptions: estimated volatility of
62%, risk-free interest rate of 4.4%, no dividend yield, and an expected life
of 3.8 years, and recorded an additional $1,101,798 as issuance costs related
to the private placement.

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

In March and June 2003, holders of an aggregate of 206,610 shares of
redeemable convertible preferred stock (preferred stock) elected to convert
shares of preferred stock to common stock under the terms of a preferred stock
purchase agreement entered into as of December 14, 2001. Each share of
preferred stock, together with accrued and unpaid dividends, is convertible at
the option of the holder, into four shares of common stock. The Company issued
826,440 shares of common stock in connection with the conversion.



|5. |  | Contingencies
|-- |  | -------------

In June 1998, Eli Lilly and Company (Lilly) filed a complaint against
the Company in the United States District Court for the Southern District of
Indiana seeking a declaration that Lilly scientists were co-inventors of patent
applications filed by the Company relating to pulmonary delivery of an insulin
analog or, in the alternative, enforcement of an alleged agreement to grant
Lilly a nonexclusive license under such patent applications. The complaint
also contained allegations of breach of contract, misappropriation of trade
secrets, breach of fiduciary duty, conversion and unjust enrichment and sought
unspecified damages and injunctive relief. Prior to trial, the Court granted
summary judgment in favor of the Company as to Lillys claims relating to an
alleged license agreement, for misappropriation of trade secrets, breach of
fiduciary duty, conversion, estoppel and breach of contract (in part),
dismissing those claims from the case. The remaining claims were tried before
a jury during April 2002. The jury returned verdicts in favor of the Company
and against Lilly on three of four of Lillys asserted claims of
co-inventorship and on Lillys unjust enrichment claim. The jury returned
verdicts in favor of Lilly on one of Lillys claims of co-inventorship and on
two breach of contract claims, awarding Lilly damages of $1 for each breach of
contract claim. On appeal to the Court of Appeals for the Federal Circuit,
Lilly has pursued only claims regarding co-inventorship, entitlement to a
royalty free license under unspecified related patents and/or restrictions on
Aradigms ability to use certain data generated in studies conducted with
Lilly-supplied material. Accordingly, management now believes that even an
adverse outcome in this litigation would not have a material adverse effect on
the Company.



|6. |  | Related Party
|-- |  | -------------

Novo Nordisk and its affiliate, Novo Nordisk Pharmaceuticals, Inc., are
considered related parties and at June 30, 2003 own approximately 13% of the
Companys total outstanding common stock (on an as-converted basis).




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 and distribution resources, obtaining and enforcing
patents important to the business, clearing the lengthy and expensive
regulatory process and





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possible competition from other products. Even if the products appear promising
at various stages of development, they may not reach the market or may not be
commercially successful for a number of reasons. Such reasons include, but are
not limited to, the possibilities that the potential products may be found to
be ineffective during clinical trials, fail to receive necessary regulatory
approvals, are difficult to manufacture on a large scale, are uneconomical to
market, are precluded from commercialization by proprietary rights of third
parties or may not gain acceptance from health care professionals and patients.
Readers are cautioned not to place undue reliance on the forward-looking
statements contained herein. We undertake no obligation to publicly release the
results of any revision to these forward-looking statements, which may be made
to reflect events or circumstances occurring after the date hereof or to
reflect the occurrence of unanticipated events.

Overview

Since our inception in 1991, we have been engaged in the development of
innovative drug delivery systems. Beginning with our AERx pulmonary delivery
system and more recently with the Intraject subcutaneous delivery technology
acquired in May 2003 from Weston, we are building a solid platform in
needle-free drug delivery. As of June 30, 2003, we had an accumulated deficit
of $205 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 during 2003. Our sources of working capital have been equity
financings, equipment lease financings, contract revenues and interest earned
on investments.

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

We expect to perform various studies evaluating our Intraject subcutaneous
delivery platform for both existing and future partnerships. The Intraject
technology is currently licensed for various compounds to
GlaxoSmithKline, Roche
Laboratories and Abbott Laboratories, as well as several smaller
companies. We are planning to enter into renegotiated replacement
license agreements with these companies, but we may elect to assume
the existing licenses, depending on the circumstances. In some cases, a partnership may not be disclosed until a long-term development
agreement has been established.

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, 2003, this partner-funded
program has contributed approximately 99% of our total contract revenues. At
June 30, 2003, Novo Nordisk and its affiliate Novo Nordisk Pharmaceuticals,
Inc. own approximately 13% of our total outstanding common stock (on an
as-converted basis) and are considered a related party.

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





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No product development or milestone payments were received from GlaxoSmithKline
during 2002 or in the first half of 2003.

