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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
 Washington, DC 20549
 
 Form 10-Q
 
  þ
    
    QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 For the quarterly period ended September 30, 2005
 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
    
    (I.R.S. Employerincorporation or organization)
    
    Identification No.)
 3929 Point Eden Way
Hayward, CA 94545  (Address of principal executive offices including zip code)  (510) 265-9000  (Registrants telephone number, including area code)
 þ o
 o þ
 o þ
  Common Stock, no par value
    
    72,813,538(Class)
    
    (Outstanding at October 31, 2005)




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ARADIGM CORPORATION
INDEX
 PageNoPART I. FINANCIAL INFORMATIONITEM 1.
    
    Condensed Financial Statements
    
    
    2Condensed Balance Sheets at September 30, 2005 (unaudited) and December 31, 2004
    
    
    2Condensed Statements of Operations for the Three Months Ended September 30, 2005 and 2004 (unaudited)
    
    
    3Condensed Statements of Operations for the Nine Months Ended September 30, 2005 and 2004 (unaudited)
    
    
    4Condensed Statements of Cash Flows for the Nine Months Ended September 30, 2005 and 2004 (unaudited)
    
    
    5Notes to Condensed Financial Statements (unaudited)
    
    
    6ITEM 2.
    
    Managements Discussion and Analysis of Financial Condition and Results of Operations
    
    
    11ITEM 3.
    
    Quantitative and Qualitative Disclosure About Market Risk
    
    
    19ITEM 4.
    
    Controls and Procedures
    
    
    19PART II. OTHER INFORMATIONITEM 6.
    
    Exhibits
    
    
    20SIGNATURES
    
    
    21INDEX TO EXHIBITSEXHIBIT 31.1EXHIBIT 31.2EXHIBIT 32.1
  1




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PART I. FINANCIAL INFORMATION
 
 Item 1. Condensed Financial Statements
 ARADIGM CORPORATION
 
 CONDENSED BALANCE SHEETS
 September 30,
    
    
    December 31,2005
    
    
    2004(Unaudited)
    
    
    (Note 1)(In thousands, except share data)ASSETSCurrent assets:Cash and cash equivalents
    
    $
    33,400
    
    
    $
    14,308Short-term investments
    
    
    3,324
    
    
    
    2,455Receivables
    
    
    286
    
    
    
    99Current portion of notes receivable from officers and employees
    
    
    62
    
    
    
    67Prepaid expenses and other current assets
    
    
    973
    
    
    
    1,602Total current assets
    
    
    38,045
    
    
    
    18,531Property and equipment, net
    
    
    9,192
    
    
    
    60,555Noncurrent portion of notes receivable from officers and employees
    
    
    162
    
    
    
    216Other assets
    
    
    550
    
    
    
    439Total assets
    
    $
    47,949
    
    
    $
    79,741LIABILITIES, REDEEMABLE CONVERTIBLE PREFERRED STOCK AND SHAREHOLDERS EQUITYCurrent liabilities:Accounts payable
    
    $
    1,494
    
    
    $
    2,469Accrued clinical and cost of other studies
    
    
    289
    
    
    
    293Accrued compensation
    
    
    3,405
    
    
    
    2,984Deferred revenue
    
    
    270
    
    
    
    7,525Other accrued liabilities
    
    
    347
    
    
    
    1,138Total current liabilities
    
    
    5,805
    
    
    
    14,409Noncurrent portion of deferred revenue
    
    
    
    
    
    
    3,966Noncurrent portion of deferred rent
    
    
    660
    
    
    
    1,943CommitmentsRedeemable convertible preferred stock, no par value; 5,000,000 shares authorized; issued and outstanding
shares: 1,544,626 at September 30, 2005 and at December 31, 2004; liquidation preference of $37,380 at
September 30, 2005 and at December 31, 2004.
    
