##### Table of Contents



UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
 Washington, DC 20549
 Form 10-Q
  þ
    
    QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
 For the quarterly period ended June 30, 2007
 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)
 þ o
  o o þ
 o þ
  (Class) 
Common
    
    (Outstanding at July 31, 2007)
53,999,817




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##### 



ARADIGM CORPORATION
TABLE OF CONTENTS
 PagePART I. FINANCIAL INFORMATIONItem 1. Financial Statements:Condensed Balance Sheets at June 30, 2007 and December 31, 2006 (unaudited)
    
    3Condensed Statements of Operations for the three months ended June 30, 2007 and 2006 (unaudited)
    
    4Condensed Statements of Operations for the six months ended June 30, 2007 and 2006 (unaudited)
    
    5Condensed Statements of Cash Flows for the six months ended June 30, 2007 and 2006 (unaudited)
    
    6Condensed Statement of Shareholders Equity for the six months ended June 30, 2007 (unaudited)
    
    7Notes to Condensed Financial Statements (unaudited)
    
    8Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
    
    14Item 3. Quantitative and Qualitative Disclosure About Market Risk
    
    27Item 4. Controls and Procedures
    
    28PART II. OTHER INFORMATION
    
    28Item 1. Legal Proceedings
    
    28Item 1A. Risk Factors
    
    28Item 4. Submission of Matters to a Vote of Security Holders
    
    39Item 6. Exhibits
    
    39SIGNATURES
    
    40EXHIBIT 31.1EXHIBIT 31.2EXHIBIT 32.1
  2




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PART I. FINANCIAL INFORMATION
 
 Item 1. CONDENSED FINANCIAL STATEMENTS
 ARADIGM CORPORATION
 
 CONDENSED BALANCE SHEETS
 (In thousands, except share data)
 June 30,
    
    
    December 31,2007
    
    
    2006(unaudited)
    
    
    (Note 1)ASSETSCurrent assets:Cash and cash equivalents
    
    $
    43,381
    
    
    $
    27,013Short-term investments
    
    
    8,294
    
    
    
    501Receivables
    
    
    45
    
    
    
    643Prepaid expenses and other current assets
    
    
    582
    
    
    
    1,002Total current assets
    
    
    52,302
    
    
    
    29,159Property and equipment, net
    
    
    3,005
    
    
    
    2,592Notes receivable from officers and employees
    
    
    32
    
    
    
    31Other assets
    
    
    282
    
    
    
    444Total assets
    
    $
    55,621
    
    
    $
    32,226LIABILITIES, CONVERTIBLE PREFERRED STOCK AND 
SHAREHOLDERS EQUITY (DEFCIT)Current liabilities:Accounts payable
    
    $
    602
    
    
    $
    1,151Accrued cost of clinical and other studies
    
    
    360
    
    
    
    278Accrued compensation
    
    
    1,970
    
    
    
    1,814Other accrued liabilities
    
    
    287
    
    
    
    511Total current liabilities
    
    
    3,219
    
    
    
    3,754Non-current portion of deferred rent
    
    
    951
    
    
    
    1,035Non-current portion of capital lease
    
    
    25
    
    
    
    29Note payable and accrued interest to related party
    
    
    7,874
    
    
    
    7,686Commitments and contingenciesConvertible preferred stock, no par value; 2,050,000 shares authorized; issued
and outstanding shares: none outstanding at June 30, 2007 and 1,544,626 at
December 31, 2006; liquidation preference of $0 at June 30, 2007 and $41,866 at
December 31, 2006
    
    
    
    
    
    
    23,669Shareholders equity (deficit):Preferred stock, 2,950,000 shares authorized, no shares issued and outstandingCommon stock, no par value, 100,000,000 shares authorized; issued and
outstanding shares: 53,999,817 at June 30, 2007 and 14,765,474 at December
31, 2006
    
    
    341,506
    
    
    
    283,914Accumulated other comprehensive income
    
    
    
    
    
    
    4Accumulated deficit
    
    
    (297,954
    )
    
    
    (287,865
    )Total shareholders equity (deficit)
    
    
    43,552
    
    
    
    (3,947
    )Total liabilities, convertible preferred stock and shareholders equity
(deficit)
    
    $
    55,621
    
    
    $
    32,226
  3




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ARADIGM CORPORATION
 
 CONDENSED STATEMENTS OF OPERATIONS
 (In thousands, except per share data)

(unaudited)
 Three months endedJune 30,2007
    
    
    2006Contract revenues (including amounts from related parties:2007 - $8; 2006 - $18)
    
    $
    297
    
    
    $
    1,807Operating expenses:Research and development
    
    
    3,841
    
    
    
    6,357General and administrative
    
    
    2,628
    
    
    
    2,685Restructuring and asset impairment
    
    
    
    
    
    
    5,370Total operating expenses
    
    
    6,469
    
    
    
    14,412Loss from operations
    
    
    (6,172
    )
    
    
    (12,605
    )Interest income
    
    
    699
    
    
    
    135Interest expense
    
    
    (96
    )
    
    
    (3
    )Other income
    
    
    46
    
    
    
    40Net loss
    
    $
    (5,523
    )
    