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

Critical Accounting Policies

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

Revenue Recognition

Contract revenues consist of revenue from collaboration agreements and
feasibility studies. We recognize revenue under the agreements as costs are
incurred. Deferred revenue represents the portion of all refundable and
nonrefundable research payments received that have not been earned. In
accordance with contract terms, milestone payments from collaborative research
agreements are considered reimbursements for costs incurred under the
agreements and, accordingly, are generally recognized as revenue either upon
the completion of the milestone effort when payments are contingent upon
completion of the effort or are based on actual efforts expended over the
remaining term of the agreements when payments precede the required efforts.
Costs of contract revenues are approximate 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 such
payments are no longer refundable.

Use of Estimates

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

Three Months Ended June 30, 2003 and 2002

Contract and License Revenues:Contract revenues for the three months
ended June 30, 2003 increased to $9.4 million from $7.3 million for the same
period in 2002. Revenue from Novo Nordisk was $9.3 million for the three months
ended June 30, 2003 and $6.6 million for the same period in 2002. The increase
in revenue is related to increased reimbursement by Novo Nordisk for clinical
supply and product development activities for the ongoing phase 3 clinical
program and offset 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 three months ended June 30, 2003 decreased to $14.0 million from $14.6
million for the same period in 2002. The decrease in research and development
expenses is primarily due to a reduction in unfunded development efforts and
cost reduction programs.





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

Our lead development program is developing pulmonary delivery systems to
manage diabetes using insulin and other blood glucose regulating compounds with
our partner Novo Nordisk. Since Novo Nordisk and we successfully initiated
Phase 3 clinical trials in September 2002, we have been focused on supporting
our partner in the existing and planned additional Phase 3 clinical trials that
will be needed for their regulatory submission and commercial scale-up
activities.

Our next program has been conducted to date with our partner
GlaxoSmithKline pursuant to our development agreement, as amended, which covers
the use of the AERx Pain Management System for the delivery of narcotic
analgesics. Activity in this program has been limited since delivery to
GlaxoSmithKline of data from the Phase 2b clinical trials in the second quarter
of 2002. We are in a position to move forward with this program and start Phase
3 trials within a year; however, future progress for this program is contingent
on either GlaxoSmithKline recommitting to this program or our entering into
another development agreement with a new partner.

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

General and Administrative Expenses:General and administrative expenses
were $2.8 million for both of the three month periods ended June 30, 2003 and
June 30, 2002.

Interest Income:Interest income for the three months ended June 30, 2003
decreased to $86,000 from $210,000 for the same period in 2002. The decrease is
due to lower invested balances and lower interest rates.

Interest Expense and Other:Interest expense for the three months ended
June 30, 2003 decreased to $39,000 from $84,000 for the same period in 2002.
The decrease is primarily due to lower outstanding capital lease and equipment
loan balances under various equipment and lease lines of credit.

Net Loss:Net loss for the three months ended June 30, 2003 of $7.4
million was lower compared to the $10.0 million loss for the same period in
2002, reflecting higher Novo Nordisk contract revenues and reduced expenses for
unfunded projects.

Six Months Ended June 30, 2003 and 2002

Contract Revenues:Contract revenues for the six months ended June 30,
2003 increased to $17.1 million from $15.4 million for the same period in 2002.
Revenue from Novo Nordisk was $16.8 million for the six months ended June 30,
2003 and $14.2 million for the same period in 2002. The increase in revenue is
related to increased reimbursement by Novo Nordisk for clinical supply and
product development activities for the ongoing phase 3 clinical program offset
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, 2003 decreased to $27.0 million from $28.9
million for the same period in 2002. The decrease in research and development
expenses is primarily due to a reduction in unfunded development efforts and
cost reduction programs.





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General and Administrative Expenses:General and administrative expenses
for the six months ended June 30, 2003 increased to $5.5 million from $5.3
million for the same period in 2002. The increase is primarily due to higher
business development and investor relations expenses and higher facility
support costs.

Interest Income:Interest income for the six months ended June 30, 2003
decreased to $194,000 from $501,000 for the same period in 2002. The decrease
is due to lower invested balances and lower interest rates.

Interest Expense and Other:Interest expense for the six months ended June
30, 2003 decreased to $95,000 from $250,000 for the same period in 2002. The
decrease is primarily due to lower outstanding capital lease and equipment loan
balances under various equipment and lease lines of credit.

Net Loss:Net loss for the six months ended June 30, 2003 decreased to
$15.3 million from $18.5 million for the same period in 2002 reflecting our
focus on the Novo Nordisk funded project and cost reduction efforts in other
area.

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,
2003, we had cash, cash equivalents and investments of approximately $28.2
million.