    
    23,669
    
    
    
    23,669Shareholders equity:Common stock, no par value; 150,000,000 authorized; issued and outstanding shares: 72,813,538 at
September 30, 2005 and 72,295,730 at December 31, 2004.
    
    
    282,001
    
    
    
    281,387Accumulated other comprehensive loss
    
    
    (8
    )
    
    
    (10
    )Deferred compensation
    
    
    (11
    )
    
    
    Accumulated deficit
    
    
    (264,167
    )
    
    
    (245,623
    )Total shareholders equity
    
    
    17,815
    
    
    
    35,754Total liabilities, redeemable convertible
preferred stock and shareholders equity
    
    $
    47,949
    
    
    $
    79,741
  2




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ARADIGM CORPORATION
 
 CONDENSED STATEMENTS OF OPERATIONS
 Three Months EndedSeptember 30,2005
    
    
    2004(Unaudited)(In thousands, except per share data)Contract revenues (Including amounts from related parties: 2005  $200; 2004  $5,918)
    
    $
    719
    
    
    $
    6,352Operating expenses:Research and development
    
    
    6,471
    
    
    
    11,407General and administrative
    
    
    2,326
    
    
    
    3,217Total operating expenses
    
    
    8,797
    
    
    
    14,624Loss from operations
    
    
    (8,078
    )
    
    
    (8,272
    )Interest income
    
    
    342
    
    
    
    45Other income (expense)
    
    
    8
    
    
    
    (3
    )Net loss
    
    $
    (7,728
    )
    
    $
    (8,230
    )Basic and diluted net loss per share
    
    $
    (0.11
    )
    
    $
    (0.13
    )Shares used in computing basic and diluted net loss per share
    
    
    72,590
    
    
    
    63,564
  3




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ARADIGM CORPORATION
 
 CONDENSED STATEMENTS OF OPERATIONS
 Nine Months EndedSeptember 30,2005
    
    
    2004(Unaudited)(In thousands, except per share data)Contract revenues (Including amounts from related parties: 2005  $7,911; 2004  $19,534)
    
    $
    9,645
    
    
    $
    20,073Operating expenses:Research and development
    
    
    20,858
    
    
    
    34,706General and administrative
    
    
    8,274
    
    
    
    8,920Total operating expenses
    
    
    29,132
    
    
    
    43,626Loss from operations
    
    
    (19,487
    )
    
    
    (23,553
    )Interest income
    
    
    980
    
    
    
    160Other income (expense)
    
    
    (37
    )
    
    
    (18
    )Net loss
    
    $
    (18,544
    )
    
    $
    (23,411
    )Basic and diluted net loss per share
    
    $
    (0.26
    )
    
    $
    (0.37
    )Shares used in computing basic and diluted net loss per share
    
    
    72,484
    
    
    
    63,350
  4




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ARADIGM CORPORATION
 
 STATEMENTS OF CASH FLOWS
 Nine Months EndedSeptember 30,2005
    
    
    2004(Unaudited)(In thousands)Cash flows from operating activities:Net loss
    
    $
    (18,544
    )
    
    $
    (23,411
    )Adjustments to reconcile net loss to cash used in operating activities:Depreciation and amortization
    
    
    1,074
    
    
    
    3,240Loss on retirement and sale of property and equipment
    
    
    25
    
    
    
    257Cost of warrants and stock options for services
    
    
    94
    
    
    
    78Amortization of deferred compensation
    
    
    10
    
    
    
    Amortization and accretion of investments
    
    
    6
    
    
    
    Changes in operating assets and liabilities:Receivables
    
    
    (187
    )
    
    
    68Prepaid expenses and other current assets
    
    
    629
    
    
    
    (232
    )Other assets
    
    
    (111
    )
    
    
    (59
    )Accounts payable
    
    
    (975
    )
    
    
    449Accrued compensation
    
    
    421
    
    
    
    2,552Other accrued liabilities
    
    
    (795
    )
    
    
    670Deferred rent
    
    
    (1,283
    )
    