    $
    (12,433
    )Basic and diluted net loss per common share
    
    $
    (0.10
    )
    
    $
    (0.85
    )Shares used in computing basic and diluted net loss per common share
    
    
    53,942
    
    
    
    14,656
  4




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ARADIGM CORPORATION
 
 CONDENSED STATEMENTS OF OPERATIONS
 (In thousands, except per share data)

(unaudited)
 Six months endedJune 30,2007
    
    
    2006Contract revenues (including amounts from related
parties:2007 - $23; 2006 - $50)
    
    $
    713
    
    
    $
    2,880Operating expenses:Research and development
    
    
    7,248
    
    
    
    13,098General and administrative
    
    
    4,713
    
    
    
    5,537Restructuring and asset impairment
    
    
    
    
    
    
    5,370Total operating expenses
    
    
    11,961
    
    
    
    24,005Loss from operations
    
    
    (11,248
    )
    
    
    (21,125
    )Interest income
    
    
    1,336
    
    
    
    380Interest expense
    
    
    (193
    )
    
    
    (5
    )Other income
    
    
    16
    
    
    
    33Net loss
    
    $
    (10,089
    )
    
    $
    (20,717
    )Basic and diluted net loss per common share
    
    $
    (0.21
    )
    
    $
    (1.42
    )Shares used in computing basic and diluted net loss per common share
    
    
    47,417
    
    
    
    14,614
  5




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ARADIGM CORPORATION
 
 CONDENSED STATEMENTS OF CASH FLOWS
 (In thousands)

(unaudited)
 Six months endedJune 30,2007
    
    
    2006Cash flows from operating activities:Net loss
    
    $
    (10,089
    )
    
    $
    (20,717
    )Adjustments to reconcile net loss to cash used in operating activities:Non-cash asset impairment on property and equipment
    
    
    
    
    
    
    4,000Amortization and accretion of investments
    
    
    (5
    )
    
    
    Depreciation and amortization
    
    
    393
    
    
    
    549Stock-based compensation
    
    
    689
    
    
    
    854Loss on retirement and sale of property and equipment
    
    
    11
    
    
    
    6Changes in operating assets and liabilities:Receivables
    
    
    598
    
    
    
    (152
    )Prepaid
expenses and other current assets
    
    
    420
    
    
    
    212Other assets
    
    
    162
    
    
    
    7Accounts payable
    
    
    (549
    )
    
    
    (2,362
    )Accrued compensation
    
    
    156
    
    
    
    (793
    )Other accrued liabilities
    
    
    43
    
    
    
    223Deferred rent
    
    
    (84
    )
    
    
    110Deferred revenue
    
    
    
    
    
    
    (5
    )Net cash used in operating activities
    
    
    (8,255
    )
    
    
    (18,068
    )Cash flows from investing activities:Capital expenditures
    
    
    (817
    )
    
    
    (974
    )Purchases of available-for-sale investments
    
    
    (8,289
    )
    
    
    (514
    )Proceeds from sales and maturities of available-for-sale investments
    
    
    496
    
    
    
    Net cash used in investing activities
    
    
    (8,610
    )
    
    
    (1,488
    )Cash flows from financing activities:Proceeds from public offering, net
    
    
    33,178
    
    
    
    Proceeds from issuance of common stock
    
    
    56
    
    
    
    249Payments
received from (paid to) officers and employees on notes receivable
    
    
    (1
    )
    
    
    20Net cash provided by financing activities
    
    
    33,233
    
    
    
    269Net increase (decrease) in cash and cash equivalents
    
    
    16,368
    
    
    
    (19,287
    )Cash and cash equivalents at beginning of period
    
    
    27,013
    
    
    
    27,694Cash and cash equivalents at end of period
    
    $
    43,381
    
    
    $
    8,407Supplemental schedule of non-cash financing activities:Conversion of redeemable convertible preferred stock to common stock
    
    $
    23,669
    
    
    
    
  6




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CONDENSED STATEMENT OF SHAREHOLDERS EQUITY (DEFICIT)
 (In thousands, except share data)
 Accumulated
    
    
    
    
    
    
    TotalConvertible
    
    
    
    
    
    
    
    
    
    
    Other
    
    
    
    
    
    
    ShareholdersPreferred Stock
    
    
    Common Stock
    
    
    Comprehensive
    
    
    Accumulated
    
    
    EquityShares
    
    
    Amount
    
    
    Shares
    
    
    Amount
    
    
    Income
    
    
    Deficit
    
    
    (Deficit)Balances at December 31, 2006
    
    
    1,544,626
    
    
    $
    23,669
    
    
    
    14,765,474
    
    
    $
    283,914
    
    
    $
    4
    
    
    $
    (287,865
    )
    
    $
    (3,947
    )Issuance of common stock in public
offering (unaudited)
    
    
    
    
    
    
    
    
    
    
    37,950,000
    
    
    
    33,178
    
    
    
    
    
    
    
    
    
    
    
    33,178Issuance of common stock upon conversion
of preferred stock related to public
offering (unaudited)
    
    
    (1,544,626
    )
    
    
    (23,669
    )
    
    
    1,235,699
    
    
    