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

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

Net cash used in operating activities for the six months ended June 30,
2003 decreased to $14.3 million from $24.3 million for the same period in 2002.
Net cash used was substantially higher in 2002 due to the greater operating
loss, payments of accrued accounts payable and accrued liabilities and greater
recognition of deferred revenue carried over from 2001.

Investing activities for the six months ended June 30, 2003 provided cash
$641,000 in contrast to the use of cash of $9.3 million for the same period in
2002. Higher capital expenditures in 2002 related to the acquisition of
manufacturing production equipment for commercial production. The majority of
the capital expenditures in 2003 relate to the acquisition of the Intraject
assets and intellectual property.

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

Net cash provided by financing activities for the six months ended June
30, 2003 was $15.2 million compared to a use of $1.4 million for the same
period in 2002. The increase in cash provided is the result of the completion
of the private placement 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





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drug delivery systems, the ability to establish and maintain favorable
collaborative arrangements with others, progress with preclinical studies and
clinical trials and the results thereof, the time and costs involved in
obtaining regulatory approvals, the cost of development and the rate of
scale-up for the required production technologies, the costs involved in
preparing, filing, prosecuting, maintaining and enforcing patent claims and the
need to acquire licenses or other rights to new technology.

We continue to review our planned operations through the end of 2003 and
beyond. We particularly focus on capital spending requirements to ensure that
capital outlays are not expended sooner than necessary. We expect our total
annual capital outlays for 2003 not to exceed $10 million.
Other than in connection with the acquisition of the Intraject related assets,
since December 31, 2002, there have been no material changes in our contractual
obligations or commitments. We believe that our existing cash balances at June
30, 2003, together with the $20.0 million unused common stock purchase
commitment from Novo Nordisk A/S, research and development funding commitments
from corporate development partners and interest earned on our investments
should be sufficient to meet our needs for at least the next 24 months. The
sale of additional common stock to Novo Nordisk A/S is subject to certain
conditions and there can be no assurance that our funding commitments from
corporate development partners will not be amended or terminated. If we cannot
exercise our option to sell additional shares of common stock to Novo Nordisk
or if our current funding commitments from corporate development partners are
amended or terminated, we will need to obtain additional sources of capital
sooner than would otherwise be the case.

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




Item 3.Quantitative and Qualitative Disclosures About Market Risk

Market Risk Disclosures

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

As of June 30, 2003, we had cash and cash equivalents and short-term
investments of $28.2 million consisting of cash and highly liquid short-term
investments. Our short-term investments will decline by an immaterial amount if
market interest rates increase, and therefore, our exposure to interest rate
changes has been immaterial. Declines of interest rates over time will,
however, reduce our interest income from our short-term investments. Our
outstanding capital lease obligations are all at fixed interest rates and,
therefore, have minimal exposure to changes in interest rates.




Item 4.Controls and Procedures

Evaluation of Disclosure Controls and Procedures

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

We believe that a controls system, no matter how well designed and
operated, cannot provide absolute assurance that the objectives of the controls
system are met, and no evaluation of controls can provide





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absolute assurance that all control issues and instances of fraud, if any,
within a company have been detected. Our disclosure controls and procedures
are designed to provide reasonable assurance of achieving their objectives, and
the Chief Executive Officer and the Chief Financial Officer have concluded that
these controls and procedures are effective at the reasonable assurance
level.

Changes in Internal Controls

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




PART II. OTHER INFORMATION




Item 1.Legal Proceedings

In June 1998, Eli Lilly and Company (Lilly) filed a complaint against us
in the United States District Court for the Southern District of Indiana
seeking a declaration that Lilly scientists were co-inventors of patent
applications filed by us relating to pulmonary delivery of an insulin analog
or, in the alternative, enforcement of an alleged agreement to grant Lilly a
nonexclusive license under such patent applications. The complaint also
contained allegations of breach of contract, misappropriation of trade secrets,
breach of fiduciary duty, conversion and unjust enrichment and sought
unspecified damages and injunctive relief. Prior to trial, the Court granted
summary judgment in our favor as to Lillys claims relating to an alleged
license agreement, for misappropriation of trade secrets, breach of fiduciary
duty, conversion, estoppel and breach of contract (in part), dismissing those
claims from the case. The remaining claims were tried before a jury during
April 2002. The jury returned verdicts in our favor and against Lilly on three
of four of Lillys asserted claims of co-inventorship and on Lillys unjust
enrichment claim. The jury returned verdicts in favor of Lilly on one of
Lillys claims of co-inventorship and on two breach of contract claims,
awarding Lilly damages of $1 for each breach of contract claim. On appeal to
the Court of Appeals for the Federal Circuit, Lilly has pursued only claims
regarding co-inventorship, entitlement to a royalty free license under
unspecified related patents and/or restrictions on our ability to use certain
data generated in studies conducted with Lilly-supplied material. Accordingly,
we now believe that even an adverse outcome in this litigation would not have a
material adverse effect on us.