    
    426Deferred revenue
    
    
    (7,201
    )
    
    
    158Net cash used in operating activities
    
    
    (26,837
    )
    
    
    (15,804
    )Cash flows from investing activities:Capital expenditures
    
    
    (4,047
    )
    
    
    (1,272
    )Proceeds from sale of property and equipment to Novo Nordisk Delivery Technologies, a related
party
    
    
    50,292
    
    
    
    Purchases of available-for-sale investments
    
    
    (5,330
    )
    
    
    (6,376
    )Proceeds from maturities and sales of available-for-sale investments
    
    
    4.457
    
    
    
    11,361Net cash provided by investing activities
    
    
    45,372
    
    
    
    3,713Cash flows from financing activities:Proceeds from issuance of common stock, net
    
    
    457
    
    
    
    481Proceeds from exercise of options and warrants for common stock
    
    
    42
    
    
    
    305Notes receivable from officers and employees
    
    
    58
    
    
    
    62Payments on lease obligations and equipment loans
    
    
    
    
    
    
    (427
    )Net cash provided by financing activities
    
    
    557
    
    
    
    421Net increase (decrease) in cash and cash equivalents
    
    
    19,092
    
    
    
    (11,670
    )Cash and cash equivalents at beginning of period
    
    
    14,308
    
    
    
    18,327Cash and cash equivalents at end of period
    
    $
    33,400
    
    
    $
    6,657
  5




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ARADIGM CORPORATION
 
 NOTES TO THE UNAUDITED CONDENSED FINANCIAL STATEMENTS
 September 30, 2005
 1. Organization and Basis of Presentation
 Organization
  Basis of Presentation
   Reclassifications
  2. Summary of Significant Accounting Policies
 Stock Based Compensation
  6




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Three Months Ended
    
    
    Nine Months EndedSeptember 30,
    
    
    September 30,
    
    
    September 30,
    
    
    September 30,2005
    
    
    2004
    
    
    2005
    
    
    2004Net loss  as reported
    
    $
    (7,728
    )
    
    $
    (8,230
    )
    
    $
    (18,544
    )
    
    $
    (23,411
    )Add:Amortization of deferred stock-based
employee compensation expense included
in reported net loss
    
    
    3
    
    
    
    
    
    
    
    10
    
    
    
    Less:Total stock-based employee
compensation expense determined under
fair value based method for all awards
    
    
    (827
    )
    
    
    (827
    )
    
    
    (2,432
    )
    
    
    (3,230
    )Pro forma net loss
    
    $
    (8,552
    )
    
    $
    (9,057
    )
    
    $
    (20,966
    )
    
    $
    (26,641
    )Basic and diluted net loss per shareAs reported
    
    $
    (0.11
    )
    
    $
    (0.13
    )
    
    $
    (0.26
    )
    
    $
    (0.37
    )Pro forma
    
    $
    (0.12
    )
    
    $
    (0.14
    )
    
    $
    (0.29
    )
    
    $
    (0.42
    )
  Computation of Net Loss Per Share
  3. Cash Equivalents and Investments
  September 30, 2005Gross
    
    
    GrossAmortized
    
    
    Unrealized
    
    
    Unrealized
    
    
    Estimated FairCost
    
    
    Gains
    
    
    Losses
    
    
    ValueMoney market funds
    
    $
    674
    
    
    $
    
    
    
    $
    
    
    
    $
    674Commercial paper
    
    
    32,731
    
    
    
    
    
    
    
    (5
    )
    
    
    32,726Government securities
    
    
    1,822
    
    
    
    
    
    
    
    (2
    )
    
    
    1,820Corporate debt securities
    
    
    1,505
    
    
    
    
    
    
    
    (1
    )
    
    
    1,504Total
    
    $
    36,732
    
    
    $
    
    
    
    $
    (8
    )
    
    $
    36,724Reported as:Cash and cash equivalents
    
    
    33,405
    
    
    