    23,669
    
    
    
    
    
    
    
    
    
    
    
    23,669Issuance of common stock under the
employee stock purchase plan (unaudited)
    
    
    
    
    
    
    
    
    
    
    53,519
    
    
    
    56
    
    
    
    
    
    
    
    
    
    
    
    56Reversal of restricted stock award due
to forfeiture (unaudited)
    
    
    
    
    
    
    
    
    
    
    (4,875
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Stock-based compensation related to
issuance of stock option grants
(unaudited)
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    689
    
    
    
    
    
    
    
    
    
    
    
    689Comprehensive loss:Net loss (unaudited)
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (10,089
    )
    
    
    (10,089
    )Net change in unrealized gain (loss) on
available-for-sale investments
(unaudited)
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (4
    )
    
    
    
    
    
    
    (4
    )Total comprehensive loss (unaudited)
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (10,093
    )Balances at June 30, 2007 (unaudited)
    
    
    
    
    
    $
    
    
    
    
    53,999,817
    
    
    $
    341,506
    
    
    $
    
    
    
    $
    (297,954
    )
    
    $
    43,552
  7




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ARADIGM CORPORATION
NOTES TO THE UNAUDITED CONDENSED FINANCIAL STATEMENTS
June 30, 2007
 1. Organization and Basis of Presentation
 Organization
  Basis of Presentation
   2. Summary of Significant Accounting Policies
 Use of Estimates
  Revenue Recognition
  8




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Impairment or Disposal of Long-Lived Assets
 Accounting
for the Impairment or Disposal of Long-Lived Assets
 Recent Accounting Pronouncements
 Accounting for Uncertainty in Income Taxes  an interpretation of FASB Statement No. 109
 Fair Value Measurement .
 The Fair Value Option for Financial Assets and
Financial Liabilities
 Accounting for the Income Tax Benefits of Dividends on Share-Based Payment Awards
 Accounting for Non-Refundable Advance
Payments for Goods or Services to Be Used in Future Research and Development Activities
 9




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3. Stock-Based Compensation
  Three months
    
    
    Six monthsended
June 30,
    
    

ended
June 30,2007
    
    

2006
    
    

2007
    
    

2006Costs and expenses:Research and development
    
    $
    161
    
    
    $
    207
    
    
    $
    254
    
    
    $
    469General and administrative
    
    
    218
    
    
    
    177
    
    
    
    435
    
    
    
    385Total stock-based compensation expense
    
    $
    379
    
    
    $
    384
    
    
    $
    689
    
    
    $
    854Impact on basic and diluted net loss
per common share
    
    $
    0.01
    
    
    $
    0.03
    
    
    $
    0.01
    
    
    $
    0.06
      2005 Equity Incentive Plan
  1996 Non-Employee Directors Plan
  10




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##### Table of Contents



Employee Stock Purchase Plan
  Valuation Assumptions
  Three months
    
    Six monthsended June 30,
    

ended June 30,2007
    

2006
    

2007
    

2006Employee Stock OptionsDividend yield
    
    
    0.0
    %
    
    
    0.0
    %
    
    
    0.0
    %
    
    
    0.0
    %Volatility factor
    
    
    78.2
    %
    
    
    85.8
    %
    
    
    81.2
    %
    
    
    85.8
    %Risk-free interest rate
    
    
    5.0
    %
    
    
    5.1
    %
    
    
    4.9
    %
    
    
    4.9
    %Expected life (years)
    
    
    4.0
    
    
    
    4.2
    
    
    
    4.0
    
    
    
    4.2Weighted-average fair value
of options granted during
the periods
    
    $
    0.8
    
    
    $
    1.1
    
    
    $
    0.8
    
    
    $
    1.6Employee Stock Purchase PlanDividend yield
    
    
    0.0
    %
    
    
    0.0
    %
    
    
    0.0
    %
    
    
    0.0
    %Volatility factor
    
    
    82.8
    %
    
    
    85.7
    %
    
    
    82.8
    %
    
    
    85.7
    %Risk-free interest rate
    
    
    4.8
    %
    
    
    4.8
    %
    
    
    4.8
    %
    
    
    4.8
    %Expected life (years)
    
    
    1.3
    
    
    
    0.7
    
    
    
    1.3
    
    
    
    0.7Weighted-average fair value
of employee stock purchases
during the periods
    
    $
    0.6
    
    
    $
    1.3
    
    
    $
    0.6
    
    
    $
    1.3
 Stock Option Activity
  Weighted-Weighted-
    
    
    averageNumber
    
    
    average
    
    
    remaining
    
    
    Aggregateof
    
    
    exercise
    
    
    contractual
    
    
    intrinsicshares
    
    
    price
    
    
    life in years
    
    
    valueOptions outstanding at January 1, 2007
    
    
    3,064
    
    
    $
    8.90
    
    
    
    8.28
    
    
    $
    Options granted
    
    
    728
    
    
    
    1.30
    
    
    
    
    
    
    
    Options exercised
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Options cancelled
    
    
    (739
    )
    
    
    11.49
    
    
    
    
    
    
    
    Options outstanding at June 30, 2007
    
    
    3,053
    
    
    