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

(a)  The Annual Meeting of Shareholders of Aradigm Corporation was held on
May 15, 2003.

(b)  Frank H. Barker, Stan M. Benson, Igor Gonda, 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: |  | For:
Against: |  | 38,055,773
573,093  
|                                                                                                                                                                |  |               |  |                     
|(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:  |  | For:
Against: |  | 37,917,031
711,835  
|                                                                                                                                                                |  |               |  |                     
|(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:      |  | For:
Against: |  | 37,306,001
1,322,865
|                                                                                                                                                                |  |               |  |                     
|(1d) 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:   |  | For:
Against: |  | 38,058,077
570,789  
|                                                                                                                                                                |  |               |  |                     
|(1e) 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:    |  | For:
Against: |  | 38,060,473
568,393  
|                                                                                                                                                                |  |               |  |                     





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##### Table of Contents



|                                                                                                                                                                                                    |  |                          |  |                             |  |  |  |  |  |  |  | 
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ------------------------ |  | --------------------------- |  |  |  |  |  |  |  | 
|(1f) 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:                                 |  | For:
Against:            |  | 38,064,186
564,680         
|                                                                                                                                                                                                    |  |                          |  |                            
|(1g) 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:                                  |  | For:
Against:            |  | 37,912,531
716,335         
|                                                                                                                                                                                                    |  |                          |  |                            
|(2) Proposal to amend the 1996 Equity
Incentive Plan to increase the maximum
number of shares available for issuance
under the evergreen feature of the 1996
Plan by 2,000,00 shares to 10,000,000: |  | For:
Against:
Abstained: |  | 28,030,868
1,236,376
48,394
|                                                                                                                                                                                                    |  |                          |  |                            
|(3) Proposal to amend the Employee Stock
Purchase Plan to increase the number of
shares authorized for issuance under the
Purchase Plan by 2,000,000 to 3,250,000
shares:                           |  | For:
Against:
Abstained: |  | 29,012,444
260,561
42,633  
|                                                                                                                                                                                                    |  |                          |  |                            
|(4) Proposal to authorize future issuances
of common stock to Novo Nordisk:                                                                                                                         |  | For:
Against:
Abstained: |  | 28,687,465
606,790
21,383  
|                                                                                                                                                                                                    |  |                          |  |                            
|(5) Ratification of the selection of Ernst
& Young LLP as independent auditors of the
Company for its fiscal year ending
December 31, 2003:                                                         |  | For:
Against:
Abstained: |  | 38,552,466
58,277
18,123   
|                                                                                                                                                                                                    |  |                          |  |                            




Item 6.Exhibits and Reports on Form 8-K



| | (a) |  | Exhibits
| | --- |  | --------

|        |  |                                                                                                                                
|------- |  | -------------------------------------------------------------------------------------------------------------------------------
|10.1(1) |  | The Companys 1996 Equity Incentive Plan, as amended.                                                                          
|10.2(1) |  | The Companys Employee Stock Purchase Plan, as amended.                                                                        
|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.



---

|(1) |  | Incorporated by reference to the Companys definitive proxy
statement filed on April 4, 2003.
|--- |  | ---------------------------------------------------------------------------------------------



| | (b) |  | Reports on Form 8-K                                                                                                                                                          
| | --- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |     |  | We filed a Current Report on
Form 8-K dated April 24, 2003 to furnish a
press release in which we announced our financial results for the first
quarter ended March 31, 2003.





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##### Table of Contents






SIGNATURES

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



| | ARADIGM CORPORATION
(Registrant)                                                               
| | -----------------------------------------------------------------------------------------------
|
| | /s/ RICHARD P. THOMPSON

Richard P. ThompsonChief Executive Officer                            
|
| | /s/ THOMAS C. CHESTERMAN

Thomas C. ChestermanSenior Vice President and Chief Financial Officer

Dated: August 11, 2003





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##### Table of Contents






INDEX TO EXHIBITS

|        |       |             |                                                                                                                                
|------- | ----- | ----------- | -------------------------------------------------------------------------------------------------------------------------------
|Exhibit |       |            
|Number  |       | Description
|        |       |            
|10      | .1(1) |             | The Companys 1996 Equity Incentive Plan, as amended.                                                                          
|10      | .2(1) |             | The Companys Employee Stock Purchase Plan, as amended.                                                                        
|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.



---

|(1) |  | Incorporated by reference to the Companys definitive proxy
statement filed on April 4, 2003.
|--- |  | ---------------------------------------------------------------------------------------------