    
    
    
    
    (5
    )
    
    
    33,400Short-term investments
    
    
    3,327
    
    
    
    
    
    
    
    (3
    )
    
    
    3,324Total
    
    
    36,732
    
    
    
    
    
    
    
    (8
    )
    
    
    36,724
 7




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4. Property and Equipment
  September 30, 2005
    
    

December 31, 2004Machinery and equipment
    
    $
    4,243
    
    
    $
    14,364Furniture and fixtures
    
    
    1,144
    
    
    
    1,917Lab equipment
    
    
    2,496
    
    
    
    4,086Computer equipment and
software
    
    
    5,599
    
    
    
    6,256Leasehold improvements
    
    
    1,533
    
    
    
    12,225Property and equipment at cost
    
    
    15,015
    
    
    
    38,848Less accumulated depreciation
and amortization
    
    
    (11,705
    )
    
    
    (27,740
    )Net depreciable assets
    
    
    3,310
    
    
    
    11,108Construction in progress
    
    
    5,882
    
    
    
    49,447Property and equipment, net
    
    $
    9,192
    
    
    $
    60,555
  5. Leases and Commitments
  8




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Payment Due by Period(amounts in thousands)Contractual obligations
    
    Total
    
    
    20051
    
    
    2006/2007
    
    
    2008/2009
    
    
    2010+Operating lease obligations
    
    $
    24,410
    
    
    $
    640
    
    
    $
    4,147
    
    
    $
    4,879
    
    
    $
    14,744Capital purchase obligations
    
    
    1,184
    
    
    
    1,184
    
    
    
    
    
    
    
    
    
    
    
    Unconditional purchase
obligations
    
    
    670
    
    
    
    670
    
    
    
    
    
    
    
    
    
    
    
    Total contractual commitments
    
    $
    26,264
    
    
    $
    2,494
    
    
    $
    4,147
    
    
    $
    4,879
    
    
    $
    14,744
 
 1
    
    For remaining three months ending December 31, 2005. 9




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6. Related Party
  7. Recent Accounting Pronouncements
  10




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Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
   Overview
   AERx
  AERx insulin Diabetes Management System
  11




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
    
    an amended and restated license agreement amending the Development and License Agreement
previously in place with Novo Nordisk A/S, expanding Novo Nordisks development and
manufacturing rights to the AERx iDMS program and providing for royalties to us on future AERx
iDMS net sales;
    
    a three-year agreement under which NNDT will perform contract manufacturing for us of AERx
iDMS-identical devices and dosage forms filled with compounds provided by us in support of
preclinical and initial clinical development by us of other AERx products; and
    
    we will receive royalties of approximately 6% on net sales of AERx iDMS products, AERx
products containing insulin analogs, and, in certain circumstances, non-AERx products by Novo
Nordisk and its sub licensees.
   Other AERx Applications
   Intraject
   
    
    Pre-filled, fixed dose and ready to use;
    
    Lightweight and pocket-sized; and
    
    Easy to operate.
  12




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Intraject Sumatriptan
  Other Intraject Applications
  Critical Accounting Policies and Estimates
  Revenue Recognition
  Long-Lived Assets
  13




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Use of Estimates
  Results of Operations
 Three Months Ended September 30, 2005 and 2004
 Contract Revenues:
  Three months ended September 30,Contract Revenues (in thousands):
    
    2005
    
    
    2004
    
    
    ChangeDevelopment revenues
    
    $
    638
    
    
    $
    6,047
    
    
    $
    (5,409
    )Milestone revenues
    
    
    81
    
    
    
    305
    
    
    
    (224
    )Total contract revenues
    
    $
    719
    
    
    $
    6,352
    
    
    $
    (5,633
    )
 Research and Development Expenses:
 Three months ended September 30,Spending for collaborative and self-initiated research and
    
    
    
    
    
    
    
    
    
    Increasedevelopment projects was as follows (in thousands):
    