    6.46
    
    
    
    7.96
    
    
    
    64Options exercisable at June 30, 2007
    
    
    1,240
    
    
    $
    13.25
    
    
    
    6.01
    
    
    $
    19
 11




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Options Outstanding
    
    Options ExercisableWeighted-averageremaining
    
    Weighted-
    
    
    
    
    
    Weighted-Number
    
    contractual
    
    average
    
    Number
    
    AverageRange of
    
    outstanding
    
    life
    
    exercise
    
    exercisable
    
    ExerciseExercise Price
    
    (in thousands)
    
    (in years)
    
    price
    
    (in thousands)
    
    Price$1.02-$1.15
    
    
    47
    
    
    
    9.38
    
    
    $
    1.07
    
    
    
    15
    
    
    $
    1.02$1.23-$1.23
    
    
    326
    
    
    
    9.62
    
    
    $
    1.23
    
    
    
    64
    
    
    $
    1.23$1.29-$1.29
    
    
    56
    
    
    
    0.22
    
    
    $
    1.29
    
    
    
    56
    
    
    $
    1.29$1.37-$1.37
    
    
    370
    
    
    
    9.97
    
    
    $
    1.37
    
    
    
    0
    
    
    $
    0$1.41-$1.70
    
    
    398
    
    
    
    9.01
    
    
    $
    1.68
    
    
    
    125
    
    
    $
    1.66$1.80-$1.80
    
    
    544
    
    
    
    9.16
    
    
    $
    1.80
    
    
    
    272
    
    
    $
    1.80$1.87-$1.87
    
    
    500
    
    
    
    9.11
    
    
    $
    1.87
    
    
    
    0
    
    
    $
    0$3.14-$5.90
    
    
    335
    
    
    
    6.13
    
    
    $
    4.90
    
    
    
    239
    
    
    $
    5.02$5.95-$24.10
    
    
    326
    
    
    
    4.59
    
    
    $
    14.15
    
    
    
    317
    
    
    $
    14.22$25.55-$120.63
    
    
    152
    
    
    
    2.33
    
    
    $
    65.03
    
    
    
    152
    
    
    $
    65.033,053
    
    
    
    
    
    
    
    
    
    
    
    1,240
 4. Net Loss Per Share
   Three
and six monthsended June
30,2007
    
    
    2006Outstanding stock options
    
    
    3,053
    
    
    
    2,573Convertible preferred stock
    
    
    
    
    
    
    1,236Unvested restricted stock
    
    
    55
    
    
    
    140Warrants to purchase common shares
    
    
    836
    
    
    
    3,944
    
    
    
    3,949
 5. Comprehensive Income (Loss)
  Three months ended
    
    
    Six months endedJune 30,
    
    

June 30,2007
    
    
    2006
    
    
    2007
    
    
    2006Net Loss
    
    $
    (5,523
    )
    
    $
    (12,433
    )
    
    $
    (10,089
    )
    
    $
    (20,717
    )Other comprehensive income (loss):Change in unrealized gain (loss)
on available-for-sale securities
    
    
    (7
    )
    
    
    3
    
    
    
    (4
    )
    
    
    (7
    )Comprehensive loss
    
    $
    (5,530
    )
    
    $
    (12,430
    )
    
    $
    (10,093
    )
    
    $
    (20,724
    )
 12




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6. Cash, Cash Equivalents and Short-Term Investments
  June
    
    
    December30, 2007
    
    
    31, 2006Cash and cash equivalents:Cash and money market fund
    
    $
    1,349
    
    
    $
    1,248Commercial paper
    
    
    42,032
    
    
    
    25,765$
    43,381
    
    
    $
    27,013Short-term investments:Corporate and government notes
    
    $
    8,294
    
    
    $
    501
  7. Income Taxes
 Accounting for Uncertainty in Income
Taxes  an Interpretation of FASB Statement No. 109,
   8. Public Offering of Common Shares
  9. CFO Departure
  13




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10. Subsequent Events
      
 Item 2. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
 The discussion below contains forward-looking statements that are based on the beliefs of
management, as well as assumptions made by, and information currently available to, management. Our
future results, performance or achievements could differ materially from those expressed in, or
implied by, any such forward-looking statements as a result of certain factors, including, but not
limited to, those discussed in this section as well as in the section entitled Risk Factors and
elsewhere in our filings with the Securities and Exchange Commission.
 Our business is subject to significant risks including, but not limited to, the success of
product development efforts, our dependence on collaborators for certain programs, obtaining and
enforcing patents important to our business, clearing the lengthy and expensive regulatory approval
process and possible competition from other products. Even if product candidates 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, may fail to
receive necessary regulatory approvals, may be difficult to manufacture on a large scale, are
uneconomical to market, may be precluded from commercialization by proprietary rights of third
parties or may not gain acceptance from health care professionals and patients.
 Investors are cautioned not to place undue reliance on the forward-looking statements
contained herein. We undertake no obligation to update these forward-looking statements in light of
events or circumstances occurring after the date hereof or to reflect the occurrence of
unanticipated events.
 Overview
  14




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##### Table of Contents



®
  Restructured Relationship with Novo Nordisk
   
    
    an amended and restated license agreement amending the
development and license agreement previously in place with
Novo Nordisk, 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 in lieu
of a percentage interest in the gross profits from the
commercialization of the AERx iDMS, which royalties run
until the later of last patent expiry or last use of our
intellectual property and which apply to future
enhancements or generations of our AERx delivery
technology;
    
    a three-year agreement under which NNDT agreed to perform
contract manufacturing of AERx iDMS-identical devices and
dosage forms filled with compounds provided by us in
support of preclinical and initial clinical development of
other products that incorporate our AERx delivery system;
and
    
    an amendment of the common stock purchase agreement in
place with Novo Nordisk prior to the closing of the
restructuring transaction, (i) deleting the provisions
whereby we can require Novo Nordisk to purchase certain
additional amounts of common stock, (ii) imposing certain
restrictions on the ability of Novo Nordisk to sell shares
of our common stock and (iii) providing Novo Nordisk with
certain registration and information rights with respect to
these shares.
 15




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##### Table of Contents




    
    our transfer to Novo Nordisk of the ownership of 23 issued
United States patents and their corresponding non-United
States counterparts, if any, as well as related pending
applications, in exchange for $12.0 million paid to us in
cash. We retained exclusive, royalty-free control of these
patents outside the field of glucose control and will
continue to be entitled to royalties with respect to any
inhaled insulin products marketed or licensed by Novo
Nordisk.
    
    our receipt of a royalty prepayment of $8.0 million in
exchange for a one percent reduction on our average royalty
rate for the commercialized AERx iDMS product. As a result,
we will receive royalty rates, should commercialization
occur, under our agreement with Novo Nordisk that will rise
to an average of five percent or higher (instead of six
percent or higher) by the fifth year after
commercialization.
    
    our issuance of an eight-year promissory note to Novo
Nordisk in connection with our receipt from Novo Nordisk of
a loan in the principal amount of $7.5 million with
interest at 5% per year that will be payable to Novo
Nordisk in three equal annual payments commencing in July
2012. Our obligations under the note are secured by royalty
payments upon any commercialization of the AERx iDMS
product.
   Purchase and Sale of Intraject Technology
   16




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##### Table of Contents



Product Candidates
  Product Candidate
    
    Indication
    
    Stage of DevelopmentProprietary Programs Under DevelopmentARD-3100 (Liposomal ciprofloxacin)
    
    Cystic Fibrosis
    
    PreclinicalARD-1100 (Liposomal ciprofloxacin)
    
    Inhalation Anthrax
    
    PreclinicalCollaborative Programs Under DevelopmentAERx iDMS (Insulin)
    
    Type 1 and Type 2 Diabetes
    
    Phase 3ARD-1300 (Hydroxychloroquine)
    
    Asthma
    
    Phase 2 (1)ARD-1500 (Liposomal treprostinil)
    
    Pulmonary Arterial Hypertension
    
    Preclinical
 
 (1)
    
    A Phase 2a clinical study did not meet pre-specified clinical
endpoints. The program is currently under review by APT and is in
our view, unlikely to continue.  Liposomal Ciprofloxacin
  ARD-3100  Liposomal Ciprofloxacin for the Treatment of Cystic Fibrosis and
Bronchiectasis
  Pseudomonas aeruginosa,
 17




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##### Table of Contents



Development
   ARD-1100  Liposomal Ciprofloxacin for the Treatment of Inhalation Anthrax
   Development
 Francisella tularensis, F. tularensis
 18




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##### Table of Contents



AERx iDMS  Inhaled Insulin for the Treatment of Diabetes
   19




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Development
   
    
    HbAlc levels, a key marker of blood glucose control, are
statistically the same in patients using AERx iDMS and
patients using subcutaneous insulin injections.
    
    The onset of action of inhaled insulin via AERx iDMS is not
significantly different from subcutaneous injection of
rapid-acting insulin, but significantly faster than
subcutaneous injection of human regular insulin.
    
    The duration of action of inhaled insulin via AERx iDMS is
not significantly different from subcutaneous injection of
human regular insulin, but significantly longer than
subcutaneous injection of rapid-acting insulin.
    
    Although small declines were seen on some pulmonary
function parameters following 12-24 months of dosing on
AERx iDMS, these declines were not considered to be of
clinical significance, and the findings are not expected to
have an impact on overall pulmonary safety of the product.
   ARD-1300  Hydroxychloroquine for the Treatment of Asthma
  20




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Development
   ARD-1500  Treprostinil for the Treatment of Pulmonary Arterial Hypertension
   Development
  21




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##### Table of Contents



Additional Potential Product Applications
  
    
    Smoking Cessation.Based on internal work and work funded
under grants from the National Institutes of Health, we are
developing intellectual property in the area of smoking
cessation. To date, we have two issued United States
patents containing claims directed towards the use of
titrated nicotine replacement therapy for smoking
cessation.
    