    2005
    
    
    2004
    
    
    (Decrease)Collaborative
    
    $
    1,140
    
    
    $
    6,684
    
    
    $
    (5,544
    )Self-initiated
    
    
    5,331
    
    
    
    4,723
    
    
    
    608Total research and development expenses
    
    $
    6,471
    
    
    $
    11,407
    
    
    $
    (4,936
    )
   14




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General and Administrative Expenses:
 Interest Income:
 Other Income (Expense)
 15




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Nine Months Ended September 30, 2005 and 2004
 Contract Revenues:
 Nine months ended September 30,Contract Revenues: (in thousands)
    
    2005
    
    
    2004
    
    
    ChangeDevelopment revenues
    
    $
    4,378
    
    
    $
    19,085
    
    
    $
    (14,707
    )Milestone revenues
    
    
    5,267
    
    
    
    988
    
    
    
    4,279Total contract revenues
    
    $
    9,645
    
    
    $
    20,073
    
    
    $
    (10,428
    )
  Research and Development Expenses:
 Nine months ended September 30,Spending for collaborative and self-initiated research
    
    
    
    
    
    
    
    
    
    Increaseand development projects was as
follows (in thousands):
    
    2005
    
    
    2004
    
    
    (Decrease)Collaborative
    
    $
    4,372
    
    
    $
    20,908
    
    
    $
    (16,536
    )Self initiated
    
    
    16,486
    
    
    
    13,798
    
    
    
    2,688Total research and development expenses
    
    $
    20,858
    
    
    $
    34,706
    
    
    $
    (13,848
    )
   16




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General and Administrative Expenses:
 Interest Income:
 Other Income (Expense)
 Liquidity and Capital Resources
      17




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Off-Balance Sheet Financings and Liabilities
  Contractual Obligations
  18




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Payment Due by Period(amounts in thousands)Contractual obligations
    
    Total
    
    
    20051
    
    
    2006/2007
    
    
    2008/2009
    
    
    2010+Operating lease obligations
    
    $
    24,410
    
    
    $
    640
    
    
    $
    4,147
    
    
    $
    4,879
    
    
    $
    14,744Capital purchase obligations
    
    
    1,184
    
    
    
    1,184
    
    
    
    
    
    
    
    
    
    
    
    Unconditional purchase obligations
    
    
    670
    
    
    
    670
    
    
    
    
    
    
    
    
    
    
    
    Total contractual commitments
    
    $
    26,264
    
    
    $
    2,494
    
    
    $
    4,147
    
    
    $
    4,879
    
    
    $
    14,744
 
 1
    
    For remaining three months ending December 31, 2005. 
 Item 3. Quantitative and Qualitative Disclosures About Market Risk
 Market Risk Disclosures
   
 Item 4. Controls and Procedures
 Evaluation of Disclosure Controls and Procedures
  Changes in Internal Controls
  Limitations on the effectiveness of controls.
  19




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PART II. OTHER INFORMATION
 
 Item 6. Exhibits
 10.23
    (1)
    
    Form of Change of Control Agreement entered into between the Registrant and certain members of the
Registrants senior management.10.24
    (1)
    
    Executive Officer Severance Benefit Plan.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 Registrants Form 8-K filed on October 13, 2005. 20




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SIGNATURES
  ARADIGM CORPORATION(Registrant)/s/ V. BRYAN LAWLISV. Bryan LawlisPresident and Chief Executive Officer/s/ THOMAS C. CHESTERMANThomas C. ChestermanSenior Vice President and Chief Financial OfficerDated: November 10, 2005
 21




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INDEX TO EXHIBITS
 ExhibitNumber
    
    Description10.23 (1)
    
    Form of Change of Control Agreement entered into between the Registrant
and certain members of the Registrants senior management.10.24 (1)
    
    Executive Officer Severance Benefit Plan.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 Registrants Form 8-K filed on October 13,
2005.