    Pain Management System.Based on our internal work and a
currently dormant collaboration with GlaxoSmithKline, we
have developed a significant body of preclinical and Phase
1 clinical data on the use of inhaled morphine and
fentanyl, and Phase 2 clinical data on inhaled morphine,
with our proprietary AERx delivery system for the treatment
of breakthrough pain in cancer and post-surgical patients.
  Critical Accounting Policies and Estimates
  Revenue Recognition
  22




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Impairment of Long-Lived Assets
  Stock-Based Compensation Expense
    Results of Operations
 Three months ended June 30, 2007 and 2006
 Revenues
 Three months endedJune 30,Change in2007
    
    
    2006
    
    
    Percent(in thousands)Revenues:Related parties
    
    $
    8
    
    
    $
    18
    
    
    
    (56
    %)Percentage of total revenues
    
    
    3
    %
    
    
    1
    %Unrelated parties
    
    
    289
    
    
    
    1,789
    
    
    
    (84
    %)Percentage of total revenues
    
    
    97
    %
    
    
    99
    %Total Revenues
    
    $
    297
    
    
    $
    1,807
    
    
    
    (84
    %)
  Research
and Development Expenses
 Three months endedJune 30,Change in2007
    
    
    2006
    
    
    Percent(in thousands)Research and
development expenses:Collaborative
    
    $
    386
    
    
    $
    1,653
    
    
    
    (77)
    %Self-funded
    
    
    3,455
    
    
    
    4,704
    
    
    
    (27)
    %Total
research and development expenses
    
    $
    3,841
    
    
    $
    6,357
    
    
    
    (40)
    %
 23




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General
and Administrative Expenses
 Three months endedJune 30,Change in2007
    
    2006
    
    Percent(in thousands)General and administrative expenses
    
    $
    2,628
    
    
    $
    2,685
    
    
    
    (2)
    %
   Interest Income, Interest Expense and Other Income
 Three months endedJune 30,Change in2007
    
    
    2006
    
    
    Percent(in thousands)Interest income, interest expense and other income:Interest income
    
    $
    699
    
    
    $
    135
    
    
    
    418
    %Interest expense
    
    
    (96
    )
    
    
    (3
    )
    
    
    (3,100)
    %Other income
    
    
    46
    
    
    
    40
    
    
    
    15
    %Total
interest income, interest and other income
    
    $
    649
    
    
    $
    172
    
    
    
    277
    %
  24




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Six Months Ended June 30, 2007 and 2006
 Revenues
 Six months endedJune 30,Change in2007
    
    
    2006
    
    
    Percent(in thousands)Revenue:Related parties
    
    $
    23
    
    
    $
    50
    
    
    
    (54
    %)Percentage of Total Revenue
    
    
    3
    %
    
    
    2
    %Unrelated parties
    
    
    690
    
    
    
    2,830
    
    
    
    (76)
    %Percentage of Total Revenue
    
    
    97
    %
    
    
    98
    %Total Revenue
    
    $
    713
    
    
    $
    2,880
    
    
    
    (75)
    %
  Research
and Development Expenses
 Six months endedJune 30,Change in2007
    
    
    2006
    
    
    Percent(in thousands)Research and
development expenses:Collaborative
    
    $
    805
    
    
    $
    2,882
    
    
    
    (72)
    %Self-Funded
    
    
    6,443
    
    
    
    10,216
    
    
    
    (37)
    %Total
research and development expenses
    
    $
    7,248
    
    
    $
    13,098
    
    
    
    (45)
    %
   25




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##### Table of Contents



General
and Administrative Expenses
 Six months endedJune 30,Change in2007
    
    2006
    
    Percent(in thousands)General and administrative expenses
    
    $
    4,713
    
    
    $
    5,537
    
    
    
    (15)
    %
   Interest
income, Interest Expense and Other Income
 Six months endedJune 30,
    
    
    Change in2007
    
    
    2006
    
    
    Percent(in thousands)Interest income, interest and other income:Interest income
    
    $
    1,336
    
    
    $
    380
    
    
    
    252
    %Interest expense
    
    
    (193
    )
    
    
    (5
    )
    
    
    3,760
    %Other income
    
    
    16
    
    
    
    33
    
    
    
    (52)
    %Total interest income, interest and other income
    
    $
    1,159
    
    
    $
    408
    
    
    
    184
    %
  Liquidity and Capital Resources
    26




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Contractual Obligations
  Payment due by period(amounts in thousands)Total
    
    
    2007(1)
    
    
    2008
    
    
    2009
    
    
    2010
    
    
    2011
    
    
    2012+Contractual obligations:Operating lease obligations
    
    $
    19,995
    
    
    $
    1,165
    
    
    $
    2,366
    
    
    $
    2,312
    
    
    $
    2,220
    
    
    $
    1,992
    
    
    $
    9,940Unconditional capital purchase
obligations
    
    
    637
    
    
    
    637
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Unconditional purchase obligations
    
    
    2,010
    
    
    
    2,010
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Total contractual commitments
    
    $
    22,642
    
    
    $
    3,812
    
    
    $
    2,366
    
    
    $
    2,312
    
    
    $
    2,220
    
    
    $
    1,992
    
    
    $
    9,940
 
 (1)
    
    For six months ending December 31, 2007  Off-Balance Sheet Financings and Liabilities
  
 Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
 Market Risk Disclosures
   27




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Item 4. CONTROLS AND PROCEDURES
 Evaluation of Disclosure Controls and Procedures.
 Changes in internal control.
 Limitations on the effectiveness of controls.
 
 PART II. OTHER INFORMATION
 
 Item 1. LEGAL PROCEEDINGS
  
 Item 1A. RISK FACTORS
 In addition to the other information contained in this Form 10-Q , and risk factors set forth
in our most recent SEC filings, the following risk factors should be considered carefully in
evaluating our business. Our business, financial condition, or results of operations could be
materially adversely affected by any of these risks. Additional risks not presently known to us or
that we currently deem immaterial may also impair our business and operations.
 The risk factors included herein include any material changes to and supersede the risk
factors associated with our business previously disclosed in Item 1A to Part I of our Annual Report
on Form 10-K for the fiscal year ended December 31, 2006. We have marked with an asterisk (*) those
risk factors that reflect substantive changes from the risk factors included in our Annual Report
on Form 10-K filed with the Securities and Exchange Commission for the fiscal year ended December
31, 2006.
 Risks Related to Our Business
 We are an early-stage company.
  * We recently changed our product development strategy, and if we do not successfully
implement this new strategy our business and reputation will be damaged.
  28




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We will need additional capital, and we may not be able to obtain it.
  
    
    our progress in the application of our delivery and formulation technologies, which may
require further refinement of these technologies;
    
    the number of product development programs we pursue and the pace of each program;
    
    our progress with formulation development;
    
    the scope, rate of progress, results and costs of preclinical testing and clinical trials;
    
    the time and costs associated with seeking regulatory approvals;
    
    our ability to outsource the manufacture of our product candidates and the costs of doing so;
    
    the time and costs associated with establishing in-house resources to market and sell
certain of our products;
    
    our ability to establish and maintain collaborative arrangements with others and the terms
of those arrangements;
    
    the costs of preparing, filing, prosecuting, maintaining and enforcing patent claims, and
    
    our need to acquire licenses, or other rights for our product candidates.
  We have a history of losses, we expect to incur losses for at least the foreseeable
future, and we may never attain or maintain profitability.
  
    
    expand drug product development efforts;
    
    conduct preclinical testing and clinical trials;
    
    pursue additional applications for our existing delivery technologies;
    
    outsource the commercial-scale production of our products; and
    
    establish a sales and marketing force to commercialize certain of our
proprietary products if these products obtain regulatory approval.
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##### Table of Contents



Our dependence on collaborators may delay or prevent the progress of certain of our programs.
    The results of later stage clinical trials of our product candidates may not be as favorable
as earlier trials and that could result in additional costs and delay or prevent commercialization
of our products.
  30




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If our clinical trials are delayed because of patient enrollment or other problems, we would
incur additional cost and postpone the potential receipt of revenues.
  We are subject to extensive regulation, including the requirement of approval before any of our
product candidates can be marketed. We may not obtain regulatory approval for our product
candidates on a timely basis, or at all.
   Regulatory authorities may not approve our product candidates even if the product candidates
meet safety and efficacy endpoints in clinical trials or the approvals may be too limited for us to
earn sufficient revenues.
  31




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##### Table of Contents



Even if we are granted initial FDA approval for any of our product candidates, we may not be
able to maintain such approval, which would reduce our revenues.
  Since one of our key proprietary programs, the ARD-3100 liposomal ciprofloxacin program,
relies on the FDAs granting of orphan drug designation for potential market exclusivity, the
product may not be able to obtain market exclusivity and could be barred from the market for up to
seven years.
  We have limited manufacturing capacity and will have to depend on contract manufacturers and
collaborators; if they do not perform as expected, our revenues and customer relations will suffer.
    32




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##### Table of Contents



We rely on a small number of vendors and contract manufacturers to supply us with specialized
equipment, tools and components; if they do not perform as we need them to, we will not be able to
develop or commercialize products.
  In order to market our proprietary products, we are likely to establish our own sales,
marketing and distribution capabilities. We have no experience in these areas, and if we have
problems establishing these capabilities, the commercialization of our products would be impaired.
  If any products that we or our collaborators may develop do not attain adequate market
acceptance by healthcare professionals and patients, our business prospects and results of
operations will suffer.
  
    
    the demonstration of efficacy and safety in clinical trials;
    
    the existence, prevalence and severity of any side effects;
    
    the potential or perceived advantages or disadvantages compared to alternative treatments;
    
    the timing of market entry relative to competitive treatments;
    
    the relative cost, convenience, product dependability and ease of administration;
    
    the strength of marketing and distribution support;
    
    the sufficiency of coverage and reimbursement of our product candidates by governmental
and other third-party payors; and
    
    the product labeling or product insert required by the FDA or regulatory authorities in
other countries.
  33




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##### Table of Contents



We depend upon our proprietary technologies, and we may not be able to protect our potential
competitive proprietary advantage.
    We may infringe on the intellectual property rights of others, and any litigation could force
us to stop developing or selling potential products and could be costly, divert management
attention and harm our business.
   34




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##### Table of Contents



We are in a highly competitive market, and our competitors have developed or may develop
alternative therapies for our target indications, which would limit the revenue potential of any
product we may develop.
  If we do not continue to attract and retain key employees, our product development efforts
will be delayed and impaired.
  Acquisition of complementary businesses or technologies could result in operating difficulties
and harm our results of operations.
  
    
    diversion of our management from the development and commercialization of our
pipeline product candidates;
    
    difficulty in assimilating and efficiently using the acquired assets or personnel; and
    
    inability to retain key personnel.
 35




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##### Table of Contents



If we market our products in other countries, we will be subject to different laws and we may
not be able to adapt to those laws, which could increase our costs while reducing our revenues.
  We may be exposed to product liability claims, which would hurt our reputation, market
position and operating results.
  If we cannot arrange for adequate third-party reimbursement for our products, our revenues
will suffer.
  36




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##### Table of Contents



Our use of hazardous materials could subject us to liabilities, fines and sanctions.
  If we are unable to effectively implement or maintain a system of internal controls over
financial reporting, we may not be able to accurately or timely report our financial results and
our stock price could be adversely affected.
  Risks Related to Our Common Stock
 Our stock price is likely to remain volatile.
  
    
    investor perception of us;
    
    research analyst recommendations and our ability to meet or exceed quarterly performance
expectations of analysts or investors;
    
    fluctuations in our operating results;
    
    market conditions relating to our segment of the industry or the securities markets in general;
    
    announcements of technological innovations or new commercial products by us or our competitors;
    
    publicity regarding actual or potential developments relating to products under
development by us or our competitors;
    
    failure to maintain existing or establish new collaborative relationships;
    
    developments or disputes concerning patents or proprietary rights;
    
    delays in the development or approval of our product candidates;
    
    regulatory developments in both the United States and foreign countries;
 37




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##### Table of Contents




    
    concern of the public or the medical community as to the safety or efficacy of our
products, or products deemed to have similar safety risk factors or other similar
characteristics to our products;
    
    period-to-period fluctuations in financial results;
    
    future sales or expected sales of substantial amounts of common stock by shareholders;
    
    our ability to raise financing; and
    
    economic and other external factors.
  Our common stock was delisted from the Nasdaq Capital Market; this delisting may reduce the
liquidity of our common stock and the price may decline.
  We have implemented certain anti-takeover provisions, which make it less likely that we would
be acquired and you would receive a premium price for your shares.
   We have never paid dividends on our capital stock, and we do not anticipate paying cash
dividends for at least the foreseeable future.
  38




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##### Table of Contents



Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
  1.
    
    To elect five directors nominees to hold office until the next Annual Meeting of Shareholders
and until their successors are elected:
  Nominee
    
    For
    
    WithheldFrank H. Barker
    
    
    45,168,719
    
    
    
    942,074Igor Gonda
    
    
    45,163,053
    
    
    
    947,740Stephen O. Jaeger
    
    
    42,612,441
    
    
    
    3,498,352John M. Siebert
    
    
    45,159,177
    
    
    
    951,616Virgil D. Thompson
    
    
    42,630,556
    
    
    
    3,480,237
 2.
    
    To approve an amendment to the Companys 2005 Equity Incentive Plan to increase the aggregate
number of shares of common stock authorized for issuance under such plan by 1,600,000 shares:
  For
    
    Against
    
    Abstain28,865,106
    
    
    1,640,350
    
    
    
    315,408
 3.
    
    To ratify the selection of Odenberg, Ullakko, Muranishi & Co. LLP as the Companys
independent registered public accounting firm for the fiscal year ending December 31, 2007:
  For
    
    Against
    
    Abstain45,338,329
    
    
    488,882
    
    
    
    283,582
 
 Item 6. EXHIBITS
 ExhibitNumber
    
    Description10.1*(1)
    
    2005 Equity Incentive Plan, as
amended31.1
    
    Certification by Chief Executive Officer pursuant to Section
302 of the Sarbanes-Oxley Act of 2002.31.2
    
    Certification by Interim Chief Financial Officer pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002.32.1
    
    Certification by Chief Executive Officer and Interim Chief
Financial Officer pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.
 
 *
    
    Indicates a management compensation plan or arrangement.(1)
    
    Incorporated by reference to the Registrants definitive proxy
statement filed on May 2, 2007. 39




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##### Table of Contents



SIGNATURES
  ARADIGM CORPORATION
(Registrant)/s/ Igor GondaIgor GondaPresident and Chief Executive Officer
(Principal Executive Officer)/s/ Norman HalleenNorman HalleenInterim Chief Financial Officer

(Principal Financial and Accounting Officer)  40




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INDEX TO EXHIBITS
 ExhibitNumber
    
    Description10.1*(1)
    
    2005 Equity Incentive Plan, as
amended31.1
    
    Certification by Chief Executive Officer pursuant to Section
302 of the Sarbanes-Oxley Act of 2002.31.2
    
    Certification by Interim Chief Financial Officer pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002.32.1
    
    Certification by Chief Executive Officer and Interim Chief
Financial Officer pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.
 
 *
    
    Indicates a management compensation plan or arrangement.(1)
    
    Incorporated by reference to the Registrants definitive proxy
statement filed on May 2, 2007. 41